2016 is shaping up to be a very unusual year in finance. Choppy capital markets, currency debasements and commodity collapses and negative interest rates have strategists and long-time market watchers scratching their collective heads.
Why All the Negativity?
There is now almost $7 trillion of global sovereign debt with negative interest rates. With negative interest rates, you actually pay the bank to custody your deposits, instead of banks paying you an interest rate for the ability to loan out your deposits. Negative rates, present mostly in Europe now, aren’t overly punitive at under 1% but who’s to say they don’t drop down to negative 1% or 2%. A Nomura Bank analysis posits that the lower bound of negative rates is the cost of physically storing the physical commodity of gold, which runs at a long-term average of 2.4%.2 But JP Morgan economists forecast that the ECB could cut rates all the way down to negative 4.5% while in the U.S., the Federal Reserve could cut rates down to -1.3%.3 A negative 4.5% would eat away at your savings rather quickly. Some fear this is akin to a currency war as central banks rush to devalue their own currencies to stay competitive.
Don’t think that it can’t happen here in the U.S. In a turn of events that has garnered surprisingly little media outrage, JP Morgan has announced that they are initiating negative interest rates, for cash balances above their FDIC level of $250,000, of as much as 5.5%.4 The goal is also to incentivize these institutions, often hedge funds or insurance companies to spend their money and not park it in the bank because new Dodd-Frank rules make holding deposits more expensive now since the bank must pay higher premiums to the FDIC for insurance. Corporations have raised record amounts of cash through debt financing at record-low interest rates. This might get them to invest the cash in capital expenditures or similar uses. An extreme example is Apple- sitting on a war chest of over $200 billion in cash, most of which is overseas.5
Another reason is that central banks are desperately trying to increase the movement of money into the system. This ‘velocity of money’ is what allows prices to increase and supports a moving economy. It is also a key metric used when measuring inflation. The velocity of money, as measured by the M2 money supply, has fallen off a cliff over the last couple years. The curious part of this is that when the Federal Reserve initiated quantitative easing, QE, it was feared to be inviting high inflation because of all the money in the system but this has clearly not happened. Perhaps deflation is the real reason.
The War on Cash
One theory that is taking hold regarding this bizarre economic scenario is that banks are trying to do away with ‘cash’. One of the cited reasons is to deter tax evasion and corruption. In Louisiana, it’s already illegal to use cash in a ‘used goods’ transaction. The state is trying to recover commonly hidden tax revenues from pawn shops, flea markets, etc. If states fiscal situations don’t improve, this practice could catch on elsewhere.
In addition to making certain payments in cash illegal, central banks may try and take it a step further-actually banning the currency bills themselves. Here in the United States, there is some noise being made about removing the $100 bill from circulation, in the name of fighting terrorism. History buffs may recall that the United States had currency denominations ranging from the $500 bill to even a $10,000 bill, both of which were eliminated in 1969.6 Incidentally, these bills are all still legal tender, but odds are you’ll never see one, there’s only a few hundred authenticated $10,000 in existence. And since they are so rare, they would be worth substantially more than their face value.
In Greece, there have already been seismic events in their banking system since 2012, when they had the infamous bailout. Greek citizens have a reputation for fudging income taxes and many find it easy to hide 500 euro ($558) bills in their mattresses, keeping it out of the financial system. Hiding just ten bills means $5,000 euros or roughly $5,580, a substantial sum. Furthering these claims, a Morgan Stanley survey showed that 80% of Greeks that withdrew deposits from the banking system in recent months have not returned them and 93% are determined not to.7
The German Finance Minister has introduced a plan to ban cash transactions above 5000 euros. As you can imagine, this was quite unpopular with the citizens and the countries best-selling newspaper, The Bild, printed an open letter entitled, “Hands off our Cash”. Germany is relatively ‘old school’-nearly 80% of payments are made in cash (compared to just 48% in the United Kingdom).8 Germans are also wary of electronic payments and 72% say they considered it safer to pay in cash.9
The European Central Bank, ECB, is discussing whether to do away with their 500 euro bill (about $558 U.S. dollars). Again, this could make money laundering, drug dealing and terrorist financing more difficult. The theory is that it is easy to smuggle cash around in suitcases for transactions without leaving a paper trail. Anti-Money Laundering experts are trying all kinds of new and innovative ways to combat economic crimes and fraud around the globe, as the levels of such crimes continues to escalate.
ECB’s Mario Draghi insisted that the purpose of withdrawing the 500 euro bill from circulation would only be for deterring the financing of terrorism and corruption. Some countries in Europe are skeptical this would even really deter crime. Economist Friedrich Schneider estimated that illegal activities would be reduced by just 2-3%.10 A system has to weight whether a 2% reduction in this type of crime of completely uprooting a financial system with unintended consequences.
Unintended Consequences of a Cash Ban
One issue with banning these currencies is that the 500 euro and the $100 dollar bills represent over 56% of all physical currency in circulation in the U.S. and Europe.11 Who knows how this would affect the system if they were simply eliminated. Could this be the first step in a real restriction on cash and a movement to a cashless society with smaller denominations to follow? Some fear this could lead to bank runs as depositors clamor to get these denominations out of banks. People could then use them to purchase precious metals.
Last year, Citibank economist Willem Buiter suggested that the ‘problem’ of cash in the system could be solved with a three part plan- 1) abolish the currency 2) tax the currency 3) remove the fixed exchange rate between currency and central bank reserves and deposits.12 Buiter claimed the need to abolish cash might come if central banks wanted rates below -1.0%. We are starting to knock on that door.
What Can You Do?
In an effort to hide cash, safe deposit boxes at banks might be stuffed with cash so it can be out of the accounts where it can be skimmed. An IRS agent might be required to be present when any customer opens their safe deposit box. Historians will recall this happened when the United States banned private ownership of gold. Of course, if you have an account with the largest bank in the United States, Chase, you may have already found out the bank disallows the storage of cash or coins (without collectible value) in safe deposit boxes. This was enacted in 2015, along with cash payments on credit cards, mortgages, equity lines of credit and auto loans.13
Another strategy would be using prepayments to avoid cash sitting in a bank account as negative interest rates eat away at the principal. For example, you could ‘overpay’ the IRS and then wait for the refunds later. Consequently, there might be a rush for prepaid card cell cards, Metro Cards for the subways or buses and at stores such as Walmart where they sell pretty much anything you need. Businesses would actually try and pay their bills as quickly as possible and try and recoup their accounts receivables slowly so that the counterparty incurs the negative rate costs.
Not to Worry
Others feel the worries about escalating cash bans are being blown out of proportion. After all, conspiracy theorists have been talking about a cashless society for decades. What we’re seeing may be just a slow, steady change as technology advances. Fewer and fewer people are carrying much cash around with them anyway these days. Debit cards and the proliferation of mobile payments have revolutionized how transactions occur. The use of PayPal accounts is becoming increasingly common as are digital currencies such as bitcoin.
There would certainly be legal challenges to negative interest rates and cash bans and supporters of such policies ban would have a real fight on their hands. In the United States, people would claim government intrusion and an infringement on freedom. The Constitutionality of cash bans would be certainly challenged and the Supreme Court could become involved. Much of our country’s poor only use cash, not by choice, but because they are unemployed or ‘unbanked’. Sure, cash and coins are dirty and unsanitary but that’s nothing new and hardly a reason to end the system.