Towards a (Mostly) Cashless Monetary System

I often talk about the misconceptions of money being a physical thing.  Austrians tend to tell us that money is something like a physical commodity while many Keynesians tell us that the ultimate form of money is paper or cash.  There’s a smaller group of (mostly economists) who believe that the ultimate form of money is currency (bank reserves, cash and coins).  I think they’re all wrong.  Money is no longer dominated by a physical thing (though it can be) or by what the central bank or government creates (cash, coins and reserves).  Today’s money is created almost entirely by private banks and tracked electronically for record keeping within a payments system that they control and the rest of us have to be members of.

Of course, our textbooks also tell us that government money matters most.  They tell us that the central bank creates some amount of money and the banking system “leverages” or “multiplies” this money, but that’s not really true.  Banks create loans first and obtain reserves second if necessary.  The money multiplier is a myth.  And that puts the private banks squarely at the center of the money creation business.  When a bank makes a loan it results in the creation of a deposit.  And those deposits are what we are all chasing in a system that is dominated by electronic bank money.

The mainstream media is nearly as oblivious to this reality as the economic textbooks.  In the mainstream, the belief is that the government “prints money” as if it’s just running a printing press running up government debt all day long to pay for things.  But the reality is that the government is a massive redistributor of bank money.  That is, when the government taxes you they’re just taking bank deposits from person A to pay person B with bank deposits.  When the government runs a budget deficit they’re selling a bond to Person A and giving person A’s bank deposit to Person B.  There’s no “money printing”.  There’s only redistribution of bank deposits.  And because these bank deposits dominate the US payments system as the means of settling payments in the process of transacting business, we are all seeking out these deposits so we can interact within that payments system.

The reality of banks “ruling the monetary roost” has only become that much more apparent as technology has developed in recent decades.  In fact, I would argue that we’re becoming increasingly bank dependent as technology begins to reduce the importance of cash and other forms of government money in the economy.  Canada, for instance, has no reserve requirement as technology has made their interbank payments system extremely efficient.  The cash market for transactions is also taking a back seat to other transactions around the world.  In the USA, cash transactions account for just 27% of all transactions. 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.   If we include wire transfers in the volume of payments data the electronic market already dwarfs the cash market (via the Cleveland Fed):

And although the US has been ahead of the trend in many regards here, other developed nations like Sweden and Canada are already on the fast track towards a cashless economy.  For instance, in Sweden, less than 3% of all transactions occur in cash.

This doesn’t mean cash as a form of money is going away entirely.  But it is becoming increasingly less significant.  And that’s precisely due to the way our money system has been designed.  Banks have been placed in charge of managing and driving the payments system around the world.  So their money dominates that system.   That’s not going to change any time soon.  In fact, we’re becoming increasingly dependent on bank money as technology makes other forms of money less and less competitive/necessary with a highly efficient electronic (bank controlled) system.


Understanding Moneyness

Understanding the Modern Monetary System

Understanding Inside Money & Outside Money


Got a comment or question about this post? Feel free to use the Ask Cullen section or leave a comment in the forum.

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.

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  1. Is this a good thing or a bad thing? I feel like the banks are increasingly monopolizing the monetary system regardless of whether they’re good stewards of that system or not.

  2. It means get used to too big to fail. The banks have us all by the nuts and they know it. They can run the economy up, run her down and win both ways.

  3. It seems to me that anybody that really digs into the system a bit comes away with nearly the same idea. For example neo-classicals like Nick Rowe and David Glasner both acknowledge the basics here about bank created money and the falseness of the money multiplier myth (although they both still ascribe special powers to central bank reserves for some reason), and even a few Austrians appear to be on the same page (they don’t like it, but some seem to acknowledge that’s how the system actually works … more or less… specifically I’m thinking of Mish Shedlock and Chris Whalen).

  4. Perhaps the banking industry needs some laws that promote competition and don’t give such a big advantage to the established TBTF institutions. That might help to lighten their grip on our “nuts!”

    Regarding cash, personally I think there is probably such a large element of the population in this country that’s hyper-suspicious of government and centralized records in general, that there will be a substantial role for cash for many years to come. Do you think Alex Jones will recommend putting your assault weapon, ammo and bunker supplies on your credit card? I think not! :D

  5. A couple of questions that need to be addressed, imo:
    1. In the end, it’s the government that is backing all this money creation, isn’t it? So shouldn’t the people have a say in the rules.
    2. Most of these loans appear to be staying within the financial commuminity — how long will the rest of us agree to this?

  6. Here’s the best way to think of the US payments system. The payment system is the playing field. The govt sets the rules for that playing field and the boundaries for what can be used to “play” in the game. Whether you know it or not, Congress has already determined that the payments system in the USA is the US banking system, they’ve laid out the rules for using that system, determined what can be used within that system (USD denominated bank deposits and reserves) and placed the banks as the central infrastructure of that system. They’ve further placed the Fed as a facilitating entity to help ensure oversight and operating efficiency. The govt is like the referee, the banks are the ball (and actually create all the balls for us to chase) and we’re all just kicking it around or chasing after it trying to score with it. But make no mistake, this is all a construct of Congress. And it could be changed if one were so inclined. But for now, the banks have been placed in charge of running the payments system and we’re all just users of it.

  7. The banks are the referees also. Their lobbyists created all the rules to begin with. Anyone who thinks this is all controlled by the government is out to lunch.

  8. What a depressing view of the future. It amazes me that society has gotten so bad that the majority allow the few to control them in such a way to such a degree. The quality of life has gone down so much that the only good thing is that we have to be closer to the end than we were a year ago. I beg for my children for the entire system to collapse while they are still young, so that it can re-build on a solid foundation.

    Today quality of life is measured by medical advancements and productivity. The slaves can now work more hours and for more years than ever before. No longer can a father support his wife and 4 kids on his factory salary and live in a middle class neighborhood. Now he and his wife can work 10 hours a day each and afford to live in the same middle class neighborhood because he has more access to debt to afford the ever increasing costs due to baker scum with no control over the money supply. His kids grow up being raised by a nanny and the family is loaded up with education debt and medical bills they will never repay.

