Negative Interest Rates and the War on Cash(Full Article)

Sep 112016

September 11, 2016 Posted by Raúl Ilargi Meijer at 1:20pm Finance Tagged with: bubble, cash, credit, debt, deflation, liquidity,Nicole Foss, NIRP, Ponzi, risk, ZIRP Comments Off on Negative InterestRates and the War on Cash (Full Article)

The Statue of Liberty at the 1878 Paris World’s Fair

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This article by Nicole Foss was published earlier at the Automatic Earth in 4chapters.

Part 1 is here: Negative Interest Rates and the War on Cash (1)

Part 2 is here: Negative Interest Rates and the War on Cash (2)

Part 3 is here: Negative Interest Rates and the War on Cash (3)

Part 4 is here: Negative Interest Rates and the War on Cash (4)

Nicole Foss: As momentum builds in the developing deflationary spiral, weare seeing increasingly desperate measures to keep the global credit ponzischeme from its inevitable conclusion. Credit bubbles are dynamic — theymust grow continually or implode — hence they require ever more money tobe lent into existence. But that in turn requires a plethora of willing and ableborrowers to maintain demand for new credit money, lenders who are not toorisk-averse to make new loans, and (apparently effective) mechanisms fordiluting risk to the point where it can (apparently safely) be ignored. As thepeak of a credit bubble is reached, all these necessary factors first becomeproblematic and then cease to be available at all. Past a certain point, thereare hard limits to financial expansions, and the global economy is set to hitone imminently.

Borrowers are increasingly maxed out and afraid they will not be able toservice existing loans, let alone new ones. Many families already have morethan enough ‘stuff’ for their available storage capacity in any case, and arelooking to downsize and simplify their cluttered lives. Many businesses arealready struggling to sell goods and services, and so are unwilling to borrowin order to expand their activities. Without willingness to borrow, demand fornew loans will fall substantially. As risk factors loom, lenders become farmore risk-averse, often very quickly losing trust in the solvency of of theircounterparties. As we saw in 2008, the transition from embracing riskyprospects to avoiding them like the plague can be very rapid,changing the rules of the game very abruptly.

Mechanisms for spreading risk to the point of ‘dilution to nothingness’, suchas securitization, seen as effective and reliable during monetary expansions,cease to be seen as such as expansion morphs into contraction. Thesecuritized instruments previously created then cease to be perceived as

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holding value, leading to them being repriced at pennies on the dollar onceprice discovery occurs, and the destruction of that value is highlydeflationary. The continued existence of risk becomes increasingly evident,and the realisation that that risk could be catastrophic begins to dawn.

Natural limits for both borrowing and lending threaten the capacity toprolong the credit boom any further, meaning that even if central authoritiesare prepared to pay almost any price to do so, it ceases to be possible to kickthe can further down the road. Negative interest rates and the war on cashare symptoms of such a limit being reached. As confidence evaporates, sodoes liquidity. This is where we find ourselves at the moment — on the cuspof phase two of the credit crunch, sliding into the same unavoidableconstellation of conditions we saw in 2008, but on a much larger scale.

From ZIRP to NIRP

Interest rates have remained at extremely low levels, hardly distinguishablefrom zero, for the several years. This zero interest rate policy (ZIRP) is areflection of both the extreme complacency as to risk during the rise into thepeak of a major bubble, and increasingly acute pressure to keep the creditmountain growing through constant stimulation of demand for borrowing.The resulting search for yield in a world of artificially stimulatedover-borrowing has lead to an extraordinary array of malinvestment acrossmany sectors of the real economy. Ever more excess capacity is being built ina world facing a severe retrenchment in aggregate demand. It is this that istermed ‘recovery’, but rather than a recovery, it is a form of double jeopardy— an intensification of previous failed strategies in the hope that a differentoutcome will result. This is, of course, one definition of insanity.

Now that financial crisis conditions are developing again, policies are beingimplemented which amount to an even greater intensification of the oldstrategy. In many locations, notably those perceived to be safe havens, thebenchmark is moving from a zero interest rate policy to a negative interestrate policy (NIRP), initially for bank reserves, but potentially for businessclients (for instance in Holland and the UK). Individual savers would benext in line. Punishing savers, while effectively encouraging banks to lend toweaker, and therefore riskier, borrowers, creates incentives for bothborrowers and lenders to continue the very behaviour that set the stage forfinancial crisis in the first place, while punishing the kind of responsibilitythat might have prevented it.

Risk is relative. During expansionary times, when risk perception is lowalmost across the board (despite actual risk steadily increasing), the riskpremium that interest rates represent shows relatively little variationbetween different lenders, and little volatility. For instance, the interest rateson sovereign bonds across Europe, prior to financial crisis, were low andbroadly similar for many years. In other words, credit spreads were very

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narrow during that time. Greece was able to borrow almost as easily andcheaply as Germany, as lenders bet that Europe’s strong economies wouldback the debt of its weaker parties. However, as collective psychology shiftsfrom unity to fragmentation, risk perception increases dramatically, and riskdistinctions of all kinds emerge, with widening credit spreads. We saw thishappen in 2008, and it can be expected to be far more pronounced in thecoming years, with credit spreads widening to record levels. Interest ratedivergences create self-fulfilling prophecies as to relative default risk,against a backdrop of fear-driven high volatility.

Many risk distinctions can be made — government versus private debt, longversus short term, economic centre versus emerging markets, inside theEuropean single currency versus outside, the European centre versus thetroubled periphery, high grade bonds versus junk bonds etc. As the riskdistinctions increase, the interest rate risk premiums diverge. Higher riskborrowers will pay higher premiums, in recognition of the higher default risk,but the higher premium raises the actual risk of default, leading to stillhigher premiums in a spiral of positive feedback. Increased risk perceptionthus drives actual risk, and may do so until the weak borrower is driven overthe edge into insolvency. Similarly, borrowers perceived to be relative safehavens benefit from lower risk premiums, which in turn makes their debtburden easier to bear and lowers (or delays) their actual risk of default. Thisreduced risk of default is then reflected in even lower premiums. The riskybecome riskier and the relatively safe become relatively safer (which is notnecessarily to say safe in absolute terms). Perception shapes reality, whichfeeds back into perception in a positive feedback loop.

The process of diverging risk perception is already underway, and it is

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generally the states seen as relatively safe where negative interest rates arebeing proposed or implemented. Negative rates are already in place for bankreserves held with the ECB and in a number of European states from 2012onwards, notably Scandinavia and Switzerland. The desire for capitalpreservation has led to a willingness among those with capital toaccept paying for the privilege of keeping it in ‘safe havens’. Note thatperception of safety and actual safety are not equivalent. States at the peakof a bubble may appear to be at low risk, but in fact the opposite is true. Atthe peak of a bubble, there is nowhere to go but down, as Iceland and Irelanddiscovered in phase one of the financial crisis, and many others will discoveras we move into phase two. For now, however, the perception of low risk issufficient for a flight to safety into negative interest rate environments.

This situation serves a number of short term purposes for the states involved.Negative rates help to control destabilizing financial inflows at times whenfear is increasingly driving large amounts of money across borders. Aprimary objective has been to reduce upward pressure on currencies outsidethe eurozone. The Swiss, Danish and Swedish currencies have all beenexperiencing currency appreciation, hence a desire to use negative interestrates to protect their exchange rate, and therefore the price of their exports,by encouraging foreigners to keep their money elsewhere. The Danishcentral bank’s sole mandate is to control the value of the currency againstthe euro. For a time, Switzerland pegged their currency directly to the euro,but found the cost of doing so to be prohibitive. For them, negative rates area less costly attempt to weaken the currency without the need to defend aformal peg. In a world of competitive, beggar-thy-neighbour currencydevaluations, negative interest rates are seen as a means to achieve ormaintain an export advantage, and evidence of the growing currency war.

Negative rates are also intended to discourage saving and encourage bothspending and investment. If savers must pay a penalty, spending orinvestment should, in theory, become more attractive propositions. Theintention is to lead to more money actively circulating in the economy.Increasing the velocity of money in circulation should, in turn, provide pricesupport in an environment where prices are flat to falling. (Mainstreamcommentators would describe this as as an attempt to increase ‘inflation’, bywhich they mean price increases, to the common target of 2%, but here atThe Automatic Earth, we define inflation and deflation as an increase ordecrease, respectively, in the money supply, not as an increase or decrease inprices.) The goal would be to stave off a scenario of falling prices wherebuyers would have an incentive to defer spending as they wait for lowerprices in the future, starving the economy of circulating currency in themeantime. Expectations of falling prices create further downward pricepressure, leading into a vicious circle of deepening economic depression.Preventing such expectations from taking hold in the first place is a majorpriority for central authorities.

Negative rates in the historical record are symptomatic of times of crisiswhen conventional policies have failed, and as such are rare. Their use is ameasure of desperation:

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First, a policy rate likely would be set to a negative value only wheneconomic conditions are so weak that the central bank haspreviously reduced its policy rate to zero. Identifying creditworthyborrowers during such periods is unusually challenging. Howstrongly should banks during such a period be encouraged toexpand lending?

However strongly banks are ‘encouraged’ to lend, willing borrowers andlenders are set to become ‘endangered species’:

The goal of such rates is to force banks to lend their excessreserves. The assumption is that such lending will boost aggregatedemand and help struggling economies recover. Using the samecentral bank logic as in 2008, the solution to a debt problem is toadd on more debt. Yet, there is an old adage: you can bring a horseto water but you cannot make him drink! With the world economysinking into recession, few banks have credit-worthy customers andmany banks are having difficulties collecting on existing loans.Italy’s non-performing loans have gone from about 5 percent in2010 to over 15 percent today. The shale oil bust has left many USbanks with over a trillion dollars of highly risky energy loans ontheir books. The very low interest rate environment in Japan andthe EU has done little to spur demand in an environment full ofmalinvestments and growing government constraints.

Doing more of the same simply elevates the already enormous risk that anew financial crisis is right around the corner:

Banks rely on rates to make returns. As the former Bank ofEngland rate-setter Charlie Bean has written in a recent paper forThe Economic Journal, pension funds will struggle to makeadequate returns, while fund managers will borrow a lot more tomake profits. Mr Bean says: “All of this makes a leveraged ‘searchfor yield’ of the sort that marked the prelude to the crisis morelikely.” This is not comforting but it is highly plausible: barely adecade on from the crash, we may be about to repeat it. This comesfrom tasking central bankers with keeping the world economygrowing, even while governments have cut spending.

Experiences with Negative Interest Rates

The existing low interest rate environment has already caused asset pricebubbles to inflate further, placing assets such as real estate ever morebeyond the reach of ordinary people at the same time as hampering thosesame people attempting to build sufficient savings for a deposit. Negativeinterest rates provide an increased incentive for this to continue. In locationswhere the rates are already negative, the asset bubble effect has worsened.

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For instance, in Denmark negative interest rates have added considerableimpetus to the housing bubble in Copenhagen, resulting in an ever largerpool over over-leveraged property owners exposed to the risks of a propertyprice collapse and debt default:

Where do you invest your money when rates are below zero? TheDanish experience says equities and the property market. Thebenchmark index of Denmark’s 20 most-traded stocks has soaredmore than 100 percent since the second quarter of 2012, which isjust before the central bank resorted to negative rates. That’s morethan twice the stock-price gains of the Stoxx Europe 600 and DowJones Industrial Average over the period. Danish house prices havejumped so much that Danske Bank A/S, Denmark’s biggest lender,says Copenhagen is fast becoming Scandinavia’s riskiest propertymarket.

Considering that risky property markets are the norm in Scandinavia,Copenhagen represents an extreme situation:

“Property prices in Copenhagen have risen 40–60 percent since themiddle of 2012, when the central bank first resorted to negativeinterest rates to defend the krone’s peg to the euro.”

This should come as no surprise: recall that there are documentedcases where Danish borrowers are paid to take on debt and buyhouses “In Denmark You Are Now Paid To Take Out AMortgage”, so between rewarding debtors and punishing savers,this outcome is hardly shocking. Yet it is the negative rates thathave made this unprecedented surge in home prices feel relativelybenign on broader price levels, since the source of housing funds isnot savings but cash, usually cash belonging to the bank.

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The Swedish property market is similarly reaching for the sky. Like Japan atthe peak of it’s bubble in the late 1980s, Sweden has intergenerationalmortgages, with an average term of 140 years! Recent regulatory attemptsto rein in the ballooning debt by reducing the maximum term to a ‘mere’ 105years have been met with protest:

Swedish banks were quoted in the local press as opposing themove. “It isn’t good for the finances of households as it will makemortgages more expensive and the terms not as good. And it isn’tgood for financial stability,” the head of Swedish Bankers’Association was reported to say.

Apart from stimulating further leverage in an already over-leveraged market,negative interest rates do not appear to be stimulating actual economicactivity:

If negative rates don’t spur growth — Danish inflation since 2012has been negligible and GDP growth anemic — what are they goodfor?….Danish businesses have barely increased their investments,adding less than 6 percent in the 12 quarters since Denmark’spolicy rate turned negative for the first time. At a growth rate of 5percent over the period, private consumption has been similarlymuted. Why is that? Simply put, a weak economy makes interest

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rates a less powerful tool than central bankers would like.

“If you’re very busy worrying about the economy and your job, youdon’t care very much what the exact rate is on your car loan,” saysTorsten Slok, Deutsche Bank’s chief international economist in NewYork.

Fuelling inequality and profligacy while punishing responsible behaviouris politically unpopular, and the consequences, when they eventuallymanifest, will be even more so. Unfortunately, at the peak of a bubble, it isonly continued financial irresponsibility that can keep a credit expansiongoing and therefore keep the financial system from abruptly crashing. Theonly things keeping the system ‘running on fumes’ as it currently is, arefinancial sleight-of-hand, disingenuous bribery and outright fraud. The priceto pay is that the systemic risks continue to grow, and with it the scale of theimpacts that can be expected when the risk is eventually realised. Politiciansdesperately wish to avoid those consequences occurring in their term ofoffice, hence they postpone the inevitable at any cost for as long as physicallypossible.

The Zero Lower Bound and the Problem of Physical Cash

Central bankers attempting to stimulate the circulation of money in theeconomy through the use of negative interest rates have a number ofproblems. For starters, setting a low official rate does not necessarily meanthat low rates will prevail in the economy, particularly in times of crisis:

The experience of the global financial crisis taught us that the typeof shocks which can drive policy interest rates to the lower boundare also shocks which produce severe impairments to the monetarypolicy transmission mechanism. Suppose, for example, that theinterbank market freezes and prevents a smooth transmission ofthe policy interest rate throughout the banking sector and financialmarkets at large. In this case, any cut in the policy rate may bealmost completely ineffective in terms of influencing themacroeconomy and prices.

This is exactly what we saw in 2008, when interbank lending seized up due tothe collapse of confidence in the banking sector. We have not seen thishappen again yet, but it inevitably will as crisis conditions resume, and whenit does it will illustrate vividly the limits of central bank power to controlfinancial parameters. At that point, interest rates are very likely to spike inpractice, with banks not trusting each other to repay even very short termloans, since they know what toxic debt is on their own books and rationallyassume their potential counterparties are no better. Widening credit spreadswould also lead to much higher rates on any debt perceived to be risky,which, increasingly, would be all debt with the exception of government

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bonds in the jurisdictions perceived to be safest. Low rates on high gradedebt would not translate into low rates economy-wide. Given the extent ofprivate debt, and the consequent vulnerability to higher interest rates acrossthe developed world, an interest rate spike following the NIRP period wouldbe financially devastating.

The major issue with negative rates in the shorter term is the ability toescape from the banking system into physical cash. Instead of causing peopleto spend, a penalty on holding savings in a banks creates an incentive forthem to withdraw their funds and hold cash under their own control, therebyavoiding both the penalty and the increasing risk associated with thebanking system:

Western banking systems are highly illiquid, meaning that theyhave very low cash equivalents as a percentage of customerdeposits….Solvency in many Western banking systems is alsohighly questionable, with many loaded up on the debts of theirbankrupt governments. Banks also play clever accounting games tohide the true nature of their capital inadequacy. We live in a worldwhere questionably solvent, highly illiquid banks are backed byunder capitalized insurance funds like the FDIC, which in turn arebacked by insolvent governments and borderline insolvent centralbanks. This is hardly a risk-free proposition. Yet your reward fortaking the risk of holding your money in a precarious bankingsystem is a rate of return that is substantially lower than theofficial rate of inflation.

In other words, negative rates encourage an arbitrage situation favouringcash. In an environment of few good investment opportunities, increasingrecognition of risk and a rising level of fear, a desire for large scale cashwithdrawal is highly plausible:

From a portfolio choice perspective, cash is, under normalcircumstances, a strictly dominated asset, because it is subject tothe same inflation risk as bonds but, in contrast to bonds, it yieldszero return. It has also long been known that this relationshipwould be reversed if the return on bonds were negative. In thatcase, an investor would be certain of earning a profit by borrowingat negative rates and investing the proceedings in cash. Ignoringstorage and transportation costs, there is therefore a zero lowerbound (ZLB) on nominal interest rates.

Zero is the lower bound for nominal interest rates if one would want to avoidcreating such an incentive structure, but in a contractionary environment,zero is not low enough to make borrowing and lending attractive. This isbecause, while the nominal rate might be zero, the real rate (the nominalrate minus negative inflation) can remain high, or perhaps very high,depending on how contractionary the financial landscape becomes. AsKeynes observed, attempting to stimulate demand for money by loweringinterest rates amounts to ‘pushing on a piece of string‘. Centralauthorities find themselves caught in the liquidity trap, where monetary

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policy ceases to be effective:

Many big economies are now experiencing ‘deflation’, where pricesare falling. In the euro zone, for instance, the main interest rate isat 0.05% but the “real” (or adjusted for inflation) interest rate isconsiderably higher, at 0.65%, because euro-area inflation hasdropped into negative territory at -0.6%. If deflation gets worsethen real interest rates will rise even more, choking off recoveryrather than giving it a lift.

If nominal rates are sufficiently negative to compensate for thecontractionary environment, real rates could, in theory, be low enough tostimulate the velocity of money, but the more negative the nominal rate, thegreater the incentive to withdraw physical cash. Hoarded cash would reduce,instead of increase, the velocity of money. In practice, lowering rates can bemoderately reflationary, provided there remains sufficient economicoptimism for people to see the move in a positive light. However, sendingrates into negative territory at a time pessimism is dominant can easily beinterpreted as a sign of desperation, and therefore as confirmation of anegative outlook. Under such circumstances, the incentives to regard thebanking system as risky, to withdraw physical cash and to hoard it for a rainyday increase substantially. Not only does the money supply fail to grow, asnew loans are not made, but the velocity of money falls as money ishoarded, thereby aggravating a deflationary spiral:

A decline in the velocity of money increases deflationary pressure.Each dollar (or yen or euro) generates less and less economicactivity, so policymakers must pump more money into the system togenerate growth. As consumers watch prices decline, they deferpurchases, reducing consumption and slowing growth. Deflationalso lifts real interest rates, which drives currency values higher. Intoday’s mercantilist, beggar-thy-neighbour world of global trade, astrong currency is a headwind to exports. Obviously, this is not thedesired outcome of policymakers. But as central banks grasp fornew, stimulative tools, they end up pushing on an ever-lengtheningpiece of string.

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Japan has been in the economic doldrums, with pessimism dominant, for over25 years, and the population has become highly sceptical of stimulationmeasures intended to lead to recovery. The negative interest ratesintroduced there (described as ‘economic kamikaze’) have had a verydifferent effect than in Scandinavia, which is still more or less at the peak ofits bubble and therefore much more optimistic. Unfortunately, loweringinterest rates in times of collective pessimism has a poor record of acting toincrease spending and stimulate the economy, as Japan has discovered sincetheir bubble burst in 1989:

For about a quarter of a century the Japanese have proved to befanatical savers, and no matter how low the Bank of Japan cutsrates, they simply cannot be persuaded to spend their money, oreven invest it in the stock market. They fear losing their jobs; theyfear a further fall in shares or property values; they have noconfidence in the investment opportunities in front of them. Sopathological has this psychology grown that they wouldrather see the value of their savings fall than spend the cash.That draining of confidence after the collapse of the 1980s“bubble” economy has depressed Japanese growth for decades.

Fear is a very sharp driver of behaviour — easily capable of over-ridingincentives designed to promote spending and investment:

When people are fearful they tend to save; and when they becomeespecially fearful then they save even more, even if the returns on

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their savings are extremely low. Much the same goes forbusinesses, and there are increasing reports of them “hoarding”their profits rather than reinvesting them in their business, such isthe great “uncertainty” around the world economy. Brexit obviouslyonly added to the fears and misgivings about the future.

