As foreshadowed in YieldReport in 2015 the European Central Bank has announced it will stop printing €500 notes (AUD$770) from the end of 2018. The rhetoric is all around the large denomination note being used by organised crime but make no mistake, the driving force is that a cash-based economy means the latest monetary policy tool of negative interest rates is less effective. In fact, many would argue it is not working at all.
The whole purpose of negative interest rates is to penalise banks and savers who have money in bank accounts. By penalising them, it is hoped they will instead go out and spend their money, thus stimulating the economy. This, however, is not happening.
The plan for those with savings to go out and spend it has gone awry and the more central banks impose negative rates, the more citizens withdraw cash and store it at home or in safe-deposit boxes. This is where human behaviour doesn’t meet with academic theory. Citizens are instead worried about the future and have been paying down debt and saving, in case the economy gets worse. History shows it has not been a bad thing to do.
A large portion of interest rates available in Europe are negative and some countries, such as Switzerland, have deeply negative interest rates. The Swiss National Bank charges Swiss banks 0.73% to leave deposits with the central bank.
When YieldReport last checked, some 62% of all notes in circulation in Switzerland were of a CHF1000 (AUD1400) denomination. This makes storing cash quite easy. AUD$1 million worth of Swiss francs can be stored in a shoe box. The same amount in Australian dollars would comprise 10,000 x $100 bank notes, a much trickier and bulkier proposition to store.
The largest denomination in the ECB’s domain is the €500 bank note. They have said it will remain legal tender but there are worries this may change. In essence, this means two things:
- Anyone holding €500 bank notes may ultimately have to exchange them for smaller denominations. This may be difficult for those with illicit funds and one should expect a healthy black market in exchanging euros for US dollars or gold.
- It will accelerate a move to a cashless economy whereby the tap and go set carries little in the way of actual bank notes. The more transactions which are performed electronically, the more governments can monitor spending and the more tax can be levied.
Needless to say, civil libertarians are outraged by the second point. These citizens expect to be able to move freely about their lives without having ‘big brother’ watching their spending habits over their shoulder.
In the bigger picture, if savers are to be penalised for holding money in the bank then holding cash becomes a sensible option. If that option is withdrawn because central banks start withdrawing cash notes from the economy, then the policy of negative interest rates may finally start to have the desired effect.
Related stories:
https://www.yieldreport.com.au/news/japanese-households-hoard-cash/
https://www.yieldreport.com.au/insights/500-euro-note-an-obstacle-to-ecb-policy/
https://www.yieldreport.com.au/insights/zero-rates-and-the-swiss-1000-franc-bank-notes/