Tuesday, April 17, 2012

Fight Recessions, Eliminate Money

I just finished reading a column by Matt Yglesias that I found particularly interesting. In it, he argues for the elimination of paper money as a medium of exchange, and instead that we switch to electronic-only transactions, like PayPal, credit cards, etc. This, he says, would greatly increase the effectiveness of monetary policy at the zero-bound. I suppose I should explain just what that means, shouldn't I?

Well, in economic downturns, the central bank, in our case, the Federal Reserve, buys up a whole bunch of Treasury bonds from banks and in return gives them newly created money. As such, banks now have cash to go 'round. Since they have more money to work with, interest rates are much lower, and the cost of investments for businesses and people are likewise lower. The idea is that this'll spur consumption and business investment to try to get us out of our current slump. That's what the Fed is doing right now. But why isn't it working, you might ask? Well, the problem for us right now is that interest rates can't go below zero, even though the equilibrium point for them to achieve full employment may be negative. This wouldn't have been an issue had we gone into this crisis with much higher interest rates (since we could then cut them a lot lower before hitting zero), but raising the rates would have in and of itself caused a recession, since inflation was subdued in the 2000s. Interest rates can't be negative, for obvious reasons--people would be effectively paying to keep their money in banks, so they would likely withdraw most of their money in the form of cash. It would be disastrous and ineffective, to say the least. This is where Yglesias' idea comes in.

What if cash didn't exist? What if, when interest rates were negative, people couldn't withdraw their money from banks? They wouldn't be able to because there would be no physical currency, only electronic money, kind of like the sci-fi idea of "credits." Well, their only option would then be to spend that money, rather than see it be diminished by negative rates. Suddenly, consumer spending is back up, firms have demand for their products, and they can hire people again. Problem solved. Why worry about restoring consumer confidence when you can just do this? After the economy has rebounded the central bank could start to raise rates so that people wouldn't be losing on their money in bank accounts, because that obviously wouldn't be good in the long-run.

You might think that negative interest rates would be punitive action to take against people, but consider the alternative that we have right now: ineffective monetary policy that is stuck at zero while Congressional gridlock is preventing any sort of fiscal stimulus to be passed. As a result, we've got extended periods of high unemployment, when we could have the kind of bounce-back recovery we had in the 80s when we could simply cut rates from double-digit highs to much lower levels. We went into this recession with interest rates in the low single digits, so we didn't have nearly as much room to cut rates as Paul Volcker did in 1983-84.

Yglesias also touches on the point of people hoarding precious metals instead of money:
"Some people could, it’s true, try to horde gold, diamonds, or other valuable primary commodities. But this would amount to a price boom, creating mining and exploration jobs. It would also increase the wealth of everyone who already owns jewelry, expanding their consumption. The savvy investor, meanwhile, will realize that the price of gold is sure to crash when the recession ends and interest rates go back up, which should put a break on hoarding."
So, really, it wouldn't be much of a downside if people did that. On top of this incredibly important benefit to monetary policy, there are quite a few others that I can think of outside of Matt's column.

Before I go on, I should note that this isn't some far-fetched idea, either: Italy is trying to ban the use of cash on transactions of 1000 Euros or more. The Italians are mostly doing this to combat tax evasion, though, since only partially banning the use of cash wouldn't be quite so effective for enhancing monetary policy. Some of you might be wary of the idea of a cashless society, I mean, we've had cash and coins for thousands upon thousands of years, why change? Well, we already are changing, for starters. How often do you use cash for anything legal? Probably not very, I'd venture. Most people nowadays use PayPal, credit cards, or checks for most purchases anyways. There are quite a few benefits to it, and very few insurmountable downsides, the way I see it.

For starters, it would be more convenient. It might be a few years before online and mobile banking is up to the task of fully replacing cash, but it certainly could get there if the need was readily apparent. Tax evasion would probably be much more difficult without the use of cash for under-the-table payments and the like. This goes hand in hand with combating crime on a number of levels (like illegal arms trader, violent drug lords, etc) because transactions would become easier to track by authorities. I should quickly note before continuing that I personally think the War on Drugs is a spectacular failure. However, so long as everything remains illegal and non-regulated, the supply of these drugs remains largely in the hands of drug lords who are, let's face it, all-too-often violent criminals, so being able to track them down is always a plus. Legalization and regulation would be simpler and more effective, I think, in eliminating the black markets for these goods than any War on Drugs has been. But I digress...

From a public health standpoint, cash is pretty germ-ridden. Since cash changes hands a lot more than other stuff, it also spreads germs a lot more, too. In fact, a lot of hospitals are trying to eliminate the use of cash in their cafeterias, so as to avoid patient infections, since something like the influenza virus can survive on a dollar bill for up to 17 days. Moreover, the U.S. spends more money to produce coins right now than they're actually worth (2.4 cents for each penny, 11.18 cents for each nickel), so it seems only prudent from a fiscal standpoint as well to be rid of them, especially since they're barely used as is. This is all in addition to the boon that a cashless economy would give to our monetary policy makers.

This is not to say, however, that implementing such a system wouldn't have downsides or would be an easy task. A cashless society would hit the poor the hardest, since they're often the ones who don't have checking or savings accounts (1 in 12 American families don't have bank accounts). I feel like this could be remedied with relative ease with something like a regulation on banks to offer free checking or savings accounts to lower-income people. Mobile payment systems are on the rise in places like Sweden, where you can send a text message to buy a bus ticket, so it isn't as if we lack the technology for implementation. As I said before, the problems that we would face with a cashless society do exist, but they're far from insurmountable in my view.

Paper money has been around in the West since 1661 in Sweden. We've done away with the gold standard because it was cumbersome and offered more problems than remedies. Now, it only seems both prudent and beneficial to do away with paper money. Sure, it's definitely difficult to stomach from a sentimental point of view, but economics, as Paul Krugman often says, is not a morality play.