The poster child of a cashless society is Sweden. There
are all sorts of anecdotes about beggars accepting cards, churches passing
around mobile payments devices instead of collection plates, and banks no
longer providing customers with cash. It is no wonder then that Sweden is the
only country in the world to show a decline in banknotes and coins in
circulation, the quantity of cash outstanding having fallen from 109 billion
SEK in 2006 to 56 billion SEK in 2018. If you want to read more, I wrote
about the Swedish miracle on my Moneyness blog here.
The death of cash scenario portended by Sweden
is contradicted by another Nordic nation, Iceland. If Sweden is close to the
forefront of the cashless revolution, Iceland is not only ahead of it but at
the very front of the pack. No country does more point-of sale payments per
capita than Iceland, clocking in at 426.9 in 2016. Whereas Sweden has an
incredibly low cash-to-GDP ratio of around 1.75% , Iceland was already
all the way down to an impressive 1.2% by the early 2000s! (The cash-to-GDP
ratio is the number of banknotes and coins outstanding at the end of the year
divided by yearly GDP. I get these numbers here).
One would probably be safe in assuming that, like Sweden,
Iceland is characterized by a steady decline in banknotes and coins
outstanding. But this isn't the case, as the chart shows below.
Not all Scandinavian countries are going cashless. You can
see precisely when Icelanders lost trust in their banks and began cashing out
of deposits into notes. pic.twitter.com/fN0i1dY9s7
— JP Koning (@jp_koning) March 12, 2018
Since the 2008 credit crisis, Iceland has seen a
tremendous resurgence in the demand for cash. Not only is the rate of growth
in króna notes and coins in circulation far exceeding that of Sweden, but as
the chart below illustrates, it is also far ahead of euro cash growth. As for
Iceland's cash-to-GDP, it has doubled to around 2.4% since the crisis, which
means that the island nation is now more cash intensive than Sweden.
What is happening? It may be useful here to borrow from a
recent Bank for International Settlements (BIS) paper Payments
are a-changin’ but cash still rules and
differentiate between means-of-payment and store-of-value demand
for coins and banknotes. It is unlikely that the resurgence of Icelandic cash
demand is due to payments needs. Rather, I'm going to show that it is
probably due to the latter type of demand, store-of-value. This sort of
demand occurs when people indefinitely lock away a few extra bills in a safe
as opposed to putting them in their wallets for tomorrow's grocery run.
The easiest way to try and determine when cash is being
held as a store-of-value or a means of payment is to observe the denomination
structure of coins and banknotes. In theory, larger-denomination notes, which
are less cumbersome, are mostly held as a store of value whereas smaller ones
will tend to be used in payments. Below I've charted the evolution of
Iceland's denomination structure over time.
You can see that growth in low-denomination banknotes and
coin slightly exceeded growth in higher denomination notes until the 2008
financial crisis, at which point the demand for high denomination banknotes
exploded. In 2013 the Central Bank of Iceland even introduced a new note, the
10,000 krónur (currently worth around US$96), to meet Icelander's growing
store-of-value requirements.
According to the BIS paper, one factor that drives the
demand for notes as a store of value is the level of interest rates. If you
choose to hold cash, you're losing out on interest, but the lower the
interest rate the smaller your loss and the more attractive a
large-denomination banknote gets. Indeed, the BIS report finds that lower
interest rates all across the world explain a large part of the post-crisis
global thirst to hold high denomination banknotes like the €500 note, 1000
Swiss franc, ¥10,000, or US$100, as illustrated in the chart below. This may
be the case in Iceland too, since rates have fallen quite a bit since 2008.
Iceland is somewhat unique because of the terrific damage
sustained by its banks during the credit crisis. All three--Kaupthing,
Glitnir, and Landsbanki--went bankrupt. Prior to the crisis Landsbanki had
established a banking presence in the UK and Netherlands. Iceland's
government refused to meet its deposit insurance commitments for these
foreign customers while protecting Icelanders. The crisis revealed that the
safety of both Iceland's banks and its deposit guarantee scheme were less
assured than most had previously thought. This may explain some of the
explosion in hoarding of Icelandic banknotes. Notes, after all, are a direct
promise of the government and are free from the sort of default risk that
bedevils a private deposit.
In addition to having a financial incentive to hold more
banknotes, Icelanders also have emotional reasons for doing so. They are
resentful of bankers, who are rightly viewed as the ones most responsible for
placing Iceland in such a precarious position on the eve of the '08 financial
crisis. Some 26 bankers have received sentences of up to five years, which
makes Iceland the only nation to have imprisoned bankers for their role in
the crisis. The country has even flirted with the idea of sovereign
money, a monetary system in which private banks can no longer issue
money, abdicating that role to the the state.
In this context, it is no wonder that demand for high
denomination banknotes is growing. Angry Icelanders can register their
protest votes against the banking system by storing five 10,000 kronur notes
under their mattress for a rainy day instead of holding 50,000 krónur in a
low-yielding savings account.
To sum up, Iceland and Sweden are both leading the world
in digital payments. Yet while Sweden hints at a world in which digital
payments lead to cash's demise, Iceland tells us something different. Even in
a world where everybody pays with a card or an app, people may still want
access to old-fashioned cash. First, banknotes and coins are still useful in
a number of payments situations, say when payments systems have gone down or
in coin-operated laundry machines. In Iceland's case, this is confirmed by
continued growth in small-denomination banknotes and coins outstanding, which
are keeping up with GDP growth.
But even more importantly, Iceland shows that
banknotes--in particular large denomination ones--are a universally available
ultra-safe investment. It took a crisis for this to be evident, since when
times are normal people are quite content to hold riskier bank-issued claims
on banknotes. Other government instruments like t-bills and bonds also
provide the same degree of safety as a banknote. But these require a degree
of financial sophistication to purchase, and are thus less accessible than
cash, which is widely available and easy to buy.
As policy makers navigate the future of cash, in
particular that of high denomination banknotes, the Swedish model has become
a much discussed benchmark. But it would be irresponsible of policy makers if
they failed to consider its fellow Nordic nation, Iceland, as an equally informative
model.
This blog post is a guest post on BullionStar's
Blog by the renowned blogger JP Koning who will be writing about monetary economics, central
banking and gold. BullionStar does not endorse or oppose the opinions
presented but encourage a healthy debate.