Should Cash be Abolished?

January 30, 2017

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By Mises. Originally published at ValueWalk.

At the World Economic Forum in Davos Switzerland, Joseph Stiglitz the Nobel Prize-winning economist argued in favor of phasing out currency and moving toward a digital economy.

The view expressed by Stiglitz is similar to that of former IMF chief economist Kenneth Rogoff who has been arguing for many years that there is an urgent need to remove cash from the economy. It is held that cash provides support to the shadow economy and permits tax evasion. Some estimates suggest this could be up to $700 billion in the US.

The Governor of the Bank of England — Mark Carney — has expressed similar views in support of the removal of cash.

Yet another justification for its removal is that in times of economic shocks, which push the economy into recession, the run for cash exacerbates the downturn — i.e., it becomes a factor contributing to economic instability by facilitating a cash-induced savings surge rather than an increase in demand.

Other arguments go further, including the position that in the modern world most transactions can be settled by means of electronic funds transfer. Money in the modern world is an abstraction, or so it is held.

But is it true that money is an abstraction?

The Emergence of Money

Money emerged because barter could not support the market economy. A butcher who wanted to exchange his meat for fruit might not have been able to find a fruit farmer who wanted his meat, while the fruit farmer who wanted to exchange his fruit for shoes might not have been 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 being the most marketable commodity.

On this 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.1

Similarly, Rothbard wrote that,

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.2

Since this general medium of exchange emerges from among a potentially wide range of commodities, money is, as such, a commodity.

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.3

Moreover, according to 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”4

Why? According to Rothbard:

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).5

In short, money is that for which all other goods and services are traded. This fundamental characteristic of money must be contrasted with those of other goods. For instance, food supplies the necessary energy to human beings, while capital goods permit the expansion of infrastructure that in turn permits the production of a larger quantity of goods and services.

Through an ongoing selection process over thousands of years, people settled on gold as money — gold served as the monetary standard. In today’s monetary system, the core of the money supply is no longer gold but coins and notes issued by the government and the central bank. Consequently, coins and notes constitute the standard money, known as cash, that is employed in transactions. Goods and services are sold for cash.

At any point in time individuals can keep their money either in their wallets, under their mattresses, in a safe deposit box or stored — deposited — in banks. In depositing money, a person never relinquishes ownership. No one else is expected to make use of 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 in time part of the stock of cash is stored, that is, deposited, in banks.

Thus if, in an economy, people hold $10,000 in cash, then 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 in 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 (the depositor) relinquishes to the bank his claim over the money for the duration of the loan. These simple credit transactions, however, — i.e., loans which are not created by the banks as multiples of funds on deposit — do not alter the amount of money 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.

These savings deposits — to be contrasted with demand deposits — therefore should not be included as money.