Even to many non-economists, Kenneth Rogoff became a household name in the years of the financial crisis. That was not least thanks to his book This time is different (co-authored with Carmen Reinhart), which chronicled centuries of sovereign defaults. It was the book that reminded us that when it comes to financial folly, mankind never seems to learn from past mistakes.
Last week, Rogoff made headlines again. This time, however, with a new mistake of his own. At a guest lecture delivered to the University of Munich, the Harvard economist and former chief economist of the International Monetary Fund made a radical proposal: abolish cash.
Doing so, Rogoff argued, would at once solve all sorts of different problems. It would deal with illicit transactions, prevent tax evasion — and it would allow central banks to more effectively introduce negative interest rates.
For Rogoff’s German audience this must have sounded rather alarming. A few weeks ago, the smallish Skatbank was the first bank to introduce negative interest rates for depositors (Taking a gamble with negative interest rates, November 6). And only last week Commerzbank AG, Germany’s second-largest bank, announced it would do the same for its business customers.
For all customers worried about being hit by negative interest rates, so far there is at least a way out of punitive fees: to withdraw their money and put it under a mattress. The wealthier you are, of course, the bigger your mattress has to be.
Mattresses aside, it is not very practical or convenient let alone safe to bunker your cash at home. But if the alternative is to lose a substantial part of it in depositor’s fees (i.e. negative interest rates), then this would probably trigger savers to withdraw money from their bank accounts and hold it in cash instead.
The cash alternative, therefore, is the main obstacle to the widespread introduction of negative interest rates. This is also why Rogoff believes cash’s time is up and we should all move towards a cashless, electronic banking future.
In Rogoff’s world without coins and notes, monetary policy would be more potent than ever. Whereas nowadays all that central banks can do is to set varying degrees of positive interest rates with an underlying floor of zero, in a no-cash world negative interest rates could easily be passed on to everyone simply because there would no longer be a way out. A central bank setting cash rates at, say, -4 per cent would then directly affect every bank customer’s deposits. Except the very term ‘cash’ rate would be somewhat misleading in the absence of cash.
Rogoff, of course, has a point when he notes that there may be some positive side effects to the end of cash. It would undoubtedly make it harder to process the proceeds of drug trafficking, dry out some black markets and probably also reduce the opportunities for tax evasion. But then again, all of this may be wishful thinking.
Even if cash were no longer available to channel illegal transactions, it may not not necessarily stop them. Where cash exchanges are difficult or impossible, history shows that people are creative in defining new forms of money to let them do what they want. Someone as familiar with economic history as Kenneth Rogoff should be aware of such evasive manoeuvres.
For example, during the monetary chaos in Germany after World War II, cigarettes became a convenient alternative currency since cash could no longer be trusted. In the total absence of cash, such alternative forms of money could once again become popular. Barter trades could be as well. However, both alternatives to conventional cash would actually be an evolutionary step backwards since the great achievement of cash was to simplify the act of payment and increase the scope of transactions.
The real problem with Rogoff’s proposal, however, is more fundamental. As desirable as negative interest rates may be from a central planner’s — sorry, central banker’s perspective — they are contrary to what interest rates are usually meant to reflect.
The fundamental reason why interest rates are positive is because we value things in the future less than we value things we already possess today. In order to sacrifice present enjoyment for future holdings, we want to be compensated. That compensation is called interest. Once interest rates are negative, it turns this evolutionary certainty around but ends us up in an absurdity. With negative interest rates in place, there is no longer a reason to hold back any present-day consumption but to spend, spend and spend now because, in a way, there is no tomorrow.
In a world in which negative interest is the norm, why would anyone still save? Why defer consumption only so that others can invest your savings in order to realise an easy profit?
Conversely, without positive interest rates, how would markets differentiate between good and bad investments? Markets usually allocate capital by their expected yields. When interest rates are low or negative, even bad investments suddenly look profitable.
However, in this way we would misallocate capital to projects that should have never been undertaken. Imagine savers would face interest rates of -10 per cent, then suddenly even an investment yielding a 5 per cent loss would look like a good alternative. It would still destroy value. But maybe that’s the intention?
Cash may not be needed to run our economy’s everyday transactions — they are mainly electronic anyway. But cash is needed as the most effective way to prevent dangerous experiments with negative interest rates. It stops central banks from using us as guinea pigs in their questionable attempts to stimulate demand through punishing savings.
There is another reason, still, why we should be wary of attempts to get rid of cash, despite all well-meaning rhetoric about drugs profits, money laundering and tax fraud.
Though we may no longer conduct the majority of our business transactions in cash, it is reassuring to know that there is a more anonymous alternative: one that government cannot track. If cash were to be abolished, government could theoretically keep a record of everything we do as we leave electronic traces with every transaction. In a world of widespread surveillance activities by a myriad of government agencies, you may appreciate those few remaining areas in which our lives cannot be monitored.
Rogoff may be a good economist but he ignores something quite fundamental about the role of money. Cash may no longer be king, but it is a little piece of freedom we carry in our wallets.