The fallacy of banning cash

Mutually beneficial exchange is the central element of economic freedom, and it extends to the right to choose a preferred medium of exchange. For centuries, this right was under constant assault – a fact easily forgotten now that national fiat currencies dominate world commerce.  Even most monetary economists now just assume that economic progress requires government provision of money.

So it is not too surprising that several prominent academics recently argued that our basic government monopoly on money does not go far enough.1 They believe that people should no longer have the right to choose even what form of national currency they use. In particular, they want to outlaw cash so that people can only transact electronically.

The anti-cash crusaders offer various reasons for banning cash, but they all share a common distrust of free markets and a desire to give bureaucrats more control over people. The latest rationale deals with monetary policy and the even more obscure topic of negative interest rates.

Negative interest rates on deposits are effectively a penalty for holding cash in a bank account.  Rather than being paid to save money (positive interest rates), people are charged a fee (a negative rate) to keep money in their account.

Naturally, people faced with high enough negative interest rates would withdraw their money and keep their cash at home.

Generally speaking, there’s no problem here because banks would eventually have to raise interest rates to induce their customers to come back. That’s how markets work.

But too many policymakers view this process as something that needs to be managed, regardless of whether bad government policies contributed to the outcome in the first place.

Instead of letting people save and spend as they see fit, advocates of managing the economy want the central bank to boost consumer spending. Supporters of such policies face a major difficulty in a low or negative interest rate environment: If consumers withdraw cash and keep it under their mattress, consumer spending falls no matter how big the penalty, i.e., how negative the interest rate, for keeping an idle bank balance.

Put differently, holding onto cash provides a way for consumers to avoid the penalty of negative interest rates. So the anti-cash crowd’s solution is to turn banks into foolproof devices that prevent consumers from avoiding this penalty.

For the purpose of managing the economy, government officials can directly assess any penalty they desire if consumption is “too low.” If consumers can use only electronic money, then the government can always assess a penalty for not spending enough.

Think of it as the financial version of the Obamacare mandate. You will be required to do a certain amount of shopping, and if you don’t, the government will fine you by taking your money right out of the bank.

Nobody should be too surprised at this policy push, because it is the logical conclusion of the Keynesian-style policies that have dominated governments for most of the last century. Freeing markets from government meddling and regulation is commonly sneered at as “doing nothing,” while policy debates focus instead on the best way for bureaucracies to implement solutions.

For instance, in 2014, Harvard’s Kenneth Rogoff wrote: “It is precisely the existence of paper currency that makes it difficult for central banks to take policy interest rates much below zero, a limitation that seems to have become increasingly relevant during this century. The low overall level, combined with the zero bound, means that central banks cannot cut interest rates nearly as much as they might like in response to large deflationary shocks.”2

Rogoff is hardly alone. Many policymakers have so little faith in free enterprise that they automatically equate the central bank’s interest with the public interest. Even setting that debate aside, though, advocates of outlawing cash are putting entirely too much faith in monetary policy.

If central banks could simply make interest rates whatever they desire, to achieve whatever economic outcome we need, why are rates so low in the first place?  The truth is that a central bank does not “set interest rates” in a developed economy.

Yes, people commonly refer to the Federal Reserve and other central banks as having raised or lowered interest rates. But such statements are much too strong, and academic economists should know better.

A central bank can certainly influence interest rates, but that’s a far cry from setting, or controlling, them.

The rate a central bank has the most influence over is its own short-term policy target rate. For the Fed, that rate is known as the federal funds rates: the overnight rate private banks charge each other to borrow reserves. The term “federal” seems to have contributed to the misperception that the Fed sets the rate, but it simply does not do so.

While it is referred to as the federal funds rate, the target rate is actually an average of the rates banks charge each other in this inter-bank lending market. Banks set the rates based on market conditions they face, and there is considerable variability in these rates. Not surprisingly, the Fed regularly misses its target.

