Cash, CHF and chuffing hell there’s a $1000 bill

This time last year there were approximately £70.5 billion in notes and coins “in circulation” in the UK. Now, there are approximately £74.5 billion in notes and coins “in circulation” in the UK. That’s a rise of 5.7% in a year when the economy grew by about 1.8% and the use of cash in retail transactions (retail spending grew 5.2%) was overtaken by the use of electronic payments. Cash is now only 48% of transactions, and the UK Payments Council say that this will fall by another third over the next decade.

Back to the same old question again then. What is this cash being used for?

Here’s a clue. A fifth of the currency “in circulation” is in the form of £50 notes, which you never see in polite society. As we have discussed before, only about a quarter of the Bank of England’s notes are used for transactional purposes so these £50 notes must be disproportionately concentrated in the non-transactional (i.e., largely criminal) uses. As everywhere else, high-value banknotes are a major cause for concern.

The EU Commission on Tuesday will pledge to investigate the suspiciously high number of the notes in circulation in the eurozone as part of a plan to choke-off financing for terrorists in the wake of November’s attacks in Paris.

From EU to probe €500 notes’ links to terrorism – FT.com

Back to another obvious question then. Why not make crime, terrorism, drug dealing, money laundering and bribing corrupt politicians marginally less convenient and marginally more expensive by getting rid of those high-value banknotes?  It is not only crazed electronic money maniacs who think this is right path to take, by the way. This kind of thinking is beginning to percolate up to the higher echelons of the financial establishment.

Mario Draghi, European Central Bank president, told the European Parliament on Monday that the matter was being studied by the central bank and that no decisions had been taken yet. “We want to make changes,” he said, adding that “we are determined not to make seigniorage a comfort for criminals.”

From EU to probe €500 notes’ links to terrorism – FT.com

What does he mean by this? Well, the “seigniorage” is the money earned by the ECB on the note issue. They sell €500 notes that cost them 10 cents (or whatever) to make. The €499.90 profit has to be invested in safe securities (government bonds, basically) and the interest earned on those securities is divided up between the eurozone members according to some arcane formula. The upshot of it all is that the stack of €500 notes underneath the Mafia boss’ pillow are earning interest for national governments. The governments are, in a very real sense, living off of the proceeds of crime. A no brainer then! Since this is clearly morally and ethically wrong, central banks are presumably wholly against it. Well, sort of. But you can see the problem that Mario faces if he does the right thing and cans the €100, €200 and €500 notes…

If we are right, the Euro will weaken, primarily against the USD and the CHF. The USD is the most liquid currency and we would expect it to capture a large share of the drop in the demand for the Euro as a store of value. However, the CHF could also benefit, having the largest note denomination in G10 economies.

From Kill the €500 note, weaken the euro | FT Alphaville

Ah, the CHF. Sooner or later the law-abiding nations of the world will have to institute sanctions against the Swiss for delivering convenience to the criminal and manna to the money launderers. I’ve just been in Switzerland and I never even saw a CHF note or coin: I used cards everywhere, and as far as I could see so did everyone else, except for the Arab gentleman who checked into the hotel in front of me and paid up front with three €500 notes. As I never see these in wild, I tried to grab a photograph of the check-in clerk running these through an anti-counterfeiting device that she had on the counter but she was too quick for me. The fact she had the device right there on the desk leads me to suspect that she sees more €500 notes than I do.

Swiss cash circulating is about five times that of Canada, and twice that of the euro area. At the same time, the rate of card use is among the lowest in western Europe — only a third of Sweden’s level and less than half that of the U.K.

From Rolex Buyers Needn’t Worry as Swiss Put Limit on Anonymous Cash – Bloomberg

The €500 isn’t the biggest note that desk clerk sees though. Switzerland has a CHF1,000. That’s right: a banknote worth $1,000. And you can spend it, too. Mind you, the Swiss have been cracking down: since January, you have had to show ID (how they verify the ID is beyond me) for cash transactions of $100,000 or more.

[then-Finance Minister Eveline Widmer-Schlumpf] spoke during a debate on an anti-money laundering law that came into force this year, establishing a ceiling of 100,000 francs on anonymous cash transactions. Charles Goodhart, a former Bank of England policy maker, said in December that the limit was so high that it could only be described as a joke.

From Cash Is Still King in Switzerland – Bloomberg

Am I taking crazy pills? The Swiss National Bank, the European Central Bank and the Federal Reserve should not be competing to be the currency of choice for Mexican drug lords, Albanian people traffickers and Syrian terrorist groups. Surely there is a moral dimension to this: all three should agree to reduce the maximum value of the circulating medium of exchange to EUR 50, USD 50 and CHF 50 and if they are not prepared to do this then the heads of the respective central banks should be prosecuted for conspiracy to support money laundering. It is time to get tough with these guys.

Where is the aggregate demand for cash coming from?

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.


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