A few days ago, I happened to be at an event where the Chief Cashier of the Bank of England gave an interesting speech about the trajectory of banknotes. These are important to the Bank of England, because the note issuing department of the bank is the most profitable nationalised industry in history. And demand for their product continues to grow.

Aggregate demand for Bank of England notes has grown quickly, increasing by around three-quarters over the past decade, and has outpaced the growth in GDP since the 1990s. Today there are nearly three-and-a-half billion notes in circulation, totalling over £60bn.

[From Working together to deliver banknotes for the modern economy – speech by Victoria Cleland | Bank of England]

But what was most interesting to me about the speech, since I don’t care about plastic banknotes and Victoria seemed most unenthusiastic about my campaign to have Sir Thomas Gresham replace the Queen on all British banknotes when I told her about it afterwards, was that she gave up heads up on today’s Bank of England Quarterly Review (3Q15), in which the Bank looks at cash usage. In the same speech, Victoria said that while “demand for cash as a medium of exchange appears broadly stable, its use as a store of value appears to have grown… We estimate that around 20% to 30% of total UK cash was in, what we refer to as, the ‘transactional cycle’ – cash held by banks, consumers, and retailers for the purposes of facilitating everyday transactions”.

In essence she said that their latest figures show that only about a quarter of the cash that they put into circulation is for transactional purposes (i.e., used). The rest of it is either shipped overseas (i.e., exported), which we will put to one side for the moment, kept outside of the banking system (i.e., hoarded) or used to support the shadow economy (i.e., stashed). In other words, not in circulation at all but stuffed under mattresses.

UK banknotes GDP:ATM

If you look at the trend growth of that cash “in circulation” over the last few years it has accelerated well ahead of trend GDP growth as well as past trend ATM withdrawal growth. And we also know that the use of cash in retailing has continued to fall steadily so the “cash gap” between the small amount of cash that is used to support the needs of commerce and the large amounts of cash that are used for other purposes has been growing. The interesting question that the Quarterly Bulletin article by Tom Fish and Roy Whymark stimulates is straightforward: “if the majority of Bank of England notes are not being used for everyday transactions in the domestic economy, what are they being used for?”

I was invited to write a comment piece on this for The Guardian, so having looked at the high level picture I thought it would be interesting to look at each category and what the key drivers in each of them might be. The first, cash that is used, is easy. We know that the driver is technology but that the impact is weak. In other words, new technology does reduce the amount of cash in circulation, but very slowly.

Moving on to the next category, I know it’s a rather simplistic analysis, but if the amount of cash that is being hoarded has been growing then that would tend to indicate that people have lost confidence in formal financial services or are happy to have loss, theft and inflation eat away their store of value while forgoing the safety and security of bank deposits irrespective of the value of the interest paid. The Bank say that “a small number of individuals hoard large amounts of cash” (Ken Dodd, rather famously, had £336,000 in suitcases in his attic) and so might account of a lot of the notes.

If, on the other hand the amount of cash that is being stashed has been growing then the Bank of England is facilitating an increasing tax gap that the rest of us are having to pay for. In this context cash is a mechanism for greatly reducing the cost of criminality while it remains a penalty on the poor who have to shoulder an unfair proportion of the cost of cash. In this case, we should expect to see a strategy to change this obviously suboptimal element of policy.

The amount of cash that is being exported is hard to calculate, although the Bank itself does comment that the £50 note (which makes up a fifth of the cash out there by value) is “primarily demanded by foreign exchange wholesalers abroad”. I suppose some of this may be transactional use for tourists and business people coming to the UK, and I suppose some of it may be hoarded, but surely the strong suspicion must be that these notes are going into stashes.

The Bank notes that “given the untraceable nature of cash” they cannot tell where cash is going. That’s true. I’m not suggesting we adopt the Chinese policy of having ATMs record the serial numbers of notes that they dispense and having cash recycling centres record the serial numbers of notes coming in to rectify this lack of data, but clearly we can look at some proxies to help us establish the rough proportions of used and hoarded, stashed and exported. The Bank says that it thinks around 25% is used and around 25% is hoarded, the rest stashed and exported. If most of the exported cash is stashed, then heading towards half of the cash out there is for, not to put to fine a point on it. criminals. 

