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The upsides and downsides to eliminating paper currency

030917 Cochrane Beltway Oped pic
Having only small bills purportedly moderates or even ends illegal undertakings.

When Kublai Khan invaded China, in addition to spreading disease and starting a postal system, he introduced paper money. It would take the Chinese a few hundred years to overcome the Mongol hordes, build a wall to keep them out, and abolish currency in the early Ming Dynasty. But now, almost 500 years later, the rest of the world is catching up with those Chinese emperors.

There is an effort gaining momentum to limit, or even abolish, physical money. There are some very positive upsides, but there are also some very disturbing downsides too. It's that way with most disruptive events in history – gunpowder, the steam engine, music videos – but this time the ledger of pluses and minuses is a little more difficult to balance.

The Chinese abandoned paper money because of inflation. Governments today say they want it eliminated because of crime, but they have other reasons too. India recently required its 1.2 billion people to surrender all of their largest notes for smaller bills, effectively eliminating more than 80 percent of the currency in circulation. The prime minister said the action was to stop counterfeiting, but there was another more subtle reason behind the move – taxes.

More than 70 percent of all transactions in India are done with cash because it's untraceable. Cash means no record of sales and that means no record for income taxes. In what has been called "India's national sport," it's estimated that billions of dollars in taxes are avoided every year by using cash. By eliminating the two largest bills in circulation, it becomes physically problematic to do business in cash.

The United States doesn't have this problem with tax evasion because less than 15 percent of all transactions stateside are completed in cash, and those only average about $21.

That's why many people support eliminating the $100 dollar bill, and even the $50 and $20 bills. Again, the idea is to make it impractical to use paper money in high-dollar transactions. A million dollars in $100 dollar bills weighs only 20 pounds, but the same amount in $10 dollar bills weighs more than 200 pounds and requires an Olympic weight-lifter to carry it. Having only small bills purportedly moderates or even ends illegal undertakings.

But arguing this is na&iuml;ve. Drug dealers would just move on to diamonds, gold coins, or even untraceable crypto currencies like Bitcoin. Yes, there would be a period of adjustment, but soon grams of cocaine would be priced in carats instead of dollars. However, there is evidence that eliminating cash does have some effect on more common street crimes.

During the 1990's, Missouri transitioned from paying public assistance by check to paying it by preloaded debit card. Most recipients of public assistance don't have bank accounts and checks they receive are cashed for currency and not deposited anywhere. A study at the University of Missouri found that common street crimes like robbery and burglary were reduced by 10 percent after the switch to debit cards. Removing cash didn't end crime, but it did temper it.

Eliminating cash has another upside for governments around the world: better macroeconomic control. Central banks often use interest rates as a tool. With lower rates, people borrow more and buy things like houses and cars. But low rates also means there is little difference between keeping money as cash in your wallet or keeping it in a savings account. But what if rates on bank deposits weren't just low, they were negative?

Negative rates have been tried by a few central banks attempting to recover from recessions, but with cash still in circulation people just withdraw it and hide it in their mattresses. Eliminate cash and you eliminate this alternative. With negative interest rates and no currency in circulation, people either pay to keep a balance in the bank or withdraw it — but the only way to withdraw money is to spend it, since it can't be held in physical cash.

However, there is a significant downside to eliminating cash — privacy. With no currency, every transaction flows through some electronic system where it's ultimately available to anyone that can access it: bank employees, government agencies, even hackers. I'm not certain I want anyone judging my second purchase this week at the liquor store, even though it was just for a case of soda on sale.

There are ways to make electronic transactions anonymous. Bitcoin does it through something called "block chain technology." Banks could also adopt systems like this and guarantee the privacy of electronic transactions. However, it's not much of a stretch to imagine bank regulators requiring banks to provide "backdoor" access to transactions, or even banning the use of technologies like block chain ledgers. After all, the U.S. government did sue Apple in an attempt to force them to break the security of iPhones.

There's another downside to eliminating cash: Not everyone has a bank account. How will the unbanked get access to their money? Perhaps the government itself would open a bank to provide universal access. But if you think a government agency could operate efficiently with offices essentially everywhere, just consider the inefficiencies of the U.S. Postal Service.

There are downsides to eliminating cash, but there are upsides as well. Even the Chinese ultimately started using paper money again (although the largest bill in circulation there is only worth about $17 dollars). Perhaps the modern world will decide to eliminate paper money, only to bring it back hundreds of years later.

Kevin Cochrane teaches business and economics at Colorado Mesa University, and is also a permanent visiting professor of economics at The University of International Relations in Beijing.

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