Economics and politics - comment and analysis
27. June 2015 I Heiner Flassbeck I Economic Policy

Abolish cash? Or how economists bend what should be straight

Recently, some economists proposed to abolish cash money. Peter Bofinger has done work on this and now even Larry Summers and Kenneth Rogoff speak out in favour of this proposal. This may sound surprising to many: what do these economists try to achieve? Why would anyone want to physically remove cash money, the generally accepted means of payment in all modern economies, from the market? In modern societies, cash settles liabilities clearly and immediately. What is the advantage? Abolishing money will, without any doubt, lead to an even greater monitoring of and intrusion into our private lives. It is difficult to understand why such a proposal is being made precisely at a time when there are already ample legitimate concerns about the surveillance of the citizenry.

The arguments put forward in favour for the abolition of cash show that these economists enter a domain that they do not understand very much at all. One of their arguments is that abolishing cash money would lead to much more accurate estimates of informal employment and (much more importantly) money laundering. But is this true? In the case of informal employment, tax avoidance is very easy, cash money or not. It happens all the time: we give someone a few bottles of good wine, accompany her or him to the supermarket to buy groceries or we give her of him a ticket to Mallorca as a birthday present. True, none of this is especially efficient, but it works nonetheless. The same is true for money laundering. Resourceful people will always find ways. It is sufficient to consider internet fraud or attacks from hackers and the ensuing opportunities for malfeasance and manipulation. How far all of this goes in reality, I can and will not judge, but it is clear that there are serious problems here also that the prohibition of cash will not resolve.

However, none of this goes to the heart of the matter. Are there macroeconomic arguments for abolishing cash money? According to the proponents, abolishing cash would make monetary policy more effective because, simply said, it will no longer be possible for households to take out their savings from their banks deposits whenever the interest rate on savings becomes negative (i.e. when there is a tax of savings). This is far from a hypothetical situation. Central banks can and do decide on a negative interest rate in order to fight deflation. They consider negative interest rates as an adequate instrument to stimulate economic growth: it encourages households to reduce their savings and spend. And spending means stimulating demand. Indeed, households can easily avoid negative interest rates on deposits as long as there is cash. Under conditions of deflation purchasing power rises because of falling prices and this creates a positive interest rate. Abolish cash and this way out to protect savings is closed. This is the theory, or, rather, the idea. It is extremely doubtful that this strategy works.

Let us, for a moment, consider this argument the other way around. Momentarily, the obsession of policy-makers with debt ceilings and a general irrational debt phobia basically make the launching of a meaningful economic stimulus policy impossible. There is no longer the option for governments to spend their way out of a recession. On the contrary, the mainstream consensus is that governments need to give priority to the reduction of the government deficits. Those economists who argue in favour of the abolishment of cash apparently present a solution to this dilemma. Governments are unable to run deficit spending but private households can and abolishing would, so they argue, force them to do so. In a way, households are to become a sort of macroeconomic substitute for the government that would stimulate the economy through additional demand induced, whenever needed, through central bank action, i.e., imposing a heavy penalty interest on savings. From the fact that there is a positive savings rate of households in most countries, economists draw the easy conclusion that there is a “savings surplus” (Larry Summers actually calls it like that) that can be used when the economy is running slow (even if the household savings rate has nothing to do with the cause of the economic downturn).

This reasoning turns the proper relationship completely on its head. The great scandal of our time is not high household savings, but it is the net savings of corporations. Corporations should be the natural investor and the counterparty to private households savings. However, today they are sitting on enormous amounts of capital instead of being forced to raise that capital on the financial markets and use the savings of private households. The solution to that problem is easily found: tax corporate profits in a sufficient manner and force them to pay decent wages and salaries. By doing so, companies are forced back into their traditional role as debtors. If corporate earnings are taxed at rates of 40 per cent and more plus wage negotiations take place at an approximate balance of power then corporations will be much more responsive to the instruments of monetary policy. Massive redistribution in favour of corporations and the permanent pressure on the compensation of employees is the real pathological phenomenon of our times. To end it is not very difficult to accomplish, if the political willingness to make it happen would exist.