    Cullen, no offense, but you have a really twisted view of a world you want to live in.
    My advice to you is to lay off the 168 hours a week you spend on the internet and get some fresh air.

  9. I don’t describe the world I want to live in. I describe the world we DO live in. There is no policy agenda or ideological view in 95% of what I write. I am simply writing what I believe is the actual reality of our money system. Nothing more. I don’t say it’s perfect or that it’s imperfect. It just is. If you want to use that understanding to try to change it then go for it!

    PS – I’m going for a run to the top of a mountain right now. :-)

  10. “…baker scum with no control over the money supply”

    I assume you meant

    “… banker scum with control over the money supply.”

    Otherwise I agree bakers have NO control over the money supply, but that’s no reason to blame them! ;)

  11. I actually wish you’d interject with a bit more of your political preferences. You understand the system so why not tell us how you think it could be improved? Obviously, something ain’t right and my guess is that you know what it is.

  12. That’s what I did 3 years ago. Left the work, distributed my money in 4 bank accounts in 3 continents, large cash pools in 4 different currencies in 3 safe boxes in 3 continents, some gold coins somewhere… and go to the mountains ! You’re perfectly right, you’re just describing the world as it is and your description is so accurate that I’ve just to mail the links to the people who are asking me “how it works”. Look at Pragcap and stop dreaming, this is what you have. But, probably as you, I don’t like it. It is techno fascism, it’s George Orwell on steroids. Freedom is risky but much more valuable than safety. It’s a pity that a country like the US is now the most orwellian country on the planet. Too much technology is killing real people.

  13. Hey I wrote “too much”, that means there is good technology and technology which is not so usefull and which can be easily abused. Internet is as usefull as easy to control, electronic money too and the increasing asymmetries in knowledge are posing a threat to democracy (or what is left of it)

  14. The problem with simply describing the system as it is is that you leave no room for hope from your readers. You’re just describing the system we have which is like describing to a bunch of factor workers how they’re slaves to some corporate juggernaut. I think people read MR and go “shit, this how it is?”

  15. Cullen’s MR description is so good that I think it scares people. I understand money and the monetary system so well now that I am actually mad about it because now I see the problems and know I can’t do anything about them.

  16. My description of the money system shouldn’t “scare” anyone. It should just make them feel more confident in understanding it.

  17. Then stick with the heavy lifting and leave the mountain running to the girly men ;)

  18. I don’t remember reading your writing about banking crisis and bank run. There are many failed banks. I believe the bank fails because it has inadequate deposit to give back to its customers. Cyprus is one example. Bank creates loans, and loans creates deposits. But somewhere in the milddle is GDP, economy and circulation. In crisis, card doesn’t work. Cashless system works until it doesn’t. In a society as whole, cash will always exist.

  19. Banks fail when they have inadequate capital levels and lose their access to funding markets as a result. I think Cullen will say that you have this backwards because bank runs are proof that the banking system can’t survive by allowing people to take cash out of the system permanently. In other words, if bank money is unstable then the system is unstable. That’s why they won’t let Cypriots take out money from the ATM. If they did it would wreck the banking system.

  20. Meh. I’m ok with the just-describing that Cullen and MR are trying to do. Not everybody needs to be everything all the time. People want Cullen’s political opinions because he’s earned their trust. Well, you don’t always get what you want!

  21. By the way, when bank makes loan, such as mortgage, it is at least three times your income, which is 3x leverage to your income. Is that not money multiplier? You have 100k annual salary, and you are buying a property for 300k. You are spending what you don’t have. How is that a myth?

  22. Pete, you write: “I believe the bank fails because it has inadequate deposit to give back to its customers.”

    If you’re talking about customer deposits, that’s not the right way to think about it. Remember that deposits are bank liabilities (what the bank owes others). If you purchase something w/ your deposit, the bank is on the hook to clear the deposit behind the scenes by raising the reserves necessary to clear the purchase with the seller’s bank. If ALL deposits are transferred out of the bank by purchases or just straight deposit transfers to other banks that’s not necessarily the end of the bank. It is if it can’t borrow reserves at a rate that allows it to still make money on the spread between its assets and liabilities (reserves it borrows to cover a deposit transfer and the deposit itself are both liabilities). Deposits are cheap liabilities, so if they were all to depart, that would most likely be bad news for the bank, but not necessarily the end of it. As for customers taking their deposits out of the bank in cash… that’s really the same as a deposit transfer (since the bank most likely will need to borrow reserves with which to purchase the paper notes and coins from the central bank). There’s likely not enough cash for ALL customers in ALL banks to do that simultaneously of course! Here are two simple examples:

  23. Petee, one way to think of capital is as equity (However, that’s not precisely true in the Basel Accords sense). Equity, in turn, is defined as assets in excess of liabilities.

    Suppose a bank had $50 of reserves (asset) and $50 of loans (asset) and $90 of deposits (liability). That means it has $50 + $50 – $90 = $10 equity (capital). But what is that capital composed of? Outside money (reserves) or the loan (BTW, I don’t think I’d count the loan as inside money here) or both? I’m not sure it makes sense to put the question that way. Here’s a simple example of a bank meeting capital requirements:

    Of course a bank could conceivably have $100 of reserves and no liabilities… in which case its capital looks pretty unambiguously like outside money:

    Probably best to take the “assets in excess of liabilities” abstract definition most of the time though.

  24. To the people above, asking Cullen about his own (political) opinion on the system: I think it is a really good thing that Cullen and MR are trying to describe only the reality of the system as it is. Keeping opinion or politics out of it as much as possible.

    The system is complex enough as it is. Once you start discussing things and mix in “should”, “would have to” and “could”, the distinction between how things are and how someone would like them to be is lost immediately. And you end up in political discussions. Those political discussions should be held of course. But first you have to know the basic facts about how the system actually works.

    Also, once you introduce politics, it probably makes it more difficult for many people to objectively judge the information. People will reject the information just based on the thought that Cullen or another author here on MR are politically “left/right/liberal/conservative/…”.

    Of course, once you read enough articles here, you can get a basic idea of what Cullen or other authors think themselves about how the system works.

