Where Does “Cash” Come From?

There’s this obsession with physical money in life.  I don’t know where it comes from or why it persists, but it does.  I guess maybe it’s the sense of security of being able to feel something and hold it in your hands.  To many people a gold bar is pure money because you can pick it up, you can feel its density, and you can see how pretty it is.  Paper notes or cash are not quite as sexy.  But they’re still pretty cool.  Even a small child knows that a cash note is cool.  Give your kid a $1 bill and their eyes light up.  Give an Austrian economist a $1 bill and he’ll flick you off (and then he’ll go buy something without admitting that he loves using paper money).  You get the point.  Money is ultimately based on trust and being able to feel something tangible gives people a sense of security, I guess.

Anyhow, I don’t fully understand the obsession with money as a physical thing because money in a modern economy is almost never a physical thing.  It’s just a number in ledgers.  Technology and the evolution of banking is rendering physical money slowly, but surely extinct.  For instance, I bank online and I have for almost a decade.  I’ve never been inside my bank.  I don’t even know where it is.  I don’t deposit money in it.  I mean, I know there’s a physical address somewhere, but that doesn’t matter much to me.  All I know is that there are numbers in a computer system attached to my name and when I want to purchase goods and services I tell my bank to shift numbers from one account to someone else’s account.  On rare occasion I go to another bank’s ATM and withdraw physical cash.  After all, there are times in life when  a stack of 100 $1 bills are necessary….

But where does this cash come from?  And how does it relate to the money supply?  Our monetary system is designed around what Monetary Realism calls “inside money” (because it comes from inside the private sector).  That is, the most common form of money for every day transactional purposes exists in the form of bank deposits as numbers in a computer.  If you have an account at a bank you can withdraw cash for convenience purposes.  Cash is what MR refers to as a form of “outside money”.  That is, it comes from outside the private sector.    Wait, how does that work?

I’ll let the NY Fed explain this part of the process:

“Each of the 12 Federal Reserve Banks keeps an inventory of cash on hand to meet the needs of the depository institutions in its District. Extended custodial inventory sites in several continents promote the use of U.S. currency internationally, improve the collection of information on currency flows, and help local banks meet the public’s demand for U.S. currency. Additions to that supply come directly from the two divisions of the Treasury Department that produce the cash: the Bureau of Engraving and Printing, which prints currency, and the United States Mint, which makes coins. Most of the inventory consists of deposits by banks that had more cash than they needed to serve their customers and deposited the excess at the Fed to help meet their reserve requirements.

When a Federal Reserve Bank receives a cash deposit from a bank, it checks the individual notes to determine whether they are fit for future circulation. About one-third of the notes that the Fed receives are not fit, and the Fed destroys them. As shown in the table below, the life of a note varies according to its denomination. For example, a $1 bill, which gets the greatest use, remains in circulation an average of 21 months; a $100 bill lasts about 7.4 years.”

So you can see where the cash came from.  Cash is sold by the US Treasury to the Fed at cost and then distributed to the banking system.  It came from “outside” the private sector and exists to facilitate the use of inside money by allowing bank customers to draw upon their accounts.  In recent decades, the amount of currency or cash in circulation has actually increased in large part due to the convenience of the ATM.  But make no mistake.  Cash does not rule the monetary roost.  Cash is merely a convenient form of money for purchasing goods and services that facilitates the existence of inside money.

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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Comments

  1. Would you give me your house (let’s assume you own one) if I wrote “1 million dollars” on a piece of toilet paper?
    Would you give me your house if I handed you 20 kilograms of gold?
    That’s the difference between fiat and non-fiat.
    You only understand the difference between physical and digital money if you saw all the dozens of people with hand-made signs along the FDR drive hoping for a ride north during the big power outage in 2003 in NYC. No cash – no ride. Digital money didn’t work. Access to digital money can be interdicted by things outside of your power (computer virus, hacking, government shutting down internet etc). The dollar in your hand is safe from such threats.

    • Your “Brownback” toilet paper note isn’t legal tender, so I don’t really know what you wanted to express with your first statement.