It also makes complete sense to raise taxes on the exorbitantly high household savings of top income earners. But such ideas appear obviously politically inopportune to many or are considered impossible and unenforceable, but how do we know as long as we do not try? It is, of course, politically speaking, much easier to target the savings of vulnerable groups, namely private households with middle or low incomes, and force them into spending than to impose taxes on the very rich. In any case, an attempt to decrease the savings of the rich by abolishing cash money in a situation of deflation is nothing but an illusion.

The proposal to urge or force citizens away from their role as savers is an attempt to let the state off the hook but it pushes governments systematically in the wrong directions. States are supposed to act in the interests of their population at large (think of Greece!). It can be argued that it is their function to protect the income and the savings of the majority of private households. But, squeezed by debt phobia and the power of corporations more and more governments are systematically looking abroad in order to find potential debtors. In order to achieve this, it is constantly necessary to improve their competitiveness, which is, as a rule, only possible if the real income of workers falls further or, in any case, if their real income lags behind productivity growth. This mad and surreal worldwide race of countries towards higher competitiveness and the corresponding scramble for foreign debtors obviously contradicts itself on the most elementary logical grounds. No one in power seems to care about that. The main result of this senseless experiment is a permanent pressure on the income of employees, eventually leading to deflation and hence to low growth and to government deficits. These deficits are then, in turn, used as the ideological justification to put more pressure on wages and the vicious circle is complete.

What happens on the side of the households? Despite income pressures, most households are trying to save as much as possible. This makes complete sense given their economic situation. The future seems more unpredictable than ever. Many households are insecure about their future income. If no efforts are being considered to make incomes rise faster and more steadily abolishing cash would have an additional negative effect on consumer confidence which is already very low. The initiative would be perceived as nothing less than an attack on the only possible way for households to protect against potential future shocks. That is why the proposal will not succeed in making people spend more but rather less. Private households will stick to their savings but will shifts towards other values and commodities (such as gold, real estate, durable consumer goods and so on). This, in turn, will lead to grotesque price bubbles in these markets. It can be expected that these bubbles will spill over to other markets. As a result, the lowest incomes will suffer the most (extreme increases in rents are the most obvious example).

The proposal to abolish cash isn’t fair and it is not intelligent either. On the one hand, households and especially those in the lower income segments, are denied gains from the increases in productivity because of the pressure on wages, while, on the other hand, the proposal to abolish cash money puts them in the unenviable position of becoming responsible for the stimulation of economic growth. On the other hand, the powerful and the rich are off the hook. This is what this amounts to and it is exactly the opposite of what is needed. The great majority of households need nothing more than positive and stable income expectations. This is the right way to stimulate aggregate demand. For this to work, the government has to take up its traditional role as a middleman between the organisations of employers and the trade unions. It is the role of government to correct the imbalance of power introduced by high and lasting unemployment. Adequate and effective participation of the unions must be guaranteed by the power of government in our democracies. If this would happen, no deflation that makes negative interests necessary would occur. Instead, higher wages would stimulate the economy.

However, in an economic downturn (or an ongoing stagnation) or, in case that the child fell into the well, as is currently the case with the euro crisis, governments (and the European Central Bank) cannot run away from their responsibility to restore economic stabilisation. They must be prepared to make additional expenses and to increase debt. This is the only way to quickly return to growth. Only governments have the overall means (when policy-makers are reasonable) to act with foresight and to make corrections to the market results. That this is politically out of the question does not mean that it is no longer sensible macroeconomic policy.

Calls for a ban on cash in order to improve the effectiveness of monetary policy through a reduction of household savings constitute the bankruptcy of economics in the broadest sense of the word. The economists who make this proposal are no longer willing to ask meaningful questions and to deal with what is really important. Instead, they concentrate upon a sideshow. In doing so, they only cause harm. Public confidence in our monetary system must not be shaken even further by this kind of adventures. Households are not the proper long-term actors capable of stabilising the system. In the longer term, companies must act as debtors and make investments instead of sitting on their gains. And in the short term, the state must intervene in order to support monetary policy and to stabilize the economy.