Should we pay the federal reserve to store wealth in currency?
Would you allow the federal reserve to ban currency so banks could charge you to store your savings?
Money is both a medium of exchange and a store of wealth. Money represents the stored value of labor not immediately converted to consumption. Historically, people used scarce items like gold that were durable, difficult to replicate, easy to store, and easy to transport both to acquire goods and services and as a store of wealth when no goods and services were required.
Gold served as money for millennia, mostly because nobody figured out how to transmute other elements into gold. However, once rulers started coining gold, they began to substitute other metals, shave the coins, and reduce the size of the coins in a process known as seigniorage. Ever since then, governments sought ever more ingenious ways to confiscate the stored wealth of citizens without direct taxation.
After several failed experiments with paper money and an ongoing problem with seigniorage, governments finally resorted to forcing people to accept their paper currency under threat of legal prosecution. US dollars have a note declaring they are good for all debts both public and private, a decree that forbids citizens from rejecting US dollars as payment for goods and services.
Perhaps as a recognition that rulers and legislatures lacked the discipline not to degrade the value of currency, most governments around the world established central banks and turned over authority to manage the currency to the central bank, and for the last 100 years or more, central banks tinkered with the money supply through interest-rate policy.
Central banks around the world gave up on a gold standard and allowed the value of their currencies to float based on supply and demand. Since then no central bank faced any restrictions on how much money they could print — how much stored wealth value they could confiscate from citizens — except the restriction imposed by the world market price for their currency by people who use other currencies. If central banks print too much, the value of the currency declines, and inflation generally ensues.
Deflation and Negative Interest Rates
Our current regime of central bank management of currency has some limitations besides inflation. The financial crisis of 2008 was precipitated by excessive debt creation, often in the form of unstable real estate loans. The widespread destruction of debt caused by defaults and the subsequent collapse of asset prices lead to deflationary conditions.
The federal reserve would have lowered rates below zero to stimulate the economy if it were possible, but negative interest rates were considered impossible, so policymakers didn’t attempt it. But why are negative interest rates impossible?
First, for ordinary people, if banks start charging depositors to hold their money — the result of negative interest rates — people would withdrawal their deposits in cash and stuff their mattresses or safe deposit boxes. When interest rates are negative, it pays to store money in cash rather than pay the bank to hold your savings. Policymakers feared massive bank runs if interest rates went negative, so they felt limited by a zero bound.
Experience in Europe over the last year or so shows that interest rates can go negative. Investors expect widespread deflation of the Euro, probably due to the impending Greek default and the likely later defaults of Spain and Italy. Investors have purchased bonds with negative yields just to store wealth in what they believe will be a deflation ravaged currency. It turns out that the storage costs of holding billions of Euros made it more attractive to store that wealth electronically rather than convert it to paper currency.
This experience has emboldened some to float the idea that currency should be abolished entirely. Emotionally, I am repelled by such an idea. I don’t want to be forced to pay a bank for the privilege of storing my money electronically. By eliminating alternative means of storing wealth, over time bankers will undoubtedly reap the benefits of lower interest rates on deposits, and it times of deflation — which are generally caused by bank excess — banks will be able to make money directly from depositors by confiscating the value of their stored wealth. It’s the kind of idea revolts are made of.
Would this save the world economy?
by Lorcan Roche Kelly, April 10, 2015
The world’s central banks have a problem.
When economic conditions worsen, they react by reducing interest rates in order to stimulate the economy. But, as has happened across the world in recent years, there comes a point where those central banks run out of room to cut — they can bring interest rates to zero, but reducing them further below that is fraught with problems, the biggest of which is cash in the economy.
It takes a remarkably twisted logic to conclude cash in an economy is a problem.
In a new piece, Citi’s Willem Buiter looks at this problem, which is known as the effective lower bound (ELB) on nominal interest rates.
Fundamentally, the ELB problem comes down to cash. According to Buiter, the ELB only exists at all due to the existence of cash, which is a bearer instrument that pays zero nominal rates. Why have your money on deposit at a negative rate that reduces your wealth when you can have it in cash and suffer no reduction?
Cash therefore gives people an easy and effective way of avoiding negative nominal rates.
Buiter’s note suggests three ways to address this problem:
- Abolish currency.
- Tax currency.
- Remove the fixed exchange rate between currency and central bank reserves/deposits.
Tax currency? Does that idea sound as crazy to everyone else as it does to me?
Yes, Buiter’s solution to cash’s ability to allow people to avoid negative deposit rates is to abolish cash altogether. (Note that he’s far from being the first to float this idea. Ken Rogoff has given his endorsement to the idea as well, as have others.)
Just because others have also floated this dumb idea doesn’t make it any better.
Before looking at the practicalities of abolishing currency, we should first look at whether it could ever be necessary. Due to the costs of holding large amounts of cash, Buiter puts the actual nominal rate at which the move to cash makes sense as closer to -100bp. So, in order for a cash abolition to become necessary, central banks would need to be in a position where they wished to set nominal rates much lower than that.
The gold bugs would love that. The main criticism of gold as a medium for storing wealth is that gold pays no interest. If interest rates went negative, any asset that did not decline in value or have excessive carrying costs becomes superior to cash. Gold would actually become a cashflow asset because it avoids a negative cashflow.
Buiter does not have to go far to find an example of where a central bank may have wanted to set interest rates much lower to -100bp. He uses (a fairly aggressive) Taylor Rule to show that Federal Reserve rates should have been as low as -6 percent during the financial crisis.
It seems Buiter is correct: Sometimes strongly negative nominal rates are called for.
It seems Buiter is correct? What a presumptuous and ignorant statement! A few squiggly lines on a graph proves nothing, other than perhaps people can use economic theory to support foolish ideas and justify immoral theft.
Buiter is aware that his idea may be somewhat controversial,
Somewhat controvercial? There’s an understatement!
so he goes to the effort of listing the disadvantages of abolishing cash.
1. Abolishing currency will constitute a noticeable change in many people’s lives and change often tends to be resisted.
It would be resisted at gunpoint by many. It would probably be easier to take away people’s guns than take away their cash.
2. Currency use remains high among the poor and some older people. (Buiter suggests that keeping low-denomination cash in circulation — nothing larger than $5 — might solve this.)
Screw the old and the poor in order to help the banks? I don’t see the federal reserve having any problem with that, do you?
3. Central banks and governments would lose seigniorage revenue.
WTF? Directly confiscating the wealth of citizens through negative interest rates would not cause the loss of seigniorage revenue, it would magnify the effect of this evil significantly.
4. Abolishing currency would inevitably be associated with a loss of privacy and create risks of excessive intrusion by the government.
No kidding. For as much as I find this idea offensive, it would do much to bring illegal activities out into the open. Crack cocaine dealers would need card readers on their iPhones to complete drug transactions. And how would people tip strippers? Would strippers have card readers in their G-strings?
5. Switching exclusively to electronic payments may create new security and operational risks.
Buiter dismisses each of these concerns in turn,
I imagine he does dismiss each concern with some completely rational and well-reasoned nonsense.
In summary, we therefore conclude that the arguments against abolishing currency seem rather weak.
In summary, I therefore conclude that the arguments in favor of abolishing currency seem like the ravings of a lunatic.
Whatever the strength of the arguments, the chances of an administration taking the decision to abolish cash seem vanishingly small.