The cashless society?

James Pomeroy

The world is steadily giving up on cash. Think about your own spending habits: how often do you use paper money nowadays compared to a few years ago? The notes in your wallet will have been replaced by cards and mobile payments – and the cheques that used to be there have long gone. Even in countries where cash usage is still rising, mainly in Latin America, the growth is electronic payments has been even faster. Cash’s share of transactions globally is waning.

This shift has been driven by a number of factors: in many countries the key has been the new technologies that make these payments possible, as well as the willingness of populations to adopt them. Across northern Europe cash payments are in freefall. Now only 12% of transactions in Sweden are estimated to be made with cash and even with small payments (< SEK100/USD11) only 20% are being made with cash. The move has gone so far that churches and the homeless take cash-free donations while many coffee shops, bars and museums across the country will no longer accept notes or coins as payment.

Sweden’s cash usage has declined sharply

But it’s not just in this tech-savvy part of the world where these shifts are happening. In Korea, government policy is helping the shift by phasing out small coins. In Kenya and other parts of sub-Saharan Africa it is mobile money, supported by a rapid uptake of mobile phones, which is helping the economy to shift away from cash. In China, social networks and associated payments through the likes of AliPay have created the largest mobile payments market in the world: more than fifty times the size of the US equivalent. A high-profile move has been in India, where Prime Minister Narendra Modi’s demonetization policy in November 2016, aimed at removing certain large bills from circulation, has led to a sharp uptake in mobile payments, with PayTM a notable player.

Sweden’s use of cash for payments

What does this mean?

From an economist’s perspective, cash has few advantages. It creates friction in the economy that makes things more expensive and time-consuming: getting cash from ATMs, counting takings in a shop and transporting it to the bank. It also facilitates crime, ranging from theft to narcotics trade to tax evasion and corruption. Moreover, businesses all over the world will save money on cash storage and security while consumers will benefit from lower costs as a result of these savings.

Governments in the emerging world could have the most to gain by cutting the amount of cash circulating in their economies: these are sometimes countries where the shadow economy is larger and corruption is usually more endemic. And across emerging markets, the advent of mobile money is allowing millions of people to enter the banking system for the first time – giving them access to credit, savings and mortgages that wasn’t possible before. This could provide a huge lift to growth prospects.

Various estimates for the size of the shadow economy

Area Estimate (% GDP)  
OECD (2015) 18.0 Friedrich Schneider
OECD (2007) 16.1 Friedrich Schneider & Colin Williams
Developing (1988-2000) 35-44 Friedrich Schneider & Dominik Enste
Transition (1988-2000) 21-30 Friedrich Schneider & Dominik Enste
OECD (1988-2000) 14-16 Friedrich Schneider & Dominik Enste
Developed (2002-2003) 13.0 Friedrich Schneider
Developing (2002-2003) 36.0 Friedrich Schneider
     
Source: Friedrich Schneider, papers available at: http://www.econ.jku.at/members/Schneider/files/publications/2015/ShadEcEurope31.pdf,https://iea.org.uk/wp-content/uploads/2016/07/IEA%20Shadow%20Economy%20web%20rev%207.6.13.pdf, https://www.imf.org/external/pubs/ft/issues/issues30/ & https://www.stlouisfed.org/publications/regional-economist/january-2015/underground-economy

Is it all good news?

The move away from cash isn’t welcomed by everyone. Older generations (who are the heaviest cash users) don’t like the speed at which this is happening: particularly with stores starting to turn cash away. In Sweden, 62% of 65-84 year olds who expressed an opinion were negative on the move away from cash. This compares to just 18% of 18-24 year olds.

A possibly even bigger challenge is cybercrime, which has been on the rise as online activity has increased. Data from Javelin Strategy & Research, showcased in the Wall Street Journal, suggests that 16.7m Americans were victims of fraud in 2017, up from 12.6m in 2012, coinciding with a greater online threat. Technology is helping to overcome these challenges, with better algorithms to spot money laundering and greater security measures to prevent hacking.

So what now?

