Over the weekend, The Financial Times published an article calling for a ban on physical cash.
This is just the latest in a series of articles being promoted by the financial media proposing this concept. The arguments presented in these articles are always the same:
1) The Central Banks are wonderful institutions that are trying to save the world.
2) The reason Central Banks have failed to create another economic boom (despite spending $11 trillion) is NOT because they are incompetent, corrupt, and following financial models that have no connection to reality.
3) The reason Central Banks cannot create growth is because of consumers’ unwillingness to spend money.
4) The solution to this is to punish the stubborn consumers and FORCE them start spending more.
5) If we outlaw cash, consumers cannot remove their money from the financial system and so will be forced to spend it eventually (most calls for a ban on physical cash also suggest a “carry tax” or making it so that physical cash loses value the longer it remains outside of the financial system).
6) If we do this, the economy will suddenly explode with growth!
In short, it’s yet another “we need to do this for the greater good argument.” It’s interesting that other options that would actually be for the greater good are never considered (options such as auditing the Fed or demanding that the Fed follow the law), but I digress.
So why are we seeing calls for the banning of cash.
It’s because actual physical cash is a MAJOR problem for the Central Banks. The reason for this concerns the structure of the financial system. As I’ve outlined previously, that structure is as follows:
1) The total currency (actual cash in the form of bills and coins) in the US financial system is a little over $1.36 trillion.
2) When you include digital money sitting in short-term accounts and long-term accounts then you’re talking about roughly $10 trillion in “money” in the financial system.
3) In contrast, the money in the US stock market (equity shares in publicly traded companies) is over $20 trillion in size.
4) The US bond market (money that has been lent to corporations, municipal Governments, State Governments, and the Federal Government) is almost twice this at $38 trillion.
5) Total Credit Market Instruments (mortgages, collateralized debt obligations, junk bonds, commercial paper and other digitally-based “money” that is based on debt) is even larger $58.7 trillion.
6) Unregulated over the counter derivatives traded between the big banks and corporations is north of $220 trillion.
When looking over these data points, the first thing that jumps out at the viewer is that the vast bulk of “money” in the system is in the form of digital loans or credit (non-physical debt).
Put another way, actual physical money or cash (as in bills or coins you can hold in your hand) comprises less than 1% of the “money” in the financial system.
As far as the Central Banks are concerned, this is a good thing because if investors/depositors were ever to try and convert even a small portion of their “wealth” into actual physical bills, the system would implode (there is simply not enough actual cash).
Indeed, this is precisely what happened in 2008 when depositors attempted to pull $500 billion out of money market funds in the span of a month.
A money market fund takes investors’ cash and plunks it into short-term highly liquid debt and credit securities. These funds are meant to offer investors a return on their cash, while being extremely liquid (meaning investors can pull their money at any time).
This works great in theory… but when $500 billion in money was being pulled (roughly 24% of the entire market) in the span of four weeks, the truth of the financial system was quickly laid bare: that digital money is not in fact safe.
To use a metaphor, when the money market fund and commercial paper markets collapsed, the oil that kept the financial system working dried up. Almost immediately, the gears of the system began to grind to a halt.
When all of this happened, the global Central Banks realized that their worst nightmare could in fact become a reality: that if a significant percentage of investors/ depositors ever tried to convert their “wealth” into cash (particularly physical cash) the whole system would implode.
As a result of this, virtually every monetary action taken by the Fed since 2008 has been devoted to forcing investors away from physical cash and into risk assets. The most obvious move was to cut interest rates to 0.25%, rendering the return on cash to almost nothing.
However, in their own ways, the various QE programs and Operation Twist have all had similar aims: to force investors away from cash, particularly physical cash.
After all, if cash returns next to nothing, anyone who doesn’t want to lose their purchasing power is forced to seek higher yields in bonds or stocks.
The Fed’s economic models predicted that by doing this, the US economy would come roaring back. The only problem is that it hasn’t. In fact, by most metrics, the US economy has flat-lined for several years now, despite the Fed having held ZIRP for 5-6 years and engaged in three rounds of QE.
As a result of this mainstream economists at CitiGroup, the German Council of Economic Experts, and bond managers at M&G have suggested doing away with cash entirely. Over the weekend, an article in the Financial Times called for it too.
The old adage says “you can lead a horse to water, but you cannot make him drink.” The Fed and other Central Banks lead the horse to the water. The horse wouldn’t drink. So now they’re talking about holding the horse’s head underwater until he does.
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