Deflation is so difficult to overcome precisely because of its strongpsychological component. When the balance of collective psychology tipsfrom optimism, hope and greed to pessimism and fear, everything isperceived differently. Measures intended to restore confidence end up beinginterpreted as desperation, and therefore get little or no traction. As suchinitiatives fail, their failure becomes conformation of a negative bias, whichincreases the power of that bias, causing more stimulus initiatives to fail. Theresulting positive feedback loop creates and maintains a vicious circle, botheconomically and socially:

There is a strong argument that when rates go negative it squeezesthe speed at which money circulates through the economy,commonly referred to by economists as the velocity of money. Weare already seeing this happen in Japan where citizens areclamouring for ¥10,000 bills (and home safes to store them in).People are taking their money out of the banking system to stuff itunder their metaphorical mattresses. This may sound extreme, butwhether paper money is stashed in home safes or moved intotransaction substitutes or other stores of value like gold, the pointis it’s not circulating in the economy. The empirical data supportthis view — the velocity of money has declined precipitously aspolicymakers have moved aggressively to reduce rates.

Physical cash under one’s own control is increasingly seen as one of theprimary escape routes for ordinary people fearing the resumption of the2008 liquidity crunch, and its popularity as a store of value is increasingsteadily, with demand for cash rising more rapidly than GDP in a widerange of countries:

While cash’s use is in continual decline, claims that it is set todisappear entirely may be premature, according to the Bank ofEngland….The Bank estimates that 21pc to 27pc of everydaytransactions last year were in cash, down from between 34pc and45pc at the turn of the millennium. Yet simultaneously the demandfor banknotes has risen faster than the total amount of spending inthe economy, a trend that has only become more pronounced sincethe mid-1990s. The same phenomenon has been seeninternationally, in the US, eurozone, Australia and Canada….

….The prevalence of hoarding has also firmed up the demand forphysical money. Hoarders are those who “choose to save theirmoney in a safety deposit box, or under the mattress, or evenburied in the garden, rather than placing it in a bank account”, theBank said. At a time when savings rates have not turned negative,and deposits are guaranteed by the government, this kind of

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activity seems to defy economic theory. “For such action to beconsidered as rational, those that are hoarding cash must begaining a non-financial benefit,” the Bank said. And that benefitmust exceed the returns and security offered by putting thathoarded cash in a bank deposit account. A Bank survey conductedlast year found that 18pc of people said they hoarded cash largely“to provide comfort against potential emergencies”.

This would suggest that a minimum of £3bn is hoarded in the UK,or around £345 a person. A government survey conducted in 2012suggested that the total number might be higher, at £5bn….

…..But Bank staff believe that its survey results understate theextent of hoarding, as “the sensitivity of the subject” most likelyaffects the truthfulness of hoarders. “Based on anecdotal evidence,a small number of people are thought to hoard large values ofcash.” The Bank said: “As an illustrative example, if one in everythousand adults in the United Kingdom were to hoard as much as£100,000, this would account for around £5bn — nearly 10pc ofnotes in circulation.” While there may be newer and moreconvenient methods of payment available, this strong preferencefor cash as a safety net means that it is likely to endure, unlesssteps are taken to discourage its use.

Closing the Escape Routes

History teaches us that central authorities dislike escape routes, at least forthe majority, and are therefore prone to closing them, so that control of alimited money supply can remain in the hands of the very few. In the 1930s,gold was the escape route, so gold was confiscated. As Alan Greenspanwrote in 1966:

In the absence of the gold standard, there is no way to protectsavings from confiscation through monetary inflation. There is nosafe store of value. If there were, the government would haveto make its holding illegal, as was done in the case of gold. Ifeveryone decided, for example, to convert all his bank deposits tosilver or copper or any other good, and thereafter declined toaccept checks as payment for goods, bank deposits would lose theirpurchasing power and government-created bank credit would beworthless as a claim on goods.

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The existence of escape routes for capital preservation undermines theviability of the banking system, which is already over-extended,over-leveraged and extremely fragile. This time cash serves that role:

Ironically, though the paper money standard that replaced the goldstandard was originally meant to empower governments, it nowseems that paper money is perceived as an obstacle to unlimitedgovernment power….While paper money isn’t as big impediment togovernment power as the gold standard was, it is nevertheless animpediment compared to a society with only electronic money.Because of this, the more ardent statists favor the abolition ofpaper money and a monetary system with only electronic moneyand electronic payments.

We can therefore expect cash to be increasingly disparaged in order tojustify its intended elimination:

Every day, a situation that requires the use of physical cash, feelsmore and more like an anachronism. It’s like having to listen tomusic on a CD. John Maynard Keynes famously referred to gold(well, the gold standard specifically) as a “barbarous relic.” Wellthe new barbarous relic is physical cash. Like gold, cash is physicalmoney. Like gold, cash is still fetishized. And like gold, cash is acostly drain on the economy. A study done at Tufts in 2013estimated that cash costs the economy $200 billion. Their studyincluded the nugget that consumers spend, on average, 28 minutesper month just traveling to the point where they obtain cash (ATM,etc.). But this is just first-order problem with cash. The realproblem, which economists are starting to recognize, is that papercash is an impediment to effective monetary policy, and thereforeeconomic growth.

Holding cash is not risk free, but cash is nevertheless king in a period ofdeflation:

Conventional wisdom is that interest rates earned on investmentsare never less than zero because investors could alternatively holdcurrency. Yet currency is not costless to hold: It is subject to theftand physical destruction, is expensive to safeguard in largeamounts, is difficult to use for large and remote transactions, and,in large quantities, may be monitored by governments.

The acknowledged risks of holding cash are understood and can be managedpersonally, whereas the substantial risk associated with a systemic bankingcrisis are entirely outside the control of ordinary depositors. The bank bail-in(rescuing the bank with the depositors’ funds) in Cyprus in early 2013 was awarning sign, to those who were paying attention, that holding money in abank is not necessarily safe. The capital controls put in place in otherlocations, for instance Greece, also underline that cash in a bank may not beaccessible when needed.

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The majority of the developed world either already has, or is introducing,legislation to require depositor bail-ins in the event of bank failures, ratherthan taxpayer bailouts, in preparation for many more Cyprus-type events, buton a very much larger scale. People are waking up to the fact that abank balance is not considered their money, but is actually anunsecured loan to the bank, which the bank may or may not repay,depending on its own circumstances.:

Your checking account balance is denominated in dollars, but itdoes not consist of actual dollars. It represents a promise by aprivate company (your bank) to pay dollars upon demand. If youwrite a check, your bank may or may not be able to honor thatpromise. The poor souls who kept their euros in the form of largebalances in Cyprus banks have just learned this lesson the hardway. If they had been holding their euros in the form of currency,they would have not lost their wealth.

Even in relatively untroubled countries, like the UK, it is becoming moredifficult to access physical cash in a bank account or to use it for largerpurchases. Notice of intent to withdraw may be required, and withdrawallimits may be imposed ‘for your own protection’. Reasons for the withdrawalmay be required, ostensibly to combat money laundering and the blackeconomy:

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It’s one thing to be required by law to ask bank customers orparties in a cash transaction to explain where their money camefrom; it’s quite another to ask them how they intend to use themoney they wish to withdraw from their own bank accounts. As oneMr Cotton, a HSBC customer, complained to the BBC’s Money Boxprogramme: “I’ve been banking in that bank for 28 years. They allknow me in there. You shouldn’t have to explain to your bank whyyou want that money. It’s not theirs, it’s yours.”

In France, in the aftermath of terrorist attacks there, several anti-cashmeasures were passed, restricting the use of cash once obtained:

French Finance Minister Michel Sapin brazenly stated that it wasnecessary to “fight against the use of cash and anonymity in theFrench economy.” He then announced extreme and despoticmeasures to further restrict the use of cash by French residentsand to spy on and pry into their financial affairs.

These measures…..include prohibiting French residents frommaking cash payments of more than 1,000 euros, down from thecurrent limit of 3,000 euros….The threshold below which a Frenchresident is free to convert euros into other currencies withouthaving to show an identity card will be slashed from the currentlevel of 8,000 euros to 1,000 euros. In addition any cash deposit orwithdrawal of more than 10,000 euros during a single month willbe reported to the French anti-fraud and money laundering agencyTracfin.

Tourists in France may also be caught in the net:

France passed another new Draconian law; from the summer of2015, it will now impose cash requirements dramatically trying toeliminate cash by force. French citizens and tourists will only beallowed a limited amount of physical money. They have financialpolice searching people on trains just passing through France tosee if they are transporting cash, which they will now seize.

This is essentially the Shock Doctrine in action. Central authorities rarelypass up an opportunity to use a crisis to add to their repertoire of repressivelaws and practices.

However, even without a specific crisis to draw on as a justification, manyother countries have also restricted the use of cash for purchases:

One way they are waging the War on Cash is to lower the thresholdat which reporting a cash transaction is mandatory or at whichpaying in cash is simply illegal. In just the last few years.

Italy made cash transactions over €1,000 illegal;Switzerland has proposed banning cash payments in excess of100,000 francs;Russia banned cash transactions over $10,000;

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Spain banned cash transactions over €2,500;Mexico made cash payments of more than 200,000 pesosillegal;Uruguay banned cash transactions over $5,000

Other restrictions on the use of cash can be more subtle, but can havefar-reaching effects, especially if the ideas catch on and are widely applied:

The State of Louisiana banned “secondhand dealers” from makingmore than one cash transaction per week. The term has a broaddefinition and includes Goodwill stores, specialty stores that sellcollectibles like baseball cards, flea markets, garage sales and soon. Anyone deemed a “secondhand dealer” is forbidden to acceptcash as payment. They are allowed to take only electronic means ofpayment or a check, and they must collect the name and otherinformation about each customer and send it to the local policedepartment electronically every day.

The increasing application of de facto capital controls, when combined withthe prevailing low interest rates, already convince many to hold cash. Thepossibility of negative rates would greatly increase the likelihood. We arealready in an environment of rapidly declining trust, and limited access towhat we still perceive as our own funds only accelerates the process in aself-reinforcing feedback loop. More withdrawals lead to more controls,which increase fear and decrease trust, which leads to more withdrawals.This obviously undermines the perceived power of monetary policy tostimulate the economy, hence the escape route is already quietly closing.

In a deflationary spiral, where the money supply is crashing, very littlemoney is in circulation and prices are consequently falling almost across theboard, possessing purchasing power provides for the freedom to pursueopportunities as they present themselves, and to avoid being backed into acorner. The purchasing power of cash increases during deflation, even aselectronic purchasing power evaporates. Hence cash represents freedom ofaction at a time when that will be the rarest of ‘commodities’.

Governments greatly dislike cash, and increasingly treat its use, or the desireto hold it, especially in large denominations, with great suspicion:

Why would a central bank want to eliminate cash? For the samereason as you want to flatten interest rates to zero: to force peopleto spend or invest their money in the risky activities that revivegrowth, rather than hoarding it in the safest place. Calls for theeradication of cash have been bolstered by evidence thathigh-value notes play a major role in crime, terrorism and taxevasion. In a study for the Harvard Business School last week,former bank boss Peter Sands called for global elimination of thehigh-value note.

Britain’s “monkey” — the £50 — is low-value compared with itsforeign-currency equivalents, and constitutes a small proportion of

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the cash in circulation. By contrast, Japan’s ¥10,000 note (worthroughly £60) makes up a startling 92% of all cash in circulation; theSwiss 1,000-franc note (worth around £700) likewise. Sands wantsan end to these notes plus the $100 bill, and the €500 note – knownin underworld circles as the “Bin Laden”.

Cash is largely anonymous, untraceable and uncontrollable, hence it makescentral authorities, in a system increasingly requiring total buy-in in order tofunction, extremely uncomfortable. They regard there being no legitimatereason to own more than a small amount of it in physical form, as itsownership or use raises the spectre of tax evasion or other illegal activities:

The insidious nature of the war on cash derives not just from thehurdles governments place in the way of those who use cash, butalso from the aura of suspicion that has begun to pervade privatecash transactions. In a normal market economy, businesses wouldwelcome taking cash. After all, what business would willingly turndown customers? But in the war on cash that has developed in thethirty years since money laundering was declared a federal crime,businesses have had to walk a fine line between serving customersand serving the government. And since only one of those twoparties has the power to shut down a business and throw businessowners and employees into prison, guess whose wishes thebusiness owner is going to follow more often?

The assumption on the part of government today is that possessionof large amounts of cash is indicative of involvement in illegalactivity. If you’re traveling with thousands of dollars in cash and getpulled over by the police, don’t be surprised when your money gets

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seized as “suspicious.” And if you want your money back, prepareto get into a long, drawn-out court case requiring you to prove thatyou came by that money legitimately, just because the courts havedecided that carrying or using large amounts of cash is reasonablesuspicion that you are engaging in illegal activity….

….Centuries-old legal protections have been turned on their headin the war on cash. Guilt is assumed, while the victims of thegovernment’s depredations have to prove their innocence….Thosefortunate enough to keep their cash away from the prying hands ofgovernment officials find it increasingly difficult to use for bothbusiness and personal purposes, as wads of cash always arousesuspicion of drug dealing or other black market activity. And socash continues to be marginalized and pushed to the fringes.

Despite the supposed connection between crime and the holding ofphysical cash, the places where people are most inclined (and able) to storecash do not conform to the stereotype at all:

Are Japan and Switzerland havens for terrorists and drug lords?High-denomination bills are in high demand in both places, a trendthat some politicians claim is a sign of nefarious behavior. Yet thetwo countries boast some of the lowest crime rates in the world.The cash hoarders are ordinary citizens responding rationally tomonetary policy. The Swiss National Bank introduced negativeinterest rates in December 2014. The aim was to drive money outof banks and into the economy, but that only works to the extentthat savers find attractive places to spend or invest their money.With economic growth an anemic 1%, many Swiss withdrew cashfrom the bank and stashed it at home or in safe-deposit boxes.High-denomination notes are naturally preferred for this purpose,so circulation of 1,000-franc notes (worth about $1,010) rose 17%last year. They now account for 60% of all bills in circulation andare worth almost as much as Serbia’s GDP.

Japan, where banks pay infinitesimally low interest on deposits, is asimilar story. Demand for the highest-denomination ¥10,000 notesrose 6.2% last year, the largest jump since 2002. But 10,000 Yennotes are worth only about $88, so hiding places fill up fast. Thatexplains why Japanese went on a safe-buying spree last month afterthe Bank of Japan announced negative interest rates on somereserves. Stores reported that sales of safes rose as much as 250%,and shares of safe-maker Secom spiked 5.3% in one week.

In Germany too, negative interest rates are considered intolerable, banksare increasingly being seen as risky prospects, and physical cash under one’sown control is coming to be seen as an essential part of a forward-thinkingfinancial strategy:

First it was the news that Raiffeisen Gmund am Tegernsee, aGerman cooperative savings bank in the Bavarian village of Gmund

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am Tegernsee, with a population 5,767, finally gave in to the ECB’smonetary repression, and announced it’ll start charging retailcustomers to hold their cash. Then, just last week, Deutsche Bank’sCEO came about as close to shouting fire in a crowded negativerate theater, when, in a Handelsblatt Op-Ed, he warned of “fatalconsequences” for savers in Germany and Europe — to be sure,being the CEO of the world’s most systemically risky bank did nothelp his cause.

That was the last straw, and having been patient long enough, theGerman public has started to move. According to the WSJ, Germansavers are leaving the “security of savings banks” for what manynow consider an even safer place to park their cash: home safes.We wondered how many “fatal” warnings from the CEO of DB itwould take, before this shift would finally take place. As it turnsout, one was enough….

….“It doesn’t pay to keep money in the bank, and on top of thatyou’re being taxed on it,” said Uwe Wiese, an 82-year-old pensionerwho recently bought a home safe to stash roughly €53,000($59,344), including part of his company pension that he took as apayout. Burg-Waechter KG, Germany’s biggest safe manufacturer,posted a 25% jump in sales of home safes in the first half of thisyear compared with the year earlier, said sales chief DietmarSchake, citing “significantly higher demand for safes by privateindividuals, mainly in Germany.”….

….Unlike their more “hip” Scandinavian peers, roughly 80% ofGerman retail transactions are in cash, almost double the 46% rateof cash use in the U.S., according to a 2014 Bundesbanksurvey….Germany’s love of cash is driven largely by its anonymity.One legacy of the Nazis and East Germany’s Stasi secret police is afear of government snooping, and many Germans are spooked byproposals of banning cash transactions that exceed €5,000. ManyGermans think the ECB’s plan to phase out the €500 bill is only thebeginning of getting rid of cash altogether. And they are absolutelyright; we can only wish more Americans showed the same foresightas the ordinary German….

….Until that moment, however, as a final reminder, in a fractionalreserve banking system, only the first ten or so percent ofthose who “run” to the bank to obtain possession of theirphysical cash and park it in the safe will succeed. Everyoneelse, our condolences.

The internal stresses are building rapidly, stretching economy after economyto breaking point and prompting aware individuals to protect themselvesproactively:

People react to these uncertainties by trying to protect themselveswith cash and guns, and governments respond by trying to limit

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citizens’ ability to do so.

If this play has a third act, it will involve the abolition of cash insome major countries, the rise of various kinds of black markets(silver coins, private-label cash, cryptocurrencies like bitcoin) thatbypass traditional banking systems, and a surge in civil unrest, asall those guns are put to use. The speed with which cash, safes andguns are being accumulated — and the simultaneous intensificationof the war on cash — imply that the stress is building rapidly, andthat the third act may be coming soon.

Despite growing acceptance of electronic payment systems, getting rid ofcash altogether is likely to be very challenging, particularly as the fear andstate of financial crisis that drives people into cash hoarding is very close toreasserting itself. Cash has a very long history, and enjoys greater trust thanother abstract means for denominating value. It is likely to prove tenacious,and unable to be eliminated peacefully. That is not to suggest centralauthorities will not try. At the heart of financial crisis lies the problem ofexcess claims to underlying real wealth. The bursting of the globalbubble will eliminate the vast majority of these, as the value of creditinstruments, hitherto considered to be as good as money, will plummet on therealisation that nowhere near all financial promises made can possibly bekept.

Cash would then represent the a very much larger percentage of theremaining claims to limited actual resources — perhaps still in excess of theavailable resources and therefore subject to haircuts. Not only the quantityof outstanding cash, but also its distribution, may not be to centralauthorities liking. There are analogous precedents for altering legal currencyin order to dispossess ordinary people trying to protect their stores of value,depriving them of the benefit of their foresight. During the Russian financialcrisis of 1998, cash was not eliminated in favour of an electronic alternative,but the currency was reissued, which had a similar effect. People wererequired to convert their life savings (often held ‘under the mattress’) fromthe old currency to the new. This was then made very difficult, if notimpossible, for ordinary people, and many lost the entirety of their lifesavings as a result.

A Cashless Society?

The greater the public’s desire to hold cash to protect themselves, thegreater will be the incentive for central banks and governments to restrict itsavailability, reduce its value or perhaps eliminate it altogether in favour ofelectronic-only payment systems. In addition to commercial banks alreadycomplicating the process of making withdrawals, central banks are activelyconsidering, as a first step, mechanisms to impose negative interest rateson physical cash, so as to make the escape route appear less attractive:

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Last September, the Bank of England’s chief economist, AndyHaldane, openly pondered ways of imposing negative interest rateson cash — ie shrinking its value automatically. You could invalidaterandom banknotes, using their serial numbers. There are £63bnworth of notes in circulation in the UK: if you wanted to lop 1% offthat, you could simply cancel half of all fivers without warning. Asecond solution would be to establish an exchange rate betweenpaper money and the digital money in our bank accounts. A fiverdeposited at the bank might buy you a £4.95 credit in your account.

To put it mildly, invalidating random banknotes would be highly likely toresult in significant social blowback, and to accelerate the evaporation oftrust in governing authorities of all kinds. It would be far more likely forfinancial authorities to move toward making official electronic money thestandard by which all else is measured. People are already used to usingelectronic money in the form of credit and debit cards and mobile phonemoney transfers:

I can remember the moment I realised the era of cash could soonbe over. It was Australia Day on Bondi Beach in 2014. In a busyliquor store, a man wearing only swimming shorts, carrying only amobile phone and a plastic card, was delaying other people’s

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transactions while he moved 50 Australian dollars into his currentaccount on his phone so that he could buy beer. The 30-oddyoungsters in the queue behind him barely murmured; they’d allbeen in the same predicament. I doubt there was a banknote orcoin between them….The possibility of a cashless society has comeat us with a rush: contactless payment is so new that the little pingthe machine makes can still feel magical. But in some shops,especially those that cater for the young, a customer reaching for abanknote already produces an automatic frown. Among centralbankers, that frown has become a scowl.