  2. The obsession with physical money is really just a way to protect against broken promises. Whether the promises are from a bank, a company or a government, promises can be broken — particularly during times of (financial) stress. Even real estate deed is nothing more than a promise from a local/state/national government to recognize your claim to land.

    Granted governments that owe their debts in their own currency are rarely ever under financial stress, but one can still use the market value of physical money (i.e. gold) to reduce overall volatility in a portfolio. And if the unthinkable ever happens (civil unrest, natural disasters, falling governments, whatever) certain types of physical money/assets will still have value when all other paper promises are broken.

    • Again, this is not to say that any of those things would ever happen. All I’m saying is that physical money (i.e. the gold market, for example) is one way that people can quantify the risk of broken promises within a portfolio — in order to reduce overall volatility.

  3. The Grey and Black Market’s need Cash and since they are intrinsically important to our economy by providing 1000′s of jobs and account for several Trillion in economic activity and generate a tax gap of near half trillion so I think Cash is pretty vital and don’t see it disapearing anytime soon.

    • Hey Cowpoke, that’s a very good point about the Black Market creating a deficit. Given that we need a bigger deficit at this time, the Black Market’s a great thing :)

      • One of cash’s great benefits is privacy. You can spend money at the strip club without your wife seeing it on a credit card. You can pay cash for services and you both avoid taxes and regulations.
        Some of those are good things, some of them are probably bad. All of them are related to our desire for privacy and freedom.
        Without cash, it is very easy to see that the government/corporations would know everything about us, which would be alarming to many people.
        If you think people get uptight about taking away their guns or their booze, just see what happens if you take away cash.
        I would imagine they would come up with a substitute very quickly.

        • Yep, Just think about how controlled your life would be with out Cash. Govt and Insurance companies would know exactly how much beer cigerettes and cheeseburgers you consume and fine you according to thier standards. Not Good.
          You make a donation to an organization, it’s tracked. How do you give digital alms to the poor street bum?

        • I think in Sweden there was an actual discussion about getting rid of cash altogether, it seems people over there pay most everything with a credit/debit card. The arguments there mostly centered around robberies of cash…

          http://www.bbc.co.uk/news/world-europe-10538032

          Looking at some recent cases here, the prospect of getting my “digital” money stolen is far more frightening. Criminals are now developing trojan horses to infect smartphones and computers to get around the 2 factor authorization banks over here use (you get a text message with an authorization code when you use online banking). Others manipulate or just switch out the terminals where credit/debit cards are swiped. What’s worse about this is that they can not only steal all you have, they can even draw on lines of credit…

          I always keep some cash around, I don’t trust my bank completely and I don’t trust my government.

  4. Something that a lot of people point out about the relation between inside and outside money is that all inside money is an implicit promise to deliver cash if demanded, and that this is what makes credit money valuable in terms of state money. While it is true that most of the “money” in the economy is “just” numbers on books, the fact that it is convertible into cash on demand is crucial to the operation of the system.

    While it is true that this concept of money as a “thing,” i.e., a note or a coin, is “primitive” and unnecessary to the operation of an economic-financial system, and many of us think that it will be replaced, it is still a cultural fetish, similar to the gold fetish. Most of us have gotten past the gold fetish, but the cash fetish is still alive and well and central to the operation of the current system.

    I think that this will change as we get deeper into the digital age and people get more comfortable with digital money. That will probably take a lot of the older folks dying off though.

    • Well, we obviously disagree that inside money obtains its value due to the ability to convert it into cash. Inside money has value for many reasons. Part of which is the fact that there is a powerful state that protects its use. But the primary reason inside money has value is because it is connected to private output. In the broader scheme of things, the govt has outsourced the creation of its unit of account to a private oligopoly. We don’t exist in a fully state system. We exist in a system by inside money and for inside money. The govt just supports this system.

      But I do agree on one thing for certain. Cash will eventually cease to exist which will further reduce the rationale behind the idea of “convertibility”.

      • Not sure if I see the necessity of differentiating between inside or outside money, both basically the same thing. The more relevant differentation is between vertical and horizontal.

