The Future of Money is Digital, not Physical

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

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

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

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

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