Thought experiment: cash crash

[Dave Birch] A couple of people mentioned to me that my post about replacing cash is based on the assumption that cash will go away, whereas cash is a very conservative technology. This is true, of course. But the fact that cash is losing market share only very slowly does not mean that it could not see a more rapid drop in the future. Nevertheless, it would appear that the cashless store remains as a common as the paperless office, to repeat a frequently-used analogy. However, as The Economist recently pointed out, while fantasies about the paperless office began in the 1960s and are still derided by lazy commentators as “as likely as the paperless bathroom”, the truth is that it takes a generation to effect change. The use of paper in American offices has indeed been falling, but the decline didn’t begin until 2001 (paper use per office worker has fallen by about a sixth since then). Perhaps cash will take a generation to go away as well. What then? Suppose all of the cash in Britain went away and was replaced by electronic cash instead. What would happen? Well, let’s begin the thought experiment by trying to figure out how much cash there actually is. Narrow money (M0) is the amount of notes and coins in circulation.

The total amount of cash in the UK is just over £50bn, with about £43bn circulating outside the banks and £7bn in banks’ safes, tills and cash machines.

[From BBC NEWS | Magazine | Where has all the money gone?]

If that went away, the first thing that would change is tax: the government earns interest on that £50 billion loan that we are granting it in exchange for bits of paper and metal and that interest — a couple of billion per annum — would need to be replaced by other tax revenue. Oh well. At the least the cost of government would be made more explicit. But I don’t think the government would see a net loss: after all, no cash means less tax evasion so we can reasonably claim that the transition to e-money will be revenue neutral and the economy as a whole will be much better off because of the high social cost of cash (resources would be freed for more productive activity).

A couple of billion! Actually, it’s not that bad. Much of the £43 billion outside the banks isn’t really circulating: it’s under mattresses and in jam jars. The euro has steadily been replacing the dollar and the pound in drug-dealer’s stashes though, so let’s say that two-thirds of M0 is the circulating medium of exchange, say £30 billion for a round number. If the seigniorage on that is five percent, that means around £1.5 billion per annum remitted to the government (which tallies roughly with the Bank of England’s figures I think). Where is that £1.5 billion going to come from? Perhaps the government will cut spending accordingly by reducing waste and getting rid of pointless programmes… no, maybe not.

To make the thought experiment more exciting, let’s bring in a good argument against e-money. What happens when the system crashes? After all, surely one of the best things about cash is that you don’t need a terminal to accept it. Therefore, cash’s trump card is that when all else fails, notes and coins still work. It’s a silly experiment, when you think about it, because if communications networks and computers go down for more than a few minutes, the country is in chaos anyway and we’ve got more to worry about than not being able to go to the supermarket. Nevertheless, it does make you think: what’s the fail safe? We must have e-cash that works offline, obviously. That goes without saying. But that will only take care of a few, small transactions. Pretty quickly, we will need online access to our money. Let’s try to imagine what happens when that doesn’t work any more…

So let’s imagine Woking in 2029. As part of an independent Wessex, Woking is a peaceful and prosperous place. But unfortunately, saddled with its share of debts when Scotland, Wales, Wessex, Mercia, Northumberland and the City State of London devolved from the formerly United Kingdom, Wessex is still paying for Gordon Brown’s legacy and couldn’t afford to install better power generation and transmission facilities. The overloaded grid collapses, and the lights go out. I go round to Waitrose and I want to buy some lamb chops and potatoes. Waitrose have two options: they can let the stuff rot on the shelves or they can sell it to me. So they decide to sell it to me. But I don’t have any cash (no-one in Wessex does: we all use the hard e-groat).

As we were discussing earlier in the year, there is a relatively recent case study of a society trying to work without cash, and this is Ireland during the bank strikes of the 1970s. There, a decentralised solution soon emerged:

People began to accept cheques from each other, and these cheques began to circulate.

[From Digital Money Forum: Payments without banks]

Since I go to the same branch of Waitrose every week, the manager recognises me so I write out and sign an IOU. The manager asks for some ID — so I show him my Psychic ID card — and then gives me the goods. When power is restored and Wessex returns to normality, the manager takes the cheque to the bank and presents it. No problem. But wait: cheques were phased out according to the National Payments Plan in 2018, so no-one knows what they are any more and even if they did there’s no system for processing them. How could we function in such circumstances?

Step forward our old friend the mobile phone. I think we can use phones to mitigate against the effects of a short term system crash in two ways. First of all, if NFC phones are running POS terminals then people could use their phones to accept offline card payments from people they think are probably good for the money and these payments can be processed when the system comes back. Further suppose we enable low-value phone-to-phone transfers (either via the mobile network, if the mobile network is up but the payments network isn’t, or via NFC or Bluetooth if the mobile network is down as well) then people could get buy with a modern version of the Irish IOUs of the 1970s. And if the mobile networks and the payment networks are down for more than a couple of days then, frankly, we’ll all have a lot more to worry about the cash-replacement e-payments because we’ll be bartering Marlboro for carrots.

These opinions are my own (I think) and presented solely in my capacity as an interested member of the general public [posted with ecto]