More Evidence of the High Collateral Damage of a War on Cash

By Lawrence H. White.

"The leading arguments for banning large-denomination currency notes are those made in a much-cited working paper by Peter Sands and at book length by Kenneth Rogoff. They have been rebutted persuasively by Pierre Lemieux and Jeffrey Hummel in their respective reviews of Rogoff’s book. I have previously offered my own rebuttals here and here.

The justification for returning to the topic now is that two recent reports, issued by the Federal Reserve Bank of San Francisco and by the European Central Bank, provide new evidence on the public’s use of large-denomination notes. This evidence is essential to any serious evaluation of proposals to ban large-denomination in notes in the United States and Europe.

The Sands and Rogoff argument assumes that the users of large bills are almost entirely criminals; use by innocent citizens is rare. Rogoff writes in his book:

The bulk of US cash in circulation cannot be accounted for by consumer surveys. Obviously, if consumers are holding only a small fraction of all cash outstanding, they cannot possibly be holding more than a small fraction of the $100 bills in circulation, since $100 bills account for nearly 80 percent of the value of US currency.

By contrast: “The drug trade is a famously cash-intensive business at every level.”
Peter Sands declares: “Eliminating high denomination notes has limited downside since such notes play such little role in the legitimate economy.” Sands downplays any effect of eliminating large notes on the welfare of non-criminals, those he calls “legitimate” currency hoarders, on the assumption that they are at most a small minority of currency holders, while criminals are the vast majority:

The other arguments for retaining high denomination notes [besides profitability to the issuing government] largely revolve around some individuals’ desire to hoard or save cash “under the bed” given concerns about banks, or the utility of high denomination notes in emergencies, war zones or natural disasters. There probably is some legitimate hoarding, particularly in countries with a history of banking crises, but the reality is that most of the money that is hoarded in cash is kept from the banking system in order to keep its origins from scrutiny. Hoarding cash appears highly correlated with tax evasion. [Legitimate hoarding] can only account for a minute fraction of high denomination notes.

In actual reality, nobody really knows the shares of the stock of large bills held by non-criminal hoarders and by various types of criminals, because people who agree to answer survey questions have every incentive to under-report their holdings, whether acquired lawfully or otherwise. It stands to reason that ordinary citizens who hoard cash, say because they dislike surveillance of their banking activity, or fear a breakdown in banking system functionality for reasons of natural disaster (such as recently happened in Puerto Rico) or political upheaval, are the very people who are least likely to divulge the true size of their hoards to strangers, no matter what assurances of anonymity they receive.

Sands argues that in cases of legally acquired hoards, the welfare loss from banning large notes would be minimal, because “lower denomination notes offer an only slightly more inconvenient solution for ordinary people, given the sums involved. Only the very wealthy would be truly inconvenienced by having to make such a substitution.” But this is a hand-waving argument rather than a factual deduction. To securely hoard any dollar amount in $10 bills rather than $100 bills requires a safety deposit box ten times as large, or buying a lockbox ten times as large to hide at home. It is far from obvious that “only the very wealthy” hoarders would be “truly inconvenienced.”
Directly addressing the concern that large bills have legitimate uses, Sands responds [footnote call omitted]:

Some suggest that high denomination notes play an important role in economic activity. There is little evidence for this assertion. Whilst low denomination notes continue to play a significant role in legitimate economic activity even in the most advanced economies given the transactional convenience they provide, high denomination notes do not.

The new FRBSF and ECB survey evidence is most relevant to assessing claims like this one, allowing us to quantify (if imperfectly) how significant a role high-denomination notes actually play.
Shaun O’Brien’s report on “Preliminary Findings from the 2016 Diary of Consumer Payment Choice” for the San Francisco Fed unfortunately does not break down US currency use by denomination. Nonetheless it has at least three useful takeaways for the “war on cash” debate:

• “Cash is held and used by a large majority of consumers, regardless of age and income.”
• “[C]ash was the most, or second most, used payment instrument regardless of household income, indicating that its value to consumers as a payment instrument was not limited to lower income households that may be less likely to have access to an account at a financial institution.”
• Cash is used to make 8 percent of all payments of $100 or more. We don’t know the mix of denominations used, but this certainly leaves open the possibility that $100 and $50 bills play a significant role in a non-negligible share of legitimate economic activity.

