The Future of Money is Digital, not Physical

In one of my previous posts I mentioned how many economists had evolved their understanding of money from a gold standard type world where bankers would hoard gold and then lend credit in the form of claims on that gold.  When we went off the gold standard a newer breed of economist simply swapped gold for central bank reserves and cash in their model and moved on as though nothing substantial had changed.  So, during the gold standard we had the gold bugs.  And once the gold standard died the gold bug economists turned into paper bugs.  But I think the paper bugs are dying out over time as the digital age renders their view increasingly less significant.

Now, Scotty Sumner really hates this view because he’s a paper bug.  He attributes a big time importance to central bank reserves and cash.  Which is fine.  They’re important, but his model essentially eliminates bank money and any need for understanding it which I think is a big mistake.  Sumner confidently says my position is “inaccurate” by noting that cash as a % of GDP has risen:

“In fact, both cash held by the public and bank reserves are a larger share of GDP than in 1929.  For reserves, that’s partly because of the crisis.  But currency as a share of GDP was higher in 2007 than 1929, so it’s not just about liquidity traps. As the role of cash has increased, bank deposits have become steadily less important with both DDs and TDs shrinking as a share of GDP.”

This completely misses the point.  In the USA, cash transactions account for just 27% of all transactions according to findings by Javelin Strategy & Research. That’s down from 80% just 50 years ago.  Credit and debit cards account for over 60% of transactions.  Cash is still the most frequently used form of payment  (because cash transactions tend to be in small denominations), but in total dollar volume it is becoming less and less significant.   And the USA is behind the curve.  Sweden is almost entirely cashless already with just 3% of total point of sale transactions occurring in cash.

So yes, Scott is right that the physical amount of cash has risen, but cash is a small piece of the transaction puzzle and that GDP number Scott notes is coming increasingly from transactions occurring in deposits, not cash, as the data confirms.  And this makes complete intuitive sense if you use online banking and take advantage of all the other wonderful technological advancements banks have made available.  I don’t know about you, but I buy packs of gum with cash.  I buy houses, cars, expensive dinners and most other substantial purchases via my bank account and bank deposits.   Scott’s claims that bank deposits have become less important is categorically wrong.  And I think this trend is only going to become increasingly magnified with time as technology evolves and banks and online payment systems become more advanced.  In other words, the future of money is digital, not physical.  And those theorizing about a physical world in a digital age will be left in the dust.

Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

More Posts - Website

Follow Me:
TwitterLinkedIn

Comments

  1. You and Scott are different generations. Probably explains a lot. My dad still doesn’t even know how to turn the computer on.

  2. The funny thing is Sumner comes from a QMT world (MV=PQ) where Q is some real-world good or service. Unless he can convince me he only pays in base money for some real world item his difference between money and credit does not make sense. For me, “money” must be denominated in dollar (or any other currency) at a fixed exchange ratio (usually 1:1) and can be used to buy any real world good or service.

  3. In Canada slowly but surely more merchants are introducing the pay wave technology that lets you use a debit or credit card for purchases by simply waving it in front of the machine. No need for PIN numbers, inserting cards, waiting for the cashier to punch the information in to the terminal. So this actually means that a credit card is becoming a faster and easier mode of payment than cash for both big and small transactions. I think there may be some cultural awkwardness to get over regarding using plastic for tiny purchases, but that will pass in time. I’d have to say that in the financial districit 99% of cash transactions are used to buy one item…coffee. The largest coffee chain in Canada, Tim Hortons, held out on non-cash transactions far longer than anyone else in order to keep business moving quickly, but even they have now capitulated to plastic.

    • Is the bank pay wave technology an effort to crush the merchant cards? For example, I think Timmy’s has their own plastic that you can pre-load, as does the public Transportation system (the Presto card). Perhaps these cards will disappear in favor the ubiquitous bank card.

  4. I no longer worry about getting mugged, except losing my cell phone. They can take my credit cards but you can always just cancel the card before any serious damage is done. Who under 40 years old carries cash on them anymore? Before you know it credit cards will be outdated and we’ll pay with cell phones or fingerprints.

    Merchants have no excuse to not take credit cards now, what with Square and others. Street vendors have been freed from cash-only.