        • No, that’s the MMT framework which states that horizontal money is just “leveraged” vertical money. That’s not correct. You must differentiate between the two in a granular manner. This idea of “leveraging” is inapplicable to the actual way the system is designed. You might want to read more on MR. I think the MMT language is too confusing here and misleads people into understanding the balance of money.

          • Leverage really has nothing to do with horizontal money except for the fact banks use leverage when making a loan. The main point with horizontal money is that it is a zero sum game, in that loans create deposits. Money is created by making the loan but someone has to take on debt in order for that to happen.

            • That’s a misleading point in many regards. First, a bank doesn’t dissave in the same way you or I might when we make a loan. A bank makes a loan out of thin air. Yes, it doesn’t involve net financial assets, but that doesn’t mean much. The truth is that the net worth of the household sector (the sector that matters) can increase regardless of the issuance of net financial assets from the public sector. In fact, the private balance as MMT presents it was negative from 1995- 2008 and yet household net worth doubled! That’s because the HH sector primarily accumulates claims against corporations in the form of debt and equity. This is why MR uses a 4 or 5 sector view of the economy as opposed to the often used MMT 2 or 3 sector versions. This was the root of the S=I+(S-I) debates that MMTers never came close to understanding.

              To claim that horizontal money is less important than vertical money is 100% wrong because it is the use of the horizontal that allows us to accumulate claims within the private sector and generate output and increases in the net worth of the household sector. Just look at the stock of financial assets (50T private vs 15T public) and it becomes clear how misguided the MMT presentation of the sectoral balances is. (S-I) = (G-T) is a point that is so narrow that it tells us practically NOTHING about our actual economy. But MMT presents this in such a way that it comes up with outrageous claims like “without a public sector deficit there can be no private sector savings”. Yes, a leading MMT economist really did say that!

              • This is such an important point. I wish everyone would try to better understand it. I find it so odd how only a few people seemed to fully grasp the importance of the S=I debates.

              • Where else do private savings come from without public sector deficits? If you were to start a new sovereign The United Republic of Roche, there is only one way to get net financial assets to your citizens to pay taxes…buying goods and services from them. There is no other way. Bank lending is an important channel for money creation but is secondary to deficit spending and is limited debt coverage ratios for borrowers and capital strength ratios for lenders.

                • “Where else do private savings come from without public sector deficits?”

                  As I explained before, they come primarily from claims on corporations. The govt does not need to spend for this to occur. As I mentioned previously, the private sector balance was NEGATIVE from 1995-2008. And household net worth DOUBLED and GDP increased 75%. According to MMT this shouldn’t be possible. But it is possible because you can’t view private savings in the narrow scope of NFA. NFA is just a slice of the savings pie. The majority of private saving occurs due to transactions within the banking system within the private sector. Again, it’s a 50:15 ratio. The numbers here don’t lie. MMT gets it wrong. You might want to revisit your understanding of all this because you don’t have it correct.

                  Not to mention, you should stop defining net saving as MMT does. They use the wrong definition. The correct definition is income less consumption. MMT uses income less spending which is why they net out Investment and focus on (S-I). That’s wrong. It’s too broad. Feel free to ask questions if you want the help….I am to help.

                    • Nevermind, you mentioned above the household sector as owning the claims, i.e. socks and bonds. I am not an MMT proponent, have read some of their stuff however. Thinking through your comments.

                  • First off private sector balances were not negative the entire period between 1995 and 2008. Secondly, you can run negative private sector flows for many years and have HH wealth rise significantly if cumulative deficits from prior years was enough to create the “equity”, sort of speak, to drive private sector borrowing (along with a banking sector eager to lend) to drive asset prices (think homes and stocks) higher.

                    • private sector was roughly flat to slightly positive from q12002 to q1 2004…thanks for pointing that out graphically.

                    • I still disagree. That implies that the pvt sector’s equity base is primarily composed of public sector NFA. Or that it’s NFA that makes pvt borrowing possible. I don’t think that’s correct. The public supplied balance can stabilize the system, but it isn’t the glue that binds. The backbone of private sector equity is private investment. Again, see the 50:15 ratio.

                    • “I just explained how stock is an asset of the owner and a liability of the corporation.”