While it may seem unbelievable, given the conventional news coverage of the Fed’s rate decisions, the evidence actually shows that the Fed tends to move its target in response to market movements. It is generally not the other way around.3

In other words, the Fed does not even “take” its policy rate anywhere. Other rates take the Fed’s policy rate up or down.

Even ignoring the micro side of the federal funds market, there’s little reason to think the Fed can simply make “interest rates” whatever it wants them to be.

The Fed is but one tiny player in the world capital market, and the empirical link between the Fed’s actions and other market rates has always been, at best, tenuous.

Aside from the fact that central banks don’t really “cut interest rates,” they can always perform their main job – ensuring market-wide liquidity – regardless of whether interest rates are close to the zero lower bound. So the so-called zero-lower bound is a weak justification for outlawing cash.

I seriously doubt, though, that any of this really matters to those who advocate banning cash. Even those economists focused on the zero-lower-bound argument against cash simultaneously highlight the usual objections to the cash economy.

For instance, Rogoff concludes his article as follows: “Nevertheless, given the role of paper currency (especially large-denomination notes) in facilitating tax evasion and illegal activity, and given the persistent and perhaps recurring problem of the zero bound on nominal interest rates, it is appropriate to consider the costs and benefits to a more proactive strategy for phasing out the use of paper currency.”4

Some version of the “cash facilitates tax evasion/drug cartels/terrorism/illegal activity” argument appears in virtually all calls to ban cash, and it is certainly not exclusive to U.S. economists. In February, for example, the German finance ministry proposed a ban on cash payments of more than €5,000 to combat “money laundering and the financing of terrorism.”5

There’s undoubtedly a strong public interest in preventing terrorist attacks and prosecuting fraudulent behavior, but there’s an equally strong public interest in protecting law-abiding citizens’ personal and financial privacy. There’s no reason these factors can’t be properly balanced without banning cash and forcing all citizens to use only one form of money.

Virtually no U.S. banker would object to, for example, providing legitimate criminal suspects’ transaction records to authorities. There’s no need to criminalize cash itself to prosecute someone engaged in criminal activity, or to ignore law-abiding citizens’ right to personal and financial privacy.

Free societies should preclude unwarranted government meddling in the private domain, and the Bill of Rights to the U.S. Constitution, together with structural federalism and separation of powers protections, is designed to further that end by protecting individual rights.

Unfortunately, however, our current financial regulatory framework, even without the ban on cash, comes awfully close to ignoring the spirit, if not necessarily the letter of, those key constitutional safeguards.

Many of the existing U.S. rules have their genesis in the Bank Secrecy Act (BSA) of 1970. The BSA was aimed at deterring foreign banks from laundering criminal proceeds and helping people evade federal income taxes.6

Later, the Money Laundering Control Act of 1986, an explicit component of the federal war on drugs and organized crime, expanded the use of the BSA rules. Then, in the wake of the 9/11 terrorist attacks, the USA PATRIOT Act expanded and levied more rules on a larger list of financial institutions.

The BSA gave banks an affirmative duty to report to the Department of the Treasury cash transactions of more than $10,000, and it criminalized the failure to report such transactions. The threshold has never been adjusted for inflation, and in 2015 dollars it represents more than $60,000.

Formally, the $10,000 threshold applies to cash transaction reports (CTRs), but the regulations go well beyond CTRs.7 And they don’t simply apply to banks.

Casinos, for instance, have a $5,000 threshold for filing suspicious activity reports (SARs).  Furthermore, some U.S. states have extended federal rules and have given casinos a $3,000 multiple transaction log (MTL) threshold. And it’s not just banks and casinos.

The rules apply to all financial institutions, a term which isn’t narrowly defined. Other than banks, casinos, and government agencies, the U.S. Code now identifies 15 classes of firms as financial institutions. The types of businesses that fall under these rules range from car dealers and pawnbrokers to securities dealers.8

Banks and firms that directly transmit money face some of the highest compliance costs, particularly with extensive know-your-customer rules. Regardless, the rules have been designed so that essentially no firm transmitting money can do so without knowing a great deal of information about its customers.

