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The Bottom Line

Evan Davis gets to the heart of the big finance stories at The Bottom Line.

In the turbulent 20th Century, you could start a riot with a piece of paper – it just had to be printed with revolutionary slogans and handed out to disgruntled crowds. In the atmospherically obsessed 21st, the same mayhem can be triggered by rolling it up and smoking it, yet soon there’ll be a bigger sin than lighting a cigarette in the building; bringing out a banknote at the checkout. Paying by cash is fast becoming a form of anti-social behaviour – the point-of-sale equivalent of wearing safety-pin jewellery, watching Jonathan Ross or window-shopping with a brick.

Seasoned users of ‘ready’ money may already be noticing a backlash against cash. While cardholders swipe and type, cash customers must ride the glare of chafing chip-and-pins, maddened by the mutual fumbling over miniaturised coins. Travellers’ only rescue from a ticket queue longer than their journey is a machine which laps up plastic, but chokes on all but the most freshly-ironed banknotes and gives no change. Sales are shifting at double-digit rates to an internet which recognises Mastercard, Visa and PayPal infallibility, but sees no virtue in any non-virtual token.

Paper profits

Not long ago, people in power loved paper money. It was a commercial invention, devised to circumvent the physical inconvenience of gold and silver. Instead of issuing invoices which then had to be swapped for precious metal, buyers and sellers started trading the bits of paper, only rarely visiting the bank to withdraw the underlying riches. Private debt had become a convenient form of currency, fulfilling the traditional requirement of storing value and speeding up exchange. This also had immense political advantages, freeing rulers from the fiscal inconvenience of scarce and theft-prone bullion.

Governments could now print notes to represent their official reserves, keeping these locked in suitably fortified central banks, and once people trusted the paper currency, more could be issued – an especially useful tactic for rulers struggling to squeeze subscriptions from their nobility, or keener to raise an army than the accompanying tax. Medieval kings and emperors could only expand the money supply this way by clipping the gold and silver coins, or smuggling base metals into the mint. Their modern successors have the happier option of issuing public debt, spending more now while passing the bill to taxpayers still too young to vote.

Issuing more public debt than private investors want to hold – today’s innocuous sounding ‘quantitative easing’ – is traditionally condemned by monetarists as cruelly clawing-back the handouts through a hidden inflation tax, but this is an occasional public indulgence in a practice that’s second nature to commercial banks. They routinely make loans that are a multiple of customer deposits, pushing assets (and corresponding liabilities) far above what is actually held in reserve. Indeed, governments only rush to quantitatively ease when banks are on their collective knees because their credit has ceased to flow.

Paper money enables the same capital to be put to work in many places simultaneously. Productivity is multiplied by turning each asset into collateral for another, and re-lending many times the wealth that used to sit idly in a vault. Securitised debt may recently have stalled the world economy, but it’s only an extension of the forces that previously drove it. That’s why governments splashed the blank cheques to redeem the chequered banks.

A bullet through the wallet

If paper money opened all these doors, why is its future in any danger? For the same reason that an abstract axe hangs over the Royal Mail, printed newspapers and music on disc. Just as we could get value from precious metal without minting it, we can now get value from an invoice without printing it. Once money’s more manageable as an electronic pulse, suspicion surrounds those who still want it in physical form.

The problem with paper money is that it leaves no ‘paper trail’. Governments have long resented the way cash transactions enable legal traders to sidestep taxes, and illegal traders to launder their profits into regular circulation. The growing skill of forgers also challenges the most jealously guarded monopoly of sovereigns, who aren’t flattered when their likeness runs off someone else’s printing press.

More influentially, big retailers and manufacturers curse cash deals that fall outside their customer databases, so it can’t then be ‘mined’ for appropriately personal marketing ploys. They also regret needing a fleet of armour-plated couriers to empty and fill their cash-heavy tills. Finance directors declare war on the ‘off card’ transaction, which lets executives scupper the expense tracking system with improbable taxi fares and budget-busting bar bills.

