Ken would like to get rid of paper currency in favor of all electronic transactions. I'm a big fan of low-cost electronic transactions using interest-paying electronic money. But I'm not ready to give up cash.
Ken has two basic points: The zero bound, and tax evasion / illegal economy.
Many economists would like the Federal Reserve to be able to set a negative interest rate target, as a way to further "stimulus."
The conventional answer is that this is impossible because of currency. As long as you--and more importantly, banks -- can hold cash, which pays a zero interest rate, the Fed can't impose a negative interest rate on bonds. In reality, holding cash is expensive, even for banks, so we can and do see slightly negative interest rates on occasion. But more than -0.5% or so would be hard to sustain.
This has led to a number of creative proposals, which Ken summarizes
Willem Buiter.. has discussed ... devices for paying negative interest rates on currency... stamp taxes... (currency would remain valid only if it were regularly stamped to reflect tax payment). ... Mankiw (2009) points out that the central bank could effectively tax currency by holding lotteries based on serial numbers, and making the “winners” worthless.Ken goes on to the ultimate version of this idea: get rid of cash all together and move entirely to electronic transactions.
Let's leave aside the (dubious, in my view) claim that negative nominal interest rates are the vital cure for our ailing economies, and just focus on the question whether eliminating currency will allow it.
So, quiz question for your economic classes: Suppose we have substantially negative interest rates -- -5% or -10%, say, and lasting a while. But there is no currency. How else can you ensure yourself a zero riskless nominal return?
Here are the ones I can think of:
- Prepay taxes. The IRS allows you to pay as much as you want now, against future taxes.
- Gift cards. At a negative 10% rate, I can invest in about $10,000 of Peets' coffee cards alone. There is now apparently a hot secondary market in gift cards, so large values and resale could take off.
- Likewise, stored value cards, subway cards, stamps. Subway cards are anonymous so you could resell them.
- Prepay bills. Send $10,000 to the gas company, electric company, phone company.
- Prepay rent or mortgage payments.
- Businesses: prepay suppliers and leases. Prepay wages, or at least pre-fund benefits that workers must stay employed to earn.
Now in each case, you might say this can be changed. The IRS could refuse pre-payments for taxes, or charge a negative interest rate or a penalty for pre-payment. Businesses now charge penalties for late payment, so institutionally they could charge penalties for early payment.
But our legal and financial system deeply enshrines the right to pay early. Imagine the string of court cases in which consumers demand their right to pay rent, gas bills, etc. vs. landlords who won't let them.
Politically, imagine the outrage at an attempt by the Federal Government and Federal Reserve to enforce negative interest rates -- to "take away people's money'' -- at a magnitude that matters -- 5% say, not 5 bp -- and to eliminate people's right to hold cash to enforce that confiscation. You might as well propose to take away their guns, gold bars, and stocks of canned food.
So, bottom line, we cannot have strongly negative nominal rates without a legal revolution essentially negative-indexing the entire economy and payment system, and upending centuries of law giving you the right to pay bills at face value.
The zero bound is not just cash.
"Illegal" transactions, regulations, and tax evasion
Paper currency facilitates making transactions anonymous, helping conceal activities from the government in a way that might [!] help agents avoid laws, regulations and taxes. This is a big difference from most forms of electronic money that, in principle, can be traced by the governmentIndeed. The central characteristic of currency is anonymity of its possession and of the transactions it facilitates. Though transactions aren't that closely monitored now, the computer revolution is making it more and more possible. And Ken is explicitly proposing even more: that the IRS and regulatory agencies will actively use their ability to monitor electronic transactions to enforce "laws, regulations and taxes."
Though anonymity facilitates evasion of "good" taxes and necessary regulations, the ability to transact anonymously is an important safety valve that protects our economy and many others around the world from a welter of "bad" taxes, laws, and overly intrusive regulations. How much of each we have now, and how desirable strict enforcement is depends on where you sit. I imagine opinions differ at Harvard vs. Cato or Mercatus.
Regulations may be more important than taxes. Big companies and wealthy people who pay most of the taxes in the US don't have to cheat; they just hire good lawyers and lobbyists. Monitoring transactions is an excellent way to enforce compliance with all sorts of regulations. And we plausibly have more bad regulations than (even) bad taxes.
In the U.S., eliminating cash would heavily impact the poor. The U.S. has 11 million undocumented immigrants, most working and transacting in cash. It is likely that many readers of this post have violated the extensive Federal and State labor laws or immigration laws, in their hiring of household help, and able to do so by transacting in cash. Sub-minimum wage jobs would disappear without currency, as would many jobs available to ex-convicts and others facing legal restrictions on their employment. What little entrepreneurship and activity exists in many poor parts of inner cities survives on cash, by being able to evade not just taxes but onerous local regulations, occupational licensing restrictions, zoning restrictions, labor laws, and so forth. Are you buying lights windows or toilets that violate zoning energy or water laws? Not any more, you're not.