                      Assets=liabilities, how then is equity created?

                    • The right question is how do households obtain equity. Treating saving as S-I effectively agrees with Mitt Romneys statement and misses the whole point. Your two sector analysis obscures reality.

                    • I don’t think we are as far apart on this subject as it seems by our posts. I don’t necessarily buy into the view that savings = (S-I) and would more likely fall into the S=I+(S-I) camp. My feeling is that I is tethered to NFA to some degree depending on private sector savings desires and banks wilingness/ability to lend.

                    • Probably not. But the way MMT presents the SFB can be misleading. For instance, Wray has stated in papers that without a govt deficit there is no private saving. That statement is so misleading it’s almost amazing he had the guts to write it. Banks don’t dissave to extend loans and corporate liabilities make up huge chunk of households savings. To present the SFB as MMT does where private net saving is the opposite of govt spending presents a very narrow view of the actual private sector.

                      The problem is not so much that the private sector can’t save without govt deficits, but simply that capitalism is an inherently unstable system because it is driven by profit maximization and risk taking. There’s nothing wrong with those things, but we shouldn’t go about life assuming that these things are somehow inherently stable. Govt provides a huge amount of stability to this reality (though it can also exacerbate instability if used incorrectly). Anyhow, to me, it’s not about making definitive statements like “government is bad” or even “government is good”. It’s about understanding the balance between the private and public roles and how each can contribute to an increase in living standards.

                • it’s helpful for me to see this MMT debate since I used the “United Republic of Roche” type argument many times…. I still don’t fully understand MR or the differences btwn MMT and MR, but I can now see what’s wrong with this particular “logic”. The problem is you’re describing the origins of a system that might some day look like the U.S. system now, but it isn’t the U.S. system – so the argument fails immediately. If Cullen were to replicate the US in a new Republic he’d start with a strong private banking system issuing currency via loans.

                  The other problem with the MMT argument is that you can re-lever a paid off asset. So sure, all loans, if paid back would sum to zero, but imagine a home loan paid back and now owned free and clear. First you have “wealth” in the home that is owned free and clear thanks to zero gov money. Then later, the owner sells it and someone takes out a new 30 year loan that won’t sum-out until then. Still no gov money, and now 30 years of new money in the system. Private loans drive innovation and advancement and create wealth, and allow for ever larger amounts of private debt and “inside money”.

                  That’s my laymen’s understanding anyway.

              • My personal NFA position consists of the $50 bucks I’ve got in my wallet. But my net worth is slightly larger according to my brokerage account. If I wanted to increase my NFAs, I could sell some stocks for cash. But why would I do that? I’m bullish.

                I guess the moral of the story is that NFA does not equal Net Worth.

    • Don’t you guys think that ” De jure dollarization” or Dollarization and the use of the US green back in other nations economies due to the lack of trust in local one’s helps to keep the Cash avalable for a very distant future?
      I have read that there is between 25 and 35% of US cash held outside our borders. I think that type of Cash demand is important for velocity sake.

  5. This is a very good and important post. You’ve come full circle destroying the myth that money is a physical thing. Money in MR is truly endogenous and the banks rule the roost as you say.

  6. Cash is the new sex. We’re obviously not getting enough because it’s all we read and talk about!

  7. Money, schmoney… It is such a pleasure to read these Cullen’s posts. I remember how he fought for some MMT nonsence a couple of years ago, always claiming that it is not a theory, but “the true description of how “modern” money work”…. Now he says the same regarding MR. And I need to admit MR sounds somewhat better than MMT, so we see clear progress of the description becoming more and more true. Which is good, and it gives hope that some time in the future MR people, or somebody else, will indeed come up with reasonable money theory.

    Now, back to “money” question. I hope, everybody would agree, that any value of any “money” only exist in our minds. There is no “inside” money and “outside” money, as there is nothing outside “private sector”. Any government is a derivative of private sector. Or we just should use more acceptable term – market. A government is a derivative of the market. Money is a derivative of the market. Any money which have been “guaranteed” by “mighty government/state” died when that government/state died. With one exception – gold. But value of gold is also, and obviously, a construct of our minds.

