Getting the effect of cash entirely wrong

An amusing proof that it's possible to start from an interesting place and then fall over into complete nonsense. The point at issue being that the amount of cash floating around the British economy has increased in recent years. OK, well, why, and what, if anything, might we want to do about it?

The chief cashier of the Bank of England says that only about a quarter of the cash they put into circulation is used to buy and sell things. The rest of it is either shipped overseas – which we will put to one side for the moment – kept outside of the banking system ie (hoarded), or used to support the shadow economy (iestashed). In other words, not in circulation at all but stuffed under mattresses.

If you look at the trend growth of that cash “in circulation” over the last few years, it has accelerated past GDP growth as well as past the amount of money being taken out of ATM machines. And we also know that the use of cash in retailing has continued to fall steadily. That means the “cash gap”, between the small amount of cash that is used to support the needs of commerce and the large amounts of cash that are used for other purposes, has been growing. The interesting question is: why?

There are two pretty simple alternatives. If the amount of cash that is being hoarded has been growing, that would suggest people have lost confidence in formal financial services. Or, that they have so little knowledge of basic arithmetic that they are happy to have inflation eat away their store of value while forgoing the safety and security of bank deposits, no matter what value of the interest paid.

Well, no, not really, a bit of elementary economics would tell us that when interest rates are on the floor, as they have been "over the last few years", and inflation has been notable by its absence, then people will be more willing to hold cash, even just inert cash, than when they could have stuck it in the bank and got some interest to over the losses from inflation. So, actually, an increase in cash in circulation is just what we would have expected in recent years. And we've not even any evidence that this produces an increase in the financing of the grey or black economies: after all, our general analysis of monetary conditions currently is that the velocity of circulation has fallen. Meaning that we need more cash to finance the same amount of activity: just as we need more base money to finance the rest of the economy which is why QE.

So, the terrors are unproven. But what really boggles is this:

Charles and Jonathan estimate that the grey economy in the UK could have expanded by about 3% of UK GDP since the beginning of the current financial crisis. That means there are an awful lot of people not paying tax, and simple calculations will show that the tax lost that can be attributed to cash is vastly greater than the seigniorage earned by the Bank of England – the money the bank earns from issuing notes. Cash makes the government considerably worse off – and that means us.

It's that last phrase. We are not the government and the government is not us. It's not necessary to come over all entirely Mancur Olson to note this. If the government has insufficient money to defend the nation that might indeed impact us in a negative manner, if it's not got enough to finance Ed Miliband's pension then that's of less impact upon the rest of us.

And, clearly, if government is sucking less money out from our own economic activities to finance those of Ed Miliband then we are better off (even if Ed and Justine are not).

Another way of putting this is that it is not true that everything belongs to the government and we only get what is left after its exactions. Even if the grey and or black markets are expanding this does not make us worse off: it is, after all, difficult to see how an expansion of economic activity does make us worse off.

There is a deeper point behind all of this which is that there are those entirely seriously suggesting that in the near future the country should simply stop using cash. In order, so it is said, to crack down on the horrors that is tax evasion. Which is silly in one manner, because cash is simply a method of keeping score of who owes what to whom, as is all money. And if people are denied one method of doing so then another will be invented. But the part that horrifies us is this idea that the erasure of tax evasion would be worth the the erosion of the simple freedom to truck and barter as one wishes. Where all transactions, even the most minor, would be open to both the examination of the State and the payment of its tithe.

Yes, we really are saying that some level of tax evasion is the only outcome consistent with the maintenance of the general liberty. And we'd rather have that general liberty than we would the payment of the supposedly proper tithes, thank you very much.