In some states almost anything, no matter how small, can be purchasedelectronically. Everything down to, and including, a cup of coffee from aroadside stall can be purchased in New Zealand with an EFTPOS (debit)card, hence relatively few people carry cash. In Scandinavian countries,there are typically more electronic payment options than cash options:

Sweden became the first country to enlist its own citizens aslargely willing guinea pigs in a dystopian economic experiment:negative interest rates in a cashless society. As Credit Suissereports, no matter where you go or what you want to purchase, youwill find a small ubiquitous sign saying “Vi hanterar ej kontanter”(“We don’t accept cash”)….A similar situation is unfolding inDenmark, where nearly 40% of the paying demographic useMobilePay, a Danske Bank app that allows all payments to becompleted via smartphone.

Even street vendors selling “Situation Stockholm”, the local version of theUK’s “Big Issue” are also able to take payments by debit or credit card.

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Ironically, cashlessness is also becoming entrenched in some Africancountries. One might think that electronic payments would not be possible inpoor and unstable subsistence societies, but mobile phones are actually verycommon in such places, and means for electronic payments are rapidlybecoming the norm:

While Sweden and Denmark may be the two nations that areclosest to banning cash outright, the most important testing groundfor cashless economics is half a world away, in sub-Saharan Africa.In many African countries, going cashless is not merely a matter ofbasic convenience (as it is in Scandinavia); it is a matter of basicsurvival. Less than 30% of the population have bank accounts, andeven fewer have credit cards. But almost everyone has a mobilephone. Now, thanks to the massive surge in uptake of mobilecommunications as well as the huge numbers of unbanked citizens,Africa has become the perfect place for the world’s biggest socialexperiment with cashless living.

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Western NGOs and GOs (Government Organizations) are workinghand-in-hand with banks, telecom companies and local authoritiesto replace cash with mobile money alternatives. The organizationsinvolved include Citi Group, Mastercard, VISA, Vodafone, USAID,and the Bill and Melinda Gates Foundation.

In Kenya the funds transferred by the biggest mobile moneyoperator, M-Pesa (a division of Vodafone), account for more than25% of the country’s GDP. In Africa’s most populous nation,Nigeria, the government launched a Mastercard-branded biometricnational ID card, which also doubles up as a payment card. The“service” provides Mastercard with direct access to over 170million potential customers, not to mention all their personal andbiometric data. The company also recently won a governmentcontract to design the Huduma Card, which will be used for payingState services. For Mastercard these partnerships with governmentare essential for achieving its lofty vision of creating a “worldbeyond cash.”

Countries where electronic payment is already the norm would be expectedto be among the first places to experiment with a fully cashless society as thetransition would be relatively painless (at least initially). In Norway twomajor banks no longer issue cash from branch offices, and recently thelargest bank, DNB, publicly called for the abolition of cash. In rich countries,the advent of a cashless society could be spun in the media in such a way asto appear progressive, innovative, convenient and advantageous to ordinarypeople. In poor countries, people would have no choice in any case.

Testing and developing the methods in societies with no alternatives andthen tantalizing the inhabitants of richer countries with more of theconvenience to which they have become addicted is the clear path towardsextending the reach of electronic payment systems and the much greaterfinancial control over individuals that they offer:

Bill and Melinda Gates Foundation, in its 2015 annual letter, adds anew twist. The technologies are all in place; it’s just a question ofgetting us to use them so we can all benefit from a crimeless,privacy-free world. What better place to conduct a massive socialexperiment than sub-Saharan Africa, where NGOs and GOs(Government Organizations) are working hand-in-hand with banksand telecom companies to replace cash with mobile moneyalternatives? So the annual letter explains: “(B)ecause there isstrong demand for banking among the poor, and because the poorcan in fact be a profitable customer base, entrepreneurs indeveloping countries are doing exciting work – some of which will“trickle up” to developed countries over time.”

What the Foundation doesn’t mention is that it is heavily investedin many of Africa’s mobile-money initiatives and in 2010 teamed upwith the World Bank to “improve financial data collection” amongAfrica’s poor. One also wonders whether Microsoft might one day

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benefit from the Foundation’s front-line role in mobile money….As aresult of technological advances and generational priorities, cash’sdays may well be numbered. But there is a whole world ofdifference between a natural death and euthanasia. It is now clearthat an extremely powerful, albeit loose, alliance of governments,banks, central banks, start-ups, large corporations, and NGOs aredetermined to pull the plug on cash — not for our benefit, but fortheirs.

Whatever the superficially attractive media spin, joint initiatives like theBetter Than Cash Alliance serve their founders, not the public. This shouldnot come as a surprise, but it probably will as we sleepwalk into giving upvery important freedoms:

As I warned in We Are Sleepwalking Towards a Cashless Society,we (or at least the vast majority of people in the vast majority ofcountries) are willing to entrust government and financialinstitutions — organizations that have already betrayed just aboutevery possible notion of trust — with complete control over ourevery single daily transaction. And all for the sake of a few minorgains in convenience. The price we pay will be what remains of ourindividual freedom and privacy.

Promoters, Mechanisms and Risks in the War on Cash

Bitcoin and other electronic platforms have paved the way psychologicallyfor a shift away from cash, although they have done so by emphasisingdecentralisation and anonymity rather than the much greater central controlwhich would be inherent in a mainstream electronic currency. The loss ofprivacy would no doubt be glossed over in any media campaign, as would therisks of cyber-attack and the lack of a fallback for providing liquidity to theeconomy in the event of a systems crash. Electronic currency is muchfavoured by techno-optimists, but not so much by those concerned aboutthe risks of absolute structural dependency on technological complexity. Theargument regarding greatly reduced socioeconomic resilience isparticularly noteworthy, given the vulnerability and potential fragility ofelectronic systems.

There is an important distinction to be made between official electroniccurrency – allowing everyone to hold an account with the central bank — andprivate electronic currency. It would be official currency which would provide

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the central control sought by governments and central banks, but ifindividuals saw central bank accounts as less risky than commercialinstitutions, which seems highly likely, the extent of the potential fundstransfer could crash the existing banking system, causing a bank run in asimilar manner as large-scale cash withdrawals would. As the power ofmoney creation is of the highest significance, and that power is currently inprivate hands, any attempt to threaten that power would almost certainly bemet with considerable resistance from powerful parties. Private digitalcurrency would be more compatible with the existing framework, but wouldnot confer all of the control that governments would prefer:

People would convert a very large share of their current bankdeposits into official digital money, in effect taking them out of theprivate banking system. Why might this be a problem? If it’s anacute rush for safety in a crisis, the risk is that private banks maynot have enough reserves to honour all the withdrawals. But that isexactly the same risk as with physical cash: it’s often forgotten thatit’s central bank reserves, not the much larger quantity of deposits,that banks can convert into cash with the central bank. Both withcash and official e-cash, the way to meet a more severe bank run isfor the bank to borrow more reserves from the central bank,posting its various assets as security. In effect, this would mean thecentral bank taking over the funding of the broader economy in apanic — but that’s just what central banks should do.

A more chronic challenge is that people may prefer the safety ofcentral bank accounts even in normal times. That would destroyprivate banks’ current deposit-funded model. Is that a bad thing?They would still have a role as direct intermediators betweensavers and borrowers, by offering investment products sufficientlyattractive for people to get out of the safety of e-cash. Meanwhile,the broad money supply would be more directly under the controlof the central bank, whereas now it’s a product of the vagaries ofprivate lending decisions. The more of the broad money supply thatwas in the form of official digital cash, the easier it would be, forexample, for the central bank to use tools such as negative interestrates or helicopter drops.

As an indication that the interests of the private banking system and publiccentral authorities are not always aligned, consider the actions of theBavarian Banking Association in attempting to avoid the imposition ofnegative interest rates on reserves held with the ECB:

German newspaper Der Spiegel reported yesterday that theBavarian Banking Association has recommended that its memberbanks start stockpiling PHYSICAL CASH. The Bavarian BankingAssociation has had enough of this financial dictatorship. Their newrecommendation is for all member banks to ditch the ECB andinstead start keeping their excess reserves in physical cash, storedin their own bank vaults. This is officially an all-out revolution ofthe financial system where banks are now actively rebelling against

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the central bank. (What’s even more amazing is that this concept oftraditional banking — holding physical cash in a bank vault — isnow considered revolutionary and radical.)

There’s just one teensy tiny problem: there simply is not enoughphysical cash in the entire financial system to support even a tinyfraction of the demand. Total bank deposits exceed trillions ofeuros. Physical cash constitutes just a small percentage of thatsum. So if German banks do start hoarding physical currency, therewon’t be any left in the financial system. This will force the ECB tochoose between two options:

Support this rebellion and authorize the issuance of morephysical cash; or

1.

Impose capital controls.2.

Given that just two weeks ago the President of the ECB spokeabout the possibility of banning some higher denomination cashnotes, it’s not hard to figure out what’s going to happen next.

Advantages of official electronic currency to governments and central banksare clear. All transactions are transparent, and all can be subject to fees andtaxes. Central control over the money supply would be greatly increased andtax evasion would be difficult to impossible, at least for ordinary people.Capital controls would be built right into the system, and personal spendinginformation would be conveniently gathered for inspection by centralauthorities (for cross-correlation with other personal data they possess). Thefirst step would likely be to set up a dual system, with both cash andelectronic money in parallel use, but with electronic money as the definedunit of value and cash subject to a marginally disadvantageous exchangerate.

The exchange rate devaluing cash in relation to electronic money couldincrease over time, in order to incentivize people to switch away from seeingphysical cash as a store of value, and to increase their preference for goodsover cash. In addition to providing an active incentive, the use of cash wouldprobably be publicly disparaged as well as actively discouraged in manyways. For instance, key functions such as tax payments could be designatedas by electronic remittance only. The point would be to forced everyone intothe system by depriving them of the choice to opt out. Once all werecaptured, many forms of central control would be possible, includingsubstantial account haircuts if central authorities deemed them necessary.

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The main promoters of cash elimination in favour of electronic currency areWillem Buiter, Kenneth Rogoff, and Miles Kimball.

Economist Willem Buiter has been pushing for the relegation of cash, at leastthe removal of its status as official unit of account, since the financial crisisof 2008. He suggests a number of mechanisms for achieving the transitionto electronic money, emphasising the need for the electronic currency tobecome the definitive unit of account in order to implement substantiallynegative interest rates:

The first method does away with currency completely. This has theadditional benefit of inconveniencing the main users of currency-operators in the grey, black and outright criminal economies.Adequate substitutes for the legitimate uses of currency, on whichpositive or negative interest could be paid, are available. Thesecond approach, proposed by Gesell, is to tax currency by makingit subject to an expiration date. Currency would have to be“stamped” periodically by the Fed to keep it current. When doneso, interest (positive or negative) is received or paid.

The third method ends the fixed exchange rate (set at one) betweendollar deposits with the Fed (reserves) and dollar bills. There couldbe a currency reform first. All existing dollar bills and coin wouldbe converted by a certain date and at a fixed exchange rate into anew currency called, say, the rallod. Reserves at the Fed wouldcontinue to be denominated in dollars. As long as the FederalFunds target rate is positive or zero, the Fed would maintain thefixed exchange rate between the dollar and the rallod.

When the Fed wants to set the Federal Funds target rate at minusfive per cent, say, it would set the forward exchange rate betweenthe dollar and the rallod, the number of dollars that have to be paidtoday to receive one rallod tomorrow, at five per cent below thespot exchange rate — the number of dollars paid today for one

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rallod delivered today. That way, the rate of return, expressed in acommon unit, on dollar reserves is the same as on rallod currency.

For the dollar interest rate to remain the relevant one, the dollarhas to remain the unit of account for setting prices and wages. Thiscan be encouraged by the government continuing to denominate allof its contracts in dollars, including the invoicing and payment oftaxes and benefits. Imposing the legal restriction that checkabledeposits and other private means of payment cannot bedenominated in rallod would help.

In justifying his proposals, he emphasises the importance of combattingcriminal activity…

The only domestic beneficiaries from the existence of anonymity-providing currency are the criminal fraternity: those engaged in taxevasion and money laundering, and those wishing to store theproceeds from crime and the means to commit further crimes.Large denomination bank notes are an especially scandaloussubsidy to criminal activity and to the grey and black economies.

… over the acknowledged risks of government intrusion in legitimatelyprivate affairs:

My good friend and colleague Charles Goodhart responded to anearlier proposal of mine that currency (negotiable bearer bondswith legal tender status) be abolished that this proposal was“appallingly illiberal”. I concur with him that anonymity/invisibilityof the citizen vis-a-vis the state is often desirable, given theirrepressible tendency of the state to infringe on our fundamentalrights and liberties and given the state’s ever-expanding capacityto do so (I am waiting for the US or UK government to contractGoogle to link all personal health information to all tax information,information on cross-border travel, social security information,census information, police records, credit records, and informationon personal phone calls, internet use and internet shopping habits).

In his seminal 2014 paper “Costs and Benefits to Phasing Out PaperCurrency.”, Kenneth Rogoff also argues strongly for the primacy ofelectronic currency and the elimination of physical cash as an escape route:

Paper currency has two very distinct properties that should drawour attention. First, it is precisely the existence of paper currencythat makes it difficult for central banks to take policy interest ratesmuch below zero, a limitation that seems to have becomeincreasingly relevant during this century. As Blanchard et al. (2010)point out, today’s environment of low and stable inflation rates hasdrastically pushed down the general level of interest rates. The lowoverall level, combined with the zero bound, means that centralbanks cannot cut interest rates nearly as much as they might like inresponse to large deflationary shocks.

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If all central bank liabilities were electronic, paying a negativeinterest on reserves (basically charging a fee) would be trivial. Butas long as central banks stand ready to convert electronic depositsto zero-interest paper currency in unlimited amounts, it suddenlybecomes very hard to push interest rates below levels of, say, -0.25to -0.50 percent, certainly not on a sustained basis. Hoarding cashmay be inconvenient and risky, but if rates become too negative, itbecomes worth it.

However, he too notes associated risks:

Another argument for maintaining paper currency is that it pays tohave a diversity of technologies and not to become overlydependent on an electronic grid that may one day turn out to bevery vulnerable. Paper currency diversifies the transactions systemand hardens it against cyber attack, EMP blasts, etc. Thisargument, however, seems increasingly less relevant becauseeconomies are so totally exposed to these problems anyway. Withpaper currency being so marginalized already in the legal economyin many countries, it is hard to see how it could be brought backquickly, particularly if ATM machines were compromised at thesame time as other electronic systems.

A different type of argument against eliminating currency relates tocivil liberties. In a world where society’s mores and customs evolve,it is important to tolerate experimentation at the fringes. This ispotentially a very important argument, though the problem mightbe mitigated if controls are placed on the government’s use ofinformation (as is done say with tax information), and the problemmight also be ameliorated if small bills continue to circulate. Lastbut not least, if any country attempts to unilaterally reduce the useof its currency, there is a risk that another country’s currencywould be used within domestic borders.

Miles Kimball’s proposals are very much in tune with Buiter and Rogoff:

There are two key parts to Miles Kimball’s solution. The first part isto make electronic money or deposits the sole unit of account.Everything else would be priced in terms of electronic dollars,including paper dollars. The second part is that the fixed exchangerate that now exists between deposits and paper dollars wouldbecome variable. This crawling peg between deposits and papercurrency would be based on the state of the economy. When theeconomy was in a slump and the central bank needed to setnegative interest rates to restore full employment, the peg wouldadjust so that paper currency would lose value relative toelectronic money. This would prevent folks from rushing to papercurrency as interest rates turned negative. Once the economystarted improving, the crawling peg would start adjusting towardparity.

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This approach views the economy in very mechanistic terms, as if it were amachine where pulling a lever would have a predictable linear effect — makeholding savings less attractive and automatically consumption will increase.This is actually a highly simplistic view, resting on the notions of stabilisingnegative feedback and bringing an economy ‘back into equilibrium’. If itwere so simple to control an economy centrally, there would never have beendeflationary spirals or economic depressions in the past.

Assuming away the more complex aspects of human behaviour — a flight tosafety, the compulsion to save for a rainy day when conditions are unstable,or the natural response to a negative ‘wealth effect’ — leads to a modeldivorced from reality. Taxing savings does not necessarily lead to increasedconsumption, in fact it is far more likely to have the opposite effect.:

But under Miles Kimball’s proposal, the Fed would lower interestrates to below zero by taxing away balances of e-currency. This is areduction in monetary base, just like the case of IOR, and by itselfwould be contractionary, not expansionary. The expansionaryeffects of Kimball’s policy depend on the assumption thathouseholds will increase consumption in response to the taxing oftheir cash savings, rather than letting their savings depreciate.

That needn’t be the case — it depends on the relative magnitudesof income and substitution effects for real money balances. Thesubstitution effect is what Kimball has in mind — raising the priceof real money balances will induce substitution out of money andinto consumption. But there’s also an income effect, whereby theloss of wealth induces less consumption and more savings. Thus,negative interest rate policy can be contractionary even thoughpositive interest rate policy is expansionary.

Indeed, what Kimball has proposed amounts to a reverseBernanke Helicopter — imagine a giant vacuum flyingaround the country sucking money out of people’s pockets.Why would we assume that this would be inflationary?

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Given that the effect on the money supply would be contractionary, thesupposed stimulus effect on the velocity of money (as, in theory, savings turninto consumption in order to avoid the negative interest rate penalty) wouldhave to be large enough to outweigh a contracting money supply. In someways, modern proponents of electronic money bearing negative interest ratesare attempting to copy Silvio Gesell’s early 20th century work. Gesellproposed the use of stamp scrip — money that had to be regularly stamped,at a small cost, in order to remain current. The effect would be for money tolose value over time, so that hoarding currency it would make little sense.Consumption would, in theory, be favoured, so money would be kept incirculation.

This idea was implemented to great effect in the Austrian town of Wörglduring the Great Depression, where the velocity of money increasedsufficiently to allow a hive of economic activity to develop (temporarily) inthe previously depressed town. Despite the similarities between currentproposals and Gesell’s model applied in Wörgl, there are fundamentaldifferences:

There is a critical difference, however, between the Wörglcurrency and the modern-day central bankers’ negativeinterest scheme. The Wörgl government first issued its new“free money,” getting it into the local economy andincreasing purchasing power, before taxing a portion of itback. And the proceeds of the stamp tax went to the city, tobe used for the benefit of the taxpayers….Today’s centralbankers are proposing to tax existing money, diminishingspending power without first building it up. And the interestwill go to private bankers, not to the local government.

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The Wörgl experiment was a profoundly local initiative, instigated at the localgovernment level by the mayor. In contrast, modern proposals for negativeinterest rates would operate at a much larger scale and would be imposed onthe population in accordance with the interests of those at the top of thefinancial foodchain. Instead of being introduced for the direct benefit ofthose who pay, as stamp scrip was in Wörgl, it would tax the people in theeconomic periphery for the continued benefit of the financial centre. As suchit would amount to just another attempt to perpetuate the current system,and to do so at a scale far beyond the trust horizon.

As the trust horizon contracts in times of economic crisis, effectiveorganizational scale will also contract, leaving large organizations (bothpublic and private) as stranded assets from a trust perspective, and thereforelacking in political legitimacy. Large scale, top down solutions will be verydifficult to implement. It is not unusual for the actions of central authoritiesto have the opposite of the desired effect under such circumstances:

Consumers today already have very little discretionary money.Imposing negative interest without first adding new money into theeconomy means they will have even less money to spend. Thiswould be more likely to prompt them to save their scarce fundsthan to go on a shopping spree. People are not keeping their moneyin the bank today for the interest (which is already nearlynon-existent). It is for the convenience of writing checks, issuingbank cards, and storing their money in a “safe” place. They wouldno doubt be willing to pay a modest negative interest for thatconvenience; but if the fee got too high, they might pull theirmoney out and save it elsewhere. The fee itself, however, would notdrive them to buy things they did not otherwise need.

People would be very likely to respond to negative interest rates byself-organising alternative means of exchange, rather than bowing to theimposition of negative rates. Bitcoin and other crypto-currencies would beone possibility, as would using foreign currency, using trading goods asunits of value, or developing local alternative currencies along the lines ofthe Wörgl model:

The use of sheep, bottled water, and cigarettes as media ofexchange in Iraqi rural villages after the US invasion and collapseof the dinar is one recent example. Another example was Argentinaafter the collapse of the peso, when grain contracts priced indollars were regularly exchanged for big-ticket items likeautomobiles, trucks, and farm equipment. In fact, Argentinefarmers began hoarding grain in silos to substitute for holding cashbalances in the form of depreciating pesos.

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For the electronic money model grounded in negative interest rates to work,all these alternatives would have to be made illegal, or at least hampered tothe point of uselessness, so people would have no other legal choice but toparticipate in the electronic system. Rogoff seems very keen to see thishappen:

Won’t the private sector continually find new ways to makeanonymous transfers that sidestep government restrictions?Certainly. But as long as the government keeps playingWhac-A-Mole and prevents these alternative vehicles from beingeasily used at retail stores or banks, they won’t be able fill the rolethat cash plays today. Forcing criminals and tax evaders to turn toriskier and more costly alternatives to cash will make their livesharder and their enterprises less profitable.