    • Yeah, all we’ll need to worry about is a thief cutting off our fingerprints or digging out an eyeball…

      Digital money is wonderful and will work up to the point that it remains connected to actual productivity.

      However, if it loses that context, we’ll be back to gold and silver.

  5. If the statement from another comment on another article is correct,”CHIPS (digital clearings) are at a pace of $1 trillion a day”. It would simply be a matter of When not If.
    But I worry. Should our ‘currency ‘ become over 95% digital,How could we possible prevent
    a bank run IF ‘digital currency’ were to drive ‘real currency’ out of circulation?
    ALSO, if “CHIPS” number is correct, does that mean we presently have over $300 trillion outstanding ‘currency’ that is backed by our ‘good faith and credit’ ?

  6. I’m surprised the number is as high as 27 percent. I would have guessed under 5 percent.

    But I supposed that simply demonstrates the relative tininess of most transactions.

    And the trend is clear. The future is digital. In which case, monetarists and all the other schools of thought that are centered around the monetary base are going to have to revise their models, me thinks.

  7. It seems to me that this is more a debate about the safest form of “money” and not practical forms of money. The inside money system is an inverted pyramid supported by the outside money system . As you have clearly laid out Cullen, the inside money system outsizes the outsizes the outside money sytem by orders of magnitude. If you believe that the inverted pyramid can maintain it´s balance and deflation has been once and for all defeated then digital money through the inside money system is the most practical form of money. If you don´t belive this case then dirty old money is not a bad option…

  8. So you perfectly know the future, infact you are not writing “the future of money will probably be digital”, which is a well founded opinion, no you are SURE. This is intellectual arrogance.

    • It seems like common sense to me. Call it a guesstimate. I am just looking at the trend of cash going from 80% of all transactions 50 years ago to 27% today and then looking at the extraordinary rise of technological advancements in payments systems like credit cards, paypal, bitcoin, online transcations, smart phones, etc and saying that I think it’s logical to assume that this cashless trend will continue.

      I could be wrong, but I think it’s an educated guess!

      • Yes, is going to continue “somewhere” but you can’t predict that digital money will be “the future”. We don’t know anything about the future. Also, every country is different, not only because of different tech infrastructure but also (and above all) different cultural roots. History can be our only teacher and tells us that cultural roots are often stronger than tech innovations. Sweden doesn’t matter, is a rather small extremely civilized country with the highest Gini coefficent in the world, which matters a lot because it means there is a strong mutual confidence between the gov, private institutions and the people. Confidence is smaller in the US, Spain or Italy and extremely smaller or not existent in India, Indonesia etc… There is not such a thing as “the future”, just some “educated guesses” with a more or less local degree of likelihood.

    • I think this debate comes down to a simple point. Sumner and others seem to be arguing that the price of base money sets the price of everything. That’s the par value of “money”. And if you increase the supply of it then the relative value to everything else has to decline which will cause inflation. But that’s not really how the system works today. Increasing the supply of base money doesn’t necessarily result in other prices being changed because the quantity of base money has no impact on the quantity of broad money. So I don’t see what all the fuss is here?

      • Exactly. Increasing the quantity of base money can influence the price of base money, but has no direct link to the price of broad money. Sumner and the other guys don’t seem to be able to understand this point. They think setting the quantity of base money will automatically change the price of broad money.

        • They also don’t seem to understand that cash balances are a fraction of deposit balances. QE swapped savings accounts to deposit accounts and some people withdrew money. Why would that be inflationary or really impactful at all?

        • LVG,
          Are you saying that since money is endogenously created, CB’s can’t control the price level by issuing more base money?

          • base money has no 1:1 impact on broad money because banks don’t need reserves to make loans and cash is only accessible by someone with a deposit account. The fed can’t force an increase in the broad money supply in any meaningful way.

            As SS noted, all QE does is swap a checking account for a savings account. Why would that cause inflation?

            • Thanks LVG, but doesn’t that imply that all open market operations by cb’s are just asset swaps and therefore cb’s have no impact on the price level?