Central banks now face a challenge. As cash becomes less of a universally accepted and accessible means of payment, what should they do? According to the BIS, 70% of central banks globally are exploring the idea of issuing their own digital currency, aimed at providing the same properties as cash, but in electronic form. The rationale for doing so varies by country, but a BIS survey suggests that most developed market central banks are concerned by financial stability and payment safety, whereas in emerging markets the priority is financial inclusion.

The exact form that this money should take is the cause of much of this research: should a central bank digital currency (CBDC) use a token or account system? A ‘token’ system, which could use blockchain technology akin to that which Bitcoin uses, would allow central banks to design a form of money that has all of the features of cash but is electronic. And it could provide the option of paying interest should a central bank decide that it is useful. An ‘account’ system would work with a mobile app and be more akin to a commercial bank account today. This account-based system would be like having a bank account at the central bank, available to the general public.

Different possibilities for central bank money

Existing central bank money Central bank digital currencies
  Cash Reserves and settlement balances General purpose Wholesale only token
Token Account
24/7 availability (✔) (✔)
Anonymity vis-á-vis central bank (✔) (✔)
Peer-to-peer transfer (✔) (✔)
Interest-bearing (✔) (✔) (✔) (✔)
Limits or caps (✔) (✔) (✔)

If such a product was possible, it could have wide-ranging implications for the economy. Clearly the role of a central bank would be quite different, as would the role of monetary policy. The BIS suggests that a CBDC would enrich the options available to a central bank, meaning that the pass-through from interest rate setting could be more effective (as it would apply directly to the population) as well as giving greater ability to pursue negative interest rates should that be necessary.

There could of course be implications for commercial banks which rely on the deposits of consumers. Given the alternative of a CBDC, the need to hold an account with a commercial bank is reduced; as well as making it far easier for any funds to disappear from commercial banks to the central bank in a time of stress. This could pose financial stability concerns, but many argue that this would be more favourable than money leaving the financial system entirely, into notes, gold or other physical assets.

Cash to continue for now

Given the work that needs to be done to explore how feasible a CDBC could be, a fully-functional example may be some way off. Equally, while many parts of the population don’t want to see cash disappear, it may be hard for governments to promote such a position and policy may have to lean against the societal shift to keep cash in circulation. For the time being we are still in a ‘less-cash’ world rather than a cashless one, but the benefits for businesses, consumers and governments should gradually become clearer.

James Pomeroy,
Associate Director, Global Research, HSBC

Different possibilities for central bank money

Existing central bank money Central bank digital currencies
  Cash Reserves and settlement balances General purpose Wholesale only token
Token Account
24/7 availability (✔) (✔)
Anonymity vis-á-vis central bank (✔) (✔)
Peer-to-peer transfer (✔) (✔)
Interest-bearing (✔) (✔) (✔) (✔)
Limits or caps (✔) (✔) (✔)

If such a product was possible, it could have wide-ranging implications for the economy. Clearly the role of a central bank would be quite different, as would the role of monetary policy. The BIS suggests that a CBDC would enrich the options available to a central bank, meaning that the pass-through from interest rate setting could be more effective (as it would apply directly to the population) as well as giving greater ability to pursue negative interest rates should that be necessary.

There could of course be implications for commercial banks which rely on the deposits of consumers. Given the alternative of a CBDC, the need to hold an account with a commercial bank is reduced; as well as making it far easier for any funds to disappear from commercial banks to the central bank in a time of stress. This could pose financial stability concerns, but many argue that this would be more favourable than money leaving the financial system entirely, into notes, gold or other physical assets.

Cash to continue for now

Given the work that needs to be done to explore how feasible a CDBC could be, a fully-functional example may be some way off. Equally, while many parts of the population don’t want to see cash disappear, it may be hard for governments to promote such a position and policy may have to lean against the societal shift to keep cash in circulation. For the time being we are still in a ‘less-cash’ world rather than a cashless one, but the benefits for businesses, consumers and governments should gradually become clearer.

James Pomeroy,
Associate Director, Global Research, HSBC

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