It is very likely that in times of crisis, people would do what they have to doregardless of legal niceties. While it may be possible to close off somealternative options with legal sanctions, it is unlikely that all could beprevented, or even enough to avoid the electronic system being fatallyundermined.

The other major obstacle would be overcoming the preference for cash overgoods in times of crisis:

Understanding how negative rates may or may not help economicgrowth is much more complex than most central bankers andinvestors probably appreciate. Ultimately the confusion residesaround differences in view on the theory of money. In a classicalworld, money supply multiplied by a constant velocity of circulationequates to nominal growth.

In a Keynesian world, velocity is not necessarily constant —specifically for Keynes, there is a money demand function (liquiditypreference) and therefore a theory of interest that allows for aliquidity trap whereby increasing money supply does not lead to

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higher nominal growth as the increase in money is hoarded. Theinterest rate (or inverse of the price of bonds) becomes stickybecause at low rates, for infinitesimal expectations of any furtherrise in bond prices and a further fall in interest rates, demand formoney tends to infinity.

In Gesell’s world money supply itself becomes inversely correlatedwith velocity of circulation due to money characteristics beingsuperior to goods (or commodities). There are costs to storage thatmoney does not have and so interest on money capital sets a bar tointerest on real capital that produces goods. This is similar toKeynes’ concept of the marginal efficiency of capital schedule beingseparate from the interest rate. For Gesell the product of moneyand velocity is effective demand (nominal growth) but because ofmoney capital’s superiority to real capital, if money supply expandsit comes at the expense of velocity.

The new money supply is hoarded because as interest rates fall,expected returns on capital also fall through oversupply — foreconomic agents goods remain unattractive to money. The demandfor money thus rises as velocity slows. This is simply a deflationspiral, consumers delaying purchases of goods, hoardingmoney, expecting further falls in goods prices before they arewilling to part with their money….In a Keynesian world ofdeficient demand, the burden is on fiscal policy to restoredemand. Monetary policy simply won’t work if there is aliquidity trap and demand for cash is infinite.

During the era of globalisation (since the financial liberalisation of the early1980s), extractive capitalism in debt-driven over-drive has created perverseincentives to continually increase supply. Financial bubbles, grounded in therediscovery of excess leverage, always act to create an artificial demandstimulus, which is met by artificially inflated supply during the boom phase.The value of the debt created collapses as boom turns into bust, crashing themoney supply, and with it asset price support. Not only does the artificialstimulus disappear, but a demand undershoot develops, leaving all thatsupply without a market. Over the full cycle of a bubble and its aftermath,credit is demand neutral, but within the bubble it is anything but neutral.Forward shifting the demand curve provides for an orgy of presentconsumption and asset price increases, which is inevitably followed by theopposite.

Kimball stresses bringing demand forward as a positive aspect of hismodel:

In an economic situation like the one we are now in, we would liketo encourage a company thinking about building a factory in acouple of years to build that factory now instead. If someone wouldlend to them at an interest rate of -3.33% per year, the companycould borrow $1 million to build the factory now, and pay backsomething like $900,000 on the loan three years later. (Despite the

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negative interest rate, compounding makes the amount to be paidback a bit bigger, but not by much.)

That would be a good enough deal that the company might moveup its schedule for building the factory. But everything runsaground on the fact that any potential lender, just by putting $1million worth of green pieces of paper in a vault could get back $1million three years later, which is a lot better than getting back alittle over $900,000 three years later.

This is, however, a short-sighted assessment. Stimulating demand todaymeans a demand undershoot tomorrow. Kimball names long term pricestability as a primary goal, but this seems unlikely. Large scale centralplanning has a poor track record for success, to put it mildly. It requires thecentral authority in question to have access to all necessary information inrealtime, and to have the ability to respond to that information both wiselyand rapidly, or even proactively. It also assumes the ability to accurately filterout misinformation and disinformation. This is unlikely even in good times,thanks to the difficulties of ‘organizational stupidity’ at large scale, andeven more improbable in the times of crisis.

Financial Totalitarianism in Historical Context

In attempting to keep the credit bonanza going with their existing powers,central banks have set the global financial system up for an across-the-boardasset price collapse:

QE takes away the liquidity preference choice out of the hands ofthe consumers, and puts it into the hands of central bankers, whothrough asset purchases push up asset prices even if it does so byexplicitly devaluing the currency of price measurement; it alsomeans that the failure of NIRP is — by definition — a failure ofcentral banking, and if and when the central bank backstop of any(make that all) asset class — i.e., Q.E., is pulled away, that asset(make that all) will crash.

It is not just central banking, but also globalisation, which is demonstrablyfailing. Cross-border freedoms will probably be an early casualty of the waron cash, and its demise will likely come as a shock to those used to arelatively borderless world:

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We have been informed with reliable sources that in Germanywhere Maestro was a multi-national debit card service owned byMasterCard that was founded in 1992 is seriously under attack.Maestro cards are obtained from associate banks and can be linkedto the card holder’s current account, or they can be prepaid cards.Already we find such cards are being cancelled and new debitcards are being issued.

Why? The new cards cannot be used at an ATM outside of Germanyto obtain cash. Any attempt to get cash can only be as an advanceon a credit card….This is total insanity and we are losing absolutelyeverything that made society function. Once they eliminate CASH,they will have total control over who can buy or sell anything.

The same confused, greedy and corrupt central authorities which have set upthe global economy for a major bust through their dysfunctional use ofexisting powers, are now seeking far greater central control, in what wouldamount to the ultimate triumph of finance over people. They are now movingto tax what ever people have left over after paying taxes. It has been triedbefore. As previous historical bubbles began to collapse, central authoritiesattempted to increase their intrusiveness and control over the population, inorder to force the inevitable losses as far down the financial foodchain aspossible. As far back as the Roman Empire, economically contractionaryperiods have been met with financial tyranny — increasing pressure on thepopulace until the system itself breaks:

Not even the death penalty was enough to enforce Diocletian’sprice control edicts in the third century.

Rome squeezed the peasants in its empire so hard, that many eventuallyabandoned their land, reckoning that they were better off with thebarbarians.

Such attempts at total financial control are exactly what one would expect atthis point. A herd of financial middle men are used to being very wellsupported by the existing financial system, and as that system begins tobreak down, losing that raft of support is unacceptable. The people at thebottom of the financial foodchain must be watched and controlled in order tomake sure they are paying to support the financial centre in the manner towhich it has become accustomed, even as their ability to do so is continuallyundermined:

An oft-overlooked benefit of cash transactions is that there isno intermediary. One party pays the other party in mutuallyaccepted currency and not a single middleman gets to wethis beak. In a cashless society there will be nothing stoppingbanks or other financial mediators from taking a small pieceof every single transaction. They would also be able to use —and potentially abuse — the massive deposits of data they collecton their customers’ payment behavior. This information is of hugeinterest and value to retail marketing departments, other financial

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institutions, insurance companies, governments, secret services,and a host of other organizations….

….So in order to save a financial system that is morally beyond thepale and stopped serving the basic needs of the real economy along time ago, governments and central banks must do away withthe last remaining thing that gives people a small semblance ofprivacy, anonymity, and personal freedom in their increasinglycontrolled and surveyed lives. The biggest tragedy of all is that thegovernments and banks’ strongest ally in their War on Cash is thegeneral public itself. As long as people continue to abandon the useof cash, for the sake of a few minor gains in convenience, the waron cash is already won.

Even if the ultimate failure of central control is predictable, momentumtowards greater centralisation will carry forward for as long as possible, untilthe system can no longer function, at which point a chaotic free-for-all islikely to occur. In the meantime, the movement towards electronic moneyseeks to empower the surveillance state/corporatocracy enormously,providing it with the tools to observe and control virtually every aspect ofpeople’s lives:

Governments and corporations, even that genius app developer inRussia, have one thing in common: they want to know everything.Data is power. And money. As the Snowden debacle has shown,they’re getting there. Technologies for gathering information, thenhoarding it, mining it, and using it are becoming phenomenallyeffective and cheap. But it’s not perfect. Video surveillance withfacial-recognition isn’t everywhere just yet. Not everyone is using asmartphone. Not everyone posts the details of life on Facebook.Some recalcitrant people still pay with cash. To the greatestconsternation of governments and corporations, stuff still happensthat isn’t captured and stored in digital format….

….But the killer technology isn’t the elimination of cash. It’s thecombination of payment data and the information stream thatcellphones, particularly smartphones, deliver. Now everything istracked neatly by a single device that transmits that data on aconstant basis to a number of companies, including that genius appdeveloper in Russia — rather than having that information spreadover various banks, credit card companies, etc. who don’t alwayseagerly surrender that data.

Eventually, it might even eliminate the need for data brokers. Atthat point, a single device knows practically everything. And fromthere, it’s one simple step to transfer part or all of this data to anygovernment’s data base. Opinions are divided over whom todistrust more: governments or corporations. But one thing weknow: mobile payments and the elimination of cash….will alsomake life a lot easier for governments and corporations in theirquest for the perfect surveillance society.

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Dissent is increasingly being criminalised, with legitimate dissenterscommonly referred to, and treated as, domestic terrorists and potentiallysubjected to arbitrary asset confiscation:

An important reason why the state would like to see a cashlesssociety is that it would make it easier to seize our wealthelectronically. It would be a modern-day version of FDR’sconfiscation of privately-held gold in the 1930s. The state will makemore and more use of “threats of terrorism” to seize financialassets. It is already talking about expanding the definition of“terrorist threat” to include critics of government like myself.

The American state already confiscates financial assets under theprotection of various guises such as the PATRIOT Act. I firstrealized this years ago when I paid for a new car with a personalcheck that bounced. The car dealer informed me that the IRS had,without my knowledge, taken 20 percent of the funds that I hadtransferred from a mutual fund to my bank account in order to buythe car. The IRS told me that it was doing this to deter terrorism,and that I could count it toward next year’s tax bill.

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The elimination of cash in favour of official electronic money only wouldgreatly accelerate and accentuate the ability of governments to punish thosethey dislike, indeed it would allow them to prevent dissenters from engagingin the most basic functions:

If all money becomes digital, it would be much easier for thegovernment to manipulate our accounts. Indeed, numeroushigh-level NSA whistleblowers say that NSA spying is aboutcrushing dissent and blackmailing opponents. not stoppingterrorism. This may sound over-the-top. but remember, thegovernment sometimes labels its critics as “terrorists”. If thegovernment claims the power to indefinitely detain — or evenassassinate — American citizens at the whim of the executive, don’tyou think that government people would be willing to shut down, orwithdraw a stiff “penalty” from a dissenter’s bank account?

If society becomes cashless, dissenters can’t hide cash. All of theirfinancial holdings would be vulnerable to an attack by thegovernment. This would be the ultimate form of control. Because —without access to money — people couldn’t resist, couldn’t hideand couldn’t escape.

The trust that has over many years enabled the freedoms we enjoy is nowdisappearing rapidly, and the impact of its demise is already palpable.Citizens understandably do not trust governments and powerfulcorporations, which have increasingly clearly been acting in their owninterests in consolidating control over claims to real resources in thehands of fewer and fewer individuals and institutions:

By far the biggest risk posed by digital alternatives to cash such asmobile money is the potential for massive concentration of financialpower and the abuses and conflicts of interest that would almostcertainly ensue. Naturally it goes without saying that most of theinstitutions that will rule the digital money space will be the verysame institutions….that have already broken pretty much everyrule in the financial service rule book.

They have manipulated virtually every market in existence; theyhave commodified and financialized pretty much every naturalresource of value on this planet; and in the wake of the financialcrisis they almost single-handedly caused, they have extortedbillions of dollars from the pockets of their own customers andtrillions from hard-up taxpayers. What about your respectivegovernment authorities? Do you trust them?…

….We are, it seems, descending into a world where newtechnologies threaten to put absolute power well within the graspof a select group of individuals and organizations — individuals andorganizations that have through their repeated actions betrayed

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just about every possible notion of mutual trust.

Governments do not trust their citizens (‘potential terrorists’) either, hencethe perceived need to monitor and limit the scope of their decisions andactions. The powers-that-be know how angry people are going to be whenthey realise the scale of their impending dispossession, and are acting insuch a way as to (try to) limit the power of the anger that will be focusedagainst them. It is not going to work.

Without trust we are likely to see “throwbacks to the 14th century….atthe dawn of banking coming out of the Dark Ages.”. It is no coincidencethat this period was also one of financial, socioeconomic and humanitariancrises, thanks to the bursting of a bubble two centuries in the making:

The 14th Century was a time of turmoil, diminished expectations,loss of confidence in institutions, and feelings of helplessness atforces beyond human control. Historian Barbara Tuchman entitledher book on this period A Distant Mirror because many of ourmodern problems had counterparts in the 14th Century.

Few think of the trials and tribulations of 14th century Europe as havingtheir roots in financial collapse — they tend instead to remember famine anddisease. However, the demise of what was then the world banking systemwas a leading indicator for what followed, as is always the case:

Six hundred and fifty years ago came the climax of the worstfinancial collapse in history to date. The 1930’s Great Depressionwas a mild and brief episode, compared to the bank crash of the1340’s, which decimated the human population. The crash, whichpeaked in A.C.E. 1345 when the world’s biggest banks went under,“led” by the Bardi and Peruzzi companies of Florence, Italy, wasmore than a bank crash — it was a financial disintegration….ablowup of all major banks and markets in Europe, in which,chroniclers reported, “all credit vanished together,” most trade andexchange stopped, and a catastrophic drop of the world’spopulation by famine and disease loomed.

As we have written many times before at The Automatic Earth, bubbles arenot a new phenomenon. They have inflated and subsequently implodedsince the dawn of civilisation, and are in fact en emergent property ofcivilisational scale. There are therefore many parallels between differenthistorical episodes of boom and bust:

The parallels between the medieval credit crunch and our currentpredicament are considerable. In both cases the money supplyincreased in response to the expansionist pressure of unbridledoptimism. In both cases the expansion proceeded to the pointwhere a substantial overhang of credit had been created — aquantity sufficient to generate systemic risk that was notrecognized at the time. In the fourteenth century, that risk wasrealized, as it will be again in the 21st century.

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What we are experiencing now is simply the same dynamic, but turbo-charged by the availability of energy and technology that have driven ourlong period of socioeconomic expansion and ever-increasing complexity. Justas in the 14th century, the cracks in the system have been visible for manyyears, but generally ignored. The coming credit implosion may appear tocome from nowhere when it hits, but has long been foreshadowed if oneknew what to look for. Watching more and more people seeking escaperoutes from a doomed financial system, and the powers-that-be fighting backby closing those escape routes, all within a social matrix of collapsing trust,one cannot deny that history is about to repeat itself yet again, only on alarger scale this time.

The final gasps of a bubble economy, such as our own, are about behind-the-scenes securing of access to and ownership of real assets for the elite,through bailouts and other forms of legalized theft. As Frédéric Bastiatexplained in 1848,

“When plunder becomes a way of life for a group of men in asociety, over the course of time they create for themselves a legalsystem that authorizes it and a moral code that glorifies it.”

The bust which follows the last attempt to kick the can further down the roadwill see the vast majority of society dispossessed of what they thought theyowned, their ephemeral electronic claims to underlying real wealthextinguished.

The Way Forward

The advent of negative interest rates indicates that the endgame for theglobal economy is underway. In places at the peak of the bubble, negativerates drive further asset bubbles and create ever greater vulnerability to theinevitable interest rate spike and asset price collapse to come. In Japan, atthe other end of the debt deflation cycle, negative rates force people intoever more cash hoarding. Neither one of these outcomes is going to lead torecovery. Both indicate economies at breaking point. We cannot assume thatcurrent financial, economic and social structures will continue in theirpresent form, and we need to prepare for a period of acute upheaval.

Using cash wherever possible, rather than succumbing to the convenience ofelectronic payments, becomes an almost revolutionary act. So other forms ofradical decentralisation, which amount to opting out as much as possiblefrom the path the powers-that-be would have us follow. It is likely to becomeincreasingly difficult to defend our freedom and independence, but if enoughpeople stand their ground, establishing full totalitarian control should not bepossible.

To some extent, the way the war on cash plays out will depend on the timing

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of the coming financial implosion. The elimination of cash would take time,and only in some countries has there been enough progress away from cashthat eliminating it would be at all realistic. If only a few countries tried to doso, people in those countries would be likely to use foreign currency that wasstill legal tender.

Cash elimination would really only work if it it were very broadly applied inenough major economies, and if a financial accident could be postponed for afew more years. As neither of these conditions is likely to be fulfilled, a cashban is unlikely to viable. Governments and central banks would verymuch like to frighten people away from cash, but that only underlinesits value under the current circumstances. Cash is king in a deflation.The powers-that-be know that, and would like the available cash to end upconcentrated in their own hands rather than spread out to act as seed capitalfor a bottom-up recovery.

Holding on to cash under one’s own control is still going to be a veryimportant option for maintaining freedom of action in an uncertain future.The alternative would be to turn to hard goods (land, tools etc) from thebeginning, but where there is a great deal of temporal and spatialuncertainty, this amounts to making all one’s choices up front, and choicesbased on incomplete information could easily turn out to be wrong. Makingsuch choices up front is also expensive, as prices are currently high. Ofcourse having some hard goods is also advisable, particularly if they allowone to have some control over the essentials of one’s own existence.

It is the balance between hard goods and maintaining capital as liquidity(cash) that is important. Where that balance lies depends very much onindividual circumstances, and on location. For instance, in the European

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Union, where currency reissue is a very real threat in a reasonably shorttimeframe, opting for goods rather than cash makes more sense, unless oneholds foreign currency such as Swiss francs. If one must hold euros, it wouldprobably be advisable to hold German ones (serial numbers begin with X).

US dollars are likely to hold their value for longer than most othercurrencies, given the dollar’s role as the global reserve currency. Reports ofits demise are premature, to put it mildly. As financial crisis picks upmomentum, a flight to safety into the reserve currency is likely to pick upspeed, raising the value of the dollar against other currencies. In addition,demand for dollars will increase as debtors seek to pay down dollar-denominated debt. While all fiat currencies are ultimately vulnerable in thebeggar-thy-neighbour currency wars to come, the US dollar should holdvalue for longer than most.

Holding cash on the sidelines while prices fall is a good strategy, so long asone does not wait too long. The risks to holding and using cash are likely togrow over time, so it is best viewed as a short term strategy to ride out thedeflationary period, where the value of credit instruments is collapsing. Thepurchasing power of cash will rise during this time, and previouslyunforeseen opportunities are likely to arise.

Ordinary people need to retain as much of their freedom of action aspossible, in order for society to function through a period of economicseizure. In general, the best strategy is to hold cash until the point where theindividual in question can afford to purchase the goods they require toprovide for their own needs without taking on debt to do so. (Avoiding takingon debt is extremely important, as financially encumbered assets would besubject to repossession in the event of failure to meet debt obligations.)

One must bear in mind, however, that after price falls, some goods may ceaseto be available at any price, so some essentials may need to be purchased attoday’s higher prices in order to guarantee supply.

Capital preservation is an individual responsibility, and during times ofdeflation, capital must be preserved as liquidity. We cannot expect eithergovernments or private institutions to protect our interests, as both havebeen obviously undermining the interests of ordinary people in favour oftheir own for a very long time. Indeed they seem to feel secure enough oftheir own consolidated control that they do not even bother to try to hide thefact any longer. It is our duty to inform ourselves and act to protectourselves, our families and our communities. If we do not, no one else will.

This article by Nicole Foss was earlier published at the Automatic Earth in 4

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chapters.

Part 1 is here: Negative Interest Rates and the War on Cash (1)

Part 2 is here: Negative Interest Rates and the War on Cash (2)

Part 3 is here: Negative Interest Rates and the War on Cash (3)

Part 3 is here: Negative Interest Rates and the War on Cash (4)

Negative Interest Rates and the War on Cash(4)

Sep 082016

September 8, 2016 Posted by Raúl Ilargi Meijer at 12:55pm Finance Tagged with: bubble, cash, credit, debt, deflation, liquidity,Nicole Foss, NIRP, Ponzi, risk, ZIRP 27 Responses »

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AlfredEisenstaedt View of Midtown Manhattan NYC 1939

This is part 4 of a 4-part series by Nicole Foss entitled “Negative InterestRates and the War on Cash”.

Part 1 is here: Negative Interest Rates and the War on Cash (1)

Part 2 is here: Negative Interest Rates and the War on Cash (2)

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Part 3 is here: Negative Interest Rates and the War on Cash (3)

We will soon publish the entire piece in one post.