              • I would say that the Fed can definitely influence the price level. The Fed is really just a big market maker who provides asset swaps at times. When liquidity is very low (like, say 2008) they can step in and make a market in assets where there is none. They can make GSE assets worth par, which they did. That’s a powerful tool. But I would argue that most of what the Fed does in normal times is just swapping assets and making marginal changes on the prices of various assets. In normal times, a non-bank is rather indifferent about holding bank deposits versus cash. They’re essentially the same thing. The Fed can influence the cost of bank money by changing the interest rate, but that’s not what Scott’s focused on. What I am saying is that in today’s environment, with the way QE is being implemented, the Fed is just swapping checking accounts for savings accounts. It’s not having a material impact on the price level of anything. Now, they could implement the policy differently or even alter net financial assets in various ways, but that would require a change in tactics.

                • Cullen, I thought JP Koning had an interesting take on this. He says essentially the same thing you do here, but he frames it terms of what he calls a “convenience yield.” Now I don’t think h’e actually saying precisely the same thing you are, but the outcome is the same: QE is not having a big impact. How does he put that “the marginal convenience yield on reserves has dropped to zero.” Once that happens, adding more does nothing. But the convenience yield, as JP frames it, seems it has a lot to do with inefficiencies in the payment system… banks wanting to hold some reserves on hand, just in case… like you or I may want to keep some money earning no interest in a bank deposit. I don’t know if I agree, but I thought it was an interesting take. So in other words, even if reserve requirements were 0%, there’d still be some convenience yield that reserves provided, but the marginal yield dissipates quickly once reserves flood the banks.

                  Now JP extends the concept to a potential manner in which the convenience yield concept could give the CB some leverage, even after all the marginal convenience yield was gone… by appealing to the future. This seems to be the weakest chain in the argument to me… and in fact is a bit of a paradox. Sumner himself admits that adding base money does no good if rates are zero and expected to stay zero forever. Sumner maintains that if they’re NOT expected to stay zero forever, then increases in the base can be stimulative (and by stimulative I mean cause inflation and or GDP growth).

                  Jared there asked Scott “but what if they’re expected to say zero for an indeterminant amount of time?” To which he replied basically “well that’s in between those two cases”

                  So, Koning says we can gain some benefit now by credibly squeezing future marginal convenience yields to zero… but even Scott admits, that if you take that too far, you get stuck.

                  So it seems to me the MM position is jammed in this paradox… let the increased base be permanent to send a message about future marginal convenience yields (because they’re already 0 today), but if you do too much of that, it looks like 0 rates from here on out, or at least for an indeterminant length of time, which means it has no stimulative effect.

                  I don’t think Koning is an MMist, but he is sympathetic to their views to some extent… but, between his logic and Scott’s it seems there’s a narrow window to work with, and a squishy lever.

                  Much better is the kind of QE you mention here (the 1st round).. no signaling required… no calculations of future marginal yields… the message is direct and the effect immediate (that’s what JP has described as the Sproulian purchase, that I referred you to before)… but Mike points out it not a bag of dirt purchase, it’s just a Fed purchase “for the wrong price” like you might argue the 1st round of QE did. But personally all the magic there seems to be in the wrong price aspect, so bags of dirt should work just fine for causing immediate inflation.

                  For anybody that’s interested, here are the two articles I’m referring to:

                  http://jpkoning.blogspot.com/2013/09/the-rise-and-fall-and-rise-of-hot.html

                  Here’s Scott’s: basically I’m proposing we may have started out in his case 5c (QE effective)… but we’re getting close to case 5b (QE not effective) (and Koning says all we got left to have an effect is to move FURTHER towards 5b… thus the paradox):

                  http://www.themoneyillusion.com/?p=23314

                  and the “Sproulian purchase” is here:

                  http://jpkoning.blogspot.com/2013/08/give-bernanke-lever-long-enough-and.html

                  But at the same time I’d be misrepresenting MMists if I said that QE is their favored tool. It’s not. Even Sumner would prefer to have an endogenous base money system… but they still think we’re closer to his case 5c than I think we really are, so QE still looks attractive to them as a back up plan.

            • LVG, I would go even further and say that the Fed can’t even force base money into the economy. At least, not unless the Fed fires dollar bills out its front door with a cannon. :)

              • Aren’t you contradicting him?
                He just said that the Fed made a market in assets where there was none in 2008. When the Fed buys a useless asset like a levered MBS, isn’t that by definition putting money back into the system?

                • It’s not putting base money into the economy. It’s changing the value of a pvt sector financial asset. You could argue that the capital gains are a roundabout way of printing money if you wanted to, but that’s a really unusual event….

