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Going Cashless

By Margarita Bozhinova

This article was featured in JMBR's Fall 2016 print edition.

In Europe, settling an everyday transaction with a €500 bill, or even a €200 one, is likely to earn you a funny look, as these notes are considered to be the transaction method of choice for criminals. That’s why, in May earlier this year, the European Central Bank decided to stop issuing the €500 note, casually referred to as the “Bin Laden.” Banknotes, especially in high denominations, are believed to facilitate illegal transactions, not only in the country where they are issued, but elsewhere as well. This adverse effect generally extends to the currencies of advanced economies, which are considered useful for crime since their value tends to be higher than the one of equally denominated bills from developing economies. For example, the size of a foreign country’s informal economy tends to correlate with its demand for US banknotes, as the currency is commonly used for underground transactions.

Part of what makes cash attractive in the context of illegal transactions is its lack of inherent transaction record. This is why cash is believed to play a central role in tax evasion, especially for small businesses. It does not leave any evidence of the exchange, letting the business owner pocket the cash without reporting the transaction to fiscal authorities.

Cash also enables the transacting parties to remain anonymous. With no record of ownership or information about its provenance, it allows criminals to weave illegal proceeds into legitimate or seemingly legitimate income sources. Such money laundering schemes seek to obscure the tie between the crime and the proceeds, before funnelling the money back to its originators. They often involve complex criminal networks whose activities and resulting cash flows span several countries. This is where high denomination banknotes can play a significant role in facilitating illegal transactions.  

When it comes to crime, one of the main drawbacks of cash is its volume, especially when it comes to transporting large sums of money. By minimizing the space occupied by any large sum of money, high denomination notes reduce the risk of interception of illegal proceeds during border inspections. In fact, according to estimates, $US20-30bn in drug-related cash flows cross the US-Mexico border every year. Of those cash flows, only a total of $US550m were seized in the entire 2003-2013 decade. Eliminating high-denomination notes would constrain criminals to use bills of lower value, which would take up significantly more physical space. Such a measure would increase interception risk and is likely to boost the currently scant number of border seizures.

In fact, in a paper which points towards a gradual phasing out of cash, Harvard economist Kenneth Rogoff reports that only 10-15% of existing US banknotes are used in the country’s legal economy. Though these numbers are slightly higher in the euro area, Rogoff still argues that paper currency should be becoming technologically obsolete and one of the main factors holding it back is its widely spread use in the underground economy.

Indeed, some countries are increasingly moving away from banknotes in favor of electronic means of payment. Danish officials want the country to be cashless by 2030. More than half of Sweden’s bank branches do not keep cash or accept cash deposits and many businesses only take payments through apps and bank cards. Even exchanges that are hardly imaginable without cash occur electronically. In Stockholm, homeless magazine vendors accept payments through cards and apps.   

However, such a transition is difficult to imagine elsewhere. In the US, the sheer size of the population would pose a problem to the elimination of cash. In certain counties, the use of paper money is especially common, namely because a high proportion of the population is unbanked. That is, there is limited access to alternative payment methods provided by banks, such as debit or credit cards. With that in mind, a transition to an entirely electronic payment system seems far-fetched.

For many others, cash carries a psychological value. The elimination of the €500 bill was met with vehement protests in certain EU nations, including Germany. In fact, compared to North Americans and to some of their European neighbours, Germans carry more paper currency on them and use it much more to settle transactions. Surveys on the phenomenon show that this is motivated by a desire to better manage spending, consistent with the country’s reputation of debt aversion and proclivity toward saving. Another explanation points toward collective memory. Having experienced the mass surveillance of two authoritarian regimes in the 20th century, Germans would prefer cash for its anonymity. Similarly, a Federal Reserve of New York study shows  the impact of “generational memory” on the demand for cash. In developing countries, a history of hyperinflation explains generation-long increases in the demand for US banknotes, which are used as physical store-of-value when the confidence in the national currency is undermined.

A preference for the anonymity of paper currency is not exclusive to criminals and those with searing memories of life under an authoritarian regime. Rather, a major ethical argument against the phasing out of cash concerns itself with privacy rights. Most common electronic alternatives leave a trail of transaction data, which, some worry, can be collected and used for marketing or other purposes with which the payer may not agree. Of course, paper currency’s anonymity can also be convenient to hide certain legitimate, everyday transactions, like the purchase of gifts.   

Governments, too, have incentives to keep paper currency in use. Putting banknotes into circulation is a source of revenue, called seigniorage, for central banks. For example, the annual seigniorage of the Bank of Canada has ranged between $1.4 and $2 billion in the recent years. Kenneth Rogoff argues that even a modest improvement in tax evasion would offset the loss of seigniorage revenue, but he himself points out a flaw in that argument;  fiscal authorities, not central banks, would be the ones receiving any increase in tax revenues.

Yet, it is worth noting that central banks would benefit from the elimination of paper currency in one major way: the ability to effectively implement negative interest rates. Negative interest rates aim to stimulate economic growth by penalizing banks for holding onto their money instead of lending it out. The negative rate may be passed onto consumers, encouraging them to spend it, at least in theory. However, the ability to avoid such rates by hoarding one’s wealth in cash hampers the effectiveness of the policy. In fact, as negative interest rates were passed onto certain German consumers earlier this year, many decided to avoid paying fees on their savings by stashing them away in cash, creating waiting lists for safety deposits in certain metropolitan areas.

While some parties stand to gain from the elimination of paper currency, many others categorically oppose any measure threatening the availability of cash. Besides concerns about whether cash should be phased out, a question worth asking is how it could ever be phased out. In his recent book, The Curse of Cash, Kenneth Rogoff advocates starting a slow transition by eliminating large denomination notes, while leaving smaller ones, such as $10 and below, because they offer both privacy and convenience for small, legitimate transactions. To accommodate the unbanked and underbanked, he proposes offering free access to deposit accounts targeted at those who do not carry the minimum required balances. Still Rogoff recognizes that we are a long way from living in a cashless society. A “less-cash” society, as he terms it, is as far as his hopes go for the near future.


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