  25. If the TBTF banks ever went kaput en masse I would guess the Congress would make some changes. It is hard to predict those changes, though.

  26. Right, there are many other blogs with a strong political imprinting. That’s good too, having a position is important, you cannot just stay at the window for ever. But to have a political standing it’s much better having an a-political, un-ideological knowledge of extremely important things like our monetary system and “how an empire works” as described by John J. Mearsheimer which is a great political scientist whose work should be read.

  27. And we now see on Cyprus how easy it would be for the government to dip in and take your money. Doesn’t keep me from using a credit card and online brokerage though ;)

    I wonder when the US will finally do away with those archaic checks?

  28. “I don’t describe the world I want to live in. I describe the world we DO live in.”

    Good and honest statement. A clear, however rather brutal, analogy would be if somebody in Nazi Germany would post that more and more people are going to the death camps, from 20% years ago, to 80% now, and this is the reality…

    Yes, it is obvious, the fully electronic money is possible, and would be a wet dream for any government/bank syndicate. Just imagine, a full control over anybody’s transactions and wealth. Yes, wealth, cause if they know who bought what with the electronic money, they can easily control it.

    Please, everybody, tell honestly, would you trust the current government/banks with fully electronic money. I would not trust them to walk my dog…

    Will we get there? It is as with Nazi Germany – it had a chance to succeed, but bigger forces crashed it. As with “fully electronic”
    abomination, I believe the market will crash it, and there will appear alternative monies, be it forex, gold, bitcoin, or something still unimaginable.

  29. are you accepting Bank of Cyprus deposits? Please, only discuss sums above euro 100,000….

  30. If 95% of “total money” is inside money, bank created credit, and 5% is outside money “currency and bank reserves”, don´t you by definition want to have cash in a severe deflationary criss? The only way for banks to remain viable institutions is to perpetuate credit growth. What happens when these institutions become to deleverage? An electronic banking account is only viable as the institution is viable. Cash is viable as long as the government is viable. I put my chips on the government. Chipre is a very good case in point.

    My perspective comes from a country that is a currency user, Spain, and we have a very leveraged banking system. Yet, I think this argument can also be applied to the financial institutions of currency issuing nations where the banks are highly leveraged.

  31. Cullen, I am interested to know your opinion on this topic. The size of the Spanish banking system is somewhere between 3 and 4 trillion euros. Our GDP is roughly 1 trillion euros. Banks are cutting credit to small business and private borrowers and NPLS are at historic highs and rising. The property market is not even close to being marked to market and the banks books are stuffed with questionable mortgages.

    I have a few questions in light of this situation.

    1) What advice what you give to the millions of families that hold non interest earning demand deposits in these banking institutions?

    2) Would you recommend that they put their faith in their electronic deposits our attempt to withdraw the equivalent in cash?

    3) In light of developments in Cypress, it appears that the day to day electronic money system is not functioning properly. There are reports that many small businesses and stores will only accept cash payments. Isn´t this situation only going to get worse as the confidence in the institutions there continues to drop?

  32. Cullen, I am interested to know your opinion on this topic. The size of the Spanish banking system is somewhere between 3 and 4 trillion euros. Our GDP is roughly 1 trillion euros. Banks are cutting credit to small business and private borrowers and NPLS are at historic highs and rising. The property market is not even close to being marked to market and the banks books are stuffed with questionable mortgages.

    I have a few questions in light of this situation.

    1) What advice what you give to the millions of families that hold non interest earning demand deposits in these banking institutions?

    2) Would you recommend that they put their faith in their electronic deposits our attempt to withdraw the equivalent in cash?

    3) In light of developments in Cypress, it appears that the day to day electronic money system is not functioning properly. There are reports that many small businesses and stores will only accept cash payments. Isn´t this situation only going to get worse as the confidence in the institutions there continues to drop?

  33. The TBTF banks DID go kaput en masse in 2006 and Congress didn’t make any changes. Instead, we’ve sat back and allowed the Fed and the Treasury to bail them out.
    Again, wish Cullen would describe the reality that bank money appears to be guaranteed by the federal government.
    Somehow we seem to have adopted a system in which loans never have to be paid back by those who know how to game the system.

  34. This sure is a doozy of a comment.

    First off comparing the voluntary choice of using electronic means for payment to the forced “attendance” of Nazi death camps is just magnificent. I think even Bill O’Reilly would marvel at that.

    I think everybody has pretty much spoken, they like electronic forms of payment. It appears to be convenient, fast and readily available. I guess that’s why these private enterprises we call banks have spent billions in continuing to develop newer technologies like remote deposit and mobile banking that their customers demand. What a brave new world we live in.

    You cap it off with a prediction that the market, which has demonstrated its demand for fully electronic payments, will crash this system and replace it with something else. One of those options you offer is a fully electronic currency created from computers which solve complex mathematical problems. The other, forex, as Cullen has shown with Canada and Sweden and almost every other developed countries currency, is moving in the exact same direction as ours, electronic.

    Again, just one superb comment.

  35. Is it not possible that the anger that is being communicated towards an all electronic monetary system is rooted in fear? Once we submit ourselves to a non cash, electronic credit, inside money system we relinquish all powers to the banking institutions and leave ourselves vulnerable in terms of the viability of their business models.

    There is no road back it seems once we move away from cash. Cash, whether you think it as antiquated or not, is in fact related to the notion of freedom and is insurance against misguided private banking institutions. Nothing I have read here has been able to change my opinion on this point. Although I do think Cullen does a very good job explaining our monetary system. :-)

  36. I agree that the Nazi analogy is over the top, but I understand what KB is saying.
    When Cullen describes the system, his silence on its flaws can be defeaning. I’m not talking about electronic payment of bills, which everybody supports. Or even banks creating loans through deposits, which can work, so long as the loans can be paid back.
    What I mean is that this is a system that is extremely fragile (it is supported today largely through government intervention) and is introducing money that isn’t backed by any substantial assets or economic activity.) And such money only moves in the financial community, not in the general public.
    Here are two analogies that might be better.
    It’s like describing the Balance of Power system in Europe in 1913 and not noticing that the system was teetering.
    Or describing the Mafioso in New York City without pointing out that the mob’s system — while it appeared to be logical and create harmony in good times — was fragile, immoral and doomed to failure.
    I don’t think there is anything ‘political’ about such observations.