Here is Nicole:

Financial Totalitarianism in Historical Context

Nicole Foss: In attempting to keep the credit bonanza going with theirexisting powers, central banks have set the global financial system upfor an across-the-board asset price collapse:

QE takes away the liquidity preference choice out of the hands ofthe consumers, and puts it into the hands of central bankers, whothrough asset purchases push up asset prices even if it does so byexplicitly devaluing the currency of price measurement; it alsomeans that the failure of NIRP is — by definition — a failure ofcentral banking, and if and when the central bank backstop of any(make that all) asset class — i.e., Q.E., is pulled away, that asset(make that all) will crash.

It is not just central banking, but also globalisation, which is demonstrablyfailing. Cross-border freedoms will probably be an early casualty of the waron cash, and its demise will likely come as a shock to those used to arelatively borderless world:

We have been informed with reliable sources that in Germanywhere Maestro was a multi-national debit card service owned byMasterCard that was founded in 1992 is seriously under attack.Maestro cards are obtained from associate banks and can be linkedto the card holder’s current account, or they can be prepaid cards.Already we find such cards are being cancelled and new debitcards are being issued.

Why? The new cards cannot be used at an ATM outside of Germanyto obtain cash. Any attempt to get cash can only be as an advanceon a credit card….This is total insanity and we are losing absolutelyeverything that made society function. Once they eliminate CASH,they will have total control over who can buy or sell anything.

The same confused, greedy and corrupt central authorities which have set upthe global economy for a major bust through their dysfunctional use of

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existing powers, are now seeking far greater central control, in what wouldamount to the ultimate triumph of finance over people. They are now movingto tax what ever people have left over after paying taxes. It has been triedbefore. As previous historical bubbles began to collapse, central authoritiesattempted to increase their intrusiveness and control over the population, inorder to force the inevitable losses as far down the financial foodchain aspossible. As far back as the Roman Empire, economically contractionaryperiods have been met with financial tyranny — increasing pressure on thepopulace until the system itself breaks:

Not even the death penalty was enough to enforce Diocletian’sprice control edicts in the third century.

Rome squeezed the peasants in its empire so hard, that many eventuallyabandoned their land, reckoning that they were better off with thebarbarians.

Such attempts at total financial control are exactly what one would expect atthis point. A herd of financial middle men are used to being very wellsupported by the existing financial system, and as that system begins tobreak down, losing that raft of support is unacceptable. The people at thebottom of the financial foodchain must be watched and controlled in order tomake sure they are paying to support the financial centre in the manner towhich it has become accustomed, even as their ability to do so is continuallyundermined:

An oft-overlooked benefit of cash transactions is that there isno intermediary. One party pays the other party in mutuallyaccepted currency and not a single middleman gets to wethis beak. In a cashless society there will be nothing stoppingbanks or other financial mediators from taking a small pieceof every single transaction. They would also be able to use —and potentially abuse — the massive deposits of data they collecton their customers’ payment behavior. This information is of hugeinterest and value to retail marketing departments, other financialinstitutions, insurance companies, governments, secret services,and a host of other organizations….

….So in order to save a financial system that is morally beyond thepale and stopped serving the basic needs of the real economy along time ago, governments and central banks must do away withthe last remaining thing that gives people a small semblance ofprivacy, anonymity, and personal freedom in their increasinglycontrolled and surveyed lives. The biggest tragedy of all is that thegovernments and banks’ strongest ally in their War on Cash is thegeneral public itself. As long as people continue to abandon the useof cash, for the sake of a few minor gains in convenience, the waron cash is already won.

Even if the ultimate failure of central control is predictable, momentumtowards greater centralisation will carry forward for as long as possible, until

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the system can no longer function, at which point a chaotic free-for-all islikely to occur. In the meantime, the movement towards electronic moneyseeks to empower the surveillance state/corporatocracy enormously,providing it with the tools to observe and control virtually every aspect ofpeople’s lives:

Governments and corporations, even that genius app developer inRussia, have one thing in common: they want to know everything.Data is power. And money. As the Snowden debacle has shown,they’re getting there. Technologies for gathering information, thenhoarding it, mining it, and using it are becoming phenomenallyeffective and cheap. But it’s not perfect. Video surveillance withfacial-recognition isn’t everywhere just yet. Not everyone is using asmartphone. Not everyone posts the details of life on Facebook.Some recalcitrant people still pay with cash. To the greatestconsternation of governments and corporations, stuff still happensthat isn’t captured and stored in digital format….

….But the killer technology isn’t the elimination of cash. It’s thecombination of payment data and the information stream thatcellphones, particularly smartphones, deliver. Now everything istracked neatly by a single device that transmits that data on aconstant basis to a number of companies, including that genius appdeveloper in Russia — rather than having that information spreadover various banks, credit card companies, etc. who don’t alwayseagerly surrender that data.

Eventually, it might even eliminate the need for data brokers. Atthat point, a single device knows practically everything. And fromthere, it’s one simple step to transfer part or all of this data to anygovernment’s data base. Opinions are divided over whom todistrust more: governments or corporations. But one thing weknow: mobile payments and the elimination of cash….will alsomake life a lot easier for governments and corporations in theirquest for the perfect surveillance society.

Dissent is increasingly being criminalised, with legitimate dissenterscommonly referred to, and treated as, domestic terrorists and potentiallysubjected to arbitrary asset confiscation:

An important reason why the state would like to see a cashlesssociety is that it would make it easier to seize our wealthelectronically. It would be a modern-day version of FDR’sconfiscation of privately-held gold in the 1930s. The state will makemore and more use of “threats of terrorism” to seize financialassets. It is already talking about expanding the definition of“terrorist threat” to include critics of government like myself.

The American state already confiscates financial assets under theprotection of various guises such as the PATRIOT Act. I firstrealized this years ago when I paid for a new car with a personal

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check that bounced. The car dealer informed me that the IRS had,without my knowledge, taken 20 percent of the funds that I hadtransferred from a mutual fund to my bank account in order to buythe car. The IRS told me that it was doing this to deter terrorism,and that I could count it toward next year’s tax bill.

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The elimination of cash in favour of official electronic money only wouldgreatly accelerate and accentuate the ability of governments to punish thosethey dislike, indeed it would allow them to prevent dissenters from engagingin the most basic functions:

If all money becomes digital, it would be much easier for thegovernment to manipulate our accounts. Indeed, numeroushigh-level NSA whistleblowers say that NSA spying is aboutcrushing dissent and blackmailing opponents. not stoppingterrorism. This may sound over-the-top. but remember, thegovernment sometimes labels its critics as “terrorists”. If thegovernment claims the power to indefinitely detain — or evenassassinate — American citizens at the whim of the executive, don’tyou think that government people would be willing to shut down, orwithdraw a stiff “penalty” from a dissenter’s bank account?

If society becomes cashless, dissenters can’t hide cash. All of theirfinancial holdings would be vulnerable to an attack by thegovernment. This would be the ultimate form of control. Because —without access to money — people couldn’t resist, couldn’t hideand couldn’t escape.

The trust that has over many years enabled the freedoms we enjoy is nowdisappearing rapidly, and the impact of its demise is already palpable.Citizens understandably do not trust governments and powerfulcorporations, which have increasingly clearly been acting in their owninterests in consolidating control over claims to real resources in thehands of fewer and fewer individuals and institutions:

By far the biggest risk posed by digital alternatives to cash such asmobile money is the potential for massive concentration of financialpower and the abuses and conflicts of interest that would almostcertainly ensue. Naturally it goes without saying that most of theinstitutions that will rule the digital money space will be the verysame institutions….that have already broken pretty much everyrule in the financial service rule book.

They have manipulated virtually every market in existence; theyhave commodified and financialized pretty much every naturalresource of value on this planet; and in the wake of the financialcrisis they almost single-handedly caused, they have extortedbillions of dollars from the pockets of their own customers andtrillions from hard-up taxpayers. What about your respectivegovernment authorities? Do you trust them?…

….We are, it seems, descending into a world where newtechnologies threaten to put absolute power well within the graspof a select group of individuals and organizations — individuals andorganizations that have through their repeated actions betrayed

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just about every possible notion of mutual trust.

Governments do not trust their citizens (‘potential terrorists’) either, hencethe perceived need to monitor and limit the scope of their decisions andactions. The powers-that-be know how angry people are going to be whenthey realise the scale of their impending dispossession, and are acting insuch a way as to (try to) limit the power of the anger that will be focusedagainst them. It is not going to work.

Without trust we are likely to see “throwbacks to the 14th century….atthe dawn of banking coming out of the Dark Ages.”. It is no coincidencethat this period was also one of financial, socioeconomic and humanitariancrises, thanks to the bursting of a bubble two centuries in the making:

The 14th Century was a time of turmoil, diminished expectations,loss of confidence in institutions, and feelings of helplessness atforces beyond human control. Historian Barbara Tuchman entitledher book on this period A Distant Mirror because many of ourmodern problems had counterparts in the 14th Century.

Few think of the trials and tribulations of 14th century Europe as havingtheir roots in financial collapse — they tend instead to remember famine anddisease. However, the demise of what was then the world banking systemwas a leading indicator for what followed, as is always the case:

Six hundred and fifty years ago came the climax of the worstfinancial collapse in history to date. The 1930’s Great Depressionwas a mild and brief episode, compared to the bank crash of the1340’s, which decimated the human population. The crash, whichpeaked in A.C.E. 1345 when the world’s biggest banks went under,“led” by the Bardi and Peruzzi companies of Florence, Italy, wasmore than a bank crash — it was a financial disintegration….ablowup of all major banks and markets in Europe, in which,chroniclers reported, “all credit vanished together,” most trade andexchange stopped, and a catastrophic drop of the world’spopulation by famine and disease loomed.

As we have written many times before at The Automatic Earth, bubbles arenot a new phenomenon. They have inflated and subsequently implodedsince the dawn of civilisation, and are in fact en emergent property ofcivilisational scale. There are therefore many parallels between differenthistorical episodes of boom and bust:

The parallels between the medieval credit crunch and our currentpredicament are considerable. In both cases the money supplyincreased in response to the expansionist pressure of unbridledoptimism. In both cases the expansion proceeded to the pointwhere a substantial overhang of credit had been created — aquantity sufficient to generate systemic risk that was notrecognized at the time. In the fourteenth century, that risk wasrealized, as it will be again in the 21st century.

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What we are experiencing now is simply the same dynamic, but turbo-charged by the availability of energy and technology that have driven ourlong period of socioeconomic expansion and ever-increasing complexity. Justas in the 14th century, the cracks in the system have been visible for manyyears, but generally ignored. The coming credit implosion may appear tocome from nowhere when it hits, but has long been foreshadowed if oneknew what to look for. Watching more and more people seeking escaperoutes from a doomed financial system, and the powers-that-be fighting backby closing those escape routes, all within a social matrix of collapsing trust,one cannot deny that history is about to repeat itself yet again, only on alarger scale this time.

The final gasps of a bubble economy, such as our own, are about behind-the-scenes securing of access to and ownership of real assets for the elite,through bailouts and other forms of legalized theft. As Frédéric Bastiatexplained in 1848,

“When plunder becomes a way of life for a group of men in asociety, over the course of time they create for themselves a legalsystem that authorizes it and a moral code that glorifies it.”

The bust which follows the last attempt to kick the can further down the roadwill see the vast majority of society dispossessed of what they thought theyowned, their ephemeral electronic claims to underlying real wealthextinguished.

The Way Forward

The advent of negative interest rates indicates that the endgame for theglobal economy is underway. In places at the peak of the bubble, negativerates drive further asset bubbles and create ever greater vulnerability to theinevitable interest rate spike and asset price collapse to come. In Japan, atthe other end of the debt deflation cycle, negative rates force people intoever more cash hoarding. Neither one of these outcomes is going to lead torecovery. Both indicate economies at breaking point. We cannot assume thatcurrent financial, economic and social structures will continue in theirpresent form, and we need to prepare for a period of acute upheaval.

Using cash wherever possible, rather than succumbing to the convenience ofelectronic payments, becomes an almost revolutionary act. So other forms ofradical decentralisation, which amount to opting out as much as possiblefrom the path the powers-that-be would have us follow. It is likely to becomeincreasingly difficult to defend our freedom and independence, but if enoughpeople stand their ground, establishing full totalitarian control should not bepossible.

To some extent, the way the war on cash plays out will depend on the timing

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of the coming financial implosion. The elimination of cash would take time,and only in some countries has there been enough progress away from cashthat eliminating it would be at all realistic. If only a few countries tried to doso, people in those countries would be likely to use foreign currency that wasstill legal tender.

Cash elimination would really only work if it it were very broadly applied inenough major economies, and if a financial accident could be postponed for afew more years. As neither of these conditions is likely to be fulfilled, a cashban is unlikely to viable. Governments and central banks would verymuch like to frighten people away from cash, but that only underlinesits value under the current circumstances. Cash is king in a deflation.The powers-that-be know that, and would like the available cash to end upconcentrated in their own hands rather than spread out to act as seed capitalfor a bottom-up recovery.

Holding on to cash under one’s own control is still going to be a veryimportant option for maintaining freedom of action in an uncertain future.The alternative would be to turn to hard goods (land, tools etc) from thebeginning, but where there is a great deal of temporal and spatialuncertainty, this amounts to making all one’s choices up front, and choicesbased on incomplete information could easily turn out to be wrong. Makingsuch choices up front is also expensive, as prices are currently high. Ofcourse having some hard goods is also advisable, particularly if they allowone to have some control over the essentials of one’s own existence.

It is the balance between hard goods and maintaining capital as liquidity(cash) that is important. Where that balance lies depends very much onindividual circumstances, and on location. For instance, in the European

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Union, where currency reissue is a very real threat in a reasonably shorttimeframe, opting for goods rather than cash makes more sense, unless oneholds foreign currency such as Swiss francs. If one must hold euros, it wouldprobably be advisable to hold German ones (serial numbers begin with X).

US dollars are likely to hold their value for longer than most othercurrencies, given the dollar’s role as the global reserve currency. Reports ofits demise are premature, to put it mildly. As financial crisis picks upmomentum, a flight to safety into the reserve currency is likely to pick upspeed, raising the value of the dollar against other currencies. In addition,demand for dollars will increase as debtors seek to pay down dollar-denominated debt. While all fiat currencies are ultimately vulnerable in thebeggar-thy-neighbour currency wars to come, the US dollar should holdvalue for longer than most.

Holding cash on the sidelines while prices fall is a good strategy, so long asone does not wait too long. The risks to holding and using cash are likely togrow over time, so it is best viewed as a short term strategy to ride out thedeflationary period, where the value of credit instruments is collapsing. Thepurchasing power of cash will rise during this time, and previouslyunforeseen opportunities are likely to arise.

Ordinary people need to retain as much of their freedom of action aspossible, in order for society to function through a period of economicseizure. In general, the best strategy is to hold cash until the point where theindividual in question can afford to purchase the goods they require toprovide for their own needs without taking on debt to do so. (Avoiding takingon debt is extremely important, as financially encumbered assets would besubject to repossession in the event of failure to meet debt obligations.)

One must bear in mind, however, that after price falls, some goods may ceaseto be available at any price, so some essentials may need to be purchased attoday’s higher prices in order to guarantee supply.

Capital preservation is an individual responsibility, and during times ofdeflation, capital must be preserved as liquidity. We cannot expect eithergovernments or private institutions to protect our interests, as both havebeen obviously undermining the interests of ordinary people in favour oftheir own for a very long time. Indeed they seem to feel secure enough oftheir own consolidated control that they do not even bother to try to hide thefact any longer. It is our duty to inform ourselves and act to protectourselves, our families and our communities. If we do not, no one else will.

Negative Interest Rates and the War on Cash(3)

Sep 072016

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September 7, 2016 Posted by Raúl Ilargi Meijer at 1:03 pm Finance Taggedwith: bubble, cash, credit, debt, deflation, liquidity, Nicole Foss, NIRP, Ponzi,risk, ZIRP 10 Responses »

Lou Stoumen Going to work 8am Times Square, NYC 1940

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This is part 3 of a 4-part series by Nicole Foss entitled “Negative InterestRates and the War on Cash”.

Part 1 is here: Negative Interest Rates and the War on Cash (1)

Part 2 is here: Negative Interest Rates and the War on Cash (2)

Part 4 will follow soon, and at the end we will publish the entire piece in onepost.

Here is Nicole:

Promoters, Mechanisms and Risks in the War on Cash

Nicole Foss: Bitcoin and other electronic platforms have paved the waypsychologically for a shift away from cash, although they have done so byemphasising decentralisation and anonymity rather than the much greatercentral control which would be inherent in a mainstream electronic currency.The loss of privacy would no doubt be glossed over in any media campaign,as would the risks of cyber-attack and the lack of a fallback for providingliquidity to the economy in the event of a systems crash. Electronic currencyis much favoured by techno-optimists, but not so much by those concernedabout the risks of absolute structural dependency on technologicalcomplexity. The argument regarding greatly reduced socioeconomicresilience is particularly noteworthy, given the vulnerability and potentialfragility of electronic systems.

There is an important distinction to be made between official electroniccurrency – allowing everyone to hold an account with the central bank — andprivate electronic currency. It would be official currency which would providethe central control sought by governments and central banks, but ifindividuals saw central bank accounts as less risky than commercialinstitutions, which seems highly likely, the extent of the potential fundstransfer could crash the existing banking system, causing a bank run in asimilar manner as large-scale cash withdrawals would. As the power ofmoney creation is of the highest significance, and that power is currently in

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private hands, any attempt to threaten that power would almost certainly bemet with considerable resistance from powerful parties. Private digitalcurrency would be more compatible with the existing framework, but wouldnot confer all of the control that governments would prefer:

People would convert a very large share of their current bankdeposits into official digital money, in effect taking them out of theprivate banking system. Why might this be a problem? If it’s anacute rush for safety in a crisis, the risk is that private banks maynot have enough reserves to honour all the withdrawals. But that isexactly the same risk as with physical cash: it’s often forgotten thatit’s central bank reserves, not the much larger quantity of deposits,that banks can convert into cash with the central bank. Both withcash and official e-cash, the way to meet a more severe bank run isfor the bank to borrow more reserves from the central bank,posting its various assets as security. In effect, this would mean thecentral bank taking over the funding of the broader economy in apanic — but that’s just what central banks should do.

A more chronic challenge is that people may prefer the safety ofcentral bank accounts even in normal times. That would destroyprivate banks’ current deposit-funded model. Is that a bad thing?They would still have a role as direct intermediators betweensavers and borrowers, by offering investment products sufficientlyattractive for people to get out of the safety of e-cash. Meanwhile,the broad money supply would be more directly under the controlof the central bank, whereas now it’s a product of the vagaries ofprivate lending decisions. The more of the broad money supply thatwas in the form of official digital cash, the easier it would be, forexample, for the central bank to use tools such as negative interestrates or helicopter drops.

As an indication that the interests of the private banking system and publiccentral authorities are not always aligned, consider the actions of theBavarian Banking Association in attempting to avoid the imposition ofnegative interest rates on reserves held with the ECB:

German newspaper Der Spiegel reported yesterday that theBavarian Banking Association has recommended that its memberbanks start stockpiling PHYSICAL CASH. The Bavarian BankingAssociation has had enough of this financial dictatorship. Their newrecommendation is for all member banks to ditch the ECB andinstead start keeping their excess reserves in physical cash, storedin their own bank vaults. This is officially an all-out revolution ofthe financial system where banks are now actively rebelling againstthe central bank. (What’s even more amazing is that this concept oftraditional banking — holding physical cash in a bank vault — isnow considered revolutionary and radical.)

There’s just one teensy tiny problem: there simply is not enoughphysical cash in the entire financial system to support even a tiny

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fraction of the demand. Total bank deposits exceed trillions ofeuros. Physical cash constitutes just a small percentage of thatsum. So if German banks do start hoarding physical currency, therewon’t be any left in the financial system. This will force the ECB tochoose between two options:

Support this rebellion and authorize the issuance of morephysical cash; or

1.

Impose capital controls.2.

Given that just two weeks ago the President of the ECB spokeabout the possibility of banning some higher denomination cashnotes, it’s not hard to figure out what’s going to happen next.

Advantages of official electronic currency to governments and central banksare clear. All transactions are transparent, and all can be subject to fees andtaxes. Central control over the money supply would be greatly increased andtax evasion would be difficult to impossible, at least for ordinary people.Capital controls would be built right into the system, and personal spendinginformation would be conveniently gathered for inspection by centralauthorities (for cross-correlation with other personal data they possess). Thefirst step would likely be to set up a dual system, with both cash andelectronic money in parallel use, but with electronic money as the definedunit of value and cash subject to a marginally disadvantageous exchangerate.

The exchange rate devaluing cash in relation to electronic money couldincrease over time, in order to incentivize people to switch away from seeingphysical cash as a store of value, and to increase their preference for goodsover cash. In addition to providing an active incentive, the use of cash wouldprobably be publicly disparaged as well as actively discouraged in manyways. For instance, key functions such as tax payments could be designatedas by electronic remittance only. The point would be to forced everyone intothe system by depriving them of the choice to opt out. Once all werecaptured, many forms of central control would be possible, includingsubstantial account haircuts if central authorities deemed them necessary.

