In memory of Dr. Andreas Höfert

The mother of all financial repression tools

| Tags: Andreas Höfert

In a recent editorial in the Financial Times1 Harvard Professor Kenneth Rogoff discusses an out-of-the-box idea: Why not abolish anonymous paper currency, starting with large-denomination notes? He comes up with good reasons for doing so.

Rogoff cites as example the discovery of some USD 200m of US 100-dollar bills during the recent arrest of Mexican drug lord Joaquín "El Chapo" Guzmán. He speculates that much of the physical money in public hands, especially large-denomination notes, might be related to criminal activity or shadow economic transactions aimed at evading the tax authorities.

Getting rid of physical money will make drug trafficking more difficult. It will also complicate, if not render impossible, paying the plumber or the cleaning lady in cash and hence avoiding sales taxes or social security contributions. Since the underground economy makes up an estimated 10% of the US GDP and likely much more in Europe, the idea seems like a no-brainer source of new funds for governments.

True, there are some drawbacks. Among them, Rogoff cites the loss of seignorage revenues, which governments derive from the difference between the face value and the intrinsic value of the paper or cotton dollar or euro bill. However, I am not even sure this is a serious issue. Seignorage revenues could be large in inflation-stricken developing countries, but they hardly exceed 2% of GDP in developed economies. In my view, it would be cheaper to create money out of electronic bits than by printing it on paper.

Another issue is privacy. Fans of US TV crime series like CSI know that perpetrators and victims are easily traceable through credit card or ATM transactions. Rogoff acknowledges this issue, but weighs it against the potentially significant revenues governments could make. Since physical currency per capita amounts to some USD 4,000 in the US and Europe and twice as much in Japan, there must be a rich, untapped source of revenues for highly indebted governments out there.

But wait, there's more – and this is where we enter the slippery slope of financial repression. Quoting an academic paper by Willem Buiter, chief economist at Citigroup and a former Bank of England policymaker, Rogoff says the absence of physical money would "eliminate the zero bound on policy interest rates that has handcuffed central banks since the financial crisis. At present, if central banks try setting rates too far below zero, people will start bailing out into cash."

To me, this is a better explanation for why the Japanese hold twice as much physical money per capita as the Europeans or Americans. It's not that the Japanese yakuza have a greater penchant for cash than do the European mafiosi or the American mobsters. Nor is it that the underground economy relative to GDP in Japan is twice as large as in the US or Europe. The explanation is simpler: the Japanese have lived in a world of zero interest rates for almost 20 years now, whereas the Americans and Europeans have been in this situation for only the last five years.

By abolishing physical currency, governments can tax money on bank accounts explicitly through negative interest rates. This tax could exceed the implicit tax when interest rates are zero and there is inflation. Since physical money no longer exists, the means to avoid negative interest rates or to preserve wealth without taking any risk becomes limited.

Coupled with the IMF's thought experiment last year about using a capital levy – a one-off tax on wealth – to reduce public debt in Europe, and how the Cypriot bank-crisis resolution was hailed as the blueprint for such endeavors, the idea of abolishing physical money becomes really scary. An all-electronic money system – completely transparent, with no transaction privacy, and at the constant mercy of government confiscation – means money will cease to be private property.

The road to hell is paved with good intentions. In my view, abolishing physical money for the sake of fighting crime and generating government revenue from the shadow economy could lead ultimately to an Orwellian nightmare of financial repression.