  37. If you’re not earning interest I would convert to Euros and hold in a safety deposit box.

  38. Cash has an extra degree of freedom. I don’t like giving up my freedoms for nothing (even though it isn’t entrenched in the Constitution or Bill of Rights).

  39. After reading some comments here, I have to ask: Is it just me, or would anybody else be in HUGE trouble should all electronic forms of money vanish overnight. I have such a small inventory of it, that I don’t feel that cash is preserving my freedom at ALL!!

  40. Cash was created by banks as a claim on a deposit of usually gold or silver. So it was created as a convenience for its customers. Before a uniform payment system, it was called bank scrip. How was that relinquishing all power to the banking system? Banks rule the monetary roost, but that is only one component of our society. Our goverment allows the private markets to rule their respective roosts, yet we our society has government to facilitate those systems. Agriculture, transportation, telecommunications,etc. are all systems that are run by the private sector, yet have goverment in someway facilitating them. Same goes for the banking system. And all these systems look to make profits by providing customers with the services and products they demand. They all have their inherent risks, like farming and droughts/floods. Furthermore, it behooves each individual to take certain precautions to insure themselves from these inherent risks as well. I don’t know what is left to fear after that?

  41. Joe, while I see that you’re around, I thought I’d take the opportunity to ask you a question: How would you describe the difference between equity and capital? I know that capital is defined by the Basel Accords and labeled Tier 1 and Tier 2 (Wikipedia gives a definition of both). And I guess regarding equity, I’m thinking shareholder equity, which I take to be assets in excess of liabilities.

    I’m really looking for a layman’s explanation here. I often conflate capital with equity for simplicity, but what is the essential difference in your mind? I just want to get a better feel for when I should be careful about oversimplifying this.

  42. It is truly amazing how much you comment on this site, yet it appears that you have never read a single word of Cullen’s. One of the main tenors of his description is the fragility of the private banking system and why the system evolved to have the interaction with the government it does today. That is how we went from free banking to a Federal Reserve System and then added deposit insurance. So he is hardly anything but silent on its flaws. Not to mention, all he does is criticize the euro system for its MAJOR flaws.

    Where the difference comes is you think the system is destined to fail and Cullen does not simply agree with you. You cry its only being backed by government intervention. Yeah so. That’s how our society set it up to manage the inherent risks in the system. There are flaws in that as well, but nothing immoral about a constitutional government. You claim that the system is introducing money that isn’t backed by any substantial assets or economic activity, when all banks do is introduce money that is backed by collateral and future cash flows. Are you just going to ignore the fact that the US produces 25% of the world’s output? Yes it is going down, but that because other countries are developing and taking some of that output, which is raising global living standards.

  43. From a simple accounting perspective, capital is the combination of equity and other sources of financing like loans or other debt. Equity is what the owners/shareholders have contributed when the capital was raised.

    From a regulatory perspective, capital, is on the balance sheet to protect the bank from unexpected losses. Basel uses tier 1 as core and tier 2 as supplemental, but in general it is the amount of ownership equity the bank has to take on these unexpected losses. It makes the argument that a well-capitalized bank can absorb unexpected losses without having to default on its debts which cause losses for its creditors/depositors.

  44. I derive much of my work from Minsky’s instability hypothesis. I wrote a paper on SSRN about this. The idea that I don’t account for banking’s inherent trend towards instability is ridiculous.

  45. You wrote: “Equity is what the owners/shareholders have contributed when the capital was raised.”

    As a simple example, say a company starts w/ a blank balance sheet, raises $100 capital by selling shares, and then makes $100 profit (still no liabilities, other than the shares). So would you say the shareholder equity is now $200? In this simple example the capital is also $200 now, true? (I’m thinking about the simple accounting perspective here and any business… not just a bank).

  46. Yes, banking is instable. The answer for that, as in any system, is to allow banks to fail.
    Farming is instable — some farms fail and the other adapt to succeed. Same in manfucaturing or any other economic activity. The way to have a robust system is to allow failure.
    There is nothing in the design of the system that support the notion that government should support failed financial institutions.
    I do claim that money is being introduced without the economic activity and assets to back it. Many people have pointed to the increase in debt far beyond economic growth.
    How can you say that Cullen disagrees that the system will fail, when it did fail just five years ago. And far from solving the problem, government intervention to paper over failed bank loans has merely made the problem worse in the long run.

  47. Cullen, BTW, here’s the follow on article from Sumner I think you were anticipating from your article over at monetaryrealism:

    On first read it still seems to me that Sumner ascribes special powers to physical cash itself!! Both Rowe and Glasner have explicitly rejected that idea…. or at least downplayed it.

  48. Other than his treatment of cash (which leapt out at me)? No. … I need to go back and really read it. I just gave it quick scan.

  49. Hi Tom, I don’t use my right of free speech everyday, and sometimes I don’t vote for years on end. But I like those freedoms. It was famously said, “Be warned, once they start burning money, they’ll start burning people!” (Or something like that ;-) )

  50. 50 years ago cash accounted for 80% of all transactions. Today, it’s about 26% and expected to continue declining. Technology is moving us away from a physical money world.

  51. My point here is the owner’s equity (same as shareholder’s equity?) can turn into MORE than what it was when capital was first raised (presumably by selling them stock), correct?

    Also, going back to your first paragraph, so Bank A starts w/ a blank BS, sells $100 stock and sells a $100 bond. So now we have:

    Assets: $200 reserves
    Liabilities: $100 bond sold to investors
    Owner’s Equity: $100 stock sold to owners

    What is the capital in this case from the “simple accounting perspective?” Is it $200?

    From the “regulatory perspective” the capital would appear to be $100, correct?

  52. Yes $100 in shareholder equity with $100 in retained earnings which is $200 in equity and capital. Assets minus liabilities equals equity. Equity plus certain liabilities equals capital. All of this is in an accounting sense, not talking about regulatory capital.