A lot of "tax evasion" using currency consists of quite poor people evading the astronomical marginal tax rates implicit in social programs. People on social security disability, and medicaid, say, who would lose lots of benefits if they reported income, pick up a lot of spare money working for cash. Do we really want them to obey all the rules strictly -- not work at all? Should the watch TV all day long?
I wrote about the pernicious consequences of e-verify here. The world in which the Federal Government must pre-approve every employment strikes me as a nightmare. The world in which the Federal Government is monitoring every transaction between people to enforce who it thinks you can and can't hire is a worse nightmare.
In other parts of the world, small businesses and labor markets only function at all by avoiding laws, taxes, or regulations. Estimates for Europe put the "shadow economy" at least 20% of GDP, and a larger fraction of employment especially for young people. Values in the rest of the world are likely larger. It's not obvious that eliminating cash and cash transactions in Europe would raise tax revenue, rather than simply lowering actual GDP and employment by 20% or more.
There is about $1.3 trillion currency outstanding, more than $3,000 per US citizen. 3/4 of it is $100 bills. Most is held abroad. You get the picture of who holds dollars and why. US policy makers my think all our taxes, rules and regulations are benificent, but we don't think that of the rest of the world. Do we really want to get rid of this safety valve for Russia, Argentina, Venezuela, Cuba, the Middle East, and so forth?
If the U.S. were willing to allow anonymous electronic transactions, then we could get rid of cash. But we already have lost a great deal of the ability to transact anonymously, and the current technological and policy trend is entirely in the other direction. One used to be able to take more than $10,000 out of banks at will; now such a withdrawal must be reported. Smaller cash transactions are voluntarily reported by banks under fear of "know your customer" and anti-terrorism regulation. Remember the glorious ending of the Shawshank Redemption, where the hero takes huge piles of cash out of a bunch of banks and heads to the Mexican border? Forget it. And it's already being used politically: Justice is using know-your-customer rules deny legal but unfavored industries such as marijuana dispensaries and payday lenders access to banking.
Treasury abolished bearer (anonymous) bonds in 1983, with the switch to electronic book-entry holdings. Anonymous Swiss bank accounts are a thing of the past. The SEC, IRS, and CFTC are none too happy about bitcoin.
More deeply, a world in which the Federal Government can observe every single transaction made by every single person and corporation, and thereby reconstruct the size and composition of every person's wealth, strikes me as an Orwellian nightmare. Among the rights to privacy, the ability to make an anonymous transaction, already severely hampered, cannot disappear totally.
Imagine the repercussions for political liberty if the Federal Government has a record of every single transaction. If a candidate for political office once bought a racy magazine, that record is in government files. And one Lois Lerner or Edward Snowden away from a twitter feed. If a prominent political voice, or even an annoying economics blogger, had a purchase somewhere in his or her history they did not want made public, or that violated some nitwit law or regulation, they could quickly be silenced. Imagine what J. Edgar Hoover could have done to the civil rights and anti-war movements with the ability to see every transaction in the country.
Ken acknowledges this point:
A different type of argument against eliminating currency relates to civil liberties. In a world where society’s mores and customs evolve, it is important to tolerate experimentation at the fringes. This is potentially a very important argument, though the problem might be mitigated if controls are placed on the government’s use of information (as is done say with tax information), and the problem might also be ameliorated if small bills continue to circulate"Experimentation at the fringes" means anyone who bought booze in prohibition, or pot in the last 50 years, or sought public office. Campaign finance law is already a political cesspool. Imagine what it will look like when a rogue prosecutor can see every transaction. I'm not sure that's a fringe.
"Controls are placed." Absolutely we need controls, and we need them now even with currency. Let's add some subjects and active verbs here: Congress should pass clear stringent laws, with strong judicial oversight and equally strong penalties, on the limits of the government's collection and use of data on financial ownership and transactions.
Substitutes and a chilling ending:
Last but not least, if any country attempts to unilaterally reduce the use of its currency, there is a risk that another country’s currency would be used within domestic borders. Even if that risk is not great for a country like the United States, there is still the loss of revenue from foreign users of currency (many of whom may be engaged in underground or illegal activities within their own borders, even if not within US borders). Thus, any attempt to eliminate large-denomination currency would ideally be taken up in a treaty that included at the very least the major global currenciesVenezuela and Argentina get along on dollars. Don't be so sure the risk is not great for the US. Bitcoin, though very imperfect in a lot of dimensions, shows the strong demand for anonymous transactions and wealth holding. We could learn to use Euros pretty fast.
A global treaty banning currency and anonymous transactions...I can see the pitchforks now.
To be clear, this is a good essay, and Ken brings up all the important points. My disagreement here is just judgement on the importance of some considerations -- "good" tax and regulatory evasion, "good" anonymity, the importance of anonymity for political freedom -- relative to others -- seignorage (trivial in my view, important in Ken's) for example.