Frank Shostack: Cash Removal Will Damage the Market Economy

According to certain experts, there is an urgent need to remove cash from the economy. It is argued that cash provides support to the shadow economy and permits tax evasion.

Another justification for its removal is that, in times of economic shocks which push the economy into a recession, the run for cash exacerbates the downturn (i.e., it becomes a factor contributing to economic instability). Moreover, it is held that, in the modern world, most transactions can be settled by means of electronic funds transfer. Money in the modern world is an abstraction.

The Emergence of Money

Money emerged through voluntary exchanges of barter goods wherein one good eventually became a generally-accepted medium of exchange. Certain exchanges would be difficult, if not impossible, under a system of pure barter. A butcher who wanted to exchange his meat for fruit might not be able to find a fruit farmer who wanted his meat. The fruit farmer who wanted to exchange his fruit for shoes might not be 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. 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.

Similarly, Rothbard held 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.

Since the general medium of exchange emerged from a wide range of commodities, money is 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.

Moreover, 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. Why?

". . .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.

Hence, money is that for which all other goods and services are traded. Through an ongoing selection process over the thousands of years, people have settled on gold as money. In the present monetary system, the money supply is no longer gold but coins and notes issued by the government and the central bank, as well as digital money.

Individuals store their money digitally or in their wallets, under their mattresses, or in a safe deposit box or stored—deposited—in banks. In depositing money, a person never relinquishes ownership over 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. These deposits, called demand deposits, form a part of the money supply.

At any point in time a 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 with 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. Now, credit transactions (i.e., loans) 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.

Electronic Money

Does electronic money change this? Electronic money is not money as such but a particular way of using existing money. For instance, Bob could transfer $1,000 to Joe. He could also transfer the $1,000 by means of a check written against his deposit in Bank A. Joe would place the check with his bank, say, Bank B. After the clearance, the money will be transferred from Bob’s demand deposit in Bank A to Joe’s demand deposit in Bank B.

All these transfers—either electronically or by means of checks—could take place because the $1,000 in cash physically exists. Without the existence of the $1,000 nothing could have been transferred.

Now, if Bob pays for his groceries with a credit card, he in fact borrows from the credit card company such as MasterCard. For instance, if he buys $100 worth of groceries using the MasterCard, then MasterCard pays the grocer $100. Bob, in turn, repays his debt to MasterCard. Again, all this could not have happened without the existence of cash. After all, what exactly had been transferred?

The fact that cash per se was not used in the above example doesn’t mean that we don’t require it any longer. On the contrary, the fact that it exists enables various forms of transactions to take place via sophisticated technology such as digital transfers. These various forms of transfer are not money as such but simply a particular way of transferring money. The medium of exchange is still cash—just the means of transferring that cash is different in the digital world.

What about the introduction of a digital currency by the central bank? Could this replace cash? This will not make the digital currency the accepted medium of exchange. To become money, a thing has to undergo the market selection process. It cannot become money because the central bank said so. If the authorities were to force upon individuals a digital currency, then individuals are likely to employ some other things as money. If the government were to apply strong regulations, then this is likely to damage the market economy.

The Removal of Cash Is Going to Harm the Market Economy

The removal of cash implies the abolition of the medium of exchange and, ultimately, the market economy. Note again, the introduction of money came as a result that barter was an inefficient way of trading goods. Hence, in the absence of money (i.e., the medium of exchange) the modern market economy could not emerge. These commentators that advocate the phasing out of cash unwittingly advocate the destruction of the market economy and moving humanity towards the dark ages of barter.

The argument that removing cash will eliminate tax evasion and crime is doubtful. Tax evasion would be reduced if the incentives for it—high taxes based on big government—were removed. The fact that during an economic crisis people run to the banks to withdraw their money indicates that they have likely lost faith in the fractional reserve banking system and would like to have their money back.

Conclusion

Irrespective of the level of technological advancement of the economy, money is the generally-accepted medium of exchange. Consequently, a policy aimed at phasing out cash runs the risk of damaging the market economy.

Frank Shostak is an Associated Scholar of the Mises Institute. His consulting firm, Applied Austrian School Economics, provides in-depth assessments and reports of financial markets and global economies. This article was sourced HERE