Tuesday, October 22, 2019

A Primer on Negative Interest Rates (Part 3): The War on Cash

Click here to read the original Cautious Optimism Facebook post with comments

8 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff examines multiple worrisome proposals by central bankers to outlaw paper currency.

“It [negative interest rate policy] could take years… … if that means for a while savers have to eat their capital to survive, then so be it.”

-Willem Buiter, former Chief International Economist at Citigroup and negative interest rate enthusiast

The Economics Correspondent urges CO readers to watch the attached three-minute video interview in which Buiter articulates masterfully New Keynesian rationales and weapons for declaring war on cash and ultimately banning its existence entirely.  Translations follow below.


In Part 2 of this monetary economics series, we summarized the repercussions of negative interest rate policy in continental Europe. Just as policymakers intended, negative rates have inflated demand for government bonds thus making borrowing cheaper (in fact most European sovereign debt yields have gone negative), and commercial banks have been forced to take bigger lending risks while also passing on their costs in the form of negative rates imposed on their customers: specifically wealthy clients and corporations.

In fact, forcing bank customers to eat negative rates was a primary policy objective from the beginning, since demand-side theories require not only banks to expand lending, but also for companies and consumers to spend more.

In economics jargon “aggregate demand must be boosted to equal aggregate supply,” one of the foundational tenets of New Keynesian theory. And when faced with the prospect of their bank account balances losing 0.4% or 0.5% in value every year, consumers and companies are more likely to handle money like a hot potato and spend it quickly.

Rapid turnover of euro balances also raises monetary velocity and drives higher inflation, another of the ECB’s policy goals.

However policymakers have only achieved their objective against two of three targets: wealthy individuals and corporations. The third target, smaller retail depositors, remains elusive. Everyday bank customers may hold smaller balances and spend less than wealthy ones, but as a group there are so many of them that their collective wealth represents an untapped sea of funds that central bankers and technocrats are just aching to make them spend.

Unfortunately for the technocrats, it’s currently impossible to compel small depositors to spend more with negative interest rates since they can always avoid the negative rate by closing their accounts and converting their deposit balances into cash.

Wealthy bank clients and corporations can theoretically convert their balances to cash as well, but rarely do due to the sheer cost and risks associated with physically holding so much paper currency. And in the case of companies the massive inconvenience of making/receiving payments with employees, creditors, suppliers, vendors, etc… exclusively with cash.

Central banks and commercial banks were aware of these limitations long ago and always knew that wealthy individuals and companies would tolerate a mildly negative interest rate so long as the penalty remains lower than the cost of storing a lot of currency.

But small depositors are different. A bank customer with, say, a $3,000 balance doesn’t have to accept negative interest rates sitting down. He can close his account and withdraw cash which pays a superior yield of zero percent. $3,000 in notes doesn’t require a lot of space to stockpile—hence virtually zero cost—and most everyday transactions for the average consumer can be handled with cash.

Ironically, if central bankers and commercial banks actually attempted to impose negative rates on small customers, the mass cash withdrawals would result in a reduction of loanable reserves, credit would become more scarce, the money supply would contract, and inflation would reverse into deflation: all producing the opposite result from what policymakers had intended.


Not to be discouraged, central bankers and New Keynesian academics have been hard at work devising strategies to deny bank customers the cash option. In what has been dubbed “the war on cash” politicians, central bankers, and economists the world over have written multiple proposals for eliminating currency and banknotes. The recommendations range from phasing out large denomination notes only, thus raising the cost of storing a larger number of smaller denomination bills, to outlawing cash altogether.

Whatever proposals might be enacted in the future, once policymakers are satisfied they have sufficiently removed the everyday consumer’s cash option, they’ll reduce negative rates even further until private banks pass on the negative rate to even their smallest retail customers. Why not? Small depositors will no longer be able to flee into cash.