Cash stands accused of causing banks to crash and civilisations to clash. Lenin famously viewed debauching the currency as the quickest way to undermine capitalism. Hitler came close to putting such pecuniary subversion into effect, with a wartime scheme to bomb Britain with banknotes, a road to ruin via rampant inflation. Guy Fawkes’s belated knighthood, for services to the global firework industry, is obstructed by his financially illiterate choice of tactics. Instead of lighting the blue touch-paper, he should have been faking the banknote paper and causing an unsustainable credit explosion.

Governments seeking faster, cheaper and more visible transactions are keen to kill the dollar bill – and its counter-clogging counterparts in the euro, yen and sterling zones. Corporations are equally concerned to stamp out logistically wasteful, electronically untraceable cash flows. To meet their demands, innovators who once promised a licence to print money now offer grand designs for making it vanish. Amid a general dearth of political visions, that of cashless society stands out like a viable mortgage in a sea of sub-prime debt.

Why cook the books when they can be vaporised?

In the brave new banknote-free world, cards will rule even at the bus stop and corner store, with mobile phones as an alternative means of payment. The mobile internet will move against cash by spreading direct transfers that have already shot down the once-mighty cheque. Formerly well-thumbed Adam Smith, Charles Darwin and Elizabeth Fry will be banished to the portrait gallery, while royal heads retreat to the postage stamp.

If robbed of officially sanctioned cash, won’t people just invent their own? Economies that ran short of legal tender were famously quick to adopt a replacement, from cigarettes in prisoner-of-war camps to elaborate IOUs in post-Soviet Russia.

However, the death of cash means only the de-materialisation of money, not its disappearance. Indeed, the biggest danger is that paperless money be further detached from underlying wealth, drowning us in devalued riches. Air Miles already rival the world’s major currencies in terms of quantity and acceptability, but so many have been created that running flights for them all would fry the world before a fraction of the holders could fly round it. Second Life is shielded from excess of virtual currency only by the infinite expandability of online real estate.

Prophets of the cashless economy promise that risks of monetary excess will be reduced, with every deposit and withdrawal electronically matched. New regulatory schemes to avert further meltdowns, including a giant register of to check that banks’ balance sheet assumptions really add up, underline the faith in data-based trading to guarantee transparency and monetary stability.

What of those who can’t afford a plastic card, aren’t online and don’t carry a mobile? Cashless commerce will compound an already serious digital divide. Those barred from the virtual marketplace may have to form their own cash-trading communities, until connections to new networks are as ubiquitous and affordable as those of the savings banks and post offices they replace. Pulling out a banknote could soon be an act of solidarity with the socially excluded, but you’ll still have to swap them on windy street corners, after the tobacco smoke has cleared.

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About the author

Alan Shipman is lecturer in economics at the Open University, and a former financial journalist. His books include The Globalization Myth, The Market Revolution, and Transcending Transaction. He is involved in OU's new courses on personal finance, and research on insurance pools, 'chaos pricing' and Eastern Europe.

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Blogging about

The Bottom Line

Evan Davis gets to the heart of the big finance stories at The Bottom Line.

The latest broadcast of The Bottom Line discusses the role of money and the relationship of the poor to contemporary capitalism, with guests drawn from the well-known companies Poundland, Cisco Systems and Barclaycard. In many ways, the discussion is a reprise of the debates about the promise of digital or cyber money at the end of the last millennium, yet despite the seductive appeal of virtual transactions, the material realities of the societies we inhabit remain. The poor, like climate change, will always be with us and no amount of cyber technologies will change that, unless of course, the dystopian visions of John Carpenter’s film Escape From New York is a means of managing the digital underclass.

At the beginning of the 21st century, the seductive delights and trappings of the digital age and the virtual universe were apparently transforming the way in which we viewed and organised our lives and relationships to each other. The networked firm and society, the virtual organisation, the virtual city, teleworking, e-business, the opening up of new private and public cyberspaces suggested that new social transformations would sweep away the old conservative forces of materialism.

