No, there is no typo in the title. We do mean demon-ization of cash and not demonetisation.
Futurists have long speculated that one casualty of technological innovation in finance will be the good old bank note as advancement in electronic payment systems and greater online connectivity means that there is no need for such an archaic and expensive relic[1].
Historically, such speculation has proved to be rather pre-emptive[2], and with studies showing that cash still dominates financial transactions (85% globally, although for several countries notably Singapore, Sweden, Denmark and the Netherlands noncash payment methods dominate[3]) the “war on cash” will not be a quick or easy victory. That said, what is clear is that there is a strong and accelerating push in this direction from global policymakers.
Over recent years limits on cash transactions have been instigated in several European countries (for example in Spain cash transactions above EUR 2,500 for residents are illegal whereas in Italy the limit stands at EUR 3,000[4]) and/or certain bank notes have been withdrawn or it has been proposed that they be withdrawn. The ECB has stopped production and distribution of the EUR 500 bank note[5], and just last month India completed the scrapping of the INR 500 and INR 1,000 bank notes (more on this later)[6]. In addition, Larry Summers[7] [8], important by virtue of his former role as US Treasury Secretary, has called for the USD 100 note to be phased out and a similar proposal has recently been made in Australia[9].
Several rationales have been put forward by officials in favour of moving towards a cashless society, but the central argument is that because of its fungibility and anonymous nature cash transactions are extremely difficult to track and monitor. Hence, it is argued, cash, especially large denomination bank notes, facilitates illegal activities, including tax evasion and even helps fund terror organizations[10].
However, coming at a time when nominal interest rates in many leading economies are close to, or below, the zero line there are solid (albeit less vocally espoused) macroeconomic grounds for policymakers to seek the abolition of cash; something that has not gone unnoticed by many investors.
The concept of the zero lower bound (ZLB) for nominal interest rates is inextricably linked to the fact that money can be held both in electronic or paper form (cash by most people’s understanding of the concept). This choice generates an important arbitrage opportunity and, because bank notes cannot be easily taxed (the economic equivalent of a negative nominal interest rate), this limits the ability of central banks to charge for money held in electronic form.
Recognizing this limitation, which in the post Great Recession period has become a binding constraint for many economies, there has been renewed interest from policymakers and academic economists in the implications of replacing paper money with its electronic equivalent. For example, in a 2013 working paper, Norwegian academic Trond Andresen[11] outlined the theoretical benefits of the move to an entirely cashless society. The scope of the working paper goes well-beyond providing a rationale for abolishing the ZLB, but it nevertheless discusses the use of negative interest rates to enhance monetary control. To wit,
“With electronic money one is able to not only enhance control of M, but also achieve control of v, which until now has been mostly ignored (in part because such control is very difficult in a system containing physical currency)”.
Combined with the fact that electronic money leaves a paper trail, ironically unlike paper money, the benefits to governments from getting rid of bank notes and coins is patently clear: the increase in control it affords is a central planner’s dream come true.
Obviously, the technology for transitioning away from bank notes and coins has existed for several decades; electronic banking and credit/debit cards became popular in the 1980s. This naturally raises the question why does cash still form the majority of transactions globally and why should this, as many predict, change any time soon?
One factor that could account for the continued use of cash is public concern about privacy because cashless transactions, as just mentioned, generate paper trials giving governments and potentially even companies unprecedented access into individuals’ lives. However, looking at the recent trends in the use of cash in financial transactions, this concern may not be as widely shared as some would expect.
The most significant determinant as to whether a transaction will be cash or noncash based turns out to be the size of the transaction, with cash dominating small-value transactions (see exhibit below).
Exhibit 1. Cash Usage by Transaction Size
Source: Richmond Fed[12]
Most likely this reflects cash’s ease of use, combined with the cost of making electronic payments which often makes such transactions uneconomic, particularly for small retailers.
Hence, it seems fair to conclude that the public on the whole is not unduly considered about the lack of anonymity related to using cashless payment systems, especially when faced with other concerns, such as security in the case of high-value transactions[13].
Another significant determinant of cash usage in financial transactions is, unsurprisingly, access to banking facilities, especially pertinent for many developing countries. With the rise in mobile apps and the ubiquity of smart phones – according to GSMA by 2015 some 2.5 billion individuals across the developing world have access to the internet via mobile devices, a figure expected to almost double by the end of the decade[14] – such impediments are being quickly eroded.
For many the most likely candidate for the world’s first cashless-economy is Sweden, given that cash-in-circulation as a percentage of GDP has already declined to just 2%, implying that not much additional change (no pun intended) is required to go completely cashless, as some commercial banks in the country have already done.
However, the country that has recently taken the most dramatic step towards embracing a cashless society is India. On November 8 last year, PM Modi announced that two bank notes the INR 500 and INR 1,000 would, from December 30 2016, no long be legal tender.
