Is $900 billion in cash missing?

See The World’s Cash Is Disappearing. Bankers Aren’t Sure Where It Went. Check your pockets. Society is increasingly going cashless, but banknotes are more in demand. Bankers search for clues. by David Winning and James Glynn of The WSJ.

As the article mentions, knowing how much money is in the economy is necessary if central bankers are going to set the optimal amount. If they set it too high we get too much aggregate demand and too much inflation (I have some information on the problems inflation causes later). Too low, and we can have a recession.

Excerpts:

"Some Australians are burying it. The Swiss might be hiding it. The Germans are probably hoarding.

Banks are issuing more notes than ever and yet they seem to be disappearing off the face of the earth. 

Central banks don’t know where they have gone, or why, and are playing detective, trying to crack the same mystery.

The puzzle is especially perplexing since societies and companies are going cashless, given the boom in payments by cards and cellphone apps.

The value of U.S. dollars in circulation hit about $1.7 trillion last year ($12.4 billion of it in $1 bills; $1.3 trillion of it in $100 bills) according to the U.S. Federal Reserve. That is up from $1.2 trillion in 2013.

A Federal Reserve economist, Ruth Judson, wrote in a 2017 paper that about 60% of all U.S. currency, and about 75% of $100 bills, had left the country by the end of 2016—for a total of about $900 billion in U.S. dollars kept overseas. Socking those bills away provides some protection against economic turmoil, especially in countries with a record of instability in their own financial systems, the paper said."

". . . about $2,000 in printed bills exists for every Australian."

"Dollar bills are . . . popular with collectors who worry about a future collapse of the financial system.

Bankers aren’t just hunting down cash to satisfy their own curiosity. If central banks don’t know how much cash is out there, they could print too much currency and risk inflation.

Construction workers recently dug up an estimated $140,000 buried in packages at a site on Australia’s Gold Coast"
"The Bundesbank thinks more than 150 billion euros are being hoarded in Germany."

"Australia’s central bank says its best guess is that only around a quarter of the bank notes in circulation are used for everyday transactions. Up to 8% of cash is used in the shadow economy—tax avoidance or illegal payments—while as much as 10% could have been lost. That is $7.6 billion Australian dollars ($5.2 billion) missing at the beach or in couch cushions.

The biggest use of cash is as a store of wealth “in safes, under beds and at the back of cupboards, both here in Australia and elsewhere around the world,” Mr. Lowe, the RBA governor, said.

Officials at the Swiss National Bank ran with another theory: hoarded bank notes should wear out less because they aren’t being used for everyday transactions.

Demand for high-denomination bank notes tends to rise when interest rates are low, households feel distrustful of the banking system or people want to make transactions anonymously."

"“Our sense is that we’re in the same boat as a lot of other central banks out there,” said Christian Hawkesby, assistant governor at the RBNZ. “We can’t fully explain why holdings of cash are rising and where they are going.”"

So what are the costs of inflation? Here are two:

1. It causes us to waste resources doing things we would not normally do.

In Germany in the early 1920’s, because prices were rising so fast, housewives would go to the factory several times a day to get their husbands pay and go to the stores to buy goods before their prices rose. This is an enormous waste of time, energy and resources. Waste (or inefficiency) hurts the economy.

Another example is that in the late 1970s, IBM had 300 workers doing nothing but change prices on invoices to keep up with inflation (recall the high inflation rates of this period). Again, this is a waste because they could do no real work like help customers or create new products.

2. It makes savings and investment hard.

When savings and investment decline, it hurts the economy. There is less money available for investment since people don’t save as much. So there are fewer new houses and factories built. So the economy stops growing and starts to shrink.

Why? Look at the equation for the nominal interest rate from the previous section. When the inflation rate is high, the interest rates are very high (In 1994, Yugoslavia had a 570,000% inflation rate-YES, that is right. It was much worse in Germany in 1923).

So if a bank wanted to make a 5% real interest rate, they would have to charge nominal interest rate of 570,005%. No business is going to borrow at that kind of rate because they have no idea if they will be able to pay it back. If the inflation rate falls to say, 100,000%, the business won’t make enough money to pay the loan. There is too much uncertainty to borrow money.

Also, no bank is going to pay that kind of interest rate to savers. Since the bank won’t pay a high enough interest rate to compensate savers for inflation, no one puts money into savings accounts and there is no money for investment.

 

Professor Mark Thoma of the University of Oregon had a post at his blog on the disagreement over what the optimal inflation rate is called Do We Need to Rethink Macroeconomic Policy? Some economists think maybe 4% would be okay. But this article gives you a good idea of the issues and controversies surrounding the unemployment-inflation tradeoff.  Excerpt:

"Just to be clear, the relative price of good A to good B is P_A/P_B. If there is inflation and one of the two prices is stickier than the other, then the two prices will change at different rates in response to inflation. This pushes relative prices away from their fundamental values, and this in turn distorts resource flows (which leads to losses and unemployment as resources are subsequently reallocated). The higher the inflation rate, the faster these prices become distorted and the higher the subsequent costs. This is not the only cost of inflation, but on this basis alone it's likely that at some point the costs of inflation will exceed the benefits. The hard question is where the breakpoint is (partly because we don't have good estimates of either the costs or the benefits, so it's possible to support most any position by picking and choosing among the empirical studies). I'd be very uncomfortable with a rate over 4%, 4% itself seems a bit high, but 3% isn't so hard to accept."