  53. It does seem a little strange to me that capital “in the accounting sense” is equity + certain liabilities. Consider the above example, but say the bank is forced to pay a fine of $100 (or in some way loses $100 in reserves). Now equity is down to $0, but do you still have $100 “accounting-sense” capital, since you still have the $100 bond liability?

  54. First off, you need to improve your reading. I did not compare electronic money system to Nazi, I used the analogy to comment on Cullen’s saying. Here it is again:

    “I don’t describe the world I want to live in. I describe the world we DO live in.”

    I am pretty sure there were many people who did exactly the same back then. I see nothing bad about it. It is just the conclusion you made based on observable facts, and your reaction to those facts, what matters. Cullen’s description of what is happening is correct. His reaction to it as well as his assumption that electronic money is the way to be are not.

    I enjoy electronic payment systems as much as anybody else here. But only on the conditions they are not mandatory. There should not be any restriction nor any hindrance if I want to use cash. And please, please, do not mention drug cartels here. Just read how very conveniently they have been using electronic money through some major US banks.

    Also, you are only partly correct saying that the market wants fully electronic money. Yes the market loves electronic money. Yet he also loves cash, I just proved this today several times. And parts of the market also still like gold to settle payments. And some few like bitcoin.

    You did not understand my point with forex. The point of forex is that if one country does something stupid, the market can switch to using another county currency. You can google many examples of that if you do not know any.

    My mentioning of bitcoins is not that I am using it or propose to use it. I do not. It is just to demonstrate that the market can come up with an alternative, and you can have no idea what would it be or where it comes from.

    Again, I enjoy electronic money and will use it in the future. We do need to understand the system to benefit from it. Yet you do not have to approve when it goes to extremes and when it start to suppress people free will.

  55. Banks can and do fail, see the FDIC failure list. However, sometimes, there can be a situation where individual bank failure can cause system failures. If the entire midwest saw grain production halt due to severe weather, there would be a more systemic strain on our food supply than just a few farms failing because of bad practices. As Cullen states below, this is Minsky’s hypothesis. What were Minksy’s solutions? Government intervention, regulation, etc. See Levy Institute working paper #655. It’s written by Wray, and adversary of Cullen so to speak, but it is mostly an overview of Minsky’s writings. Letting a system get to a point where a few parts failing can cause a systemic failure is foolish, especially when it can be prevented so I agree with you on that point. However, you have distorted this argument now to the stability of the banking system and the cash that is created to facilitate that system, when we first started discussing why there is no difference between a cash based banking system and a cashless based banking system. Its just a matter of customer preferene and does not add to the inherent fragility of the system itself.

  56. From a regulatory perspective if that bond meets the Basel definition of subordinated debt than it is considered Tier 2 supplemental capital.

  57. In the accounting sense, you raised 100 by selling the bond. That can be used to purchase revenue generating assets. That is why it is considered capital accountants. See definitions for working capital and return on capital.

  58. As I noted above, cash transactions account for just 27% of all **KNOWN** transactions.

    If usage was dropping as fast as that stat asserts, it wouldn’t have grown from about 4.2% of GDP in 1980, to about 7.2% today.

    It’s not just about the black market, and the Fed/Treasury doesn’t create currency if it’s not being used.

  59. Ok, you’re backtracking a little, because your second and third paragraphs were critical of banks/government having “control” of electronic money and you were implying evil intentions, such as controlling wealth.

    The point is no one is saying cash is going away because that is what the system is forcing upon us. Cash is being used less because of personal preferences. The system is designed around settling payments with bank deposits. Cash exists to facilitate this system. If there is a demand for it, you can bet banks will provide it. Before EFT’s, you could use checks to use your bank deposit as a payment. Did that suppress people’s free will?

  60. No, I am not backtracking. The control issue is critical. Obviously, the banks, and hence the government, will have control over electronic money (unless it is some sort of bitcoin). This is unavoidable. But it is perfectly fine for as long as use of cash is not restricted.

    My big problem is the there are more and more artificial government designed restrictions on cash use. Most recent in the US are reporting requirements on purchases above certain limit. In some EU countries – upper limits on cash purchases. That is what I do not like.

    Again, my point is that any system of payment should have equal standing and be the private business between buyer and seller.

  61. Also, I disagree with you here – you saying that “The system is designed around settling payments with bank deposits. Cash exists to facilitate this system.” Really, it is the other way around. Electronic payment system exists to facilitate cash use. Electronic money is derivative, not cash. And please, do not tell me about size of electronic money versus cash money – notional size of derivatives is typically much bigger than the size of underlying securities.

  62. “In the accounting sense, you raised 100 by selling the bond. That can be used to purchase revenue generating assets.”

    Yes, that makes sense, but it seems it depends on the bank hanging onto the assets it raised in the bond’s sale. That seems to be the underlying assumption.

    On your suggestion, I found these:

    The 1st of these articles defines:

    working capital = current assets – current liabilites

    The “current” values have a time frame associated with them (1 year or less). So again this definition puts a minus sign ahead of the liabilities rather than a plus sign (which makes sense to me, and what I’m used to) in defining “capital.” I guess I still don’t see how that article relates to replacing the minus sign with a plus sign in front of liabilities in defining any kind of capital. That’s what’s confusing me: how does the minus change to a plus?

    Joe, thanks so much for you patience in answering these questions!

  63. Funny.. On CNN they just had the presenter Richard Quest with rubber gloves on holding euros and dollars interviewing Hany Fam from Master Card talking about the literal dirtiness of cash (statistics on the bacteria counts on the bills).

    And the spokesman from Master Card saying that cash is only good for money laundering and drug dealers. I guess it is cash is bad and dirty day.. :-)

  64. Electronic payment system AND cash exist to facilitate bank deposit use. That is the point. Banks issued scrip before there was a Federal Reserve. It was paper cash created to facilitate the use of the deposits.

    As far as restrictions on cash, I am not familiar with the EU, but in the US the only reporting I am aware of is currency transaction reports for instruments over $10,000, which banks must report. It doesn’t stop you from buying a money order with 10,000 cash, and the bank notifies you it must be completed. The report is sent to FinCEN and it may be investigated if there is suspicion of money laundering, terrorist financing, illicit activity. And let’s be honest, this reporting is not the driver of less cash use. Cash use, like money creation is endogenous.

