On September 8, we issued a report laying out the risks of coming too close to the zero lower bound (ZLB). Some said then we were alarmist; now, not so much. As markets push nominal yields below zero for the reasons we laid out, central bankers are as we forecast flirting with nominal rates below the ZLB. Our paper also described the flight to physical cash that comes with going below the ZLB. We missed something, though—at least one central banker, England’s Andrew Haldane, had a solution to the flight to physical cash: abolishing cash. Respondents to Mr. Haldane have emphasized the threat to personal freedom if stores of value are governmental play-things, but none so far has laid out another profound change with destructive impact: without cash, we won’t have financial intermediation, just barter.
Mr. Haldane described an impediment to going below the nominal ZLB as a “technological” one: that is, currency now is paper and coin, but doing away with them in favor of digital signals gives him “money” that can be altered when monetary policy needs money to do its bidding. Getting the blockchain vibe, he notes that this technology could do the trick, although he concedes that it might still be necessary to exchange virtual currency for fiat paper if fuddy-duddies demand this. He corrects for this challenge to abolishing cash as one slips below the ZLB by positing a government-set exchange rate between virtual and fiat currency, a system that would, as some others have noted, essentially make money the equivalent of frequent-flyer miles.
Essentially, money would be a medium defined by what monetary policy wants it to be, not what personal and economic interests dictate. Let’s work this through the financial-intermediation chain, remembering all the while that central bankers know—or should—that they are to be safeguards not only of effective monetary policy, but also of robust financial stability. If they get what they want for monetary policy at the cost of a functioning financial system, that’s a high price to pay for making their jobs a bit less taxing.
First to the deposit end of the intermediation chain, broadening this to consider other front-end funders of financial activity (e.g., MMF investors). Without physical cash, depositors and their like would have no way of ensuring that there is no loss of principal because the central bank could expressly devalue the dollar—or, less technically, seize some of its value by, more or less, waking up and saying so. Long-term investors always have the risk of principal loss in real terms (i.e., through inflation, exchange-rate devaluation), but the prospect of principal loss via government edict could well lead panicky depositors and investors to safeguard principal in physical objects.
This isn’t theoretical—the U.S. saw this in the 1980s due to hyper-inflation when “collectibles” soared in value as hedges against purchasing-power loss. Now, we’re seeing it in Greece, where a combination of physical-object hoarding and barter is replacing a currency at risk of government-dictated loss of principal.
In short, depositors and investors below the ZLB could well flee from newly-uncertain, volatile fiat currency—intermediation’s engine—into the equivalent of gold coins. How then to fund investment—the other side of financial intermediation and the rationale for the financial system as we know it?
With money the equivalent of frequent-flyer miles, it can lose value at any time for seemingly any reason. As a result, the only way I can think of to fund purchases beyond those of physical goods that stay put under people’s mattresses would be for the government to become the currency intermediary. That is, the central bank or its buddies in the finance ministry would print and acquire currency at stipulated value and lend it to worthy projects for desired rates of return. Central banks—not private ones—would have to take on this role, I fear, because banks would have no deposits and lenders would have no way to anticipate a real return on investment.
Market forces of course always affect return throughout the intermediation chain—those who forecast these well profit handsomely thereby. Each of us thinks we’re smart enough to make this work for us, but if we aren’t, we have ready stores of value that at least promise us a dollar of nominal value back for a dollar of nominal value given. Or, we comfort ourselves that there’s principal protection out there and let central bankers do what they can. Interest rates set by central banks have thus become the fulcrum of financial markets and the macro-economy that depends on them. We’ve all become servants of the central bank, but we at least comfort ourselves with the knowledge that market forces constrain them to some extent and, if they don’t, we’ve places to run and hide. Even with stable fiat currency, we nonetheless see highly-volatile markets, hoarding of stores of principal protection, and slow economic growth.
Wouldn’t central-bank dictated money exacerbate the quandary of ever-less effective monetary policy combined with ever more volatile financial markets? Would we all so trust our central bankers as knowingly to hand them our wallets? And, if we do, would our benevolent bankers stay benevolent despots or would personal or political ambition get the better of them? The lesson of history argues for limits to power, which include limits to those of central banks to tell us just how much we’ve got in our pockets when they want to. Before we give back our piggybanks, central bankers need to lay out how an end to physical cash affects the rest of us, not just the ease of decision-making at their next round of closed-door meetings.