So where is the demand coming from? The Bank says that “no single source of demand is likely to have been behind the sustained growth” but I’m not so sure, because I think stashes have grown at the expense of hoards. In a fascinating paper that I looked at last year by Prof. Charles Goodhart (London School of Economics) and Jonathan Ashworth (UK economist at Morgan Stanley), they note that the ratio of currency to GDP in the UK has been rising and argue that the rapid growth in the shadow economy has been a key cause. If you look at the detailed figures, you can see that there was a jump in cash held outside of banks around about the time of the Northern Rock affair, but as public confidence in the banks was restored fairly quickly and the impact of low interest rates on hoarding behaviour seems pretty marginal, there must be some other explanation as to why the amount of cash out there kept rising. Two rather obvious factors that do seem to support the shape of the curve are the increase in VAT to 20% and the continuing rise in self-employment (this came up a couple of times in comments to The Guardian piece), both of which serve to reinforce the contribution of cash to the shadow economy. The Bank say that there is “limited research to confirm the extent of cash held for use in the shadow economy”, but Charles and Jonathan make a reasonable estimate that the shadow economy in the UK could have expanded by around 3% of UK GDP since the beginning of the current financial crisis.

While the BoE paper notes that academic evidence does not suggest the black economy is expanding in the UK

[From UK savers hoard at least £3bn of cash at home – FT.com]

According to Tax Justice UK, there were £100 billion in sales not declared to UK tax authorities that meant a tax loss of £40 billion in 2011/12 and that will rise to £47 billion this year. That sounds like expansion to me. The IMF have noted that while Her Majesty’s Revenue and Customs (HMRC) is not good at estimating losses outside the declared tax system, which is why their latest estimates for the tax gap are low at £33 billion for 2011/12. And while we all read about Starbucks and Google and other large corporates engaging in (entirely legal) tax avoidance, half of all tax evasion is down to SMEs and a further quarter down to individuals (according to HMRC).  There are a awful lot of people not paying tax and simple calculations will show that the tax gap that can be attributed to cash is vastly greater than the seigniorage earned by the Bank on the note issue. Cash makes the government (i.e. us) considerably worse off.

In summary, I think think that the Bank’s view on hoarding is generous and that it is the shadow economy fuelling the growth in cash “in circulation”. There’s something wrong about this, especially when we know that the cost of cash falls unfairly on the poor. It is time for Bank of England to develop an active strategy to start reducing the amount of cash in circulation. For a start they could take a look at what’s been going on in Sweden where a broad alliance between the government, banks, trade unions (it is their members who get beaten up and stabbed in cash robberies) and Bjorn from ABBA has made it the first country in the world where the amount of cash “in circulation” is falling.

Next week we’ll take a look at the second part of the Quarterly Bulletin article about what might influence the demand for cash in the future.


  1. By way of analogy, I’d like to reply with an article in the Economist recently concerning the apparent mystery behind Nairobi’s property boom:


    And this particularly precious paragraph:

    “The source of this glut of cash is unclear. Some comes from savings; some from emigrants who repatriate earnings from abroad. But there are hints of less salubrious sources. The spoils of corruption are rarely kept in foreign bank accounts these days. Instead, they are invested at home. And just as Russians are blamed for inflating house prices in London and New York, in Kenya some blame rich Somalis.”

    The answer is easy to see, if you go there and do the research. I did, and I hate to think I’m special. The answer is *cold hard savings*, perhaps an elusive concept in western society, but widely practiced in the emerging markets.

    It is only an analogy. But, the point is this: if The Economist is having trouble about something that every Mama Biashara in Nairobi knows and holds dear to heart, maybe there is serious mystery in figuring out the facts in a complicated western economy? For a soft science, economics can be surprisingly hard.

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