  65. clarification on the CTR, it’s any deposit, withdrawal, exchange or purchase of payment instrument over $10,000. Bank does not have to inform customer of reporting unless inquired by customer. The customer can decline the transaction at this point, but the bank must file a suspicious activity report if this occurs. Banks also have AML monitoring tools to determine if their customers are systematically trying to circumvent these reporting requirements, such as consistent deposits under the $10,000 threshold. These are means to combat money laundering, which is cash earned from an illicit activity and attempting to deposit it INTO the banking system. So why the black market uses cash, the black market shop keepers want to put their money in the bank.

  66. Joe, is it fair to say that putting the “+” in front of “certain liabilities” when defining “accouting sense” capital is really a shorthand? For example, say bank B has a clear BS and it sells $100 of bonds w/ maturity > 1 year, then with the wiki “working capital” definition and the following resultant BS:

    Assets: $100 reserves
    Liabilities: $100 bonds w/ maturity > 1 year
    Equity: $0

    Working capital = current assets – current liabilities = $100 – $0 = $100

    So in a sense, you can add this “certain kind of liability” in calculating “working capital” because:

    1) There’s an assumption here that the $100 in reserves (or other liquid assets) raised from the bond sale is still there

    2) The bill won’t come due on the principal of that liability in the near term.

    … but really, in the long hand calculation, we’re still putting a minus sign on it, only it’s maturity date removes it from the equation? Is that’s what’s going on?

  67. Thanks for the response. And indeed, this is what many Spanish depositors are doing. I am very curious to know what are the implications of a bank run in a country with a 3 to 4 trillion euro, highly leveraged banking sector.

    It seems very relevant to the idea of a mostly cashless monetary system and the perception of the importance of physical cash as mistrust in private banks grows. The old “too big too bail” seems to be coming back to bite us in the rear. And, of course, we are living in an interlinked global financial system, right?

    In this world, cash seems to be king,, at least compared to an electronic demand deposit.

    In a more general context, my doubt regarding the importance of cash over electronic money in severe deflationary times still remains unanswered, Cullen? :-) But I can insure the readers here that cash is very much gaining importance in Spain over electronic demand deposits.

  68. Well, it is nice to go medieval on the subject… To be precise, cash, although not fiat, existed before banks. Then banks appeared to facilitate cash use. And to preserve wealth, but this is forgotten, and of no use now. All the “receipts”, “banks”, “bank deposits”, “electronic payment systems” and such only exist to facilitate use of money.

  69. No, I was meaning not $10,000 rule, but the thing discussed some time ago, when it was proposed to make mandatory for the sellers to file some government form if a buyer pays more than $1600 in cash. I do not actually know what happened with that proposition, maybe it died quietly.

  70. Cash only exists so clients of banks can draw down accounts in bank money. It’s a convenience money. A facilitating money. You’re doing what most of the mainstream does by centering the money system around govt money. That’s not correct. Banks are the center of the system. Govt money like cash and reserve facilitate this system.

  71. Yes, in a crisis people will always turn to physical forms of money that they can touch, feel and hold in their hands. That’s prefectly natural. Money is base largely on trust and when trust is low people turn to things like gold and guns and cash. But a crisis doesn’t mean this is always true. It just means it’s true 1% of the time. I say anything can serve as “money”, but that certain things have higher levels of moneyness than other things. In our system bank deposits have the highest level of moneyness 99% of the time. But yes, there’s that 1% of the time where the scale shifts and eletronic forms of money could fall down the scale below commodity money or physical cash.

  72. Record keeping in a non-physical form has ALWAYS preceded physical money. Monkeys use money as promises, for instance. Do the evolutionary math….

  73. Joe, I just looked up “subordinated debt.” I guess that makes sense. Also looked up Tier 2:

    Again though, it seems to me, that rather than adding these items to calculate Tier 2 capital, don’t you just NOT subtract them?

    Example: Bank C starts w/ clean BS and then sells $100 bond which counts as “subordinated debt.” Resulting BS:

    Assets: $100 reserves

    Liabilities: $100 subordinated debt bond

    Equity: $0

    … and also:

    Tier 2 capital: $100 reserves – $0 bond (do not count since this is “subordinated”) = $100

    It seems clear that if the bank buys a $100 lottery ticket (when the regulators aren’t looking) and loses, then the new balance sheet looks like:

    Assets: $0

    Liabilities: $100 subordinated debt bond

    Equity: -$100 (or Negative Equity: $100)

    … and also:

    Tier 2 Capital: $0 – $0 = $0

    Is that correct or did I go wrong some where?

  74. Thanks for the response Cullen. So in these very rare 1% events, cash has a higher form of moneyness. Here are a few follow up questions:

    1) Don´t these rare 1% events leave the door open to contagion? Ie the banking situation in Cypress and the PIIGS and new EU policy can bring further deterioration in trust and spark even more dependence on physical forms of moneyness?

    2) Won´t cash also remain high on the level of moneyness in the case of a new crisis, brought by contagion from Europe.. Especially where so many tools have already been used to rebuild trust in the financial system around the globe? Each crisis seems to chip away trust in the private banking system.

    3) And finally, even taking Europe out of the equation, don´t deflationary pressures pose a risk to the inside monetary system? If credit expansion can not be sparked inside money will begin to collapse, right?

    In all three scenarios cash will gain in moneyness, right?


  75. I don’t think so. Why? Because almost all modern money systems are built around inside money (bank money). So the system of outside money MUST support this inside money system. Even in a worst case scenario the govt or the banks will protect the inside money system because it is the lifeblood of the payments system. That’s why you see capital controls and ATM limits in Cyprus. They’re protecting the infrstructure of the inside money system because they know the health of the system ultimately relies on this part of the system. Depositors might ASSUME that cash has a higher level of moneyness during a crisis, but the authorities will NEVER think that because they know they must defend the inside money system at ANY cost.

  76. Yes it looks like you have to accounting/finance concept of working capital. It’s a short term metric. Most liabilities due within a year are payables that result in operating expenses like payroll, supplies, etc. you also include any debt payments to be made in that period You subtract this amount from your current assets, which is mostly cash. Now if a company has issued long term debt, they receive cash, a current asset, in return for the promise to pay back down the road. So in essence the capital from the debt is included in the current asset portion of the equation. The difference is working capital, which helps an entity identify its short term liquidity needs.

