Bank of England Chief Economist Andy Haldane wants to abolish cash, so central banks can run policies of seriously negative interest rates, abolishing the “Zero Lower Bound” rate constraint on central bank activity. Technology will soon allow this goal to be achieved; we all make far more electronic payments and far fewer cash ones than we did a decade ago. However I don’t think Haldane, in his Keynesian enthusiasm has fully thought through the economic implications of this policy, which would be both bizarre and in the long term truly disastrous.
Central bankers of this generation are frustrated by the effective zero lower bound on interest rates that is provided by cash — if interest rates go more than very marginally negative savers can withdraw their money from the banking system and keep it under the mattress in the “Bank of Sealy Posturepedic.” One can see their point; there is little enjoyment to be gained from creating a fiat currency if inflation resolutely fails to appear, so that you can’t pump up the economy with funny money.
I dealt a few weeks ago with the possibilities of unlimited “quantitative easing” by which banks could buy up government bonds and thereby fund all the government’s most foolish desires, but I have not dealt with Haldane’s solution to the zero-bound problem, by eliminating it altogether rather than simply printing money to overcome it.
Bank of England Governor Mark Carney is a friend to the more extreme versions of conventional bien-pensant thought – witness his claim or threat that oil companies should reconsider their investments in new reserves because of the danger of their becoming “stranded assets” through global warming regulation. So it’s likely that Haldane cleared his “trial balloon” with his boss before floating it, and that Carney is in favor of the idea.
Moreover the British people have repeatedly been told that using cash is expensive and old-fashioned, have largely converted to debit cards, and – speaking as an observer from across the Atlantic – have a certain “sheeple” quality when ordered about by the nomenklatura on matters such as free speech. So it would at least theoretically be possible to implement Haldane’s scheme in Britain without mass armed revolt (because of tight gun regulation the law-abiding portion of the British sheeple have very few guns these days anyway, poor things.)
However, economically it would be both dangerous and fairly pointless for Carney and Haldane to abolish cash and impose sharply negative interest rates unilaterally. For one thing, Britain currently has no exchange controls, so the populace could simply resort to holding cash or indeed bank accounts in dollars, euros or renminbi. The zero lower bound would thereby remain effectively in place, to the accompaniment of much teeth grinding in Threadneedle Street.
For ZLB abolition to work, two conditions would be necessary. The first would be for Britain to reintroduce exchange controls, as it had before 1979, probably including an FDR-type ban on holding gold and silver. This would be highly economically damaging and a gross violation of civil liberties, but such considerations would not matter much to the Bank of England fanatics attempting to abolish cash.
The second condition, necessary even with exchange controls if reserves are not to drain uncontrollably out of the Bank of England’s coffers, is for other countries as well as Britain to adopt the same policies. Japan could probably be persuaded pretty easily; its citizens have suffered a quarter century of zero interest rates, Keynesian deficit spending and declining living standards, so the new sacrifice could be painted as yet another “iron rice bowl” to be endured for the sake of national glory.
The United States would be more difficult. It has both a well-armed populace and a Tea Party that will quickly blow the whistle on any cash-abolition idea, which it will rightly see as another attempt by Washington bureaucrats to enslave and impoverish ordinary people. With a President Hillary Clinton and a Fed Chairman Ben Bernanke it might be attempted, but Clinton has yet to persuade the electorate to install her and Janet Yellen appears to lack the stomach to face the outrage it would generate.
The most likely ally for a Carney/Haldane attempt to abolish cash is the EU, or more precisely the eurozone. Eurozone inhabitants have no great sentimental attachment to euro cash, which has been in existence for less than twenty years. They were forced to relinquish their deutschmarks, French francs and guilders, currencies with 1,000 years of history, less than two decades ago at the behest of Brussels “experts” so the new step, if backed by a suitably idealistic and massive EU propaganda campaign, will seem natural enough.