Even though this framework has been in place for decades, it is still far from clear how well the existing rules have worked. According to one in-depth analysis, “[money-laundering controls] are worthy of a serious research effort that they have not yet received.”9 At the very least, policymakers should establish the effectiveness of the existing framework before going even further by completely banning cash.

Stopping criminal and terrorist activity is certainly a laudable goal, but regulatory agencies have enough data to do more than theorize about what they’ve been doing to stop it. Has forcing banks and money transmitters to collect reams of customer information and file millions of reports on perfectly legal transactions helped diminish crime?

It is at least plausible that law enforcement officials could better spend their time focusing on predicate crimes than poring over millions of legal CTR, SAR, and MTL reports. After all, most people transacting through the U.S. banking system are not criminals.

It is also possible that the existing rules have pushed some law-abiding people out of the mainstream financial world, precisely because they do not want to report so much personal information to banks.

One recent study reported: “More than a third of the households in the Albuquerque [N.M.] metro area do little or no mainstream banking.”10 A 2013 Federal Deposit Insurance Corporation (FDIC) study reported that almost 8 percent of all U.S. households were unbanked in 2013. This figure represents almost 10 million households across the U.S.11

Naturally, most of these unbanked consumers use cash for many of their transactions, but it’s not only unbanked customers using cash. A recent Federal Reserve study reports: “Cash plays a dominant role for small-value transactions, is the leading payment instrument for many types of purchases, and stands as the key alternative when other options are not available. In certain cases, including that of mostly lower-income consumers who lack access to alternative payment options or find them too costly or difficult to obtain, cash is also used for relatively larger-value transactions.”12

There’s been very little talk of how banning cash could disproportionately harm people in lower-income groups, but these types of distributional impacts really shouldn’t matter. In a free society, law-abiding citizens should be able to use cash without being labeled as criminals.

Furthermore, while criminals should be prosecuted for illegal activity, we should not criminalize legitimate economic activity to make that possible. Doing so implies the government can criminalize any sort of activity in the name of keeping people safe, and this sort of “safety” can be defined so broadly that it threatens all sorts of basic freedoms.

Is it really out of the realm of possibility, for example, that the government would prevent someone with high blood pressure from ordering a pizza? Perhaps, but policymakers have been discussing remedies for so-called problems in financial markets that, until the last few years, would have been scoffed at by any serious observer.

We now have prominent academics advocating policies such as ending deposit banking as we know it and shutting down both the Eurodollar market and the money market mutual fund industry.13 These proposals are being justified as necessary to maintain financial stability, and few people are even debating whether a large financial firm’s bankruptcy would actually cause a recession.

Even though such an outcome is far from certain, very serious policymakers are contemplating shutting down markets where millions of people invest their money, just in case it might prevent a recession. And there’s even less talk of holding politicians accountable for bailing out financial firms’ creditors, or for implementing the policies that contributed to previous crises in the first place. The anti-cash crowd is using similar logic.

Rather than hold criminals directly responsible for their illegal activity, they would ban cash so that millions of law-abiding citizens can no longer transact with the type of money they choose.  And rather than fix the government policies that create ultra-low interest rates, they urge us to implement new polices so that government bureaucrats can push interest rates even lower.  Never mind that the so-called stimulus policies of the past did not produce a high-growth economy.

Banning cash is an extreme action that would leave all people wholly dependent on a government-regulated – some would say government-controlled – electronic network. It would endanger law-abiding citizens’ privacy and subject them to the whims of both elected and unelected government officials.

Policymakers should pause and redirect their efforts at the source of the real economic problems and criminal activity.