In case you think this is black helicopter conspiracy talk, or that “war on cash” proponents are powerless upstarts, think again. In 2015, a meeting of negative interest rate/war on cash economists and policymakers was held at the “Removing the Zero Lower Bound” conference in London to share strategies for pushing interest rates even further below zero.

Banning paper currency was a hot topic of discussion among the dignitaries representing:

-Harvard University
-Princeton University
-Carnegie-Mellon University
-University of Michigan
-Florida State University
-London School of Economics
-Imperial College of London
-The U.S. Federal Reserve System
-The European Central Bank
-The Swiss National Bank
-The Danmarks Nationalbank
-The Swedish Finance Ministry
-The Bank of England (retired)
-The Center for Economic Policy Research
-Generali France, S.A.
-Brevan Howard Asset Management
-Soros Investment Fund

Among the most eloquent champions of the war on cash was Willem Buiter, the then-Chief International Economist at Citigroup. His short interview from 0:34 to 3:18 summarizes perfectly the rationale, objectives, and weapons that zero lower bounders plan to employ against paper currency.

If the economics jargon is too difficult to follow, the Economics Correspondent has included translations below:


1) “The existence (inaudible) of currency of cash sets the lower bound of policy rates.”

Translation: The public's fondness of cash limits what we as policymakers can force them to do.

2) “Since currency is the culprit—cash—get rid of currency. Offer every man, woman, and child an account guaranteed by the central bank that cash currently does but allows negative interest rates to be set.”

Translation: Force consumers to surrender their already crummy central bank notes and drive them into an even crummier account that can be fully manipulated by central bankers. Buiter then addresses “dealing with the problem of the poor and ill” by generously “allowing” small denominations to exist.

3) “To tax currency… …require people to present currency once a year… …at the central bank or a branch office and have it stamped and give five pennies for every pound.”

But Buiter then squirms that “that’s kind of intrusive.”

Why is he worried about intrusion now?

Answer: “You have to enforce it.”

Oh, for a moment I was na├»ve enough to believe he might consider compelling the common folk to surrender their cash and eat negative interest rates “intrusive” too, but... never mind.

4) Buiter really turns up the heat at 1:56. His third solution is “To keep currency, but to end the fixed exchange rates, one-for-one, between currency and deposits.”

Translation: We central planners will still magnanimously permit you to use cash, but the central bank will charge you a large penalty every time you withdraw it from your bank. Once that penalty exceeds a high enough pain threshold, you will be rightfully deterred from using cash altogether and leave your money in the bank—subject to the negative interest rate we can then force you to eat with impunity.

5) At 2:56 Buiter incredulously claims “There is no right or wrong level of interest rate. The question is what level of interest rate is necessary to get aggregate demand to equal aggregate supply and create full employment.”

This is just more erroneous New Keynesian theory, only upgraded: with unlimited compulsion by the State to shepherd people and their money like cows into whatever cattle car they think—in their enlightened wisdom—is best for them.

His credo of “no right or wrong level of interest rate” harkens back to Nixon-era price controllers who saw no right or wrong price of gasoline either, thus clearing the way to force prices down arbitrarily and create shortages and an energy crisis. Or Venezuelan Chavistas who decided the “right” price was whatever they dictated, emptying store shelves of basic commodities. Or Zimbabwe’s central bankers who decided there was no right or wrong interest rate when they manufactured a giant hyperinflation a few short years ago.

6) And of course “If this means savers have to eat their capital to survive, so be it.”

How casually he unilaterally judges (like a eugenicist) who will be allowed to sustain themselves and how.

If you’re fascinated by this intellectual arrogance which economist F.A. Hayek dubbed “The Fatal Conceit,” there’s more from crusty Charles Goodhart, a former Bank of England Monetary Policy Committee member (equivalent to Federal Open Market Committee member at the Federal Reserve):

Goodhart touches on a favorite rationalization by zero lower bounders for phasing out high denomination notes: they’re used disproportionately by criminals, tax evaders, and money launderers. Harvard economist and former IMF Chief Economist Ken Rogoff also uses this excuse in his famous book “The Curse of Cash” to inch closer to their shared goal of unrestricted negative interest rates thrust upon the masses.

