Many economic commentators are in favor of phasing out cash. They are of the view that cash provides support to the shadow economy and permits tax evasion. It is also held that in times of economic shocks that push the economy into a recession the rising demand for cash exacerbates the downturn—it becomes a factor of ...
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Many economic commentators are in favor of phasing out cash. They are of the view that cash provides support to the shadow economy and permits tax evasion. It is also held that in times of economic shocks that push the economy into a recession the rising demand for cash exacerbates the downturn—it becomes a factor of instability. Rather than spend money and boost aggregate demand, the increased demand for cash works against this. Consequently, it is argued that individuals’ access to cash should be curtailed in order to minimize the potential negatives that cash can pose to economy’s health.
Furthermore, it is held that in the modern world there is hardly any need for cash since most transactions can be settled by means of electronic money transfer.
The Emergence of Money
According to mainstream economics, the correct definition of money is not something permanent but flexible. Most economists hold that since the early 1980’s, as a result of financial deregulation, the nature of financial markets has changed and consequently the past definitions of money no longer hold. The past definition of money, it is held, is also likely to be affected by the expected introduction of the cryptocurrency. Is this is however the case?
The purpose of a definition is to present the essence and the distinguishing characteristic of the subject we are trying to identify. The subject matter of a definition is what the fundamentals of a particular entity are.
To establish the definition of money we have to ascertain how a money-using economy came about. Money emerged as a result of the fact that barter could not support the market economy. A butcher who wanted to exchange his meat for fruit might have difficulties finding a fruit farmer who wanted his meat, while the fruit farmer who wanted to exchange his fruit for shoes might not be able to find a shoemaker who wanted his fruit.
The distinguishing characteristic of money is that it is the general medium of exchange. It has evolved from the most marketable commodity.
On this Ludwig von Mises wrote,
There would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money.
Similarly, Murray N. Rothbard wrote that
[j]ust as in nature there is a great variety of skills and resources, so there is a variety in the marketability of goods. Some goods are more widely demanded than others, some are more divisible into smaller units without loss of value, some more durable over long periods of time, some more transportable over large distances. All of these advantages make for greater marketability. It is clear that in every society, the most marketable goods will be gradually selected as the media for exchange. As they are more and more selected as media, the demand for them increases because of this use, and so they become even more marketable. The result is a reinforcing spiral: more marketability causes wider use as a medium which causes more marketability, etc. Eventually, one or two commodities are used as general media—in almost all exchanges—and these are called money.
Since the general medium of exchange emerged from a wide range of commodities, money must be such a commodity. According to Rothbard,
Money is not an abstract unit of account, divorceable from a concrete good; it is not a useless token only good for exchanging; it is not a “claim on society”; it is not a guarantee of a fixed price level. It is simply a commodity.
Moreover, as Mises notes, “an object cannot be used as money unless, at the moment when its use as money begins, it already possesses an objective exchange value based on some other use.”
Why? Rothbard explains:
In contrast to directly used consumers’ or producers’ goods, money must have pre-existing prices on which to ground a demand. But the only way this can happen is by beginning with a useful commodity under barter, and then adding demand for a medium to the previous demand for direct use (e.g., for ornaments, in the case of gold).
Money is that for which all other goods and services are traded. This fundamental characteristic of money must be contrasted with those of other goods. For instance, food supplies necessary energy to human beings, while capital goods permit the expansion of infrastructure that in turn permits the production of a larger quantity of goods and services.
Through an ongoing selection process over thousands of years, people settled on gold as money. Gold served as the standard money.
In today’s monetary system, the money supply is no longer gold but coins and notes issued by the government and the central bank.
Consequently, coins and notes constitute the standard money, known as cash, that is employed in transactions. But note that the essence of money remains intact, i.e., it is that for which all other goods and services are traded.
Distinction between Claim and Credit Transactions
At any point in time, an individual can keep his money in his wallet, somewhere at home, or deposit the money with a bank. In depositing his money, an individual never relinquishes his ownership over the money. No one else is expected to make use of it.
When Joe deposits his money with a bank, he continues to have an unlimited claim against it and is entitled to take charge of it at any time. Consequently, these deposits, labeled demand deposits, are part of money.
If in an economy individuals hold $10,000 in cash at any point in time, we would say that the money supply in this economy is $10,000.
Now, if some individuals have stored $2,000 in demand deposits, the total money supply will still remain $10,000: $8,000 in cash and $2,000 in demand deposits—that is, $2,000 cash is stored in bank demand deposits. Finally, if individuals deposit their entire stock of cash, the total money supply will remain $10,000, all of it in demand deposits.
This must be contrasted with a credit transaction, in which the lender of money relinquishes his claim over the money for the duration of the loan. As a result, in a credit transaction, money is transferred from a lender to a borrower. A credit transaction does not alter the amount of money. If Bob lends $1,000 to Joe, the money is transferred from Bob’s demand deposits or from Bob’s wallet to Joe’s possession.
Electronic Money Transfer and Money
An electronic money transfer is a particular way of using existing money. For instance, by means of electronic devices Bob can transfer his $1,000 to Joe.
Note that the electronic money transfer can take place because the $1,000 in cash exists. Without the existence of the $1,000 cash, the transfer from Bob’s demand deposits to Joe’s would not be possible. After all, existing cash must be transferred.
This is similar to money transfer by means of a check. When Bob writes a check for $1,000 to Joe, he instructs his bank to transfer the $1,000 to Joe’s demand deposits. Obviously, the transfer of the $1,000 cannot take place if Bob does not have the $1,000 at his bank.
The fact that various electronic money transfers are taking place does not mean that we do not require cash any longer. On the contrary, the fact that the cash exists enables electronic money transfers to take place.
The so-called electronic money is not money as such but a particular way of using existing money. Thus, by means of electronic devices the buyer of goods can transfer money to the seller of goods. At the end of the transaction, the seller of goods knows that the amount of cash in his bank account has risen because of the sale of goods. At any time, he is entitled to take the money out of his demand deposits.
Now, if the central banks work toward the removal of cash, i.e., money, without replacing it with some other form of money which is linked to the present money, this is going to undermine the medium of exchange and the market economy.
So-called electronic money is not money as such, but a particular way of using existing money, which is coin and notes, i.e., cash. The removal of cash, as advised by various experts, is going to undermine the market economy and result in a drastic decline in individuals' well-being.
Observe that those experts that recommend the removal of cash imply that in the modern world we can make electronic transfers of money without the physical existence of money. In the real world, however, to facilitate the transfer of cash, i.e., money, one must have the cash in order to make the transfer. After all, there must be something that can be transferred.
Regardless of how sophisticated the monetary system is, individuals require a medium of exchange in order to facilitate transactions. Regardless of the sophistication of the monetary system, money will remain that for which all other goods and services are traded.