    It is just so happens that it is somehow more stable menthal construct comparing to any other types of “money” so far. So, we can use gold as a basic level of “money” – a mental construct used by market to facilitate transactions and/or safe wealth.

    In this case, any fiat would be a derivative of basic “money” – a promise of a promise of a value of some sorts. And, quite obviously, any deposit, be it a cash deposit or gold deposit, is not a cash or gold, but a promise of a bank to give you cash/gold either on demand or after some time. Thus, so called “digital money” is in fact a promise of a promise of a promise of a value of some sorts…. A third derivative of a mental constuct defining some value! A sand castle built in the middle of digital nothing. And still it exists and functions quite well, at least up to now. And why? Because market – the people believe in it!!!

    So the real question is which belief is more broad and stable – in first, second, or third derivative of a mental construct defining value of real goods, services and wealth between us, people? An example provided by Alex Gloy gives good empirical evidence… And on the question “what rules?”. Well, as of now, the third derivative rules. But give us slight distress – power shortage, and the second derivative becomes the ruler. Some more stress, and the first derivative would be the king. And, god forbid, if a collapse happens, all mind constructs might cease ot exist, and we would have to revert to direct barter – bullets versus cans of tuna )))).

    • I think the evolution of MR from MMT is great progress. I was there criticizing this website when the MMT stuff was being discussed. It just didn’t add up. I don’t have many complaints with MR though. It appears about as close to an accurate description as I can find out there.

      • MR wouldn’t exist without Brett, JKH, Carlos and Mike. Those guys are the real brain power behind the whole concept. I am just a guy with a megaphone.

        • Past theories are always used for the new ones, either as a source of ideas, or as a rejection basis. Cullen, you are doing a great job, working on this stuff!!

          • I just can’t let this naive thinking go by the wayside; Sorry Cullen.

            “There’s this obsession with physical money in life. I don’t know where it comes from or why it persists, but it does. I guess maybe it’s the sense of security of being able to feel something and hold it in your hands.”

            Uncle Joe and aunt EMM own a coin operated Car wash in a small suburban California town. They make enough money to support themselves and are able to feed and cloth their 2 grand children who live with them because their parents died in a car wreck and had no life insurance.

            Sadly though, the Govt is mandating that ALL car-washes implement new reporting standards of currency usage and any such businesses that do not implement the new credit card system (THAT COST TWENTY THOUSAND TO INSTALL) must CLOSE SHOP!!!
            Sadly uncle Joe and aunt Emm have to close up shop and they can no longer afford to take care of their grand children who are then awarded to the STATE..

            Cullen, with all due respect mon frere, re-read 1984.

              • Uhh, Cullen, My MR Mentor, I think you misunderstand, I am not here to prove a point that Govts and you want all transactions to be electronic. I am here (in this thread) to point out the foolish errands of your consistent support of turning over your entire financial life’s blood to the Osiris of the US Govt.

                It’s pretty silly and quite frankly SCARY to think that all of mankind should simply turn over every transaction he does to the guidance and watchful eye of a govt.

                Your mere simple nod in acquiescence of this with out any apprehension gives me pause to accept anything you propose.

                My Goodness, My Good man, Even our fore fathers 200+ years ago saw the need to protect people privacy and you seem to so naively just say OH well people who want to have a bit of secret fiscal control of their own behind DER Furer urr.. I mean GOVT’s back are “Obsessed” with protecting themselves?

                Man Think about it. hell YES I am “Obsessed” With protecting myself and family from Govt intervention.

                Cullen my good man, Do you just go to your tax accountant and say “Why do I Need You, You are A relic, I just Pay what I am Told”????
                I Think Not… Cullen, You are Smarter than this, think a bit deeper. Otherwise I think you post these sort of thing to either yank folks chains (which I really don’t think is your intentions).

                • Cowpoke,

                  I think you misunderstand MR though (tell me if I am wrong!). The US govt does not control the money supply. The US govt has outsourced the money supply to the private banking system. Now, that doesn’t mean there aren’t problems there, but would you rather have the US govt control the money supply or would you rather have the US govt control the money supply? The US govt essentially deems the unit of account and determines the rule of law mandating its use. But the actual supply is privatized. In my opinion, it’s a pretty market friendly design.

