The War on Cash Could Destroy the Economy

U.S. one hundred dollar notes in a photo illustration taken in Seoul, South Korea, on Feb. 7, 2011. Lee Jae-won/Reuters

Commentary

According to some “experts,” there is an urgent need to remove cash from the economy. They hold that cash provides support to the “shadow economy” and permits tax evasion. They also argue that, in times of economic shocks, which push the economy into a recession, the run for cash exacerbates the downturn—it becomes a factor contributing to economic instability. Moreover, in the modern world, most transactions can be settled by means of electronic funds transfer. Money in the modern world is allegedly an abstraction.

The first monetary system emerged because barter could not support the market economy. A butcher who wanted to exchange his meat for fruit might not be able to find a fruit farmer who wanted his meat, while the fruit farmer who wanted to exchange his fruit for shoes might not be able to find a shoemaker who wanted his fruit. The distinguishing characteristic of money is that it is the general medium of exchange. It has evolved as the most marketable commodity. Of this process, Ludwig von Mises wrote, “There would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money.”

Similarly, Murray Rothbard held: “Just as in nature there is a great variety of skills and resources, so there is a variety in the marketability of goods. Some goods are more widely demanded than others, some are more divisible into smaller units without loss of value, some more durable over long periods of time, some more transportable over large distances. All of these advantages make for greater marketability.

“It is clear that in every society, the most marketable goods will be gradually selected as the media for exchange. As they are more and more selected as media, the demand for them increases because of this use, and so they become even more marketable. The result is a reinforcing spiral: more marketability causes wider use as a medium which causes more marketability, etc. Eventually, one or two commodities are used as general media—in almost all exchanges—and these are called money.”

Since the general medium of exchange emerged from a wide range of commodities, money is a commodity. Again, according to Rothbard, “Money is not an abstract unit of account, divorceable from a concrete good; it is not a useless token only good for exchanging; it is not a ‘claim on society’; it is not a guarantee of a fixed price level. It is simply a commodity.”

Moreover, in the words of Mises, “An object cannot be used as money unless, at the moment when its use as money begins, it already possesses an objective exchange value based on some other use.”

Why must this be the case? Rothbard explains further: “In contrast to directly-used consumers’ or producers’ goods, money must have pre-existing prices on which to ground a demand. But the only way this can happen is by beginning with a useful commodity under barter, and then adding demand for a medium to the previous demand for direct use (e.g., for ornaments, in the case of gold).”

Hence, money is that for which all other goods and services are traded. Through an ongoing selection process over thousands of years, people settled on gold as money. In today’s monetary system, the money supply is no longer gold, but coins and notes issued by the government and the central bank. This fiat money still has exchange value because of its prior connection with true money and the inertia caused by the fact that it is already accepted as a general medium of exchange. Consequently, coins and notes still constitute money, known as cash, which are employed in transactions. Goods and services are exchanged for cash.

Individuals keep their money either in their wallets, under their mattresses, in safety deposit boxes, or stored—deposited—in banks. In depositing money, a person never relinquishes ownership over it. When Joe stores his money with a bank, he continues to have an unlimited claim against it and is entitled to take charge of it at any time. Consequently, these deposits—labeled demand deposits—form part of money.

At any point, part of the stock of cash is stored, that is, deposited in banks. Thus, in an economy, if people hold $10,000 in cash, the money supply of this economy is $10,000. But if some individuals have stored $2,000 in demand deposits, the total money supply will remain $10,000—$8,000 cash and $2,000 in demand deposits with banks. Should all individuals deposit their entire stock of cash with banks, then the total money supply would remain $10,000—all of it held as demand deposits.

This must be contrasted with a credit transaction. Credit always involves the creditor’s purchase of a future good in exchange for a present good. As a result, in a credit transaction, money is transferred from a lender to a borrower. Such transactions include savings deposits. These are, in fact, loans to the bank. With these deposits, the lender of money relinquishes to the bank his claim over the money for the duration of the loan. These credit transactions (i.e., loans), however, do not alter the money supply in the economy. If Bob lends $1,000 to Joe, the money is transferred from Bob’s demand deposit or from Bob’s wallet to Joe’s possession.

Electronic Money

Does electronic money change this? Electronic money is not money as such, but a particular way of using existing money. For instance, by means of electronic devices Bob can transfer $1,000 to Joe. He could also transfer the $1,000 by means of a check written against his deposit in Bank A. Joe, in turn, can place the check with his bank—Bank B. After the clearance, the money will be transferred from Bob’s demand deposit in Bank A to Joe’s demand-deposit in Bank B. Note that all these transfers—either electronically or by means of checks—can take place because the $1,000 in cash physically exists. Without the existence of the $1,000, nothing can be transferred.

Now, if Bob pays for his groceries with a credit card, he in fact borrows from the credit card company, such as MasterCard. For instance, if he buys $100 worth of groceries using MasterCard, then MasterCard pays the grocer $100. Bob, in turn, repays his debt to MasterCard. Again, all this could not have happened without the prior existence of cash. After all, what exactly has been transferred?

The fact that cash per se was not used in the above example doesn’t mean that we don’t require it any longer. On the contrary, the fact that it exists enables various forms of transactions to take place via sophisticated technology such as digital transfers. These various forms of transfer are not money as such but simply a particular way of transferring money. The medium of exchange is still cash—just the means of transferring that cash is different in a digital world.

What about the introduction of a digital currency by the central bank? Could this replace cash? Arguably, this would not make the digital currency the accepted medium of exchange. To become money, a thing has to undergo the market selection process. It cannot become money because the central bank said so. If the authorities were to force upon individuals the digital currency, then individuals are likely to utilize some other things as money. If the government were to apply vicious regulations, then this is likely to destroy the market economy.

The removal of cash is going to harm the market economy.

Any attempt to remove cash—money—implies the abolition of the market-selected medium of exchange and, ultimately, the market economy. The introduction of money came about because barter was inefficient. Hence, in the absence of money (i.e., the medium of exchange), the market economy could not emerge. Those commentators that advocate phasing out cash unwittingly advocate the destruction of the market economy and moving humanity toward the dark ages.

The argument that removing cash will eliminate tax evasion and crime is doubtful. Tax evasion would be reduced if the incentives for it—high taxes based on big government—were removed. The fact that during an economic crisis people run to the banks to withdraw their money indicates that they have likely lost faith in the fractional-reserve banking system and would like to have their money back.

Conclusion

Irrespective of the level of technological advancement of the economy, money is that against which we exchange goods and services. Therefore, any policy that is aimed at phasing out cash runs the risk of destroying the market economy.

From Mises.org

Views expressed in this article are opinions of the author and do not necessarily reflect the views of The Epoch Times.