Oct 13

Will Eliminating Cash Save The Economy? (Spoiler Alert: Don’t Be Stupid!):

Given the still-subdued economic growth many experts are of the view that the presence of cash has constrained central banks from setting negative rates to stimulate the subdued economic activity. In a future economic or financial crisis, current low rates would restrict the effectiveness of monetary policy, so it is held.

The presence of cash, it is argued, prevents the central banks from lowering policy rates to a level, which is going to meaningfully revive economic activity. What prevents the dramatic lowering of rates is that this is going to severely hurt savers who keep their cash in various bank accounts and so this is seen as politically unacceptable.

The abolition of cash, it is held, is going to enhance the ability of the central banks to use negative rates (perhaps as low as minus 5 percent per year) and this would provide central banks with additional flexibility and tools to deal with a slowdown.

Will We Get More Economic Growth Without Cash?

By advocating the abolition of cash, many experts are implying that cash can be replaced by electronic money. Electronic money can function, however, only as long as individuals know that they can convert it into fiat money, i.e., cash on demand.

Without a frame of reference or a yardstick, the introduction of new forms of settling transactions is not possible.

Money emerged out of barter conditions to permit more complex forms of trade and economic calculation. The distinguishing characteristic of money is that it is the general medium of exchange, evolved from private enterprise from the most marketable commodity. On this Mises wrote,

There would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money.

Also, on this Rothbard wrote,

Just as in nature there is a great variety of skills and resources, so there is a variety in the marketability of goods. Some goods are more widely demanded than others, some are more divisible into smaller units without loss of value, some more durable over long periods of time, some more transportable over large distances. All of these advantages make for greater marketability. It is clear that in every society, the most marketable goods will be gradually selected as the media for exchange. As they are more and more selected as media, the demand for them increases because of this use, and so they become even more marketable. The result is a reinforcing spiral: more marketability causes wider use as a medium which causes more marketability, etc. Eventually, one or two commodities are used as general media-in almost all exchanges-and these are called money.

Money is the thing for which all other goods and services are traded. Furthermore, money must emerge as a commodity. An object cannot be used as money unless it already possesses an objective exchange value based on some other use. The object must have a pre-existing price for it to be accepted as money.

Why is this so? Demand for a good arises from its perceived benefit. For instance, people demand food because of the nourishment it offers. With regard to money, people demand it not for direct use in consumption, but in order to exchange it for other goods and services. Money is not useful in itself, but because it has an exchange value, it is exchangeable in terms of other goods and services.

The benefit money offers is its purchasing power, i.e., its price in terms of goods and services. For something to be accepted as money, it must have a pre-existing purchasing power — a price. This price could have only emerged if it had an exchange value established in barter.

Why Even Fiat Money Continues to be Used as Money

Once a thing becomes accepted as the medium of exchange, it will continue to be accepted even if its non-monetary usefulness disappears. The reason for this acceptance is that people now possess previous information about its purchasing power. This in turn enables them to form the demand for money.

The key to acceptance is the knowledge of the previous purchasing power. It is this fact that made it possible for governments to abolish the convertibility of paper money into gold, thereby paving the way for the introduction of the paper standard.

The crux here is that an object must have an established purchasing power for it to be accepted as a general medium of exchange, i.e., money.

In today’s monetary system, the core of the money supply is no longer gold, but coins and notes issued by governments and central banks.

Coins and notes constitute the standard money we know as cash that are employed in transactions. Notwithstanding, it is the historical link to gold that makes paper money acceptable in exchange.

It was through a prolonged process of selection that people had settled on gold as the most marketable commodity.

Gold therefore had become the frame of reference for various forms of payments. Gold formed the basis for the value of today’s fiat money.

Besides, electronic money is not a new form of money that replaces previous forms, but is just a new way of employing existent money in transactions.

Because electronic money is not real money but merely a different way of employing existent fiat money, obviously, it cannot replace it.

One could argue that a government decree could enforce electronic money and displace the current paper standard. This would not work, however.

Electronic money is merely a device of storing information concerning debits and credits. It cannot acquire any independent purchasing power; it cannot become money itself.

It functions in the same way as checks, which cannot acquire an independent purchasing power from money.

The mere fact that people would hold less currency in their pockets and to a greater extent employ electronic money doesn’t imply a fall in the demand for fiat money, as some commentators have suggested.3

So long as people exchange goods and services with each other, there will be a demand for money.

A new way of employing money doesn’t mean that money will be replaced or that there will be a fall in demand for it.

Besides, should this disappearance in demand really occur, it would be the end of the division of labor and the market economy.

In an unpublished paper titled  “Technology and the Case for Free Banking,” David Friedman and Kerry Macintosh argue that the new technology would make it possible to implement sophisticated barter. This in turn would completely remove the need for money.

However, why should the essence of barter be altered on account of a new technology? How could a professor of economics make his living if food producers, for instance, were not interested in directly exchanging their goods for lectures in economics?

Low Interest Rates Don’t Create Economic Growth

The view that very low interest rates can revive economic growth is based on a belief that low interest rates cause economic growth.

The interest rate is just an indicator as it were. In an unhampered market economy it mirrors individuals’ time preferences.

Any policy that stifles interest rates in fact falsifies the signals coming from individuals to producers thereby setting in motion a misallocation of real wealth.

This in turn weakens the process of wealth generation and the ability of businesses to grow their business and hence the economy as a whole.

Furthermore, economic growth cannot be boosted by means of low interest rates, which it is held is going to boost the demand for goods and services.

The increase in the production of final goods and services, which is what economic growth is all about, cannot be lifted by demand as such but by means of the enhancement of the infrastructure that enables lifting the production of goods and services.

(A lowering of interest rates and the consequent misallocation of real wealth weakens the wealth generation process and thus weakens the ability to enhance the infrastructure.)

If low interest rates were the solution for robust economic growth why has the near zero rates in major economies failed so far in this endeavor? Furthermore why would interest rates at minus 5 percent revive economic growth? Why not minus 10 percent or perhaps minus 20 percent?

Note that the abolition of cash implies the removal of money and hence the destruction of the division of labor and the market economy. It is likely that rather than promoting economic growth, abolishing cash to permit the central banks to lower interest rates into deeper negative territory will lead to the destruction of the market economy and promote massive economic impoverishment.

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