Last week Citi’s Willem Buiter published a note on the three ways to get rid of the effective lower bound to nominal interest rates, one of which is to abolish cash. He goes on to say that
politically, the abolition of currency would run into opposition from some of the legitimately cash-dependent poor and elderly, from those for whom the anonymity of cash is desired because they are engaged in illegal activities and from libertarians. The first constituency can be helped, the second can be ignored and the third one should take one for the team.
I think that Buiter is wrong to characterize libertarians as necessarily opposed to the abolition of cash. Their take on cash is probably (or at least should be) a bit more nuanced. Since libertarians generally advocate government withdrawal from lines of business like health care or liquor retailing, an exit of central banks from the cash business should be a desirable outcome.
What Buiter is advocating is a bit more extreme than just government exit, however. An across-the-board banning of cash would not only take the government out of the cash business but also prevent individuals and businesses from entering the product niche. The participation of the private sector in the provision of cash isn’t just science fiction. Historically, commercial banks were intimately involved in the production of paper currency. In modern times, the majority of banknotes that circulate in Scotland are issued by three private banks—the Bank of Scotland, the Royal Bank of Scotland, and the Clydesdale Bank, while in Hong Kong, the major commercial banks are charged with issuing currency.
Buiter would probably object to private banknotes. After all, if private banks are able to issue negotiable bearer instrument that pay a zero nominal interest rate, a central banker will continue to be plagued by the problem that he/she can’t reduce interest rates below zero—instead of fleeing into 0% government paper, the public will hide in private banknotes. It’s the same liquidity trap as before, with private currency in the place of central bank currency.
However, there would be one key difference. Private banks must abide by the Darwinian calculus of profit and losses, central banks don’t have to. Take a world with privatized cash. A recession hits and the rate of return on capital falls plummets. At the same time, the central bank drops its deposit rate deep into negative territory. As a private bank tries to match with deposit rate reductions of its own, say to -2%, customers will convert negative yielding deposits into the bank’s higher-yielding 0% bank notes. The bank, whose survival depends on a healthy spread between the rates on borrowing and lending, faces a sudden spike in borrowing costs to 0%, the rate on their cash base. Spreads will shrink, even invert. Bankruptcy looms.
In order to avert this disaster, private issuers will quickly institute limits on their cash business. This could involve adopting any one of Buiter’s three remedies: 1) cancel their note issue; 2) impose a fee on cash, or; 3) remove the fixed exchange rate between deposits and cash. Thus,the lower bound probably wouldn’t be a problem in a banking system characterized by privatized paper issuance. The necessity of maintaining a spread would force private banks to rapidly innovate any one of these three escapes come recession and negative nominal rates. Upon recovery, they can remove these limitations and continue with their regular cash business.
Imagine that private banks all choose the first option when nominal rates fall below zero, cancellation. With cash no longer in existence, banks will have succeeded in restoring their margins to health. The population, however, will have effectively lost their ability to make anonymous transactions. This puts a libertarian in a tough philosophical position. On the one hand, a cashless world poses a serious threat to personal liberty. John Cochrane calls it an “Orwellian nightmare,” and Chris Dillow has referred to banning cash as “a grossly illiberal measure – the banning of capitalist acts between consenting adults.”
On the other hand, if cash threatens a bank’s existence, no libertarian would advocate the use of force to prevent said bank from exiting the business of cash provision. Capitalistic acts cannot be forced upon non-consenting adults, or, put differently, Jack’s desire for anonymity-providing products doesn’t justify Jill being put into chains in order to provide those products. Therefore, a withdrawal of cash by banks as nominal rates fall below zero, and the loss of anonymity that comes with it, is consistent with libertarianism.
So oddly, Buiter’s proposed end point—a cancellation of cash in order to rid the world of the lower bound—is very similar to what a libertarian end point could look like. Both institutions will elect to withdraw cash from circulation because it interferes with their institutional prerogatives. For a central bank, this mission boils down to the targeting of some nominal variable like inflation while in the case of a private bank it is its ability to earn a competitive return. That’s not to say that a libertarian ought to support Buiter’s abolition, only that the subject is more nuanced than it might seem upon a superficial reading.
As a postscript, it’s worth noting that neither Buiter’s central banker nor a libertarian’s private banker need go as far as abolishing cash in order to remove the effective lower bound. Buiter provides two other options, the best of which (in my opinion) is removing the fixed exchange rate between cash and deposits. Miles Kimball has gone through this option exhaustively. I’ve outlined some even less invasive, though not as effective, options here.
Does the zero lower bound exist thanks to the government’s paper currency monopoly? (link)
Is legal tender an imposition on free markets or a free market institution? (link)
Bill Woolsey on how the private sector would withdraw cash at negative rates (link | link )
FTAlphaville: Buiter on the death of cash ( link )
Note: I changed some wording on September 26, 2015. The message remains the same.