Modi’s demonetisation process only affected two bank notes, and was justified on the basis of tackling corruption and the “black economy” (as per the standard argument – see above), but given these two notes represented over 80% of currency-in-circulation, it is abundantly clear that Modi saw it as a stepping stone to making India to a “less-cash” and, in time, a “cashless” society. Indeed, he has publicly stated as much subsequent to the demonetisation announcement.
With the possible exception of the likes of Singapore or Sweden, such an abrupt monetary shock would constitute a significant hit for any economy. But for one where the overwhelming majority of transactions are cash-based (between 80-90% on most estimates), cash-in-circulation equates to 12% of GDP, and where almost a fifth of the world’s unbanked adults[15] live, the announcement proved to be highly disruptive. This was clearly illustrated by the lengthy queues seen outside banks during the 50-day exchange window.
In light of this self-induced monetary shock which has been widely criticized by numerous mainstream economists, 2017 Indian GDP growth expectations have been marked significantly lower.
Yet, just like the Brexit shock last year, there is a gap between the shock and the release of “hard” macro data by which to gauge the severity or duration of the economic hit. Some early data are already available, such as vehicle sales, bank lending and government fiscal data, which all point to a deceleration in activity in November. This trend appears to have continued in December, if the manufacturing and service sector PMIs are anything to go by – the headline indices having declined to 49.6 and 46.8 respectively.
Given the liquidity crunch associated with the demonetisation shock, it is hardly surprising that the immediate effect on the Indian economy has been rather negative. However, as we saw with the UK last year, economies can prove surprisingly resilient to what are ex ante considered to be significant negative shocks; much depends upon the resulting psychological impact.
In order to gauge such effects, we monitor crowd-sourced sentiment data. And, in much the same way as we tracked developments in the UK economy in the aftermath of the Brexit vote to great effect[16], we can do the same in India.
As a brief aside, one official data release that we found particularly noteworthy was the RBI announcement that almost all of the INR 15.3 tr of bank notes taken out of circulation have found their way back into the commercial banking system – a level of success that must surely raise questions as to the underlying need for such a dramatic policy change, if indeed the goal was as stated[17].
Looking at Indian crowd-sourced economic growth sentiment there is a substantial disconnect between the two media types: mainstream and social. The former has collapsed whereas the latter has, after falling initially, staged a modest recovery. Such divergence[18] may be the first evidence that the hit will not be as severe or lengthy as some have suggested (especially those in the mainstream media who many suspect – again not unlike the UK – of having been overly pessimistic).
Exhibit 2. Crowd-sourced Economic Growth Sentiment – India
Source: www.amareos.com
Also encouragingly, crowd-sourced measures of economic uncertainty, which is often a key catalyst for compounding the effect of negative economic shocks, have also moderated over recent weeks (see exhibit below[19]).
Exhibit 3. Crowd-sourced Economic Uncertainty Sentiment – India
Source: www.amareos.com
Such a reduction in perceived economic uncertainty could, of course, reflect the crowd anticipating a more supportive policy backdrop going forward. Improvement in government tax revenues (albeit perhaps not as high as some envisaged as a result of most of the withdrawn bank notes going back into the banking sector[20]) could pave the way for more government spending and/or much needed state sector bank recapitializations.
Similarly, continuation of the recent disinflationary process (as suggested by the softness in crowd-sourced future inflation sentiment – see exhibit below) may prompt the RBI to resume its easing cycle, after the unexpected pause last month. Together with the boost to liquidity in the commercial bank sector from the jump in retail deposits, which at a minimum should help improve the monetary transmission mechanism in India, this mix points to more accommodative monetary conditions going forward.
Exhibit 4. Crowd-sourced Future Inflation Sentiment – India
Source: www.amareos.com
So where does this leave Indian financial assets, specifically equities? As can be seen in the exhibit below, last year’s first-half rebound saw sentiment rise to historically elevated levels (sentiment peaked in mid-October), but has since fallen back markedly to more average levels. Arguably, this decline represents a welcome tempering of crowd optimism.
That said, in terms of the individual emotions, Joy and Anticipation and Fear are all elevated. Overall, we would interpret this combination as the crowd remaining hopeful on the prospects for Indian equities, but with fingers firmly crossed.
Exhibit 5. Crowd-sourced Equity Sentiment – India
Source: www.amareos.com
Clearly, if the Indian economy pans out as the social media crowd think then such guarded confidence will have been validated[21]. However, if the mainstream media’s pessimism proves to be nearer the mark then the downside for Indian equities could be considerable[22].
As befitting a supposed “post-truth”[23] world, it comes down to this – do you trust the mainstream media or not?