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The main promoters of cash elimination in favour of electronic currency areWillem Buiter, Kenneth Rogoff, and Miles Kimball.

Economist Willem Buiter has been pushing for the relegation of cash, at leastthe removal of its status as official unit of account, since the financial crisisof 2008. He suggests a number of mechanisms for achieving the transitionto electronic money, emphasising the need for the electronic currency tobecome the definitive unit of account in order to implement substantiallynegative interest rates:

The first method does away with currency completely. This has theadditional benefit of inconveniencing the main users of currency-operators in the grey, black and outright criminal economies.Adequate substitutes for the legitimate uses of currency, on whichpositive or negative interest could be paid, are available. Thesecond approach, proposed by Gesell, is to tax currency by makingit subject to an expiration date. Currency would have to be“stamped” periodically by the Fed to keep it current. When doneso, interest (positive or negative) is received or paid.

The third method ends the fixed exchange rate (set at one) betweendollar deposits with the Fed (reserves) and dollar bills. There couldbe a currency reform first. All existing dollar bills and coin wouldbe converted by a certain date and at a fixed exchange rate into anew currency called, say, the rallod. Reserves at the Fed wouldcontinue to be denominated in dollars. As long as the FederalFunds target rate is positive or zero, the Fed would maintain thefixed exchange rate between the dollar and the rallod.

When the Fed wants to set the Federal Funds target rate at minusfive per cent, say, it would set the forward exchange rate betweenthe dollar and the rallod, the number of dollars that have to be paidtoday to receive one rallod tomorrow, at five per cent below thespot exchange rate — the number of dollars paid today for one

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rallod delivered today. That way, the rate of return, expressed in acommon unit, on dollar reserves is the same as on rallod currency.

For the dollar interest rate to remain the relevant one, the dollarhas to remain the unit of account for setting prices and wages. Thiscan be encouraged by the government continuing to denominate allof its contracts in dollars, including the invoicing and payment oftaxes and benefits. Imposing the legal restriction that checkabledeposits and other private means of payment cannot bedenominated in rallod would help.

In justifying his proposals, he emphasises the importance of combattingcriminal activity…

The only domestic beneficiaries from the existence of anonymity-providing currency are the criminal fraternity: those engaged in taxevasion and money laundering, and those wishing to store theproceeds from crime and the means to commit further crimes.Large denomination bank notes are an especially scandaloussubsidy to criminal activity and to the grey and black economies.

… over the acknowledged risks of government intrusion in legitimatelyprivate affairs:

My good friend and colleague Charles Goodhart responded to anearlier proposal of mine that currency (negotiable bearer bondswith legal tender status) be abolished that this proposal was“appallingly illiberal”. I concur with him that anonymity/invisibilityof the citizen vis-a-vis the state is often desirable, given theirrepressible tendency of the state to infringe on our fundamentalrights and liberties and given the state’s ever-expanding capacityto do so (I am waiting for the US or UK government to contractGoogle to link all personal health information to all tax information,information on cross-border travel, social security information,census information, police records, credit records, and informationon personal phone calls, internet use and internet shopping habits).

In his seminal 2014 paper “Costs and Benefits to Phasing Out PaperCurrency.”, Kenneth Rogoff also argues strongly for the primacy ofelectronic currency and the elimination of physical cash as an escape route:

Paper currency has two very distinct properties that should drawour attention. First, it is precisely the existence of paper currencythat makes it difficult for central banks to take policy interest ratesmuch below zero, a limitation that seems to have becomeincreasingly relevant during this century. As Blanchard et al. (2010)point out, today’s environment of low and stable inflation rates hasdrastically pushed down the general level of interest rates. The lowoverall level, combined with the zero bound, means that centralbanks cannot cut interest rates nearly as much as they might like inresponse to large deflationary shocks.

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If all central bank liabilities were electronic, paying a negativeinterest on reserves (basically charging a fee) would be trivial. Butas long as central banks stand ready to convert electronic depositsto zero-interest paper currency in unlimited amounts, it suddenlybecomes very hard to push interest rates below levels of, say, -0.25to -0.50 percent, certainly not on a sustained basis. Hoarding cashmay be inconvenient and risky, but if rates become too negative, itbecomes worth it.

However, he too notes associated risks:

Another argument for maintaining paper currency is that it pays tohave a diversity of technologies and not to become overlydependent on an electronic grid that may one day turn out to bevery vulnerable. Paper currency diversifies the transactions systemand hardens it against cyber attack, EMP blasts, etc. Thisargument, however, seems increasingly less relevant becauseeconomies are so totally exposed to these problems anyway. Withpaper currency being so marginalized already in the legal economyin many countries, it is hard to see how it could be brought backquickly, particularly if ATM machines were compromised at thesame time as other electronic systems.

A different type of argument against eliminating currency relates tocivil liberties. In a world where society’s mores and customs evolve,it is important to tolerate experimentation at the fringes. This ispotentially a very important argument, though the problem mightbe mitigated if controls are placed on the government’s use ofinformation (as is done say with tax information), and the problemmight also be ameliorated if small bills continue to circulate. Lastbut not least, if any country attempts to unilaterally reduce the useof its currency, there is a risk that another country’s currencywould be used within domestic borders.

Miles Kimball’s proposals are very much in tune with Buiter and Rogoff:

There are two key parts to Miles Kimball’s solution. The first part isto make electronic money or deposits the sole unit of account.Everything else would be priced in terms of electronic dollars,including paper dollars. The second part is that the fixed exchangerate that now exists between deposits and paper dollars wouldbecome variable. This crawling peg between deposits and papercurrency would be based on the state of the economy. When theeconomy was in a slump and the central bank needed to setnegative interest rates to restore full employment, the peg wouldadjust so that paper currency would lose value relative toelectronic money. This would prevent folks from rushing to papercurrency as interest rates turned negative. Once the economystarted improving, the crawling peg would start adjusting towardparity.

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This approach views the economy in very mechanistic terms, as if it were amachine where pulling a lever would have a predictable linear effect — makeholding savings less attractive and automatically consumption will increase.This is actually a highly simplistic view, resting on the notions of stabilisingnegative feedback and bringing an economy ‘back into equilibrium’. If itwere so simple to control an economy centrally, there would never have beendeflationary spirals or economic depressions in the past.

Assuming away the more complex aspects of human behaviour — a flight tosafety, the compulsion to save for a rainy day when conditions are unstable,or the natural response to a negative ‘wealth effect’ — leads to a modeldivorced from reality. Taxing savings does not necessarily lead to increasedconsumption, in fact it is far more likely to have the opposite effect.:

But under Miles Kimball’s proposal, the Fed would lower interestrates to below zero by taxing away balances of e-currency. This is areduction in monetary base, just like the case of IOR, and by itselfwould be contractionary, not expansionary. The expansionaryeffects of Kimball’s policy depend on the assumption thathouseholds will increase consumption in response to the taxing oftheir cash savings, rather than letting their savings depreciate.

That needn’t be the case — it depends on the relative magnitudesof income and substitution effects for real money balances. Thesubstitution effect is what Kimball has in mind — raising the priceof real money balances will induce substitution out of money andinto consumption. But there’s also an income effect, whereby theloss of wealth induces less consumption and more savings. Thus,negative interest rate policy can be contractionary even thoughpositive interest rate policy is expansionary.

Indeed, what Kimball has proposed amounts to a reverseBernanke Helicopter — imagine a giant vacuum flyingaround the country sucking money out of people’s pockets.Why would we assume that this would be inflationary?

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Given that the effect on the money supply would be contractionary, thesupposed stimulus effect on the velocity of money (as, in theory, savings turninto consumption in order to avoid the negative interest rate penalty) wouldhave to be large enough to outweigh a contracting money supply. In someways, modern proponents of electronic money bearing negative interest ratesare attempting to copy Silvio Gesell’s early 20th century work. Gesellproposed the use of stamp scrip — money that had to be regularly stamped,at a small cost, in order to remain current. The effect would be for money tolose value over time, so that hoarding currency it would make little sense.Consumption would, in theory, be favoured, so money would be kept incirculation.

This idea was implemented to great effect in the Austrian town of Wörglduring the Great Depression, where the velocity of money increasedsufficiently to allow a hive of economic activity to develop (temporarily) inthe previously depressed town. Despite the similarities between currentproposals and Gesell’s model applied in Wörgl, there are fundamentaldifferences:

There is a critical difference, however, between the Wörglcurrency and the modern-day central bankers’ negativeinterest scheme. The Wörgl government first issued its new“free money,” getting it into the local economy andincreasing purchasing power, before taxing a portion of itback. And the proceeds of the stamp tax went to the city, tobe used for the benefit of the taxpayers….Today’s centralbankers are proposing to tax existing money, diminishingspending power without first building it up. And the interestwill go to private bankers, not to the local government.

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The Wörgl experiment was a profoundly local initiative, instigated at the localgovernment level by the mayor. In contrast, modern proposals for negativeinterest rates would operate at a much larger scale and would be imposed onthe population in accordance with the interests of those at the top of thefinancial foodchain. Instead of being introduced for the direct benefit ofthose who pay, as stamp scrip was in Wörgl, it would tax the people in theeconomic periphery for the continued benefit of the financial centre. As suchit would amount to just another attempt to perpetuate the current system,and to do so at a scale far beyond the trust horizon.

As the trust horizon contracts in times of economic crisis, effectiveorganizational scale will also contract, leaving large organizations (bothpublic and private) as stranded assets from a trust perspective, and thereforelacking in political legitimacy. Large scale, top down solutions will be verydifficult to implement. It is not unusual for the actions of central authoritiesto have the opposite of the desired effect under such circumstances:

Consumers today already have very little discretionary money.Imposing negative interest without first adding new money into theeconomy means they will have even less money to spend. Thiswould be more likely to prompt them to save their scarce fundsthan to go on a shopping spree. People are not keeping their moneyin the bank today for the interest (which is already nearlynon-existent). It is for the convenience of writing checks, issuingbank cards, and storing their money in a “safe” place. They wouldno doubt be willing to pay a modest negative interest for thatconvenience; but if the fee got too high, they might pull theirmoney out and save it elsewhere. The fee itself, however, would notdrive them to buy things they did not otherwise need.

People would be very likely to respond to negative interest rates byself-organising alternative means of exchange, rather than bowing to theimposition of negative rates. Bitcoin and other crypto-currencies would beone possibility, as would using foreign currency, using trading goods asunits of value, or developing local alternative currencies along the lines ofthe Wörgl model:

The use of sheep, bottled water, and cigarettes as media ofexchange in Iraqi rural villages after the US invasion and collapseof the dinar is one recent example. Another example was Argentinaafter the collapse of the peso, when grain contracts priced indollars were regularly exchanged for big-ticket items likeautomobiles, trucks, and farm equipment. In fact, Argentinefarmers began hoarding grain in silos to substitute for holding cashbalances in the form of depreciating pesos.

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For the electronic money model grounded in negative interest rates to work,all these alternatives would have to be made illegal, or at least hampered tothe point of uselessness, so people would have no other legal choice but toparticipate in the electronic system. Rogoff seems very keen to see thishappen:

Won’t the private sector continually find new ways to makeanonymous transfers that sidestep government restrictions?Certainly. But as long as the government keeps playingWhac-A-Mole and prevents these alternative vehicles from beingeasily used at retail stores or banks, they won’t be able fill the rolethat cash plays today. Forcing criminals and tax evaders to turn toriskier and more costly alternatives to cash will make their livesharder and their enterprises less profitable.

It is very likely that in times of crisis, people would do what they have to doregardless of legal niceties. While it may be possible to close off somealternative options with legal sanctions, it is unlikely that all could beprevented, or even enough to avoid the electronic system being fatallyundermined.

The other major obstacle would be overcoming the preference for cash overgoods in times of crisis:

Understanding how negative rates may or may not help economicgrowth is much more complex than most central bankers andinvestors probably appreciate. Ultimately the confusion residesaround differences in view on the theory of money. In a classicalworld, money supply multiplied by a constant velocity of circulationequates to nominal growth.

In a Keynesian world, velocity is not necessarily constant —specifically for Keynes, there is a money demand function (liquiditypreference) and therefore a theory of interest that allows for aliquidity trap whereby increasing money supply does not lead to

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higher nominal growth as the increase in money is hoarded. Theinterest rate (or inverse of the price of bonds) becomes stickybecause at low rates, for infinitesimal expectations of any furtherrise in bond prices and a further fall in interest rates, demand formoney tends to infinity.

In Gesell’s world money supply itself becomes inversely correlatedwith velocity of circulation due to money characteristics beingsuperior to goods (or commodities). There are costs to storage thatmoney does not have and so interest on money capital sets a bar tointerest on real capital that produces goods. This is similar toKeynes’ concept of the marginal efficiency of capital schedule beingseparate from the interest rate. For Gesell the product of moneyand velocity is effective demand (nominal growth) but because ofmoney capital’s superiority to real capital, if money supply expandsit comes at the expense of velocity.

The new money supply is hoarded because as interest rates fall,expected returns on capital also fall through oversupply — foreconomic agents goods remain unattractive to money. The demandfor money thus rises as velocity slows. This is simply a deflationspiral, consumers delaying purchases of goods, hoardingmoney, expecting further falls in goods prices before they arewilling to part with their money….In a Keynesian world ofdeficient demand, the burden is on fiscal policy to restoredemand. Monetary policy simply won’t work if there is aliquidity trap and demand for cash is infinite.

During the era of globalisation (since the financial liberalisation of the early1980s), extractive capitalism in debt-driven over-drive has created perverseincentives to continually increase supply. Financial bubbles, grounded in therediscovery of excess leverage, always act to create an artificial demandstimulus, which is met by artificially inflated supply during the boom phase.The value of the debt created collapses as boom turns into bust, crashing themoney supply, and with it asset price support. Not only does the artificialstimulus disappear, but a demand undershoot develops, leaving all thatsupply without a market. Over the full cycle of a bubble and its aftermath,credit is demand neutral, but within the bubble it is anything but neutral.Forward shifting the demand curve provides for an orgy of presentconsumption and asset price increases, which is inevitably followed by theopposite.

Kimball stresses bringing demand forward as a positive aspect of hismodel:

In an economic situation like the one we are now in, we would liketo encourage a company thinking about building a factory in acouple of years to build that factory now instead. If someone wouldlend to them at an interest rate of -3.33% per year, the companycould borrow $1 million to build the factory now, and pay backsomething like $900,000 on the loan three years later. (Despite the

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negative interest rate, compounding makes the amount to be paidback a bit bigger, but not by much.)

That would be a good enough deal that the company might moveup its schedule for building the factory. But everything runsaground on the fact that any potential lender, just by putting $1million worth of green pieces of paper in a vault could get back $1million three years later, which is a lot better than getting back alittle over $900,000 three years later.

This is, however, a short-sighted assessment. Stimulating demand todaymeans a demand undershoot tomorrow. Kimball names long term pricestability as a primary goal, but this seems unlikely. Large scale centralplanning has a poor track record for success, to put it mildly. It requires thecentral authority in question to have access to all necessary information inrealtime, and to have the ability to respond to that information both wiselyand rapidly, or even proactively. It also assumes the ability to accurately filterout misinformation and disinformation. This is unlikely even in good times,thanks to the difficulties of ‘organizational stupidity’ at large scale, andeven more improbable in the times of crisis.

Negative Interest Rates and the War on Cash(2)

Sep 052016

September 5, 2016 Posted by Raúl Ilargi Meijer at 1:16 pm Finance Taggedwith: bubble, cash, credit, debt, deflation, liquidity, Nicole Foss, NIRP, Ponzi,risk, ZIRP 13 Responses »

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Berenice Abbott Broad St., NYC 1936

This is part 2 of a 4-part series by Nicole Foss entitled “Negative InterestRates and the War on Cash”.

Part 1 is here: Negative Interest Rates and the War on Cash (1)

Parts 3 and 4 will follow in the next few days, and at the end we will publishthe entire piece in one post.

Here, once again, is Nicole:

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Closing the Escape Routes

Nicole Foss: History teaches us that central authorities dislike escaperoutes, at least for the majority, and are therefore prone to closing them, sothat control of a limited money supply can remain in the hands of the veryfew. In the 1930s, gold was the escape route, so gold was confiscated. AsAlan Greenspan wrote in 1966:

In the absence of the gold standard, there is no way to protectsavings from confiscation through monetary inflation. There is nosafe store of value. If there were, the government would haveto make its holding illegal, as was done in the case of gold. Ifeveryone decided, for example, to convert all his bank deposits tosilver or copper or any other good, and thereafter declined toaccept checks as payment for goods, bank deposits would lose theirpurchasing power and government-created bank credit would beworthless as a claim on goods.

The existence of escape routes for capital preservation undermines theviability of the banking system, which is already over-extended,over-leveraged and extremely fragile. This time cash serves that role:

Ironically, though the paper money standard that replaced the goldstandard was originally meant to empower governments, it nowseems that paper money is perceived as an obstacle to unlimitedgovernment power….While paper money isn’t as big impediment togovernment power as the gold standard was, it is nevertheless animpediment compared to a society with only electronic money.Because of this, the more ardent statists favor the abolition ofpaper money and a monetary system with only electronic moneyand electronic payments.

We can therefore expect cash to be increasingly disparaged in order tojustify its intended elimination:

Every day, a situation that requires the use of physical cash, feelsmore and more like an anachronism. It’s like having to listen tomusic on a CD. John Maynard Keynes famously referred to gold(well, the gold standard specifically) as a “barbarous relic.” Wellthe new barbarous relic is physical cash. Like gold, cash is physicalmoney. Like gold, cash is still fetishized. And like gold, cash is a

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costly drain on the economy. A study done at Tufts in 2013estimated that cash costs the economy $200 billion. Their studyincluded the nugget that consumers spend, on average, 28 minutesper month just traveling to the point where they obtain cash (ATM,etc.). But this is just first-order problem with cash. The realproblem, which economists are starting to recognize, is that papercash is an impediment to effective monetary policy, and thereforeeconomic growth.

Holding cash is not risk free, but cash is nevertheless king in a period ofdeflation:

Conventional wisdom is that interest rates earned on investmentsare never less than zero because investors could alternatively holdcurrency. Yet currency is not costless to hold: It is subject to theftand physical destruction, is expensive to safeguard in largeamounts, is difficult to use for large and remote transactions, and,in large quantities, may be monitored by governments.

The acknowledged risks of holding cash are understood and can be managedpersonally, whereas the substantial risk associated with a systemic bankingcrisis are entirely outside the control of ordinary depositors. The bank bail-in(rescuing the bank with the depositors’ funds) in Cyprus in early 2013 was awarning sign, to those who were paying attention, that holding money in abank is not necessarily safe. The capital controls put in place in otherlocations, for instance Greece, also underline that cash in a bank may not beaccessible when needed.

The majority of the developed world either already has, or is introducing,legislation to require depositor bail-ins in the event of bank failures, ratherthan taxpayer bailouts, in preparation for many more Cyprus-type events, buton a very much larger scale. People are waking up to the fact that abank balance is not considered their money, but is actually anunsecured loan to the bank, which the bank may or may not repay,depending on its own circumstances.:

Your checking account balance is denominated in dollars, but itdoes not consist of actual dollars. It represents a promise by aprivate company (your bank) to pay dollars upon demand. If youwrite a check, your bank may or may not be able to honor thatpromise. The poor souls who kept their euros in the form of largebalances in Cyprus banks have just learned this lesson the hardway. If they had been holding their euros in the form of currency,they would have not lost their wealth.

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Even in relatively untroubled countries, like the UK, it is becoming moredifficult to access physical cash in a bank account or to use it for largerpurchases. Notice of intent to withdraw may be required, and withdrawallimits may be imposed ‘for your own protection’. Reasons for the withdrawalmay be required, ostensibly to combat money laundering and the blackeconomy:

It’s one thing to be required by law to ask bank customers orparties in a cash transaction to explain where their money camefrom; it’s quite another to ask them how they intend to use themoney they wish to withdraw from their own bank accounts. As oneMr Cotton, a HSBC customer, complained to the BBC’s Money Boxprogramme: “I’ve been banking in that bank for 28 years. They allknow me in there. You shouldn’t have to explain to your bank whyyou want that money. It’s not theirs, it’s yours.”

In France, in the aftermath of terrorist attacks there, several anti-cashmeasures were passed, restricting the use of cash once obtained:

French Finance Minister Michel Sapin brazenly stated that it wasnecessary to “fight against the use of cash and anonymity in theFrench economy.” He then announced extreme and despoticmeasures to further restrict the use of cash by French residentsand to spy on and pry into their financial affairs.