 

ENDNOTES

  1. See Lorcan Roche Kelly, “Citi Economist Says It Might Be Time to Abolish Cash,” Bloomberg, April 10, 2015, http://www.bloomberg.com/news/articles/2015-04-10/citi-economist-says-it-might-be-time-to-abolish-cash  (accessed May 12, 2016).
  2. Kenneth Rogoff, “Costs And Benefits To Phasing Out Paper Currency,” NBER Working Paper No. 20126, May 2014, http://www.nber.org/papers/w20126 (accessed May 12, 2016).
  3. For an overview see Norbert J. Michel, “Fascination with Interest Rates Hides the Fed’s Policy Blunders,” Heritage Foundation Issue Brief No. 4500, December 15, 2015, http://www.heritage.org/research/reports/2015/12/fascination-with-interest-rates-hides-the-feds-policy-blunders; and Norbert J. Michel, “Why You’d Be Wrong in Thinking the Fed Just Raised Interest Rates,” The Daily Signal, December 16, 2015, http://dailysignal.com/2015/12/16/why-youd-be-wrong-in-thinking-the-fed-just-raised-interest-rates/ (accessed May 13, 2016).
  4. Rogoff, “Costs And Benefits To Phasing Out Paper Currency,” Pg. 12.
  5. Philip Oltermann, “German Plan To Impose Limit On Cash Transactions Met With Fierce Resistance,” The Guardian, February 8, 2016, http://www.theguardian.com/world/2016/feb/08/german-plan-prohibit-large-5000-cash-transactions-fierce-resistance (accessed May 13, 2016).
  6. Michael Levi and Peter Reuter, “Money Laundering,” in Crime and Justice: A Review of Research, Vol. 34, ed. by M. Tony (Chicago: University of Chicago Press, 2006), pp. 289–375.
  7. The U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN), the agency that enforces U.S. anti–money laundering laws and know-your-customer rules, also has the discretion to lower the cash transaction thresholds; it has done so on several occasions. See news release, “FinCEN Targets Money Laundering Infrastructure with Geographic Targeting Order in Miami,” FinCEN, April 21, 2015, http://www.fincen.gov/news_room/nr/html/20150421.html (accessed May 5, 2015). Also see American Gaming Association, “Best Practices for Anti-Money Laundering Compliance,” December 2014, http://www.americangaming.org/sites/default/files/aga-best-practices-re-aml-compliance-122014.pdf (accessed May 5, 2015).
  8. The code also defines a financial institution as “any other business designated by the [Treasury] Secretary whose cash transactions have a high degree of usefulness in criminal, tax, or regulatory matters.”  See 31 U.S. Code § 5312(a)(2)(z).
  9. Michael Levi and Peter Reuter, “Money Laundering,” in Crime and Justice: A Review of Research, Vol. 34, ed. by M. Tony (Chicago: University of Chicago Press, 2006), pp. 289–375
  10. Richard Metcalf, “‘Unbanking’ Fuels Financial Fallout,” Albuquerque Journal, September 7th, 2015, http://www.abqjournal.com/640346/fuels-financial-fallout.html (accessed May 13, 2016).
  11. See “2013 FDIC National Survey of Unbanked and Underbanked Households,” FDIC, October 2014, https://www.fdic.gov/householdsurvey/ (accessed May 13, 2016).
  12. See Barbara Bennett, Douglas Conover, Shaun O’Brien, and Ross Advincula, “Cash Continues to Play a Key Role in Consumer Spending: Evidence from the Diary of Consumer Payment Choice,” Federal Reserve Bank of San Francisco, April 2014, http://www.frbsf.org/cash/files/FedNotes_Evidence_from_DCPC.pdf (accessed August 4, 2015).
  13. See, for example, Morgan Ricks, “A Simpler Approach to Financial Reform,” Regulation, Winter 2013/2014, http://object.cato.org/sites/cato.org/files/serials/files/regulation/2014/1/regulation-v36n4-8.pdf (accessed May 22, 2016).
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Norbert Michel
Expert on Financial Regulation, The Heritage Foundation

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