How much will you pay to hold cash?

It’s a serious question. I’m not joking.

You may have seen your bank deposits earn anywhere between 0-1% interest. That’s nothing compared to the 4-5% we enjoyed before 2008.

Governments have adopted this zero-interest-rate policy (ZIRP) to boost growth. The idea is to punish savers for holding their savings in cash and make them pay down debt, invest in risky assets and create businesses. These actions help the economy.

Obviously ZIRP has pushed all risky asset prices higher. House prices, stocks, gold, you name it. These assets usually go up anyway, thanks to inflation. But if money is almost free, then they go up even higher.

Now I’m far from an economics expert but I read a lot. And lately, a what would otherwise be a far-fetched clickbait title has become an upcoming reality in my view.

You will pay money to hold cash.

One thing governments do to try to create growth is money printing. You may have heard the official economic buzzword quantitative easing.

But another way, perhaps stronger way to boost economic growth is to lower interest rates. The theory is this: Loans are cheaper, businesses can borrow at more competitive rates to start projects and create jobs. People then have money to spend which boosts business profits and so on. Also, mortgages get cheaper! 😉 Dalio has a nice video on how the economic machine works.

The US government reduced interest rates by 5% during the 2008 crisis. But we’ve been running a zero-interest-rate policy for 10 years or so now. If rates are already near 0, what happens when you cannot lower rates any longer? This useful tool is now useless. And taxes can only increase so much before the ruling party becomes massively unpopular.

Some countries have gone to the extreme and have dropped rates to below zero. Switzerland, Germany, Japan, Sweden and more. And their bonds are trading in negative territory. So you lend money to the government and you get back less than you invested.

Obviously some people prefer to keep their money in cash. Cash earns nothing, so nothing is better than minus!

Now I’m not sure why we couldn’t have increased rates before shit hits the fan. It may be that growth was anyway weak so increasing rates would cause a recession. But we are where we are.

What do I care? These non-sense bonds are not affecting my wallet

Here’s why you should care. Have you noticed that banks now pay almost nothing to you as a saver? Me too.

As I’m writing this article in mid-2020, the highest-interest paying bank is Marcus Goldman Sachs at 1.05%. Which has just stopped accepting new customers because they’ve received so much money in deposits. My mortgage is also at its cheapest, around 2.2%. I know some readers will point out some better deals in the 0.70% territory.

How banks make money

One of the main ways retail banks make money is by charging interest on money they lend. This can be mortgages, credit cards, business loans, overdraft etc. They can fund the loans using customer deposits and pay a small interest, borrow from other banks (aka interbank rate) or from the central bank.

Now, everything is working fine when interest rates are positive. Paying 1% to attract customer money is not that bad when you can lend it out at 5% and make 4% profit. But what happens when Bank of England rates drop to -2% and you lend money at 1%? Suddenly paying 1% for customer deposits is just too expensive.

If a central bank attempts to move its policy rate significantly below zero, commercial banks will see their interest margin compressed as long as they do not charge negative interest on deposits. If they pass on negative interest to depositors, those may, in turn, decide to switch from (negative) interest-bearing deposits to cash, which could lead to a substantial outflow of deposits from the banking sector.

This risk of substitution from deposits and reserves into cash is at the core of the existence of a lower bound on interest rates.

Assenmacher, Krogstrup IMF Paper, 2018: Monetary Policy with Negative Interest Rates: Decoupling Cash from Electronic Money

In other words, there is only so low that the customer interest on deposits can go before you keep the cash under the mattress.

If they pass on the cost to us, the consumers, then no-one will use banks for stashing money there anymore.

Which is why it’s really hard for central banks to drop rates to deep negative territory. Retail banks will start charging customers/businesses for keeping their money or otherwise they will make no money, and eventually default. Bad, and bad. People would withdraw all their cash before the bank takes their share. Cash has an interest rate of zero after all.

If this sounds too sci-fiy to you, the majority of Swiss banks have now introduced negative interest rates to customers with deposits of one million Swiss Francs or more. I guess it’s harder to keep a million under the mattress so you’ll have to swallow the negative rates. I’d say it’s coming to us faster than expected.

Will governments abolish cash?

An cashless society paves the path to deep negative rates without the fear of customers keeping cash at home.

Another proposal is to abolish cash altogether. But cash is what makes money… money! Obviously, this depends on which country you look at. Some countries like cash more than others.

currency in circulation in percent of GDB
Sweden is well on the way of becoming a cash-free society.

Also, older people transact more in cash than electronically so that will disrupt them. In Europe cash is still the main form of payment at the point of sale. Plus you may want privacy in your transactions. Or you want to avoid being hacked.

Maybe we will see one of the following:

  • Expiry date on cash notes
  • A tax when converting cash to electronic money
  • a lottery scheme that declares a certain number of banknotes invalid at regular intervals (yes I’ve read that too!)

What the IMF paper is proposing is a dual currency system. One local using cash and one electronic. Similar to what we have today but decoupled from each other.

Imagine going to the till: Your Big Mac costs £5.00 but if you want to pay cash that’ll be £6.20 sir!

Sweden has already started a pilot project to issue central bank digital currency, an e-krona that can work as a complement to cash. They’ve also issued a press release which includes: The digitalisation of payment may lead to cash not being generally accepted in the future.

Projects like this will definitely pave the way to a cashless society. And good luck keeping cash under the mattress if this happens.

I don’t know to what extent governments will keep pushing to maintain inflation targets and growth rates. It seems to me like the theory behind technology removing jobs and causing deflation is true now more than ever.

I’m also wondering whether people will seek to hold riskier assets to maintain their spending levels. Will this drive stocks and property even higher? What’s next?

Resources:

  1. IMF working paper (Assenmacher, Krogstrup) Monetary Policy with Negative Interest Rates: Decoupling Cash from Electronic Money
  2. The Riksbank proposes a review of the concept of legal tender (Riksbank)
  3. Technical solution for the e-krona pilot (Riksbank)
  4. What to do with negative rates (Klement)
  5. Pragmatic Capitalism – Cullen Roche

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9 thoughts on “How much will you pay to hold cash?”

    • I think this is a great suggestion if negative interest rates become a thing. It’s capped at £50,000 per person and current returns are only 1.4%. I expect to receive around half of that typically, but there is always the excitement of getting a big one! Backed by the government it’s safe as.

      Reply
  1. Maybe those invested in peer-to-peer lenders can tell us what it’s like to get negative returns on cash investments. I’m wondering whether many loans might turn bad next year once the Covid-19 redundancy tsunami passes through. Or am I too pessimistic?

    Seems like there are no safe investment nowadays.

    Reply
    • I’m invested in peer to peer, they’ve halved the interest rate for the rest of the year. Seems to be a stampede away from it, me included so there’s a huge delay on cashing it in. They’re currently working on requests made in Mid March.

      Reply
    • I’m surprised p2p lending has managed to avoid losses to principal as of yet. Maybe it’s too early to say but returns are still positive in my Zopa and RateSetter.

      Reply
  2. a vicious cycle, perhaps the only way out is to print new money, to pay back the old ones, in the sense that assets value will be kept floated.

    Reply

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Hi! I’m Michael and I love writing about different ways to earn, save and invest our money. Coffee addict :)

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