                  • What if the Fed bought a worthless house in Detroit? And held it to ‘maturity’ when the city razes it.
                    And the homeowner put that money in the bank as a deposit. Wouldn’t that be adding to the money supply?

                    • The Fed buying real goods is the equivalent of shooting money out the front doors. They don’t do that. They swap financial assets.

                    • What if the homeowner wrote $1 million on a piece of paper? Could the Fed call that a ‘financial asset’ and give him $1 million, like they did when the banks did the exact same thing?

                    • The Fed bought govt guaranteed assets issued by the GSEs. But yes, if you could get the Fed to buy a piece of paper from you then that would be the same as getting them to buy a bag of dirt from you as I’ve described in the past. It would be a direct infusion of cash into your bank account. These are silly examples though. The Fed doesn’t buy houses and pieces of paper you scribbled on.

                    • The Fed bought GSEs, after the banks dumped their worthless pieces of paper at Fannie Mae, etc.

                    • They were selling for 50 cents on the dollar, but that was just a ‘liquidity’ issue. As an investor, I’m sure you are willing to buy them back at par. (sarcasm).
                      Banks created ‘financial assets,’ which the Fed ‘swaps’ for deposits.
                      Very neat.
                      Don’t you see how grotesque that is? And you defend it!

                    • The Fed saved the system from collapse during the worst financial crisis of our lifetime. Personally, I wouldn’t call that “grotesque”.

                    • What if the FEDS bought ALL the worthless mortgages, then gave the homeowners or any new party a chance to purchase
                      at 50% of principal with 0 down and 1% for 72 years.
                      A simple zero sum book entry. $10 trillion out with a return of $10 trillion over 72 years? Call it ,”QE 4 The People”
                      But we would have to have a Central Bank (The Fed) working for the people, instead of the one we have working for PRIVATE FOR PROFIT BANKS.
                      Prepare the people for prosperity-a Central Bank that would redistribute
                      its Net Interest Income “to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defense, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity,…”

                • Good point, JE. If the Fed buys trash for cash, they do indeed put money in the system and even increase the net worth of the private sector. But QE1 was an extremely rare situation, and arguably bordered on fiscal policy.

                  One could say that QE1 was the equivalent of firing cash out the front door.

                  • JP Koning dubbed such a move a “Sproulian purchase” after Real Bills advocate, Mike Sproul, who agrees with the definition, but does not endorse the policy. Mike says a Sproulian Purchase is both inflationary and stimulative. Neither here nor there, but I thought that was interesting.

                    • WHAT IF.. QE1, and QE 3 were purchases of all residential and commercial mortgages at market value
                      plus 2%, would that have ended the “systemic failure” immediately?(If banks had to take a haircut they would be allowed to borrow any loss at 2% for 36 years). And what if the Fed were to then have Freddie and Frannie service all these loans after being reset at 2% for 36 years, would that establish 2 0r 3 million jobs in the housing sector and terminate foreclosures since the homeowners would start paying and reset the housing market?
                      OMG, if 36 trillion were needed that translates to $2 trillion/year FEDERAL REVENUE INCOME !!
                      QE 4 the people.
                      End Federal personal income taxes,end FICA.
                      ONE BOLD STROKE.
                      All banks must be 100% solvent,no more ‘printing’, flow will be maintain by Fed open window policy
                      “Banks may borrow at 2% for 36 years (up to 25X capital)
                      If that could only be $72 trillion…that’s $4 trillion/year CONGRESS MUST SPEND just to make it possible for the notes to be paid.
                      OMG,(as stated on ” 60 minutes” (12/11/11)” President Obama said,”You can’t raise revenues by lowering taxes unless you get the money from somewhere else.” ? YES, JUST COLLECT INTEREST ON OUR OWN MONEY, INSTEAD OF TAXES !
                      PLEASE,PLEASE challenge or endorse.
                      Please,please read: http://bit.ly/MlQWNs Read what Steve Keen has to say about “credit expansion, von Mises as to what the result of credit expansion could be, William Black has to say about banks and Michael Hudson about compound interest (excerpts are in the article). An explanation of where we went wrong with a solution to how we can fix it. Challenge it. Improve it. ” ***** “Believe nothing merely because you have been told it…But whatsoever, after due examination and analysis,you find to be kind, conducive to the good, the benefit,the welfare of all beings – that doctrine believe and cling to,and take it as your guide.”- Buddha[Gautama Siddharta] (563 – 483 BC), Hindu Prince, founder of Buddhism.
                      http://bit.ly/MlQWNs

