Currency in circulation

The Chief Cashier of the Bank of England, Andrew Bailey, gave a fascinating speech last month on various aspects of currency in circulation in the UK. The key point is that while cheques have been in terminal decline in the UK (see this blog post), cash has in recent years been growing not only in notional value, but even as a percentage of GDP.

Bailey thinks that people are increasingly using cash as a store of value (and not just as a medium of exchange) partly because of a lack of confidence in the banking system and partly because at near zero interest rates, the opportunity cost of holding cash is negligible. If people are indeed stuffing cash under their mattresses, it tells us how harsh the global financial crisis has been.

Another interesting point is about the quality of notes. In India, ATMs typically give out better notes than the bank branches do, but Bailey tells us that in the UK, it is the reverse. The new generation of ATM machines can dispense notes so soiled that a human teller would regard them as unfit to be dispensed. One almost hopes that India remains stuck in the old generation of easily jammed ATMs that give out relatively clean notes.

The most important point that Bailey makes is that “banknotes are central-bank money in a form that can be held by the public, in other words the retail equivalent of reserve accounts at the central bank.” I would like to push this point further – if technology allows electronic accounts to be maintained at near zero cost, should not the central banks provide electronic reserve accounts to all citizens? As India moves toward issuing a unique identity number to every citizen, would it not be nice for each such number to be linked to a no frills account at the RBI?

Why in other words should only the rich and powerful institutions have access to central bank money? When a variety of tax laws and money laundering laws attempt to prevent the use of central bank money in the form of cash, should they not then facilitate the use of central bank money in the form of electronic reserve accounts at the central bank?

The shocking thing in finance is that financial markets settlements do not reach the highest standards of DVP (delivery versus payment) – simultaneous and irrevocable payment in central bank money. If you go to a grocery shop, pay for your purchases in cash and walk out with your goods, the transaction conforms to the highest standards of DVP because cash is central bank money. In most financial markets on the other hand, we do not get this level of DVP because the settlement systems do not settle in central bank money. This is a shame.

Posted at 1:36 pm IST on Mon, 11 Jan 2010         permanent link

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