On July 29 we published a long piece entitled “Cash, NIRP & Bonds.”
Now we see a German bank succumbing to pressure and starting to charge its customers a pass-through of the negative interest rate that the commercial bank is paying to the central bank. In the eurozone, the lowest negative rate is minus 40 basis points. Under this scheme, a million-euro deposit now pays 4000 euros a year to store cash in the bank. Some economic tests can be applied to estimate what the charge will do by way of changing behaviors. A depositor with 10,000 euros in the bank could be charged only 4 euros a year, and many banks would not charge smaller and retail customers. The typical cutoff is at 100,000 euros. Thus our guess is that smaller depositors will not change their behavior by very much.
On the other end of the spectrum, we are seeing very large institutions developing cash-storage and cash-hoarding systems. An institution with cash reserves of 100 million euros might well spend less than 400,000 euros a year for a storage facility and thus be better off with cash than with a bank deposit. Readers may wish to develop their own estimates of behaviors and the break points that will trigger changes in those behaviors.
By looking at the physical cash (currency) in circulation in the various currencies where there is some type of negative-rate structure, we can watch the aggregate actions of all agents affected by negative rates. In all 6 currencies and in all 24 countries involved, we see increases in physical cash in circulation. Nowhere is cash shrinking. In addition, we can examine other currencies where the central bank rate is positive but the acceptance of the currency is widespread and reaches beyond the border of the country. America and the US dollar is the global leader in that category. We see US physical cash in circulation rising at about a 7% annual rate, and the rate seems to be accelerating. Various estimates place as much as two-thirds of that US dollar denominated cash outside of the United States.
One would expect cash used for transactional purposes to rise in aggregate in a way that resembles the growth rate of nominal GDP. That is the traditional test. Furthermore, the proliferation of electronic payment systems would suggest that the use of physical cash should be diminishing. (One can easily observe this trend by standing in any Starbucks (NASDAQ:SBUX) line and noting how many customers use an electronic payment instead of cash.) So if electronic payments are growing but actual physical cash use is also growing, something else is going on.
Some say it is the underground economy or illegal uses of cash that have caused the demand for physical cash to rise. There is some truth in that, as anyone can discern based on anecdotal evidence. But those uses of cash have been around for a long time and estimates of their use are relatively stable. An exception may be the rising use of cash for the marijuana business as federal law inhibits traditional banking for that use. In Colorado, there is a lot of cash in circulation for this reason.
We think there is a second reason for rising worldwide physical cash demand, and that is negative-rate regimes. Negative rates change behavior. They are counterintuitive. They are using a form of central bank policy that penalizes economic players in order to try to achieve lending, borrowing, investing, and economic growth. But negative rates are damaging financial institutions that are dependent on a positive interest rate for their operations. And the world is now realizing the dangers that accompany negative rates.
As cash use rises, the monetary creation of additional money in electronic form morphs into physical cash. Electronic money ends up in a repo or as an excess reserve deposit at the central bank. Cash is held outside the system of banking. Thus rising cash in circulation impacts the money policy maker two ways. It reduces the reserves that are in the banking system and that itself may be a reduction of ways to be stimulative. And Cash is neutral or sterile. It is a permanent liability of the central bank or government and it has no credit multiplier in the traditional sense.
Thus rising use of cash in circulation is a tightening of monetary policy by definition. In the US it has been underway since the Fed stopped QE. In other jurisdictions rising cash use is dampening the central bank’s attempt to be stimulative. In our view, a static balance sheet size at a central bank like our Fed is an automated tightening structure, all else being equal. For policy makers this is something to think about. For investors, it means that the Fed may be tighter than many believe.