[Satyajit Das] Think twice about going cashless

Even now, after the chaos caused by India’s decision last November to eliminate nearly 90 percent of its banknotes, few people would argue with the policy’s underlying assumption: Going cashless is, if handled well, a good thing. Yet the fact is, most arguments in favor of demonetization don’t stand up to scrutiny. And those that do should raise other concerns.

Proponents of moving beyond paper money cite several rationales. They say it’ll make life harder for tax cheats, terrorists and other criminals, and speed up the flow of funds, thus reducing costs and enhancing economic efficiency. Some even suggest that it will improve hygiene, by eliminating crumpled and germ-infested bills.

These arguments aren’t terribly convincing. To start, banning cash is inherently discriminatory. It doesn’t distinguish between legitimate and illegitimate uses of paper money, assuming that anyone holding large amounts of cash must be guilty of something. This disadvantages the clear majority of the population in order to punish a minority.

More importantly, abolishing cash isn’t likely to solve the problems it’s meant to address. Criminals and terrorists will simply seek out alternative methods of transferring funds, even if they happen to be more expensive. Unless taken unawares, tax cheats can easily convert their illicit hoardings into gold, foreign currency or property. Even in India, where Modi’s decision came out of the blue, most of the outstanding currency was redeposited into bank accounts without providing the predicted increase in tax collections.

Surely, though, moving to virtual cash will boost innovation and efficiency? Fintech firms, sensing a gold rush, have indeed proposed innovative digital payment solutions. But there’s no clear-cut evidence that electronic payments are especially efficient or cost-effective. European studies have found that cash incurred the lowest cost per transaction in most countries, followed by debit-card transactions.

This shouldn’t be surprising, given economies of scale and high usage of existing systems. In the US, cash is still used for a bit more than 40 percent of consumer transactions by volume, around half that by value. In emerging markets, and for small-value transactions generally, the numbers are even higher. Meanwhile, the digital-payments sector remains fragmented and requires large infrastructure investments, often duplicating existing systems.

The real arguments in favor of cashlessness aren’t as often discussed. Demonetization, for example, would provide central banks with a powerful new tool. Currently, negative rates can be circumvented by investors physically withdrawing cash and holding it to avoid the effective tax on savings. That helps explain why large cash holdings are particularly prevalent in Japan and Switzerland -- two countries not generally associated with criminals or terrorists, but which do feature negative interest rates.

In a future economic or financial crisis, this so-called zero-lower-bound constraint could restrict the effectiveness of monetary policy. The only way to overcome the hurdle may be to eliminate cash, as the Bank of England’s chief economist Andrew Haldane argued in 2015.

Demonetization could help governments in other ways as well. Behavioral studies show that consumers spend more when using a credit card than when using cash. Eliminating cash could thus in theory be used to boost consumption.

On the other hand, forcing citizens to do all their spending digitally would also provide states with unprecedented levels of personal information. The anonymity of cash is useful to everyone, not just tax cheats and criminals.

The costs to abolishing cash aren’t insignificant either. Central banks would lose seigniorage revenue, or the difference between the minimal cost of creating currency and the investment return on government bonds. This would reduce their loss-absorption capacity and impact a source of revenue, affecting public finances.

Cash use remains high in emerging markets, and among the poor and older people globally. As quickly became clear in India, demonetization can thus worsen social and financial exclusion. The costs of converting citizens to digital payments can quickly add up.

An exclusively digital or electronic payment system also increases security and operational risks. The risks of online fraud or cyber-theft, as well as disruptions to operations due to technology failures, are significant.

The intrusion of the state on this scale is an explosive social or political issue rather than an arcane economic matter. In his speech advocating cashlessness, Haldane accepted that public support was uncertain. Citizens may not easily surrender their anonymity and privacy. Where the elimination of cash is linked to negative rates, they may resist what’s effectively a tax on savers.

Nations that truly want to go cashless need to confront these questions truthfully and openly, rather than hiding behind more politically palatable arguments. Simply imposing such a radical change on citizens would only further erode trust in governments. That’s a cost they’re ill-equipped to pay.


By Satyajit Das

Satyajit Das is a former banker, whom Bloomberg named one of the world’s 50 most influential financial figures in 2014. -- Ed.


(Bloomberg)