Sentiment Analytics are based on Thomson Reuters MarketPsych indices
[1] According to estimates contained in a Tufts University study the annual cost of using cash in the US (printing, collecting, sorting, transporting etc) equates to USD 200b; a not inconsiderable sum – see: http://fletcher.tufts.edu/CostofCash/~/media/Fletcher/Microsites/Cost%20of%20Cash/CostofCashStudyFinal.pdf
[2] Take a look at this clip from the BBC’s Tomorrows World programme from 1969. Quaint but surprisingly accurate. Note the use of a pin number to verify transactions – see: https://www.youtube.com/watch?v=SSTMraoURco
[3] The information was taken from a report published in 2014. Given the speed of the transition these figures as likely to be underestimates. See: http://newsroom.mastercard.com/wp-content/uploads/2014/08/MasterCardAdvisors-CashlessSociety-July-20146.pdf
[4] Or EUR 2,999.99 to be factually correct. See: http://abroad.cash/blog/cash-payment-limit-in-the-european-union/. Interestingly, proposals for a similar limit in Germany met with fierce resistance with one of the country’s leading newspaper publishing an open letter titled “Finger weg von unserem Bargeld” (hands off our cash) – see: http://www.bild.de/politik/inland/bundesministerium-finanzen/finger-weg-von-unserem-bargeld-44469892.bild.html.
[5] See: https://www.ecb.europa.eu/press/pr/date/2016/html/pr160504.en.html
[6] The deadline for depositing or converting these bank notes was December 30th.
[7] See: https://www.washingtonpost.com/news/wonk/wp/2016/02/16/its-time-to-kill-the-100-bill/?postshare=8671455627637815&tid=ss_tw&utm_term=.25f6a187a812
[8] Summer’s Harvard colleague and respected former IMF chief economist Kenneth Rogoff published a book last year entitled “The Curse of Cash”.
[9] See: http://www.news.com.au/finance/economy/australian-economy/government-floats-100-note-removal/news-story/042220701a8310c39a1a87da4e20de35
[10] For example see the following Harvard working paper: https://www.hks.harvard.edu/centers/mrcbg/publications/awp/awp52. The EUR 500 bank note is sometimes referred to as the “Bin Laden” reflective of such perceptions.
[11] In addition to advocating the abolition of paper money, Andresen also proposes scrapping the commercial banking sector’s ability to create money (as occurs under the fiat money system) and transferring the power solely to a centralised monetary authority. For Andresen, the importance of such a radical transformation in the money creation process is that it provides policymakers with much greater macroeconomic control by allowing them to influence not only the stock of money (M) but also its velocity (v). Money velocity is one aspect of monetary policy analysis that is seriously neglected and as a direct result is responsible for many erroneous conclusions (see: http://www.paecon.net/PAEReview/issue63/Andresen63.pdf)
[12] See: https://www.richmondfed.org/~/media/richmondfedorg/banking/payments_services/understanding_payments/pdf/psg_ck_20141118.pdf
[13] In our view anything that increases the seamless nature of payment processing will further encourage the demise of cash. We are watching with interest the beta test of the Amazon Go store recently opened in Seattle. Customers just logon to their Amazon app as they enter the store, pick-up the items they want and leave. Simple. No checkouts, no queues, no annoying “unexpected item in the bagging area”. (Apologies if the latter phrase does not resonate outside of the UK – those who are familiar with it though will no doubt share our annoyance).
[14] See: http://www.gsma.com/mobileeconomy/
[15] According to the World Bank only 53% of all adults in India have a bank account – see: http://documents.worldbank.org/curated/en/187761468179367706/pdf/WPS7255.pdf#page=3
[16] See: https://amareos.com/blog/pride-and-prejudice/ and https://amareos.com/blog/pain-trades/
[17] The rumour mill as to the real reason for the decision has been going full tilt, especially after it was revealed this week that the government “advised the RBI” to void the INR 500 and INR 1,000 notes, rather than the other way round, which is what many would have expected. This has prompted speculation that Modi’s motivation was political inspired ahead of the upcoming elections in Uttar Pradesh.
[18] Sentiment from the two media types has diverged in the past notably in late 2015 with sentiment on social media rising sharply, in contrast to mainstream media which stayed close to its long-run average.
[19] With much more uniformity between the two media types on this macroeconomic topic.
[20] There is some uncertainty as to whether the RBI could repatriate “profits” to the government associated with demonetisation that did not yet make their way back into the banking system. This is because the December 30th deadline related to commercial banks; there was no deadline for depositing at the RBI. Moreover, there is also a definitional distinction to be made between demonetisation (no longer legal tender but on the central bank balance sheet) and derecognition (off the central bank balance sheet) – a legislative minefield in short!
[21] It is also likely to encourage other governments to pursue a similar objective.
[22] In our view, a bearish hedge or two – just in case – is probably not be the silliest idea at present.
[23] We discussed post-truth in a recent Market Insight – see: https://amareos.com/blog/post-truth-truths/