Transactions, hoards, stashes and exports

In 2016, cash was used for 44% of all consumer transactions in the UK. That was down from 50% the previous year and from 68% a decade earlier. Victoria Cleland, Chief Cashier at the Bank of England says that the value of notes “in circulation” has been increasing year on year for the past decade or so and that “we are still seeing growth in total demand for cash”. This seems puzzling, considering that this year the UK will see 13.4 billion debit card payments (of which a third will be contactless) but only 13.3 billion cash payments (according to PaymentsUK).

 Studio 34

Now, as it happens, Victoria and I were both guests on the BBC’s flagship personal finance programme Moneybox last month [you can listen to the show here]. We’d been invited to take part in a phone-in about the trend to the cashless society, along with Andrew Cregan (Head of Payments Policy at the British Retail Consortium). The topic had been triggered by the head of the Swedish central bank calling for a pause in Sweden’s rush to cashlessness. At the end, Victoria and I rather agreed on the need to have a strategic conversation about cash at the national level. The issue in Sweden is that cashlessness is just happening: it’s not part of a plan that addresses the issues associated with a cashless economy (eg, inclusion). In the UK, we can learn from this.

But back to the steady growth in notes “in circulation”. The trend growth of cash in circulation running ahead of GDP growth isn’t a UK phenomenon. The amount of cash “in circulation” around the world has gone from 7% of GDP in 2000 to 9% of GDP in 2016.  On the show, I couldn’t resist an oblique snark about what these notes being used for (ie, money laundering, tax evasion and so on) since they aren’t being used to buy things.

That’s right. Banknotes, statistically, not being used to buy things. Cash is no longer primarily a means of exchange. The latest figures from the Bundesbank show that nine out of every ten euro banknotes issued in Germany are never used in payments but hoarded at home and abroad as a store of value. Not “rarely”. Not “infrequently”. Never. The notes are not in circulation at all but are stuffed under mattresses.

Similarly, down under, the Reserve Bank of Australia (RBA) Bulletin for September 2017 notes that the value of notes “in circulation” has gone up 6% per annum for the past decade while the use for payments has collapsed (from two-thirds of consumers payments down to one-third) over the same period. It goes on to note that higher cash usage may be concentrated in “groups not included in the survey of consumers (who may well use cash more often than the average consumer)” as well as the shadow economy.

Aha. The shadow economy.

A couple of years ago I was at an event where Victoria said that only about a quarter of the cash the Bank puts into circulation is for “transactional purposes”. I wrote a comment piece on it for The Guardian at the time, so I thought it might be interesting to review and update my comments using the Bank of England’s four-way categorisation of the demand for cash, which is that cash is required for:

  1. Transactions. Here the trends are clear. Technology is a driver for change but that the impact is weak. In other words, new technology does reduce the amount of cash in circulation, but very slowly.

  2. Hoards. These are stores of money legally acquired but held outside of the banking system, like the 300 grand that Ken Dodd used to keep in his loft. 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.

  3. Stashes. These are stores of money illegally acquired or held outside the banking system to facilitate criminal behaviour. My personal feeling is that stashes have grown at the expense of hoards.

    In a fascinating paper 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 crash, 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 seemed 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 that Guardian piece by the way), both of which serve to reinforce the contribution of cash to the shadow economy.

  4. Exports. 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 at lot of these notes are going into stashes.

If, as I strongly suspect, the amount of cash 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. Cash makes the government (i.e. us) considerably worse off. In summary, therefore, 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”. Hence my point that it is time for Bank of England to develop an active strategy to start reducing the amount of cash in circulation, starting with the abolition of the £50 note as well as the ending the production of 1p and 2p coins (almost half of which are never used in a transaction before being returned to the banking system or simply thrown away).

As it happens, the future of those coins and that note are the subject of a current HM Treasury “consultation”. I urge all you of sound mind to reply to the consultation and hasten their abolition here.

Germany is an outlier

The G4S World Cash Report came out and I was e-leafing through it when it struck me once again just how much Germany is an outlier when it comes to retail payments. The average German wallet contains 103 physical euros, the European Central Bank (ECB) estimated last year, more than three times the figure in France. Bloomberg says that cash is used in 80% of German point-of-sale (POS) transactions, compared with only 45 percent—and falling fast—next door in the Netherlands. I think they must mean 80% by value because the FT says that 48% of retail transactions are in cash (down from 58% a decade ago).

Perhaps it is that Germans are just naturally conservative people. The Roman historian Tacitus (55-117CE) wrote in his history “Germany and its Tribes” that the barbarian inhabitants of that land had traditionally exchanged weapons, slaves, cattle, women and such like to settle up between themselves but that the Romans had introduced them to money. Having changed their medium of exchange once in the last two millennia, perhaps they just don’t want more change for change’s sake. Or perhaps there is another explanation. The use of cash in retail is falling slowly and we all know that Germans prefer to keep some of their money as cash at home rather than in the bank, maybe much of the cash “in circulation” there just isn’t.

Given the suspicion that much of the cash in Germany is stuffed under mattresses rather than circulation in the economy, it was still rather surprising to hear from the Bundesbank that nine in ten of the euro banknotes that they are are never used in transactions. That’s right: nine in ten. Approximately all of the cash printed in Germany is never used. Not rarely, not occasionally, but never. So this led me wonder whether this huge volume of never used banknotes are in “hoards” (that is, legitimate money held outside of the banking system) or in “stashes” (that is, illegitimate money held outside of the banking system). Can it really be that the German predilection for holding some of their money in the form of cash account for these billions of euros in inert paper money?

Well, because of the current unusual circumstances with respect to interest rates and so forth, it’s certainly a plausible hypothesis. The European Central Bank (ECB) interest rate for bank deposits is currently minus 0.4%. Conventional economic theory would predict that at a minus rate, depositors would prefer to hold cash rather than pay the banking system to look after their money for them.

(One of the reasons why economists are interested in getting rid of cash is in order to allow the interest rates to go further into negative territory in order to stimulate economic activity over hoarding.)

Now, it clearly costs something to manage cash over and above the cost of managing an electronic deposit hence it is interesting to speculate what the German “crossover” negative interest rate might be, the modern version of the old “specie point” at which it was cheaper to hold bullion for monetary purposes rather than paper instruments.

The current negative interest rate cost German banks about a quarter of a billion euros per annum. The Bavarian Savings Bank Association sent around a circular to their members some time ago setting out their calculation of the crossover rate, which they calculated as something like -0.2%, or half of the current negative rate. However, as I wrote at the time, this isn’t really a serious calculation because, as it says at the end, it doesn’t take into account the significant costs of cash in transit (CIT) or the additional security expenditure that would be needed to guard cash hoards. But it does make a fun point, at least to me, which is that the existence of the €500 notes has an impact on that crossover rate. Now that the ECB has decided stop printing the 500s, banks will have to store masses of 200s, so the cost of storage and transport will be higher (which, in turn, will put a premium on the 500s in circulation so that they will trade above par). Just as an indication, two billion euros in 200 euro notes weighs about 11 tonnes.

While that calculation may not be complete, it does make the interesting point that although we have passed the crossover point already, no banks have to date decided to store their squillions under the mattress rather than leave them on deposit. It seems to me therefore that Bavarian estimates must be too low and that the costs of transport, security, insurance and so on are actually quite high, so the ECB will be able to push interest rates further negative before it gets close to a genuine crossover point that would see banks investing in larger mattresses.