For several years now, economists and central bankers have been trying to solve the so-called “banknote paradox”, a question of monetary policy that works more or less like this: for decades, in all developed economies, cash payments are less and less, but the quantity and value of banknotes in circulation are more and more. But why are more and more banknotes printed, if apparently no one uses them? As he wrote theEconomist, central banks have tried to give several explanations for this paradox, none of them particularly satisfying.
The most likely answer – and the most embarrassing for the international financial system – is that the huge demand for cash is attributable to the activity of criminal groups and illicit organizations, for which cash is the safest way to operate and finance themselves without risk of being discovered by the authorities. But despite this, he always writes theEconomist, the world’s financial authorities are doing little to stem the problem and reform the cash system. Partly because they see it as less important than other major financial issues, and partly because current economic and political balances make it inconvenient to limit the issuance of banknotes.
In recent years, the use of cash for payments by citizens has declined significantly in all developed economies. This trend has been accentuated in the last year and a half of the coronavirus pandemic, which has favored the spread of digital payment systems and contactless. According to the European Central Bank (ECB), the value of non-cash payments in euros increased by 8.7 percent in 2020 alone, while the value of cash payments has been in slow and steady decline for a couple of decades. although between 70 and 80 percent of all transactions continue to be made in cash.
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The cash crisis, however, is not matched by a cash crisis. In Europe as well as in the United States, the quantity and value of cash in circulation is constantly increasing. In 2020 in the United States, as the use of cash among the population plummeted, the value of cash in circulation increased by 16 percent compared to 2019. The same was true in the European Union, with an increase of 11 percent.
In 20 years, the total value of dollar-denominated banknotes has quadrupled, and that of pounds has tripled (the value of euro banknotes has increased even more, but since it is a currency that was born about 20 years ago the figure is less. relevant).
By reducing the issue to a minimum, it can be said that cash in circulation increases because demand increases. All major financial institutions have no particular limits on the issuance of cash, and indeed one of their objectives is to ensure its availability. Whenever a commercial bank deposits a certain amount of electronic currency with its state central bank and asks for cash, the central bank gives it back cash equivalent to the value of the deposit. Therefore, if central banks continue to put cash into circulation, the reason is that there are more and more entities requesting it. The problem is that it is difficult to understand why it is requested, considering that the use of cash to pay for goods and services is less and less widespread.
Central bankers have been trying to explain this paradox for years, with unsatisfactory results. In 2009 Andrew Bailey, at the time executive of the Bank of England (the British Central Bank; today Bailey is the governor) explained the paradox of the banknotes by saying that due to the financial crisis more and more people preferred to keep money at home; in addition, the number of ATMs for withdrawing money was increasing, making it necessary to use more cash to keep them stocked. In the years since, both of these reasons have been proven wrong: the crisis is over and the number of ATMs in the UK has been declining for years, but cash in circulation continues to rise.
The Fed, the American Central Bank, tried to explain the phenomenon by saying that since inflation and interest rates have been very low for decades, citizens had no incentive to deposit their cash in the bank: if the banknotes do not lose value and if putting them in the bank earns very little in interest, there was no reason not to keep your cash with you.
In February 2021, the ECB tried to explain the banknote paradox with a study that is, however, very unsatisfactory. The ECB notes that only between 20 and 22 per cent of banknotes in circulation are used to buy goods and services within the European Union, between 28 and 50 per cent of banknotes are held as a store of value (i.e. as savings) and unspent, while between 30 and 50 per cent of euro banknotes are located abroad. The reason for the constant proliferation of banknotes, however, is not clearly explained, even though the ECB insists that more and more euro banknotes are used as a store of value.
None of the official explanations provided by international financial institutions mention illegal activities or organized crime. But this, according to theEconomist, is the main reason cash circulation is still so high and increasing. Since the 1980s, the international banking system has become increasingly supervised and controlled, and money laundering via banks and offshore accounts increasingly difficult. The only way to conduct illicit economic activity, now, passes through the use of cash, which is difficult to trace (although the use of cryptocurrencies has also been growing for some time).
According to some estimates, about half of all banknotes in circulation are used “to allow criminals to evade governments’ increasingly careful surveillance of the financial system.”
L’Economist cites a large case of cash seizure in 2020, when a woman was stopped at London airport with six suitcases full of cash, worth a total of nearly two million pounds (around 2.3 million euros) that her donna was trying to smuggle abroad. It was the biggest cash seizure of the year in the UK, but it was a wake-up call to the authorities, as the fact that £ 2 million was being stolen so rudimentary (in baggage on an airliner) showed how negligible that sum was for the criminal group that organized the transport, and how likely the authorities missed much larger cash movements.
There are several solutions that financial institutions could take to limit the problem. One of the simplest would be to remove from circulation the higher denomination banknotes, such as the 500 or 200 euro banknotes, whose large face value makes recycling and their use for illegal activities much easier.
The 500 euro banknotes in fact allow you to move or hide large amounts of money in a small space and for this reason they are often used for illegal activities. In a pack of cigarettes, for example, it is possible to keep up to 40 bills of 500 euros, for a value of 20 thousand euros. An envelope full of 2 thousand 500 euro banknotes has a value of 1 million euro and a weight of just over 2 kilos, while to reach 1 million euro with 20 euro denominations, 50 thousand banknotes and some suitcases would be needed.
There are good intentions in this regard (some countries of the European Union, for example, would like to make the 500 euro banknotes illegal), but there are also many resistances, both for cultural and economic reasons. In Germany, for example, the exceptional attention to privacy leads many people to be wary of electronic means of payment, and many Germans continue to use cash even for large expenses. In any case, the ECB has stopped producing 500-euro banknotes, but there are still 400 million pieces in circulation (and 750 million 200-euro banknotes).
Among the reasons cited byEconomist for which the cash system has not yet been reformed there is the fact that central bankers struggle to deal with it because they face much more pressing macroeconomic issues on a daily basis.
Another reason is that cash issuance is a source of income for states. This happens through the so-called “seigniorage”, which is a well-known phenomenon, studied and recognized by all financial authorities, and has nothing to do with the conspiracy theories that were fashionable a few years ago. According to the Bank of Italy, seigniorage is «the set of income deriving from the issue of money» and consists, in short, in the interest that central banks obtain by making use of the counterpart they receive for banknotes in circulation. The seigniorage income, although not small, still corresponds to small sums for the economy as a whole (in Italy it is about 0.02 per cent of GDP) and is almost entirely paid to the state.
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The point, in any case, is that thanks to the issuance of banknotes the states obtain – in a non-controversial way, let us remember – a small but not indifferent income.
This, writes theEconomist, causes many states to be reluctant to adopt measures such as the elimination of large-denomination banknotes from circulation: “If the Fed or the ECB committed to eliminating large-denomination banknotes, for example, international criminals would exchange currency for their operations. This would mean that all profits from printing banknotes would go to the central bank which would continue to issue those banknotes, and that others would get little benefit from reducing global crime. ‘ The only possible solution, that is, a multilateral and concerted action, seems very difficult: no large financial institution, at least for now, is dealing with it.
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