The ECB study by Henk Esselink and Lola Hernández, entitled “The use of cash by households in the euro area,” reports on cash use in all 19 eurozone countries, based on a 2016 survey. Two immediately relevant findings are that many ordinary members of the public store cash for emergency use, and commonly handle even the highest denomination notes:

The study confirms that cash is not only used as a means of payment, but also as a store of value, with almost a quarter of consumers keeping some cash at home as a precautionary reserve. It also shows that more people than often thought use high denomination banknotes; almost 20% of respondents reported having a €200 or €500 banknote in their possession in the year before the survey was carried out. […]

Of those respondents who acknowledged that they put cash aside, only 23 percent kept €100 or less.  22 percent kept between €101 and €250, 19 percent between €251 and €500, 15 percent between €500 and €1000, and 12 percent more than €1000. In addition 10 percent refused to specify the amount. If we assume conservatively that the non-specifiers were distributed in the same proportions as the specifiers, then those who kept more than €100 as a precautionary reserve comprised about 75 percent of respondents (almost 25 percent of those surveyed) who reported keeping cash in reserve. Thus about 18 percent of the Eurozone population has cash holdings large enough that they may benefit from using notes of €100 and above merely as a compact means of storing wealth.
By contrast with the US figure of 8 percent cash among payments over $100, Europeans use cash to make 32 percent of payments over €100. Such payments, the authors report,

amounted to 10% of the value of all cash payments at the POS [point of sale] in the euro area. The share of cash payments above €100 in the total value of cash payments at the POS was wide-ranging, from 3% in France or 5% in Belgium, to 21% in Ireland and Slovenia or 26% in Greece.

These numbers do not indicate to me that law-abiding cash use is negligible — but armed with the figures, the reader can make his or her own judgement about what level of cash use counts as non-negligible.

I want to add a somewhat tangential but related additional comment: Besides making the debatable quantitative assumption that law-abiding cash use is negligibly small, Sands and Rogoff also make a normative assumption that strongly tilts their seemingly neutral estimates of overall welfare effects. They assume that the welfare of people who use cash for illicit purposes doesn’t count, while disrupting their operations by banning large notes is pure benefit to the rest of us.

As Lemieux, Hummel, and also David Henderson have noted, however, an economic analyst may justifiably distinguish, among the set Sands lumps together as “financial criminals,” those actors who violate personal and property rights (kidnappers, thieves and fences, extortionists, terrorists) from those whose illicit activity consists of peacefully trading in illicit goods and services (drug dealers, sex workers, and the like). The first group clearly generates negative-sum outcomes, while the second group generates positive-sum outcomes — mutual gains from trade — from the point of view of the participants. Taking the point of view of the participants is the standard approach in modern welfare economics. The principle of gains from trade — gains from capitalist acts between consenting adults — applies to drug sales and sex work despite their illicit status in many jurisdictions. Banning high-denomination notes in order to raise the cost of such trades means reducing the economic welfare of the participants in those markets. To the extent that the main illicit use of high-denomination notes is in victimless markets, a policy to suppress their use is harmful rather than beneficial from this perspective

Cases of people who make or take illicit bribes, pursuing this logic, have to be sorted between trade-enhancing bribes and trade-restricting bribes. Making bribery more costly is not an unmixed blessing if without certain bribes the economy fails to function as smoothly. It likewise cannot be taken for granted that all tax evasion reduces overall economic welfare once it is recognized that some taxes may be too high from a Kaldor-Hicks efficiency standpoint, meaning at a level where their marginal deadweight loss (the uncaptured gains due to tax-blocked trades) exceeds the net gains from the government projects they finance."