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These measures…..include prohibiting French residents frommaking cash payments of more than 1,000 euros, down from thecurrent limit of 3,000 euros….The threshold below which a Frenchresident is free to convert euros into other currencies withouthaving to show an identity card will be slashed from the currentlevel of 8,000 euros to 1,000 euros. In addition any cash deposit orwithdrawal of more than 10,000 euros during a single month willbe reported to the French anti-fraud and money laundering agencyTracfin.

Tourists in France may also be caught in the net:

France passed another new Draconian law; from the summer of2015, it will now impose cash requirements dramatically trying toeliminate cash by force. French citizens and tourists will only beallowed a limited amount of physical money. They have financialpolice searching people on trains just passing through France tosee if they are transporting cash, which they will now seize.

This is essentially the Shock Doctrine in action. Central authorities rarelypass up an opportunity to use a crisis to add to their repertoire of repressivelaws and practices.

However, even without a specific crisis to draw on as a justification, manyother countries have also restricted the use of cash for purchases:

One way they are waging the War on Cash is to lower the thresholdat which reporting a cash transaction is mandatory or at whichpaying in cash is simply illegal. In just the last few years.

Italy made cash transactions over €1,000 illegal;Switzerland has proposed banning cash payments in excess of100,000 francs;Russia banned cash transactions over $10,000;Spain banned cash transactions over €2,500;Mexico made cash payments of more than 200,000 pesosillegal;Uruguay banned cash transactions over $5,000

Other restrictions on the use of cash can be more subtle, but can havefar-reaching effects, especially if the ideas catch on and are widely applied:

The State of Louisiana banned “secondhand dealers” from makingmore than one cash transaction per week. The term has a broaddefinition and includes Goodwill stores, specialty stores that sellcollectibles like baseball cards, flea markets, garage sales and soon. Anyone deemed a “secondhand dealer” is forbidden to acceptcash as payment. They are allowed to take only electronic means ofpayment or a check, and they must collect the name and otherinformation about each customer and send it to the local policedepartment electronically every day.

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The increasing application of de facto capital controls, when combined withthe prevailing low interest rates, already convince many to hold cash. Thepossibility of negative rates would greatly increase the likelihood. We arealready in an environment of rapidly declining trust, and limited access towhat we still perceive as our own funds only accelerates the process in aself-reinforcing feedback loop. More withdrawals lead to more controls,which increase fear and decrease trust, which leads to more withdrawals.This obviously undermines the perceived power of monetary policy tostimulate the economy, hence the escape route is already quietly closing.

In a deflationary spiral, where the money supply is crashing, very littlemoney is in circulation and prices are consequently falling almost across theboard, possessing purchasing power provides for the freedom to pursueopportunities as they present themselves, and to avoid being backed into acorner. The purchasing power of cash increases during deflation, even aselectronic purchasing power evaporates. Hence cash represents freedom ofaction at a time when that will be the rarest of ‘commodities’.

Governments greatly dislike cash, and increasingly treat its use, or the desireto hold it, especially in large denominations, with great suspicion:

Why would a central bank want to eliminate cash? For the samereason as you want to flatten interest rates to zero: to force peopleto spend or invest their money in the risky activities that revivegrowth, rather than hoarding it in the safest place. Calls for theeradication of cash have been bolstered by evidence thathigh-value notes play a major role in crime, terrorism and taxevasion. In a study for the Harvard Business School last week,former bank boss Peter Sands called for global elimination of thehigh-value note.

Britain’s “monkey” — the £50 — is low-value compared with itsforeign-currency equivalents, and constitutes a small proportion ofthe cash in circulation. By contrast, Japan’s ¥10,000 note (worthroughly £60) makes up a startling 92% of all cash in circulation; theSwiss 1,000-franc note (worth around £700) likewise. Sands wantsan end to these notes plus the $100 bill, and the €500 note – knownin underworld circles as the “Bin Laden”.

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Cash is largely anonymous, untraceable and uncontrollable, hence it makescentral authorities, in a system increasingly requiring total buy-in in order tofunction, extremely uncomfortable. They regard there being no legitimatereason to own more than a small amount of it in physical form, as itsownership or use raises the spectre of tax evasion or other illegal activities:

The insidious nature of the war on cash derives not just from thehurdles governments place in the way of those who use cash, butalso from the aura of suspicion that has begun to pervade privatecash transactions. In a normal market economy, businesses wouldwelcome taking cash. After all, what business would willingly turndown customers? But in the war on cash that has developed in thethirty years since money laundering was declared a federal crime,businesses have had to walk a fine line between serving customersand serving the government. And since only one of those twoparties has the power to shut down a business and throw businessowners and employees into prison, guess whose wishes thebusiness owner is going to follow more often?

The assumption on the part of government today is that possessionof large amounts of cash is indicative of involvement in illegalactivity. If you’re traveling with thousands of dollars in cash and getpulled over by the police, don’t be surprised when your money getsseized as “suspicious.” And if you want your money back, prepareto get into a long, drawn-out court case requiring you to prove thatyou came by that money legitimately, just because the courts havedecided that carrying or using large amounts of cash is reasonablesuspicion that you are engaging in illegal activity….

….Centuries-old legal protections have been turned on their headin the war on cash. Guilt is assumed, while the victims of the

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government’s depredations have to prove their innocence….Thosefortunate enough to keep their cash away from the prying hands ofgovernment officials find it increasingly difficult to use for bothbusiness and personal purposes, as wads of cash always arousesuspicion of drug dealing or other black market activity. And socash continues to be marginalized and pushed to the fringes.

Despite the supposed connection between crime and the holding ofphysical cash, the places where people are most inclined (and able) to storecash do not conform to the stereotype at all:

Are Japan and Switzerland havens for terrorists and drug lords?High-denomination bills are in high demand in both places, a trendthat some politicians claim is a sign of nefarious behavior. Yet thetwo countries boast some of the lowest crime rates in the world.The cash hoarders are ordinary citizens responding rationally tomonetary policy. The Swiss National Bank introduced negativeinterest rates in December 2014. The aim was to drive money outof banks and into the economy, but that only works to the extentthat savers find attractive places to spend or invest their money.With economic growth an anemic 1%, many Swiss withdrew cashfrom the bank and stashed it at home or in safe-deposit boxes.High-denomination notes are naturally preferred for this purpose,so circulation of 1,000-franc notes (worth about $1,010) rose 17%last year. They now account for 60% of all bills in circulation andare worth almost as much as Serbia’s GDP.

Japan, where banks pay infinitesimally low interest on deposits, is asimilar story. Demand for the highest-denomination ¥10,000 notesrose 6.2% last year, the largest jump since 2002. But 10,000 Yennotes are worth only about $88, so hiding places fill up fast. Thatexplains why Japanese went on a safe-buying spree last month afterthe Bank of Japan announced negative interest rates on somereserves. Stores reported that sales of safes rose as much as 250%,and shares of safe-maker Secom spiked 5.3% in one week.

In Germany too, negative interest rates are considered intolerable, banksare increasingly being seen as risky prospects, and physical cash under one’sown control is coming to be seen as an essential part of a forward-thinkingfinancial strategy:

First it was the news that Raiffeisen Gmund am Tegernsee, aGerman cooperative savings bank in the Bavarian village of Gmundam Tegernsee, with a population 5,767, finally gave in to the ECB’smonetary repression, and announced it’ll start charging retailcustomers to hold their cash. Then, just last week, Deutsche Bank’sCEO came about as close to shouting fire in a crowded negativerate theater, when, in a Handelsblatt Op-Ed, he warned of “fatalconsequences” for savers in Germany and Europe — to be sure,being the CEO of the world’s most systemically risky bank did nothelp his cause.

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That was the last straw, and having been patient long enough, theGerman public has started to move. According to the WSJ, Germansavers are leaving the “security of savings banks” for what manynow consider an even safer place to park their cash: home safes.We wondered how many “fatal” warnings from the CEO of DB itwould take, before this shift would finally take place. As it turnsout, one was enough….

….“It doesn’t pay to keep money in the bank, and on top of thatyou’re being taxed on it,” said Uwe Wiese, an 82-year-old pensionerwho recently bought a home safe to stash roughly €53,000($59,344), including part of his company pension that he took as apayout. Burg-Waechter KG, Germany’s biggest safe manufacturer,posted a 25% jump in sales of home safes in the first half of thisyear compared with the year earlier, said sales chief DietmarSchake, citing “significantly higher demand for safes by privateindividuals, mainly in Germany.”….

….Unlike their more “hip” Scandinavian peers, roughly 80% ofGerman retail transactions are in cash, almost double the 46% rateof cash use in the U.S., according to a 2014 Bundesbanksurvey….Germany’s love of cash is driven largely by its anonymity.One legacy of the Nazis and East Germany’s Stasi secret police is afear of government snooping, and many Germans are spooked byproposals of banning cash transactions that exceed €5,000. ManyGermans think the ECB’s plan to phase out the €500 bill is only thebeginning of getting rid of cash altogether. And they are absolutelyright; we can only wish more Americans showed the same foresightas the ordinary German….

….Until that moment, however, as a final reminder, in a fractionalreserve banking system, only the first ten or so percent ofthose who “run” to the bank to obtain possession of theirphysical cash and park it in the safe will succeed. Everyoneelse, our condolences.

The internal stresses are building rapidly, stretching economy after economyto breaking point and prompting aware individuals to protect themselvesproactively:

People react to these uncertainties by trying to protect themselveswith cash and guns, and governments respond by trying to limitcitizens’ ability to do so.

If this play has a third act, it will involve the abolition of cash insome major countries, the rise of various kinds of black markets(silver coins, private-label cash, cryptocurrencies like bitcoin) thatbypass traditional banking systems, and a surge in civil unrest, asall those guns are put to use. The speed with which cash, safes andguns are being accumulated — and the simultaneous intensificationof the war on cash — imply that the stress is building rapidly, and

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that the third act may be coming soon.

Despite growing acceptance of electronic payment systems, getting rid ofcash altogether is likely to be very challenging, particularly as the fear andstate of financial crisis that drives people into cash hoarding is very close toreasserting itself. Cash has a very long history, and enjoys greater trust thanother abstract means for denominating value. It is likely to prove tenacious,and unable to be eliminated peacefully. That is not to suggest centralauthorities will not try. At the heart of financial crisis lies the problem ofexcess claims to underlying real wealth. The bursting of the globalbubble will eliminate the vast majority of these, as the value of creditinstruments, hitherto considered to be as good as money, will plummet on therealisation that nowhere near all financial promises made can possibly bekept.

Cash would then represent the a very much larger percentage of theremaining claims to limited actual resources — perhaps still in excess of theavailable resources and therefore subject to haircuts. Not only the quantityof outstanding cash, but also its distribution, may not be to centralauthorities liking. There are analogous precedents for altering legal currencyin order to dispossess ordinary people trying to protect their stores of value,depriving them of the benefit of their foresight. During the Russian financialcrisis of 1998, cash was not eliminated in favour of an electronic alternative,but the currency was reissued, which had a similar effect. People wererequired to convert their life savings (often held ‘under the mattress’) fromthe old currency to the new. This was then made very difficult, if notimpossible, for ordinary people, and many lost the entirety of their lifesavings as a result.

A Cashless Society?

The greater the public’s desire to hold cash to protect themselves, thegreater will be the incentive for central banks and governments to restrict itsavailability, reduce its value or perhaps eliminate it altogether in favour ofelectronic-only payment systems. In addition to commercial banks alreadycomplicating the process of making withdrawals, central banks are activelyconsidering, as a first step, mechanisms to impose negative interest rateson physical cash, so as to make the escape route appear less attractive:

Last September, the Bank of England’s chief economist, AndyHaldane, openly pondered ways of imposing negative interest rateson cash — ie shrinking its value automatically. You could invalidaterandom banknotes, using their serial numbers. There are £63bnworth of notes in circulation in the UK: if you wanted to lop 1% offthat, you could simply cancel half of all fivers without warning. Asecond solution would be to establish an exchange rate betweenpaper money and the digital money in our bank accounts. A fiver

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deposited at the bank might buy you a £4.95 credit in your account.

To put it mildly, invalidating random banknotes would be highly likely toresult in significant social blowback, and to accelerate the evaporation oftrust in governing authorities of all kinds. It would be far more likely forfinancial authorities to move toward making official electronic money thestandard by which all else is measured. People are already used to usingelectronic money in the form of credit and debit cards and mobile phonemoney transfers:

I can remember the moment I realised the era of cash could soonbe over. It was Australia Day on Bondi Beach in 2014. In a busyliquor store, a man wearing only swimming shorts, carrying only amobile phone and a plastic card, was delaying other people’stransactions while he moved 50 Australian dollars into his currentaccount on his phone so that he could buy beer. The 30-oddyoungsters in the queue behind him barely murmured; they’d allbeen in the same predicament. I doubt there was a banknote orcoin between them….The possibility of a cashless society has comeat us with a rush: contactless payment is so new that the little pingthe machine makes can still feel magical. But in some shops,especially those that cater for the young, a customer reaching for a

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banknote already produces an automatic frown. Among centralbankers, that frown has become a scowl.

In some states almost anything, no matter how small, can be purchasedelectronically. Everything down to, and including, a cup of coffee from aroadside stall can be purchased in New Zealand with an EFTPOS (debit)card, hence relatively few people carry cash. In Scandinavian countries,there are typically more electronic payment options than cash options:

Sweden became the first country to enlist its own citizens aslargely willing guinea pigs in a dystopian economic experiment:negative interest rates in a cashless society. As Credit Suissereports, no matter where you go or what you want to purchase, youwill find a small ubiquitous sign saying “Vi hanterar ej kontanter”(“We don’t accept cash”)….A similar situation is unfolding inDenmark, where nearly 40% of the paying demographic useMobilePay, a Danske Bank app that allows all payments to becompleted via smartphone.

Even street vendors selling “Situation Stockholm”, the local version of theUK’s “Big Issue” are also able to take payments by debit or credit card.

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Ironically, cashlessness is also becoming entrenched in some Africancountries. One might think that electronic payments would not be possible inpoor and unstable subsistence societies, but mobile phones are actually verycommon in such places, and means for electronic payments are rapidlybecoming the norm:

While Sweden and Denmark may be the two nations that areclosest to banning cash outright, the most important testing groundfor cashless economics is half a world away, in sub-Saharan Africa.In many African countries, going cashless is not merely a matter ofbasic convenience (as it is in Scandinavia); it is a matter of basicsurvival. Less than 30% of the population have bank accounts, andeven fewer have credit cards. But almost everyone has a mobilephone. Now, thanks to the massive surge in uptake of mobilecommunications as well as the huge numbers of unbanked citizens,Africa has become the perfect place for the world’s biggest socialexperiment with cashless living.

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Western NGOs and GOs (Government Organizations) are workinghand-in-hand with banks, telecom companies and local authoritiesto replace cash with mobile money alternatives. The organizationsinvolved include Citi Group, Mastercard, VISA, Vodafone, USAID,and the Bill and Melinda Gates Foundation.

In Kenya the funds transferred by the biggest mobile moneyoperator, M-Pesa (a division of Vodafone), account for more than25% of the country’s GDP. In Africa’s most populous nation,Nigeria, the government launched a Mastercard-branded biometricnational ID card, which also doubles up as a payment card. The“service” provides Mastercard with direct access to over 170million potential customers, not to mention all their personal andbiometric data. The company also recently won a governmentcontract to design the Huduma Card, which will be used for payingState services. For Mastercard these partnerships with governmentare essential for achieving its lofty vision of creating a “worldbeyond cash.”

Countries where electronic payment is already the norm would be expectedto be among the first places to experiment with a fully cashless society as thetransition would be relatively painless (at least initially). In Norway twomajor banks no longer issue cash from branch offices, and recently thelargest bank, DNB, publicly called for the abolition of cash. In rich countries,the advent of a cashless society could be spun in the media in such a way asto appear progressive, innovative, convenient and advantageous to ordinarypeople. In poor countries, people would have no choice in any case.

Testing and developing the methods in societies with no alternatives andthen tantalizing the inhabitants of richer countries with more of theconvenience to which they have become addicted is the clear path towardsextending the reach of electronic payment systems and the much greaterfinancial control over individuals that they offer:

Bill and Melinda Gates Foundation, in its 2015 annual letter, adds anew twist. The technologies are all in place; it’s just a question ofgetting us to use them so we can all benefit from a crimeless,privacy-free world. What better place to conduct a massive socialexperiment than sub-Saharan Africa, where NGOs and GOs(Government Organizations) are working hand-in-hand with banksand telecom companies to replace cash with mobile moneyalternatives? So the annual letter explains: “(B)ecause there isstrong demand for banking among the poor, and because the poorcan in fact be a profitable customer base, entrepreneurs indeveloping countries are doing exciting work – some of which will“trickle up” to developed countries over time.”

What the Foundation doesn’t mention is that it is heavily investedin many of Africa’s mobile-money initiatives and in 2010 teamed upwith the World Bank to “improve financial data collection” amongAfrica’s poor. One also wonders whether Microsoft might one day

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benefit from the Foundation’s front-line role in mobile money….As aresult of technological advances and generational priorities, cash’sdays may well be numbered. But there is a whole world ofdifference between a natural death and euthanasia. It is now clearthat an extremely powerful, albeit loose, alliance of governments,banks, central banks, start-ups, large corporations, and NGOs aredetermined to pull the plug on cash — not for our benefit, but fortheirs.

Whatever the superficially attractive media spin, joint initiatives like theBetter Than Cash Alliance serve their founders, not the public. This shouldnot come as a surprise, but it probably will as we sleepwalk into giving upvery important freedoms:

As I warned in We Are Sleepwalking Towards a Cashless Society,we (or at least the vast majority of people in the vast majority ofcountries) are willing to entrust government and financialinstitutions — organizations that have already betrayed just aboutevery possible notion of trust — with complete control over ourevery single daily transaction. And all for the sake of a few minorgains in convenience. The price we pay will be what remains of ourindividual freedom and privacy.

Negative Interest Rates and the War on Cash(1)

Sep 042016

September 4, 2016 Posted by Raúl Ilargi Meijer at 1:16 pm Finance Taggedwith: bubble, cash, credit, debt, deflation, liquidity, Nicole Foss, NIRP, Ponzi,risk, ZIRP 7 Responses »

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Irving Underhill City Bank-Farmers Trust Building, William & Beaver streets, NYC 1931

It’s been a while, but Nicole Foss is back at the Automatic Earth -whichmakes me very happy-, and for good measure, she starts out with a very longarticle. So long in fact that we have decided to turn it into a 4-part series, ifonly just to show you that we do care about your health and well-being, aswell as your families and social lives. The other 3 parts will follow in the nextfew days, and at the end we will publish the entire piece in one post.

Here’s Nicole:

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Nicole Foss: As momentum builds in the developing deflationary spiral, weare seeing increasingly desperate measures to keep the global credit ponzischeme from its inevitable conclusion. Credit bubbles are dynamic — theymust grow continually or implode — hence they require ever more money tobe lent into existence. But that in turn requires a plethora of willing and ableborrowers to maintain demand for new credit money, lenders who are not toorisk-averse to make new loans, and (apparently effective) mechanisms fordiluting risk to the point where it can (apparently safely) be ignored. As thepeak of a credit bubble is reached, all these necessary factors first becomeproblematic and then cease to be available at all. Past a certain point, thereare hard limits to financial expansions, and the global economy is set to hitone imminently.

Borrowers are increasingly maxed out and afraid they will not be able toservice existing loans, let alone new ones. Many families already have morethan enough ‘stuff’ for their available storage capacity in any case, and arelooking to downsize and simplify their cluttered lives. Many businesses arealready struggling to sell goods and services, and so are unwilling to borrowin order to expand their activities. Without willingness to borrow, demand fornew loans will fall substantially. As risk factors loom, lenders become farmore risk-averse, often very quickly losing trust in the solvency of of theircounterparties. As we saw in 2008, the transition from embracing riskyprospects to avoiding them like the plague can be very rapid,changing the rules of the game very abruptly.

Mechanisms for spreading risk to the point of ‘dilution to nothingness’, suchas securitization, seen as effective and reliable during monetary expansions,cease to be seen as such as expansion morphs into contraction. Thesecuritized instruments previously created then cease to be perceived asholding value, leading to them being repriced at pennies on the dollar onceprice discovery occurs, and the destruction of that value is highlydeflationary. The continued existence of risk becomes increasingly evident,and the realisation that that risk could be catastrophic begins to dawn.

Natural limits for both borrowing and lending threaten the capacity toprolong the credit boom any further, meaning that even if central authoritiesare prepared to pay almost any price to do so, it ceases to be possible to kickthe can further down the road. Negative interest rates and the war on cashare symptoms of such a limit being reached. As confidence evaporates, sodoes liquidity. This is where we find ourselves at the moment — on the cuspof phase two of the credit crunch, sliding into the same unavoidableconstellation of conditions we saw in 2008, but on a much larger scale.

