One of my least favourite things about living in a modern city is the scramble for loose change to pay for parking. Of course, some shopping centres have embraced the cashless New World Order – but then there are those that went cheap on the parking machines. At which point, you have to hunt around for a nearby ATM to charge you R16.50 for the privilege of withdrawing a R50 note from a Not-My-Bank machine in order to pay a R6 parking fee.

At which point, you discover that the parking meter doesn’t take payment in fifties. And you have to beg and plead with a parking attendant to let you out without paying anyway.

The apparent problem of paper money

Modestly-famous economist Kenneth Rogoff wrote a paper about the costs and benefits of phasing out paper currency. And it’s entirely readable.

Here’s the basic summary:

1. We should phase out paper currency.
2. Because this will allow Central Banks to break through the Zero Interest Bound.
3. But also because this would stop all the illicit activities that take place in cash (tsk tsk).
4. On the other hand, seigniorage.
5. And infringement on civil liberties.
6. And also, people are irrational – who knows what could happen if you take away physical notes?

Some Theoretical Background

There are two main types of macroeconomic policy:

1. Fiscal Policy; and
2. Monetary Policy

Each of those is basically the activities of one of two big economic agents:

1. The Government (fiscal policy); and
2. The Central Bank (monetary policy).

That is:

1. Fiscal policy is all about government spending and government financing (tax collection and government borrowing); while
2. Monetary policy is all about credit and money creation, through the tools of interest rates, printing presses and foreign currency reserves.

Since 2008, many of the world’s big economies have been hamstrung by a series of really gridlocked governments – making fiscal policy most redundant (if not actively unhelpful). So Central Banks have been left to fill in the role of economic stabiliser and stimulator. And they’ve performed that role through:

1. Firstly, lowering interest rates as much as possible; and
2. Quantitative Easing.

Here’s a picture of the Zero Interest Bound:

What is the Zero Interest Bound?

Well – essentially, no Central Bank really wants to make interest rates negative.

Why?

Because then you might just choose to hold your wealth in physical cash. To quote Mr Rogoff:

As long as Central Banks stand ready to convert electronic deposits to zero-interest paper currency in unlimited amounts, it suddenly becomes very hard to push interest rates below levels of, say, -0.25 to -0.50 percent, certainly not on a sustained basis. Hoarding cash may be inconvenient and risky, but if rates become too negative, it becomes worth it.

So his argument is: if you take away that paper money convertibility, then you could charge really negative interest rates. Or:

If all Central Bank liabilities were electronic, paying negative interest on reserves (basically charging a fee) would be trivial.

The Old School Solution

Traditionally Central Banks have gotten around this issue of cash hoarding by saying to themselves:

1. Hmmmm.
2. We want to discourage people from saving, because we need them to spend in order to get ourselves out of this doldrum.
3. Ideally, we’d like to charge them a penalty for not spending money.
4. But if we do that, we’ll have bank runs on our hands as they convert their money to cash, which we don’t want.
5. So what we need to do is debase the money in their hands.
6. We’ll charge them effective negative interest (let’s call it “inflation”) by pumping more money into the economy, which will drive up the price of goods, which will cause people to spend their savings in order to avoid it being eroded by this inflationary force that we’ve created.
7. But we have to be careful that we don’t overdo it.
8. Because then: Venezuela. And Zimbabwe. Etc.

So when it comes to dis-incentivising you from saving your money, a Central Bank has two options:

1. A direct tax on holding bank balances (the negative interest rate on electronic deposits); or
2. An indirect tax on holding bank balances (inflation driven by money creation).

But it’s difficult to impose that direct tax in a world with cash in it.

Solution: make society cashless.

However

Consider the outcome of a world where your bank account is directly taxed.

What would you do with it?

You would probably seek to avoid that tax by locking your wealth up in investments as soon as possible. And/or buying up consumables as soon as possible.

And for liquidity, you’d borrow money.

In fact: I think you’d see many of the things that happen in hyperinflationary economies, where economic activity gets driven underground. Alternative currencies (foreign currency, petrol coupons, possibly gold) would spring up. And the whole thing could irrationally devolve.

Perhaps this is biased: as the only fully cash-less scenarios that the world has really witnessed have taken place within the context of hyperinflation, where printing presses have been unable to keep pace with the rate of inflation, thereby driving the economy into cash shortages.

And as for the illicit activities story, I doubt that’s something you can reduce by taking away the paper money… There’s lots of anonymous value out there: gold, diamonds, mineral rights, drug stockpiles, alternative foreign currencies, art, vintage wine, cryptocurrencies…

So to summarise:

1. Going cashless makes it easier for Monetary Authorities to penalise you for saving money instead of spending it; and
2. It won’t stop criminals from operating outside of the formal banking sector – they’ll just find other ways of transacting.

Remind me again why we’re doing this?

Oh, right. To make it easier to pay for parking.

Rolling Alpha posts opinions on finance, economics, and sometimes things that are only loosely related. Follow me on Twitter @RollingAlpha, or like the Rolling Alpha page on Facebook at www.facebook.com/rollingalpha.