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Noted

by David Birch

[Dave Birch] In his keynote address to the “Banknote 2009” conference in Washington the chief cashier of the Bank of England, Andrew Bailey, talked about

the apparent ‘paradox of banknotes’ – the increasing value of notes in circulation alongside their gradually declining use as a means of payment.

[From More bank notes needed as we use cash less, and why £5 notes are tatty ]

What he meant was that as a share of nominal GDP, the value of notes in circulation declined from 6% in 1970 to a low point of 2.4% in the mid-1990s but has since actually increased, noticeably over the past two years. He explain this by saying that from a macroeconomic perspective, sustained low inflation has increased confidence in the real value of the currency since the mid-1990s, while more recently demand for banknotes has risen during the recession, particularly for £50 notes. Cash currently accounts for 60% of UK transaction volume but only 4% of transaction value.

Andrew suggests that rising demand for notes might reflect some loss of confidence in banks and very low interest rates, which reduce the opportunity cost of holding banknotes as a non-interest bearing asset. What he means by this is that when you have cash in the bank, it doesn’t earn very much interest, so you may as well keep it at home and reduce transportation and access costs whilst obtaining maximum liquidity.

Although I’m not an economist, I suspect this argument needs to be revisited, because I think in some cases holding cash reduces liquidity, because you can’t use it to buy what you want on eBay or Amazon. What’s more, when you hold cash, it is much more likely to be lost than if you leave it in the bank.

People who keep their savings in cash at home rather than in banks make themselves easier prey for criminals and are more likely to lose their money to fire, flood, or just neglect.

[From New underground economy - Washington Times]

Any sensible UK consumer would not hold a government-backed fiat banknote, but instead put the money in a government-owned bank (such as Northern Rock or RBS) where the money is 100% guaranteed against all circumstances (including the incompetence of bank management, outright fraud and so on) and receives interest.

A loss of confidence coupled with a sudden drop in IQs? Maybe. I think a more likely explanation is that taxes have been rising thus leading to a growth in the black economy (government tax revenues are down substantially this year) and during the recession (with bad unemployment) people are paying in cash to avoid VAT.

Shouldn’t the Bank of England be reducing M0, not increasing it? Providing more £50 notes does nothing for commerce and industry (since they can takes cards and, for the next few years, cheques) but merely makes tax avoidance easier while simultaneously reducing the overall efficiency of the payment system. A double whammy.

If some people are avoiding taxes, that makes the rest of us not only have to pay more than their fair share but also grow even more resentful about handing over money to the government. Thus, we work harder at avoiding tax or work less and avoid income (why work a few hours’ overtime if you’re going to keep less than half of it?), in both cases reducing government revenues even further.

Should we expect payment systems to act as tax collectors (and policemen) for the greater good? I’m not sure about this, but on the other hand there’s no reason to create payment systems that make matters worse.

Creating money is easy. The hard part is getting it accepted.
Economist Hyam Minsky (1986).

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