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From ZIRP to NIRP

Interest rates have remained at extremely low levels, hardly distinguishablefrom zero, for the several years. This zero interest rate policy (ZIRP) is areflection of both the extreme complacency as to risk during the rise into thepeak of a major bubble, and increasingly acute pressure to keep the creditmountain growing through constant stimulation of demand for borrowing.The resulting search for yield in a world of artificially stimulatedover-borrowing has lead to an extraordinary array of malinvestment acrossmany sectors of the real economy. Ever more excess capacity is being built ina world facing a severe retrenchment in aggregate demand. It is this that istermed ‘recovery’, but rather than a recovery, it is a form of double jeopardy— an intensification of previous failed strategies in the hope that a differentoutcome will result. This is, of course, one definition of insanity.

Now that financial crisis conditions are developing again, policies are beingimplemented which amount to an even greater intensification of the oldstrategy. In many locations, notably those perceived to be safe havens, thebenchmark is moving from a zero interest rate policy to a negative interestrate policy (NIRP), initially for bank reserves, but potentially for businessclients (for instance in Holland and the UK). Individual savers would benext in line. Punishing savers, while effectively encouraging banks to lend toweaker, and therefore riskier, borrowers, creates incentives for bothborrowers and lenders to continue the very behaviour that set the stage forfinancial crisis in the first place, while punishing the kind of responsibilitythat might have prevented it.

Risk is relative. During expansionary times, when risk perception is lowalmost across the board (despite actual risk steadily increasing), the riskpremium that interest rates represent shows relatively little variationbetween different lenders, and little volatility. For instance, the interest rateson sovereign bonds across Europe, prior to financial crisis, were low andbroadly similar for many years. In other words, credit spreads were verynarrow during that time. Greece was able to borrow almost as easily andcheaply as Germany, as lenders bet that Europe’s strong economies wouldback the debt of its weaker parties. However, as collective psychology shiftsfrom unity to fragmentation, risk perception increases dramatically, and riskdistinctions of all kinds emerge, with widening credit spreads. We saw thishappen in 2008, and it can be expected to be far more pronounced in thecoming years, with credit spreads widening to record levels. Interest ratedivergences create self-fulfilling prophecies as to relative default risk,against a backdrop of fear-driven high volatility.

Many risk distinctions can be made — government versus private debt, longversus short term, economic centre versus emerging markets, inside theEuropean single currency versus outside, the European centre versus thetroubled periphery, high grade bonds versus junk bonds etc. As the riskdistinctions increase, the interest rate risk premiums diverge. Higher riskborrowers will pay higher premiums, in recognition of the higher default risk,

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but the higher premium raises the actual risk of default, leading to stillhigher premiums in a spiral of positive feedback. Increased risk perceptionthus drives actual risk, and may do so until the weak borrower is driven overthe edge into insolvency. Similarly, borrowers perceived to be relative safehavens benefit from lower risk premiums, which in turn makes their debtburden easier to bear and lowers (or delays) their actual risk of default. Thisreduced risk of default is then reflected in even lower premiums. The riskybecome riskier and the relatively safe become relatively safer (which is notnecessarily to say safe in absolute terms). Perception shapes reality, whichfeeds back into perception in a positive feedback loop.

The process of diverging risk perception is already underway, and it isgenerally the states seen as relatively safe where negative interest rates arebeing proposed or implemented. Negative rates are already in place for bankreserves held with the ECB and in a number of European states from 2012onwards, notably Scandinavia and Switzerland. The desire for capitalpreservation has led to a willingness among those with capital toaccept paying for the privilege of keeping it in ‘safe havens’. Note thatperception of safety and actual safety are not equivalent. States at the peakof a bubble may appear to be at low risk, but in fact the opposite is true. Atthe peak of a bubble, there is nowhere to go but down, as Iceland and Irelanddiscovered in phase one of the financial crisis, and many others will discoveras we move into phase two. For now, however, the perception of low risk issufficient for a flight to safety into negative interest rate environments.

This situation serves a number of short term purposes for the states involved.Negative rates help to control destabilizing financial inflows at times whenfear is increasingly driving large amounts of money across borders. A

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primary objective has been to reduce upward pressure on currencies outsidethe eurozone. The Swiss, Danish and Swedish currencies have all beenexperiencing currency appreciation, hence a desire to use negative interestrates to protect their exchange rate, and therefore the price of their exports,by encouraging foreigners to keep their money elsewhere. The Danishcentral bank’s sole mandate is to control the value of the currency againstthe euro. For a time, Switzerland pegged their currency directly to the euro,but found the cost of doing so to be prohibitive. For them, negative rates area less costly attempt to weaken the currency without the need to defend aformal peg. In a world of competitive, beggar-thy-neighbour currencydevaluations, negative interest rates are seen as a means to achieve ormaintain an export advantage, and evidence of the growing currency war.

Negative rates are also intended to discourage saving and encourage bothspending and investment. If savers must pay a penalty, spending orinvestment should, in theory, become more attractive propositions. Theintention is to lead to more money actively circulating in the economy.Increasing the velocity of money in circulation should, in turn, provide pricesupport in an environment where prices are flat to falling. (Mainstreamcommentators would describe this as as an attempt to increase ‘inflation’, bywhich they mean price increases, to the common target of 2%, but here atThe Automatic Earth, we define inflation and deflation as an increase ordecrease, respectively, in the money supply, not as an increase or decrease inprices.) The goal would be to stave off a scenario of falling prices wherebuyers would have an incentive to defer spending as they wait for lowerprices in the future, starving the economy of circulating currency in themeantime. Expectations of falling prices create further downward pricepressure, leading into a vicious circle of deepening economic depression.Preventing such expectations from taking hold in the first place is a majorpriority for central authorities.

Negative rates in the historical record are symptomatic of times of crisiswhen conventional policies have failed, and as such are rare. Their use is ameasure of desperation:

First, a policy rate likely would be set to a negative value only wheneconomic conditions are so weak that the central bank haspreviously reduced its policy rate to zero. Identifying creditworthyborrowers during such periods is unusually challenging. Howstrongly should banks during such a period be encouraged toexpand lending?

However strongly banks are ‘encouraged’ to lend, willing borrowers andlenders are set to become ‘endangered species’:

The goal of such rates is to force banks to lend their excessreserves. The assumption is that such lending will boost aggregatedemand and help struggling economies recover. Using the samecentral bank logic as in 2008, the solution to a debt problem is toadd on more debt. Yet, there is an old adage: you can bring a horseto water but you cannot make him drink! With the world economy

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sinking into recession, few banks have credit-worthy customers andmany banks are having difficulties collecting on existing loans.Italy’s non-performing loans have gone from about 5 percent in2010 to over 15 percent today. The shale oil bust has left many USbanks with over a trillion dollars of highly risky energy loans ontheir books. The very low interest rate environment in Japan andthe EU has done little to spur demand in an environment full ofmalinvestments and growing government constraints.

Doing more of the same simply elevates the already enormous risk that anew financial crisis is right around the corner:

Banks rely on rates to make returns. As the former Bank ofEngland rate-setter Charlie Bean has written in a recent paper forThe Economic Journal, pension funds will struggle to makeadequate returns, while fund managers will borrow a lot more tomake profits. Mr Bean says: “All of this makes a leveraged ‘searchfor yield’ of the sort that marked the prelude to the crisis morelikely.” This is not comforting but it is highly plausible: barely adecade on from the crash, we may be about to repeat it. This comesfrom tasking central bankers with keeping the world economygrowing, even while governments have cut spending.

Experiences with Negative Interest Rates

The existing low interest rate environment has already caused asset pricebubbles to inflate further, placing assets such as real estate ever morebeyond the reach of ordinary people at the same time as hampering thosesame people attempting to build sufficient savings for a deposit. Negativeinterest rates provide an increased incentive for this to continue. In locationswhere the rates are already negative, the asset bubble effect has worsened.For instance, in Denmark negative interest rates have added considerableimpetus to the housing bubble in Copenhagen, resulting in an ever largerpool over over-leveraged property owners exposed to the risks of a propertyprice collapse and debt default:

Where do you invest your money when rates are below zero? TheDanish experience says equities and the property market. Thebenchmark index of Denmark’s 20 most-traded stocks has soaredmore than 100 percent since the second quarter of 2012, which isjust before the central bank resorted to negative rates. That’s morethan twice the stock-price gains of the Stoxx Europe 600 and DowJones Industrial Average over the period. Danish house prices havejumped so much that Danske Bank A/S, Denmark’s biggest lender,says Copenhagen is fast becoming Scandinavia’s riskiest propertymarket.

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Considering that risky property markets are the norm in Scandinavia,Copenhagen represents an extreme situation:

“Property prices in Copenhagen have risen 40–60 percent since themiddle of 2012, when the central bank first resorted to negativeinterest rates to defend the krone’s peg to the euro.”

This should come as no surprise: recall that there are documentedcases where Danish borrowers are paid to take on debt and buyhouses “In Denmark You Are Now Paid To Take Out AMortgage”, so between rewarding debtors and punishing savers,this outcome is hardly shocking. Yet it is the negative rates thathave made this unprecedented surge in home prices feel relativelybenign on broader price levels, since the source of housing funds isnot savings but cash, usually cash belonging to the bank.

The Swedish property market is similarly reaching for the sky. Like Japan atthe peak of it’s bubble in the late 1980s, Sweden has intergenerationalmortgages, with an average term of 140 years! Recent regulatory attemptsto rein in the ballooning debt by reducing the maximum term to a ‘mere’ 105years have been met with protest:

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Swedish banks were quoted in the local press as opposing themove. “It isn’t good for the finances of households as it will makemortgages more expensive and the terms not as good. And it isn’tgood for financial stability,” the head of Swedish Bankers’Association was reported to say.

Apart from stimulating further leverage in an already over-leveraged market,negative interest rates do not appear to be stimulating actual economicactivity:

If negative rates don’t spur growth — Danish inflation since 2012has been negligible and GDP growth anemic — what are they goodfor?….Danish businesses have barely increased their investments,adding less than 6 percent in the 12 quarters since Denmark’spolicy rate turned negative for the first time. At a growth rate of 5percent over the period, private consumption has been similarlymuted. Why is that? Simply put, a weak economy makes interestrates a less powerful tool than central bankers would like.

“If you’re very busy worrying about the economy and your job, youdon’t care very much what the exact rate is on your car loan,” saysTorsten Slok, Deutsche Bank’s chief international economist in NewYork.

Fuelling inequality and profligacy while punishing responsible behaviouris politically unpopular, and the consequences, when they eventuallymanifest, will be even more so. Unfortunately, at the peak of a bubble, it isonly continued financial irresponsibility that can keep a credit expansiongoing and therefore keep the financial system from abruptly crashing. Theonly things keeping the system ‘running on fumes’ as it currently is, arefinancial sleight-of-hand, disingenuous bribery and outright fraud. The priceto pay is that the systemic risks continue to grow, and with it the scale of theimpacts that can be expected when the risk is eventually realised. Politiciansdesperately wish to avoid those consequences occurring in their term ofoffice, hence they postpone the inevitable at any cost for as long as physicallypossible.

The Zero Lower Bound and the Problem of Physical Cash

Central bankers attempting to stimulate the circulation of money in theeconomy through the use of negative interest rates have a number ofproblems. For starters, setting a low official rate does not necessarily meanthat low rates will prevail in the economy, particularly in times of crisis:

The experience of the global financial crisis taught us that the typeof shocks which can drive policy interest rates to the lower boundare also shocks which produce severe impairments to the monetary

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policy transmission mechanism. Suppose, for example, that theinterbank market freezes and prevents a smooth transmission ofthe policy interest rate throughout the banking sector and financialmarkets at large. In this case, any cut in the policy rate may bealmost completely ineffective in terms of influencing themacroeconomy and prices.

This is exactly what we saw in 2008, when interbank lending seized up due tothe collapse of confidence in the banking sector. We have not seen thishappen again yet, but it inevitably will as crisis conditions resume, and whenit does it will illustrate vividly the limits of central bank power to controlfinancial parameters. At that point, interest rates are very likely to spike inpractice, with banks not trusting each other to repay even very short termloans, since they know what toxic debt is on their own books and rationallyassume their potential counterparties are no better. Widening credit spreadswould also lead to much higher rates on any debt perceived to be risky,which, increasingly, would be all debt with the exception of governmentbonds in the jurisdictions perceived to be safest. Low rates on high gradedebt would not translate into low rates economy-wide. Given the extent ofprivate debt, and the consequent vulnerability to higher interest rates acrossthe developed world, an interest rate spike following the NIRP period wouldbe financially devastating.

The major issue with negative rates in the shorter term is the ability toescape from the banking system into physical cash. Instead of causing peopleto spend, a penalty on holding savings in a banks creates an incentive forthem to withdraw their funds and hold cash under their own control, therebyavoiding both the penalty and the increasing risk associated with thebanking system:

Western banking systems are highly illiquid, meaning that theyhave very low cash equivalents as a percentage of customerdeposits….Solvency in many Western banking systems is alsohighly questionable, with many loaded up on the debts of theirbankrupt governments. Banks also play clever accounting games tohide the true nature of their capital inadequacy. We live in a worldwhere questionably solvent, highly illiquid banks are backed byunder capitalized insurance funds like the FDIC, which in turn arebacked by insolvent governments and borderline insolvent centralbanks. This is hardly a risk-free proposition. Yet your reward fortaking the risk of holding your money in a precarious bankingsystem is a rate of return that is substantially lower than theofficial rate of inflation.

In other words, negative rates encourage an arbitrage situation favouringcash. In an environment of few good investment opportunities, increasingrecognition of risk and a rising level of fear, a desire for large scale cashwithdrawal is highly plausible:

From a portfolio choice perspective, cash is, under normalcircumstances, a strictly dominated asset, because it is subject to

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the same inflation risk as bonds but, in contrast to bonds, it yieldszero return. It has also long been known that this relationshipwould be reversed if the return on bonds were negative. In thatcase, an investor would be certain of earning a profit by borrowingat negative rates and investing the proceedings in cash. Ignoringstorage and transportation costs, there is therefore a zero lowerbound (ZLB) on nominal interest rates.

Zero is the lower bound for nominal interest rates if one would want to avoidcreating such an incentive structure, but in a contractionary environment,zero is not low enough to make borrowing and lending attractive. This isbecause, while the nominal rate might be zero, the real rate (the nominalrate minus negative inflation) can remain high, or perhaps very high,depending on how contractionary the financial landscape becomes. AsKeynes observed, attempting to stimulate demand for money by loweringinterest rates amounts to ‘pushing on a piece of string‘. Centralauthorities find themselves caught in the liquidity trap, where monetarypolicy ceases to be effective:

Many big economies are now experiencing ‘deflation’, where pricesare falling. In the euro zone, for instance, the main interest rate isat 0.05% but the “real” (or adjusted for inflation) interest rate isconsiderably higher, at 0.65%, because euro-area inflation hasdropped into negative territory at -0.6%. If deflation gets worsethen real interest rates will rise even more, choking off recoveryrather than giving it a lift.

If nominal rates are sufficiently negative to compensate for thecontractionary environment, real rates could, in theory, be low enough tostimulate the velocity of money, but the more negative the nominal rate, thegreater the incentive to withdraw physical cash. Hoarded cash would reduce,instead of increase, the velocity of money. In practice, lowering rates can bemoderately reflationary, provided there remains sufficient economicoptimism for people to see the move in a positive light. However, sendingrates into negative territory at a time pessimism is dominant can easily beinterpreted as a sign of desperation, and therefore as confirmation of anegative outlook. Under such circumstances, the incentives to regard thebanking system as risky, to withdraw physical cash and to hoard it for a rainyday increase substantially. Not only does the money supply fail to grow, asnew loans are not made, but the velocity of money falls as money ishoarded, thereby aggravating a deflationary spiral:

A decline in the velocity of money increases deflationary pressure.Each dollar (or yen or euro) generates less and less economicactivity, so policymakers must pump more money into the system togenerate growth. As consumers watch prices decline, they deferpurchases, reducing consumption and slowing growth. Deflationalso lifts real interest rates, which drives currency values higher. Intoday’s mercantilist, beggar-thy-neighbour world of global trade, astrong currency is a headwind to exports. Obviously, this is not thedesired outcome of policymakers. But as central banks grasp for

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new, stimulative tools, they end up pushing on an ever-lengtheningpiece of string.

Japan has been in the economic doldrums, with pessimism dominant, for over25 years, and the population has become highly sceptical of stimulationmeasures intended to lead to recovery. The negative interest ratesintroduced there (described as ‘economic kamikaze’) have had a verydifferent effect than in Scandinavia, which is still more or less at the peak ofits bubble and therefore much more optimistic. Unfortunately, loweringinterest rates in times of collective pessimism has a poor record of acting toincrease spending and stimulate the economy, as Japan has discovered sincetheir bubble burst in 1989:

For about a quarter of a century the Japanese have proved to befanatical savers, and no matter how low the Bank of Japan cutsrates, they simply cannot be persuaded to spend their money, oreven invest it in the stock market. They fear losing their jobs; theyfear a further fall in shares or property values; they have noconfidence in the investment opportunities in front of them. Sopathological has this psychology grown that they wouldrather see the value of their savings fall than spend the cash.That draining of confidence after the collapse of the 1980s“bubble” economy has depressed Japanese growth for decades.

Fear is a very sharp driver of behaviour — easily capable of over-riding

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incentives designed to promote spending and investment:

When people are fearful they tend to save; and when they becomeespecially fearful then they save even more, even if the returns ontheir savings are extremely low. Much the same goes forbusinesses, and there are increasing reports of them “hoarding”their profits rather than reinvesting them in their business, such isthe great “uncertainty” around the world economy. Brexit obviouslyonly added to the fears and misgivings about the future.

Deflation is so difficult to overcome precisely because of its strongpsychological component. When the balance of collective psychology tipsfrom optimism, hope and greed to pessimism and fear, everything isperceived differently. Measures intended to restore confidence end up beinginterpreted as desperation, and therefore get little or no traction. As suchinitiatives fail, their failure becomes conformation of a negative bias, whichincreases the power of that bias, causing more stimulus initiatives to fail. Theresulting positive feedback loop creates and maintains a vicious circle, botheconomically and socially:

There is a strong argument that when rates go negative it squeezesthe speed at which money circulates through the economy,commonly referred to by economists as the velocity of money. Weare already seeing this happen in Japan where citizens areclamouring for ¥10,000 bills (and home safes to store them in).People are taking their money out of the banking system to stuff itunder their metaphorical mattresses. This may sound extreme, butwhether paper money is stashed in home safes or moved intotransaction substitutes or other stores of value like gold, the pointis it’s not circulating in the economy. The empirical data supportthis view — the velocity of money has declined precipitously aspolicymakers have moved aggressively to reduce rates.

Physical cash under one’s own control is increasingly seen as one of theprimary escape routes for ordinary people fearing the resumption of the2008 liquidity crunch, and its popularity as a store of value is increasingsteadily, with demand for cash rising more rapidly than GDP in a widerange of countries:

While cash’s use is in continual decline, claims that it is set todisappear entirely may be premature, according to the Bank ofEngland….The Bank estimates that 21pc to 27pc of everydaytransactions last year were in cash, down from between 34pc and45pc at the turn of the millennium. Yet simultaneously the demandfor banknotes has risen faster than the total amount of spending inthe economy, a trend that has only become more pronounced sincethe mid-1990s. The same phenomenon has been seeninternationally, in the US, eurozone, Australia and Canada….

….The prevalence of hoarding has also firmed up the demand forphysical money. Hoarders are those who “choose to save their

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money in a safety deposit box, or under the mattress, or evenburied in the garden, rather than placing it in a bank account”, theBank said. At a time when savings rates have not turned negative,and deposits are guaranteed by the government, this kind ofactivity seems to defy economic theory. “For such action to beconsidered as rational, those that are hoarding cash must begaining a non-financial benefit,” the Bank said. And that benefitmust exceed the returns and security offered by putting thathoarded cash in a bank deposit account. A Bank survey conductedlast year found that 18pc of people said they hoarded cash largely“to provide comfort against potential emergencies”.

This would suggest that a minimum of £3bn is hoarded in the UK,or around £345 a person. A government survey conducted in 2012suggested that the total number might be higher, at £5bn….

…..But Bank staff believe that its survey results understate theextent of hoarding, as “the sensitivity of the subject” most likelyaffects the truthfulness of hoarders. “Based on anecdotal evidence,a small number of people are thought to hoard large values ofcash.” The Bank said: “As an illustrative example, if one in everythousand adults in the United Kingdom were to hoard as much as£100,000, this would account for around £5bn — nearly 10pc ofnotes in circulation.” While there may be newer and moreconvenient methods of payment available, this strong preferencefor cash as a safety net means that it is likely to endure, unlesssteps are taken to discourage its use.

src: https://www.theautomaticearth.com/2016/09/negative-interest-rates-and-the-war-on-cash-full-article/

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