  9. You probably have a 99% chance of being correct, the question is not IF rather WHEN.
    It also may be the reason there wasn’t a run on the banks with the housing MBS collaspe.
    The banks that were hit gave Bank checks (Certified,even if that means anything). But all that money transfer did not demand cash.No matter what amount came out of one bank, it had to be deposited in another.

  10. Sumner responded to another commenter:

    “notice that in that quotation he does not present any data refuting my claim that bank deposits are a shrinking share of GDP and currency is an increasing share of GDP. Facts are facts.”

    Sumner is such a fool. He doesn’t even read your post and misses the fact that you did post data from an actual study. I left the following comment, but it won’t post:

    Cullen actually did provide data, just not in the paragraph Mark posted:

    “In the USA, cash transactions account for just 27% of all transactions according to findings by Javelin Strategy & Research. That’s down from 80% just 50 years ago. Credit and debit cards account for over 60% of transactions.”

    • LVG, did you include a link? I’ve noticed that WordPress won’t accept certain links, like to JP Koning’s site for example… or Vincent’s (lucky WordPress readers!) … (relax Vincent, that’s a joke!).

      Vincent says it won’t even allow him to use his name either (he REALLY made the list I guess… way to go VC!).

      • No, i published that comment in quotes above as is. Maybe he has a spam mod filter on or something? I don’t know.

      • After a few emails to the nice wordpress people they have agreed that I am not a robot and unblocked me. I can now post to wordpress sites using my real name again, and even link to my blog. Life is good again!

  11. Help. According to your statement 27% is MS issued currency, via coin and/or note.
    that would mean 73% is digital. Regardless of who issued the digital money does that mean that all 100% is ‘guaranteed by the government of the USA’s good faith and credit’ to be redeemable upon demand thereby EXCHANGEABLE into goods and services?
    If so, how much is out there. OCC stated ,derivatives are 130 trillion plus (OK, if 10% change ONLY $13 trillion is need to ‘cash’ out? But what is the total? Maybe,perhaps the Austrians still have a chance to be correct:****** “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of the voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” — Ludwig von Mises

    • According the the St Louis Fed data there is about $1T of currency in circulation and the MZM is about $12 T. Currency in circulation has dropped relative to MZM almost certainly exactly for the reasons Cullen pointed out.

      • Help,tell me it isn’t so. There is ONLY $1 trillion real sovereign currency in circulation. What if 20% of the people went to their US banks and demanded cash and when the other 80% found out that half of them would have to come back or accept a BANK CHECK (Digital Dollars).what would happen to the $30 trillion stock market, when 100% of the people realize
        they CAN’T cash out. Pray tell me what bank would ‘exchange’ the brokerage check for ‘coin’.

  12. Digital did not work out so well for some folks in Cyprus recently. And we probably have not seen the last of such bail ins.

    • In Argentina they had a bank holiday where all the digital US dollars were forcibly converted to pesos at what turned out to be a really bad deal for the account holders.

      In many hyperinflation cases bank accounts have been frozen and by the time they were unfrozen the money was worth far less.

      Even if you like digital, it is probably not wise to keep all your money in digital form when times are as volatile as they are now.

      • Agreed, Vincent. There is deposit insurance but better to be safe than sorry. And it isn’t just a bank issue, but also a sovereign one. For example, when Greece was in danger of pulling out of the Euro (not that they are currently out of danger), there was a real risk that Greek bank accounts could be frozen overnight and arbitrarily converted from Euros to Drachmas at who knows what exchange rate.

        • In the cases I am talking about deposit insurance would not have helped at all. It is not that the bank did anything wrong, it only did what the government’s new law made them do.

  13. Sumner never posted my comment. I guess having young Cullen look smarter than him is worth hiding from his readers. LOL.

    • Sumner: “Mark, Yes, I erred. The data series I used did not have all types of bank deposits. But surely bank deposits have a long downward trend, as you show, and the recent surge reflects near zero rates.”