                  • Cullen my good man, seriously You Jest??:
                    Currency transaction report:
                    http://en.wikipedia.org/wiki/Currency_transaction_report

                    Bank Secrecy Act:
                    http://en.wikipedia.org/wiki/Bank_Secrecy_Act

                    The govt is ALWAYS monitoring the “money supply”. Heck this is a whole another website concept on money. The simple policing of it.

                    Cullen did you ever serve in the military? Did you serve or know someone who did serve in a forward opps setting?

                    Think about the young soldier Army or Marine who rides into town to liberate the town. Ask yourself, are the people of this blown out town better served with an Apple I-phone that is fancy and smart OR a $20.00 Andrew Jackson cash bill? I think Andy will better serve their purpose for now.
                    Just a thought.

                    • Oh, but that’s how all these theories spawn. Marx and his followers postulated in their research that it is not just a theory, it is “true”, “unbiased”, “unpolitical” description of how the system “really works”. When I see such wording, I immediately recognize old good socialist mumbo-jumbo. In this particluar case, I think the MR camaraderie is not socialist/statist at heart, unlike their MMT buddies.
                      MR people just are not familiar enough with methodology of science, and need to look up the difference between theory, postulate, description, and other such concepts…
                      However, I think that on some deep cognitive level they do not grasp the elements of statism (or even outright faschism), which they incorporate in their musings. The currency example is quite clear. They try to present a hard money concept as inferior to electronic money. This discussion is stemming from gold/fiat relationship. Here they either do not understant or choose to ignore (jest on) control and accessibility limitations.
                      To them power outrages never happen. They choose to ignore that in statist environment it does not matter who controls your transactions – the government or visa cartel. In the end they probably see no harm (or even some benefit) in the little things the government does – like banishing oversize soft drinks in NYC.
                      The whole foundation of their theory regarding market(economy)/government relationship is based on a small period of existance of one state – the US. It is like saying that some hipsters who bought and are using iphones became homo novus, and all previous anthropology empirical findings are irrelevant. Oh, happy new world!
                      Of cause, I may be mistaken. There is a lot of interesting in their theory, and it keeps evolving. So, I continue to watch it and read the excellent and entertaining comments. It is much better than Marx’s stuff to me!!!

  8. Cash Is King: Printing of $100 Bills Soars

    http://finance.yahoo.com/blogs/breakout/cash-king-printing-100-bills-soars-132438479.html

    “Cash really is king if you want to preserve wealth in an increasing tax environment,” Colas says, noting that while gold is a viable strategy for saving some money, “nothing beats a $100 bill if you have to buy some food.”

    But alas, there is a silver lining to be found within all of this dollar debasement that at least one Wall Street veteran points to. “It proves beyond a doubt that the dollar is still the reserve currency of choice around the world,” Colas concludes. “It may not [always] be from the most savory part of the economy, but it does signal that there’s still a lot of faith in the dollar.”

  9. MR is as good a description of the monetary system in th eUS as one can get.

    My disagreements are with:
    - Their apologist attitude towards the state / private fascistic relationship; you know socialism is not so bad by design, but it failed in the USSR and Eastern Europe due to it perverting itself in totalitarianism and corrupted buraeucracy. And this is why the corrupt organization around the western monetary system is leading the world to repeating the same mistake, even if the starting point in terms of wealth is much higher. The least result is a further growth of wealth disparity and masses of poor people in the “developed” world
    - Ignoring the history of how the current inside money came to be – it is a legalized fraud, protected by govt. If of something based on the wrong principles can become something is doubtful for me

    • Wrong measure. Use cash versus M2. As you can see, the % of cash surged in the 90′s due to ATM machines and has since flatlined or declined.

  10. Can you explain how this works in regards to bank reserves? One common refute I see about banks not being able to lend reserves, is people bring up cash. So is cash considered a reserve to a bank? And if so, when they give you cash, are those reserves deducted from the banking system and now considered currency held by the public?

    If there is any reading material on the accounting behind cash in regards to bank reserves, that would be awesome. Thanks