The soft money group within the European Central Bank is frustrated with the zero interest rate policy’s failure to revive the moribund economies of France, Italy, etc., so will support the new freedom from constraints. France in particular will see the new policy as freeing it blessedly from the costs of financing a budget deficit that has recurred in every year since 1974. Furthermore, if this is presented as a British initiative those wishing to keep Britain within the EU will see the possibility of giving Britain a policy “win” for once. (For France, of course, this will be seen as one of the scheme’s few disadvantages.)
With the Eurozone on board with cash abolition, and with Britain’s exchange controls perhaps relaxed to allow Britons to hold euro bank accounts (but not cash) as a gesture of EU solidarity, the Haldane/Carney experiment could then go ahead. There would be little point in abolishing the ZLB merely to set interest rates at a level that might be feasible anyway, so we can suppose that a triumphant Bank of England might set the policy rate at say minus 5%, allowing the new system to make a real difference.
With a short-term rate at that level, the rate on long-term gilts would also become heavily negative, perhaps minus 3% (in the good old days, this would have resulted in bearer bond holders ostentatiously not presenting their coupons on the due date, but alas in a book-entry world all things are possible.) Prime borrowers would find they were indeed stimulated; they would be able to borrow from the banks at a fixed rate of minus 2%, with the banks as usual making a 3% “gapping” spread between their long-term loans and their short-term funding cost of minus 5%. Prime home mortgage rates would also cost around minus 2%, thus solving the problem for Millennials anxious to get on the ladder of London housing.
After a year or two of exuberant construction activity and price rises in both residential and commercial real estate, developers would find themselves running into a familiar worry – what would happen to the value of their properties if property prices ever reverted to their long-term level. After all, rents would not be rising much if at all in real terms, so a return to traditional valuation metrics would cause a massive property price crash, bankrupting property owners. Individuals would be able to continue cashing their interest checks on the gigantic mortgages they had taken out, so would run into no difficulty until the mortgages matured in perhaps 30 years’ time.
(Alas homebuyers couldn’t solve the problem by taking out 50 year amortizing mortgages at minus 2%, using the interest payments they received to pay off principal and making the mortgages self-liquidating and effectively free. Because the amortization would reduce their interest receipts, mortgages amortized this way would have an infinite maturity, though the principal outstanding would have got quite small within a century or so. The other alternative, of putting the interest payments received under a rock and liquidating the loan in 50 years, would not be available because there would be no way of turning them into rock-friendly cash, so they would be eaten away at the minus 5% deposit interest rate.)
The solution would be to build properties of great value, which did not provide a monetary return and therefore would maintain their value. The Egyptians and Babylonians understood this. Clever developers would thus seek to revive the spirituality of the British public by building ziggurats dedicated to the Babylonian god Marduk, of immense and indeed incalculable beauty and value, but offering no monetary return. Modern Britons lacking a spiritual guide could be induced to adopt Marduk as their deity, conducting the occasional human sacrifice at the ziggurats on feast days to demonstrate their commitment to the new religion. The ziggurats, financed at minus 2%, would then offer a steady return to the developers from their borrowing, without any vulgar questions of eventual repayment.
In the EU, recalcitrant governments such as Greece would find the possibilities even more compelling. Instead of dickering about the interest rates on a mere $300 billion of their existing debt Greece could raise new loans totaling say $2 trillion, prepay all its existing debt, and gain a subsidy of $40 billion a year from the bankers which could be used to fund the social programs and handouts to politicians that are so essential to the Greek economy. Debts coming due would simply be refinanced, and a gigantic statue of Charles Ponzi erected in gratitude next to the Parthenon.
In the long run, the negative interest rate policy would have another perverse effect. By the forces of arbitrage, sterling with minus 5% short-term rates would appreciate at 5% per annum against any remaining currencies that still used cash. Hence over time Britain would develop a sharp and persistent deflation at around 5% per annum, negating the “benefit” of the negative interest rates. With real long-term interest rates now positive, the result would be an almighty asset price crash and universal ruin.
Simple-minded Keynesians like Haldane may think cash abolition would work. We who follow the great Austrian economists think it would lead to an immense pile of malinvestment followed by a hugely impoverishing crash. Capitalism does not work if the returns to saving are negative; we should not force ourselves to re-learn this the hard way.
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)