Saturday, December 31, 2016

The Curse of Cash – Book Review

This book toys with a revolutionary idea that has so far been limited to sporadic economic papers and journals. As we speak, India a country of 1.2 billion claims to have been one of the first such partial experiments in this direction (why partial – we will come on to this later).

Kenneth Rogoff first espoused this idea around 20 years ago in his paper. Over the period of years, he seems to have gained much deeper insight in the penetration of cash in the system while serving as Chief Economist of The International Monetary Fund and various other roles. This book seems to be an attempt by him to share all the detailed reasons.

He has taken special care to point out that he advocates less cash (doing away with higher denomination bills) and NOT cash-less. There’s a subtle difference between the two terms but a vast difference in the world in which they will lead into. His arguments are set in the US, an advanced economy which in his assessment is perfectly placed to usher in such a bold “economic reform”.

In 2016, the IRS estimated around $458 billion was lost due to tax evasion. And much of it is contributed by higher denomination USD bills ($100 being the highest in present day). USD is undoubtedly the most valued currency in the world with various governments holding reserves it not to mention the drug lords and the underground economy.
  • The amount of USD floating around in the world can be gauged by the fact that – for every US citizen there is $4200 present.
  • Translating in terms of $100 bills alone it means that every US citizen should be holding 34 USD 100 bills at any given time.

But the reality is quite different. And it is because most of it resides in the illegal underground economy. Rogoff argues for a gradual abolition (over one or two decades) of USD 100 bills to the point only USD 5 bills and coins are legal tender. Although, he warns that it does not guarantee going away of crime and illegal activity but even the slightest gain in tax revenue will allow government some room for tax cuts. Another key thing is that many employers pay employees in cash to skirt employment regulations and avoid making contributions like Social Security (EPF in India). Abolishing cash

Now there are some side-effects to abolishing cash which the book talks about. One key thing is privacy. Why the govt or for that matter anyone know on what does a person spend on. Electronic transactions are going to leave a trail unlike cash transactions which are anonymous. Leaving lower denomination notes in practice can possibly take care of such private transactions.

Another key reason for adopting a less-cash society would be the ability to introduce negative interest rates which will ultimately provide abundant room to Central Bankers to maneuver in times of financial crisis.
[Now understandably, this is an area which people world over dare not ponder about. It was the same for me but on giving some effort I realized it is not hard to understand. So much for financial literacy!]

Presently, the interest rates are zero bound i.e cannot fall below zero. And then there’s the sacred rule of

Real term interest rate = Nominal Interest Rate – Rate of Inflation

In 2008, with advanced economies like US having less rate of inflation the room to cut interest rates was pretty much restricted considering the US Fed had set a target rate of inflation as 2%.
With a less-cash society the Central Bankers can set interest rates to negative which basically means that you need to pay the bank to hold your deposit. And with higher denomination notes already abolished, hoarding cash has a lot of cost (storage, security etc) so practically infeasible. Negative interest rates will turbocharge the economy out of deflationary recession.

It sounds a better instrument than Quantitative Easing (QE) or tremendous amounts of government spending to simulate the economy. Now keep in mind that the debate is still out over whether the three tranches of QE actually did good.
[Here is a really famous video I came across as I tried to get my head around QE]

The author acknowledges that negative interest rates might give rise to strange situations like for example in case of a bond holder – the borrower needs to pay the lender. Legal and administrative issues can arise but they can be handled as the payments due can be deducted from the principal in this case.

Overall, it might sound weird or even scary but some countries like Japan, Denmark, Sweden and Switzerland have already tip-toed into that territory. In theory, negative interest rates sound promising as a monetary tool is what Ken Rogoff seems to say.

There’s one interesting alternative to negative interest rates shared in the book from the academic economic circles – the two currency system.

It calls for identifying as paper currency and currency in electronic form in banking system as two different. And it calls for an exchange rate when a person goes to the bank to deposit his paper currency which will ultimately be recorded in the banking system as an electronic form. This will give rise to three monetary instruments which the Central Bankers can then play with –

i.               Interest rates on electronic currency
ii.             Exchange rate b/w Electronic and Paper Currency
iii.            Forward (future) exchange rate

As these days the chatter increases about digital or crypto-currencies, Rogoff is of the view that these innovations are admirable but these currencies are at a major disadvantage as the govt. has tremendous power at its disposal to impose its will over them. But eventually, the technology like public ledger will be adopted.


Ken Rogoff is very clear that the method to abolish high denomination currency and move towards electronic transactions has to be adopted ONLY by developed economies. Even for a country like US (with solid infrastructure and less than 5% of unbanked population) he proposes a gradual transition period of 1 or 2 decades!

He very clearly says for emerging economies the dangers and costs are simply too high. Financial inclusion and infrastructure are key problems. He mentioned the challenges in India explicitly as well in Chapter 13]

Secondly, Rogoff's principle works only when you take out the higher denomination notes and leave behind only lower denomination notes. What happened in India is a 180 degree - the highest denomination note was abolished and then a currency bill even higher was introduced. So much for less-cash?!

P.S – 
I had the fortune to meet Kenneth Rogoff and listen to his talk. :-)
While reading the book I had to look up the Web as there were lot of terms I didn’t know. Sharing some useful terms/links –

Seigniorage = Govt. revenue from manufacture of coins calculated as difference between the face value and metal value of coins.