  77. I understand your position, but I am not so confident that governments are able to “support” the inside money system. In concrete, at what point do real world events over run the inside monetary system and governments ability to protect it.

    The “flawed” currency user system in Europe is showing cracks in regards to the inside monetary system: the European inside monetary system is very leveraged and there is no political mandate for a banking union. In my opinion, a run is already in process in parts of europe. As the cracks emerge, it seems that the entire global system is exposed. This is not 2008, extreme measures have already been taken to protect the inside monetary system in the last 4 years. It seems like trust is at its limit and policy measures already maxed out.

    If the inside banking system is built on credit and it is incredibly leveraged, won´t governments choose to defend their bond markets and currencies over the inside banking system if it comes down to self preservation? A new payment system can be created in such an extreme case, can´t it?

    In Europe the question is much more pressing because we are all, as you have outlined, currency users. There is no “banking union” and the troika seems to be saying that “bail ins” are possible across all of Europe moving forward. This is just another crack in the inside monetary system, and is a complete game changer, right?

    If you have a system where every 20 inside dollars, euros, whatever is backed by 1 dollar, euros, etc in currency; trust seems to be the foundation of the entire system.

    A final question, if the authorities defend the inside monetary system at any cost. What could that cost be in the above scenarios?

  78. Joe, I think a light just went off for me. Just referring to regulatory capital here, in this article:

    it states:

    “Tier 2 is limited to 100% of Tier 1 capital”

    OK, that is key! So I think prior to the lottery ticket, Tier 1 = $0, thus Tier 2 must be $0. After the lottery ticket, Tier 2 is still $0 since Tier 1 is < $0.

    Perhaps a better example would be a bank BS like this:

    Assets: $150 reserves

    Liabilities: $100 subordinated debt

    Equity: $50 = $150 reserves – $100 subordinated debt

    Then I think the calculation would go like this:

    Tier 1 = owner's equity (in this case) = $50

    Tier 2 = $100 subordinated debt limited to 100% of Tier 1, thus $50

    Thus Tier 1 + Tier 2 = $50 + $50 = $100.

    Still floundering, or am I getting closer?

    Also, the wiki article here:

    Has an example which I think is wrong:

    "As an example, assume a bank with $2 of equity receives a client deposit of $10 and lends out all $10. Assuming that the loan, now a $10 asset on the bank's balance sheet, carries a risk weighting of 90%, the bank now holds risk-weighted assets of $9 ($10*90%). Using the original equity of $2, the bank's Tier 1 ratio is calculated to be $2/$9 or 22%."

    What I think is wrong about that is the following:

    Assets: $2 reserves
    Liabilities: $0
    Equity: $2

    After "client deposit":

    Assets: $12 reserves
    Liabilities: $10 deposit
    Equity: $2

    After it "lends out all $10"

    Assets: $12 reserves + $10 loan
    Liabilities: $20 of deposits
    Equity: $2

    Now perhaps they meant that the $10 was spent by the borrower and that the seller had an account at a different bank, in which case we'd have:

    Assets: $2 reserves, $10 loan
    Liabilities: $10 deposit
    Equity: $2

    Thus the Tier 1 ratio would be $2 / ($2*1 + $10*0.9) = $2 / $11 = 0.18 = 18%

  79. Well, it’s not really a matter of choice in my opinion. The monetary system is designed around inside money. So if you let the inside money system fail then you’re staring at a total economic catastrophe. The ECB and the Euro leaders know this so they will do everything in their power to keep it from failing just like the Fed threw the kitchen sink at the economy in 2008 in the USA. There is no option but to defend the system. The inside money system is too large and too integrated into economic life to let it fail. So I don’t think it’s realistic to assume that the system will fail because its creators know full well that it can’t be allowed to fail.

  80. Oh, please! Do they use reserve requirements or fractional reserve banking??? Everybody every time makes a “promise”, even if it lasts a second during which I pass my dollar bills already holding my latte. Oh, I could have run away with it – a default of sorts… or levy on reach Starbucks…

    So, if we have a promise imputed in every single transaction, let’s just drop it, or consider is as a sort of a vacuum in the market universe.

  81. Do we use reserve requirements or fractional reserve banking? No. Canada, for instance, has no reserve requirement and you should know by now that FRB is a myth that lives only in textbooks. Banks are no more constrained to make money than anyone else who can keep good on their promises. This idea that money is always a physical thing or a derivative of govt money needs to end. It’s not an accurate portrayal of what money actually is. Money, in our system, is almost entirely endogenous. A bank deposit is not a claim on govt money. It is a claim on a certain amount of goods and services. I could care less about being able to “claim” govt money. I don’t use bank deposits so I can “claim” govt money. I use bank deposits so I can claim goods and services. That’s it.

  82. Well, yes and no. Both government and banks are only parts of what is the market or society. Money is a creature of the market. It is so happened that money creation/regulation is delegated to the government. Then, in turn, government delegated it to the banks to some extend. Honestly, I cannot separate the conglomerate of government-Fed-banks, so I prefer to consider it as one entity when thinking about money creation/regulation. And its happened only very short time ago by historic means, and there is no guarantee it will continue into the future.

    I think we already discussed what comes first – gold, fiat, or electronic fiat. It is something close to hen/egg problem, but, as you very truly mentioned in the previous piece, “promise” or trust is the key to its existence. When I said that gold is base, fiat is derivative, and current electronic fiat is derivative of derivative, I just meant that with each iteration the ways to break “promise” are getting easier and easier.

    A fully electronic fiat system would be a quantum leap in the direction of full financial repression and control, and would allow to break “promise” in infinite ways and very easily.

