Suparit Suwanik: Putting Paper Currency In Its Proper Place

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I am delighted to be able to start another season of student guest posts with this guest post by Suparit Suwanik. The students in my “Monetary and Financial Theory” class are required to do 3 blog posts each weak during the semester. From among the best of these I choose some to be guest posts here. (You can see the class assignment and resource blog here, and links to student guest posts from previous semesters here.) I am impressed by Suparit’s level of understanding of what I have been proposing. Suparit’s post below is the 1st student guest post this semester:

Amid the growing popularity of the world’s newest monetary policy tool - negative interest rates, many newspapers, including the Wall Street Journal, are paying attention to the possibility of related changes in paper currency policy. The interesting editorial, “The Political War on Cash”, touches on how politicians and central bankers around the world are massively rallying to limit the use of cash, especially large-denomination bills. From Mario Draghi to Larry Summers, they are planning to get rid of the large notes, for example, €500 notes and $100 bills, which would mean it’s time to say goodbye to Benjamin Franklin. The author cites that “The real reason the war on cash is gearing up now is political: Politicians and central bankers fear that holders of currency could undermine their brave new monetary world of negative interest rates…” which suggests an unwarranted prejudice against negative interest rates. Also, he points out many reasons why paper currency shouldn’t be entirely eliminated (Yes, he’s going that far!). It’s such a pity he’s never taken a class with Prof. Miles Kimball of University of Michigan, a strong supporter of negative interest rate policy.

I take the liberty of crystallizing Kimball’ several posts, such as:

blended with my thoughts to counter argue the author’s reasons, point by point.

First, the Wall Street Journal editorial board argues that cash allows legitimate transactions to be executed quickly, without either party paying fees to a bank or credit-card processor. I somewhat agree that we need to pay fees to use credit cards, or electronic money, while we can use cash free of charge (cash earns zero interest rate). Yet, in the world of negative interest rates where the time-varying fee on cash deposits is additionally imposed, as Kimball suggested, cash, or paper currency has its value even less than electronic money. If you go buying something at a retail store, the shopkeeper will sell you at the higher price if you pay by the greenback than what it costs in electronic currency. That is, paying by cash even costs you more than (or equal to) paying by electronic currency, which includes fees to a bank or credit-card processor. This, in other words, means that the electronic currency is taking a role of “unit of account”, instead of the paper currency.

Second, the Wall Street Journal editorial board states that cash lets millions of low-income people participate in the economy without maintaining a bank account. This may be going too far since, according to Kimball, we will not entirely eliminate paper currency, at least, just yet. Subordinating paper money to electronic money as an economic yardstick is a big enough step for now; the question of whether to further demote paper currency can wait. We still keep the paper currency to function as “the medium of exchange” as it has always been doing, especially for low-income people that frequently use cash to buy relatively inexpensive necessity goods. Only one function of money, unit of account, will be given exclusively to the electronic currency.

Third, while there’s a chance of theft for cash, digital transactions are subject to hacking and computer theft. Again, this is going too far since, by the time when cash is going to be largely eliminated (but small bills are kept for those reasons mentioned above), the electronic system will have had large upgrades and enhanced security. Also, the security risk has long been presented, either you hold paper or electronic currency. So why are you so afraid as if it never existed?

Finally, cash is the currency of gray markets because high taxes and regulatory costs drive otherwise honest businesses off the books. The author warns that governments may need to reconsider since it might destroy businesses and leave millions of people unemployed. To my thought, this is a fallacy: why do we need to keep those businesses avoiding tax underground? Is it a duty of government to ignore those unlawful businesses just for the reason that they stimulate economy?

I agree that the government may reduce the role of paper currency that greatly compromises the privacy of transactions, but try weighing between pros and cons of going “electronic” as the new economic yardstick, in order to have effective policy in preventing the economy from the recession. I see no reason to deny it.