However, in a recent debate with Rogoff, George Mason University economist Lawrence H. White argued that many things are disproportionately used by criminals, tax evaders, and money launders—such as fast cars, fast boats, flashlights, and dark clothing. Also the Fourth and Fifth Amendments of the U.S. Constitution. Should we outlaw them too?


Rogoff has recommended phasing out the one-hundred dollar bill as a starting point for eliminating high denomination notes. Incidentally, a twenty dollar bill in 1975 had the same purchasing power of $100 today, so Rogoff is effectively arguing that the equivalent of the twenty in 1975 should be banned.

However, Rogoff and his like-minded colleagues still claim to care about our freedoms and he pleads "I view this as a balance between your right to privacy, an individual’s right to privacy, and society’s right to regulate, collect taxes, etc..”

Yet this promise that “giving up one more right will yield the ideal balance between regulating crime and the business cycle and preserving your freedom” has been invoked repeatedly over the last century, only to lead to another major crash and petitions to repeal additional freedoms.

For example:

-In 1914 the architects of the Federal Reserve argued “Just let us force commercial banks to centralize all your (bank customers') gold reserves at our district banks and there will never be another boom-bust business cycle. Your monetary freedoms shall not be further infringed.”

The Depression of 1920-21, the second worst of the 20th century, struck six years later.

-Shortly afterwards the Federal Reserve and Congress argued “Just let us make commercial bank notes illegal and replace them with a central bank monopoly, and there will never be another major recession. Your monetary freedoms shall not be further infringed.”

-In 1925, the Bank of England argued “Just let us take away your legal right to redeem your cash into small gold coins, and allow you only to redeem in 400-ounce bullion bars (worth $500,000 at today’s gold price, practically irredeemable for all but the wealthiest depositors) and we can manage the economy into Utopian prosperity. Your monetary freedoms shall not be further infringed.”

The Great Depression struck four years later.

-After the Fed inflated the stock market and real estate bubbles of 1927-29, and then failed miserably to do the very job it was created to do during the 1929-33 crash, President Franklin D. Roosevelt argued “Just let us take away your legal and contractual right to redeem currency into gold and there will never again be bubbles, busts, or deep economic slumps. Your monetary freedoms shall not be further infringed.”

The Depression of 1937-38 followed four years later, the third worst downturn of the 20th century. From trough to peak, unemployment rose from 11% to 20% in just nine months.

-In 1971 Richard Nixon argued “Just let us delink the dollar from gold completely, even for international holders, end fixed exchange rates, and the economy can be fine-tuned by technocrats into perpetual moderation. Your monetary freedoms shall not be further infringed.” Twelve years later interest rates were 21% and unemployment was 11%.

-In 1971 the Federal Reserve argued “Just let us expropriate the value of your money a little faster with higher inflation and recessions will be ended and the business cycle solved.” Twelve years later the dollar was worth 38 cents and America was on its third recession.

-And now in 2019 the zero lower bounders are arguing “Just let us take away your ability to conduct commerce with paper money altogether, and there will be economic growth marking the end of deep recessions and sluggish recoveries. Your monetary freedoms shall not be further infringed.”

Why should anyone believe either claim today? That this is the last freedom they will ever erase, and that banning cash is the only policy tool they need to end bubbles, end financial crises, end deep recessions, and in case of any future recession, guarantee rapid and vigorous recovery forever? All those promises were already made during the founding of the Federal Reserve in 1914.

The western world has gone from private, competitive commercial bank note issuance redeemable in specie to a central bank monopoly of irredeemable paper, perpetual inflation, exchange rate manipulation, and soon the criminalization of cash completely.

What has the subsequent track record of the monetary central planners been? Have they kept their promises to end the economic boom-bust cycle forever, and forever abstain from contravening the public’s freedoms?

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