  83. I personally don’t see the big “leap”. A gold rock only has value because people BELIEVE it has value. A piece of paper only has value because its users BELIEVE it has value. An elecontric bank deposit only has value because its users BELIEVE it has value. These things can all serve as a medium of exchange and all have a belief input in them. For instance, if an alien came to Earth and saw our system and wanted to buy a cow from one of us what do you think he’d use to buy that cow? Well, he’d use whatever the cow salesman accepts for payment. The alien doesn’t care whether he uses a rock, a piece of paper or a bank deposit because they’re all equally stupid and useless to him. He just wants to buy a cow with whatever the cow salesman will accept so he’ll work to obtain that which the cow salesman accepts. That’s our money system in a nutshell. We work to obtain that which most people accept for payment in exchange of goods and services. This isn’t cash or bank reserves for most of us. It’s bank deposits.

  84. Re: separating out the Fed vs the government. Think of it this way: if the Fed were a desk in Treasury, Obama calls up Jack Lew and tells him “Tell your Fed boys to create another $1T in reserves and buy bonds with them! … congress isn’t being co-operative!” … that’s obviously NOT the way it works!

  85. Yeah, “guys, someone get out there and swap out checking accounts for savings accounts faster! Maybe if we relabel them and convince the market’s participants that we’re doing something real they’ll believe we’re printing money and keep this economy humming!”

  86. But that exactly what I am talking about! Something, being it gold or digits in the computer, has any “promise” in them for as long as market actors believe in it. Can people believe in static electricity in the computers? Yes, of cause. And, as you absolutely correctly mentioned, the digits are as good as anything for as long as they are exchangeable for goods and services.

    The little problem is, there is only so much goods and services available. And how many (or much?) static electric charges are available in the computers? And who is producing them? At least, with gold, I know quite well that only given amount is produced per year… So, it is obvious that it extremely easy to increase amount (or number?) of static electric charges in the computers by any multitude. It is also extremely easy to take away my (or yours) small amount of those charges stored somewhere. A levy? Or computer crash? Choose yourself. Again, having some dollar banknotes, I, at least, can hide them in my basement. It can be “levied”, yet it would be somewhat more difficult comparing to static charges….

    And getting back to the trust issue. Let’s review history. How many times people lost trust in gold? How many times people lost trust in paper fiat? How many times people lost trust in the resent paper/electronic fiat combination? Again, it’s base, derivative, and derivative of derivative.

  87. You’re worried about the universe running out of energy? Not so sure about that point, KB.

    Historically, the USA has lost total faith in commodity money as the primary form of money. That’s why it’s no longer the dominant medium of exchange. Commodity money systems are neturally restrictive and cause imbalances in the same way that the Euro system does. People reject these systems because they fail us and lead to depressions. Fiat money, as far as I cant tell, is what dominates today. Will people one day reject it entirely? Maybe, but for now fiat is beating the pants off commodity money which has gone nearly extinct in modern money systems. There are ZERO commodity based systems today which means ALL of them have failed in some way.

  88. Sorry, but if something is set up by the government and appointed by the government, it is government. It is just “the world as it is”. The government agencies can play any “independence” games they want, especially when the need to maintain “trust”, but in the time of need all the games will be broken. Again this is “world we DO live in”. It is not my judgment, it is the way any government works.

    Trust have been broken several times already in much more “capitalistic” US. Somebody would say it was for good, somebody would call it “confiscation”. Again, I am just stating the facts. Will it happen again? You bet it will! And the electronic system would be of great help for the next round of “absolutely necessary drastic measures to save our society from…”.

  89. he he. The world will not run out of energy. But the computer containing your own static charges may )

    I never said “commodity” money systems. I used gold as an example. Gold is not commodity. It has no use – Buffet said so! Of cause all gold-based money systems died. An easy explanation – Gresham’s law, you probably heard about it. But note, all who kept those extinct gold money, preserved their wealth quite successfully.

    No money system is bad enough to lead any nation to depression. Fraud, theft, and misuse of the system by related powers – usually government/banks, were always the cause.

    Yet my point, as a practitioner who wants to preserve wealth, is not to criticize that, but to preserve wealth. And, as I showed you on concrete examples, with gold as money it is easier than with fiat or electronic fiat. Do you disagree?

  90. Funny how that works…MasterCard talking about bacteria laden cash, all the while rolling out their mobile payments system MasterPass

  91. The poor here in south america need cash to live. banks do not lend them credit or credit cards. millions of people rely on selling black market for cash and avoid taxes. there are 1000’s of towns with out basic services like electricity or phone service. they have to have cash to exist.

  92. I think a cashless society is critical. We have to stop tax evading scofflaws like cab drivers and waiters.

  93. The risk weighting of the reserves would be zero because there is no risk attached to this asset so the tier 1 ratio would be $2/$9. The riskier the asset the higher the rating and the larger the denominator which means you would need a higher numerator (regulatory capital) to meet requirements

  94. Joe, of course! you’re absolutely right. I don’t know why I weighted that by 1. Now how about my attempts to fold “subordinated debt” into the Tier 2 calculation above? Where did I go wrong in either of those two comments (above)?

  95. I think Cullen has this argument pretty much nailed. Electronic transactions represent a real gain in productivity and we aren’t going back. As we have seen in recent times, the trust factor becomes critical, but I expect this will improve slowly as we have more crisis that we muddle through and learn from. Each crisis provides valuable data on how to adapt to what really is a pretty rapid change in the human concept of “money”.

  96. Joe, to summarize what I think I’ve learned here in this discussion with you, I created the following blog post:

    If you get a chance, please give it a glance and see if that makes sense. I think I found the right way to think about the basic problem I was having with *adding* liabilities in calculating capitals (either regulatory or accounting). I resolved the problem by thinking of it in terms of adding liabilities to equity (as you stated), and thus what we’re really doing is just NOT subtracting certain liabilities since they were already subtracted in forming the equity term. Does that make sense?

    In the “regulatory” case, Tier 1 is my stand-in for equity here, and thus Tier 2 can have a positive liability component since those liabilities were already subtracted in calculating Tier 1. You don’t normally consider Tier 2 on it’s own, right? It’s always summed with Tier 1. That’s what was confusing me: What kind of “capital” is composed of just liabilities?? But if it’s summed with Tier 1, that makes sense in terms of an expanded definition of capital: Tier 1 + Tier 2

    I sure hope all that is right, because looking at it that way really seems a lot clearer to me!