The universalisation of information and its communications media seems to promise a new democratisation that cannot be easily contained or institutionalized. The brave new digital world is now extending into prospects for different private cybermonies. Resisting the rhetoric and hype, we find this age carries with it its own exclusivity, its own marginality and peripherality. In the case of money, the confusion between form and content in digital transfers of all financial assets does not cloak an important historical fact. Money is an abstraction from real relations of production, exchange and distribution and as such bestows social power. In other words, money has always been virtual and the source of marginality and peripherality in the kind of societies we inhabit.

The evolution of banks – from crude coinage to plastic money, financial globalization, the implications of technology and money futures – constitutes the narrative of digital transformation. In re-telling the narrative of money, the standard textbook classification of money remains a constant:

• a generally acceptable means of exchange for goods and services;
• an effective store of value;
• a unit of account.

Money can also be said to be “at rest” and “in motion”. In a cyber age, money at rest is where its store of value is held in computer disks or electronically formatted cards. Money in motion occurs where there is a transfer of liabilities between individuals and / or organisations. Electronic transfers speed things up and reduce periods of free credit (or “float”). Money is created through the generation of deposits by banking institutions (not necessarily banks per se) underwritten by reserves held in central banks. Borrowers or lenders are paid through the central bank creating a new deposit (a liability), but the key question is, can we really create our own e-money? We merely transfer the form in which money is held from a conventional one to an ethereal one, but it is the e-money issuers, not us, that do the money creating, backed by official money, which we have entrusted to them. If it is not backed by official money e-money becomes no different from Monopoly money or Second Life, bounded by the internal rules of a particular game.

There is also a regulatory implication that is analogous to the “black economy,” within which transactions are only conducted with cash; still a common experience of most large metropolises around the globe, namely that if agents increasingly circulate money outside the official system, the banking system’s share of money declines. This situation is related to the problems of estimating its size and impact where, in certain places, large sums of cash (and therefore officially underwritten) never touch the banking system. Indeed, the “black economy” is the lifeblood of many communities, who neither have the infrastructure nor the aspiration for their exchange to become wired or networked. Thus, the de-materialisation and re-materialisation of money is not a recent or cyber phenomenon.

A number of years ago, two Irish economists, then working at the European Investment Bank, suggested that the complete electronic transmission of money would kill off inflation. They forgot one fundamental law of economics, which is that money bestows purchasing power. Furthermore, the different magnitudes of purchasing power come out of the struggle over the distribution of the social product. Clearly, they hadn’t told a former Governor of the Bank of England nor the citizens of Britain’s northern cities, upset at his statement that “unemployment in the North is a price well worth paying for controlling inflation in the South”. Eighty years before John Maynard Keynes's Treatise on Money, Karl Marx anticipated the former’s view that: “we cannot get rid of money even by abolishing gold and silver and legal tender instruments.” Again, the possibilities of e-money and cyber money do not change this elemental fact. Money can only be digital if it still remains money – complete with its conventional functions and its relationship to the production of commodities.

Inflation has been temporarily conquered because of the global recession and also because governments have intervened to sustain the fractional reserve system. Without this intervention, a number of economies may have collapsed and the ability to produce, exchange and consume goods and services could have been undermined. There does not seem to be a digital solution to this material problem – unless of course, we all become avatars in a cyborg world.

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About the author

Leslie Budd is Reader in social enterprise at The Open University Business School. He is an economist and has written extensively on the relationship between regional and urban economics, and international financial markets.

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Evan and Janette in conversation.

This week, in a change to our Bottom Line format, we’ve something a bit special for you: Janette Rutterford from The Open University Business School turns the tables and puts Evan into the interviewee’s chair.

You can watch two interviews on the Bottom Line website.

In the first, the managerial make-up, Evan shares his experiences from talking to numerous CEOs during his time on the programme. Are there differences between female and male management styles? Do Americans manage differently to the British? And are those large executive paycheques ever really justifiable?

Watch the managerial make-up

In part two, a different recession, Janette and Evan explore what makes the current world recession so unlike anything we’ve experienced before. And is there a way out?

Watch a different recession.