Save the Eurozone – Scrap the €500 Note

The Eurozone, Japan, Switzerland and some Scandinavian countries now have negative official interest rates, so they charge commercial banks for holding excess funds at the central bank. The idea is to incentivise them to lend more money instead into the real economy. This has not really been happening: business firms are too nervous to borrow and do not feel the need for extra productive capacity. The European Central Bank is considering whether its charge on bank credit balances should be increased to power up the incentive, that is, whether the negative rate should be even more negative. There are numerous snags attaching to this latest venture into unorthodox policy.
The first is that commercial banks, whose balance sheets remain fragile, find it very hard to make money when interest rates get this low. Healthy bank profits are hardly a priority for most people but loss-making banks are not a very attractive prospect either. The other problem is that negative official interest rates mean that monetary policy is already reaching its limits. Economists have long written about the ‘zero lower bound’ for interest rates: nobody will hold deposits at a cost and will resort instead to cash. Interest rates on demandable deposits are already zero in Ireland (or 0.01% to be more accurate) and some Swiss banks are now levying a charge. If you deposit €1000 they will pay you back only €999, or €995, a year from now. This is not an attractive deal and people will prefer to keep their money in banknotes.
The trouble is that most bank deposits by value are in amounts much larger than €1000. Many business corporations, nonbank financial companies and pension funds keep deposits in the multiple millions. They cannot stuff the filing cabinets with physical banknotes. But they are not captive customers of the commercial banks either. If they can find somebody trustworthy to hold banknotes on their behalf it might be a better deal even if there is a storage cost. It appears that storage costs could be cheaper than the negative interest rates now threatened, particularly given the availability of large denomination notes such as the $100 bill or, even more attractive, the €500 note in the Eurozone. You could fit a million easily into a briefcase in the form of €500 notes. The ECB’s negative rate is currently 0.3% and it may penalise depositors even further at its next monetary policy meeting on March 10th next. Wholesale interest rates on large deposits will inevitably follow the ECB rate. There have been calculations that storing millions in the form of €500 notes would cost less than the likely wholesale penalty if the ECB goes even more negative.
So somebody needs to come up with a cunning wheeze to escape this latest policy cul-de-sac and there are active proposals to, you guessed it, abolish the €500 note. It would not be acceptable to explain that this was necessary because of another policy misadventure, so the spin coming out of both Brussels and Frankfurt is that the €500 note is mainly used by criminals, and since nobody likes criminals, it has got to go. The coincidence of this discovery with the dilemma over negative interest rates is just that, a coincidence.
The logic is impeccable at first glance. Criminals use €500 notes, ban them and this will inconvenience the criminals. Like it did with machine guns. Ban them and, oops, the only ones with machine guns are criminals. Various international law enforcement agencies, including Interpol and Europol, have confirmed that the €500 note is popular with money launderers and drug dealers and there is no reason to doubt them. But there are many billions in €500 notes out there already and the ECB can hardly cancel them. They will continue to circulate in the shadows. There are lots of non-criminal users of large notes, not just horse dealers and bookmakers in Ireland but also wholesale traders in countries outside the Eurozone with dodgy currencies and unreliable money transmission systems. As much as half of all €500 notes is believed to circulate outside the Eurozone, especially in the Balkans, Turkey and Russia. Its predecessor was the German 1000 Deutschmark note which circulated widely in these places and the ECB version was consciously introduced so as to facilitate existing users.
As for the mafia, there have been prosecutions of numerous banks for facilitating their illicit transfers and it is hard to believe that the withdrawal of the largest ECB note will inspire their professional retirement. Readers will recall the spin justifying depositor haircuts in Cyprus including the assertion that the money belonged to the mafia, Russian chapter. They survived.
The proposal to scrap the €500 note is further evidence of the absence of a serious Eurozone macroeconomic policy.

28 thoughts on “Save the Eurozone – Scrap the €500 Note”

  1. Hear Hear and all that.
    My personal bugbear is that in order to protect the bottom line of the banks the government keeps reducing the prize fund for Prize Bonds after the banks complained bitterly about the likes of me withdrawing savings from their crappy deposit accounts and putting it into bonds.
    Commercial banks interest and national interest still seen as one and the same.
    Will that ever change?

  2. While I can imagine that the retirement of the 500Euro will have an impact on medium sized amounts, isn’t it less likely to impact the small or really large depositors?

    At the retail end, the difference between life savings in 100 or 500 bills isn’t meaningful. It’s not the volume that’s the limit, but the risk of having your savings in cash in the first place. I doubt too many people’s savings make more than a briefcase in either denomination.

    And if you get to storing billions then whether you have to make 2 pallets or ten pallets of cash you’re already putting major security in place for large volumes. A concrete ingot filled with cash can be maintained and guarded at either volume (as a for instance). Easy to break open after a year or two.

    It’s more of an issue in the middle. Turning a safe in an office into a vault. Turning a briefcase into a pallet. Fairly inconvenient tipping points for businesses that might need liquidity and access.

    And in either case, even if we think of discussions last year (http://goo.gl/nHFHLr) is the effect ever going to be more than a few basis points? It doesn’t sound like a major weapon in the armoury.

    What feels more significant is that the monetary situation has gotten to the stage where holders of large amounts of liquid assets might seriously debate burying cash in concrete ingots rather than putting it in the bank.

  3. This issue has been around for a long time. But the real reason for the continuation of the large denomination note lies in Germany.

    http://qz.com/262595/why-germans-pay-cash-for-almost-everything/

    The move to negative rates may have been the trigger for the latest development but the really interesting question is whether Draghi had his entire board onside before floating the idea. If he did, it suggest that Germany policymakers are agreeable to attempting to bring German payment systems into line with the rest of the EA and, indeed, the world.

    If so, a very welcome change.

  4. Martin Sandbu on negative rates.

    http://www.ft.com/intl/cms/s/3/b2898cd2-d3ef-11e5-8887-98e7feb46f27.html#axzz40cDM3uf0

    In short, the jury is still out. However, the euro can hardly be viewed as the sole culprit for creating the need for such rates.

    On the issue of large denomination notes, it is of course a political fact of life that consumers aka voters generally, and in Germany in particular, are whiter than the driven snow and when they make large cash transactions their motives for doing so are beyond question.

    It is not clear, however, how exactly reducing the black economy would increase economic activity although it would improve tax collection which, given the cost to Germany of the migrant/refugee crisis, must be helpful to a finance minister viscerally attached to balancing the German budget.

  5. “Absconding with the urine again are we, Colm?”

    “European Central Bank is considering whether its charge on bank credit balances should be increased to power up the incentive, that is, whether the negative rate should be even more negative.”

    Ah! Yes! Aversion therapy is always the ‘best policy’ – indeed. What we actually need, in reality, is for Big Pharma to synthesise a virtual, anti-aversion crystal syrup – in suppository formulation you understand, which would rapidly anaesthetize negative demand. Jizz up those pesky non-consumers it would. Now they can go out and spend, spend, spend ….

    “On what?”. “I dunno”.
    “With what?”. “Dunno again”. But its sure to work, ain’t it?”.
    “Ever hear of Snake Oil?. “Heh?” – What’s that?”.
    “No worries!”.

    The 500 is a symptom: nay the disease. But the best aversion therapies are actually successful failures. And they tend to be very heroic successes indeed. Folk ain’t averse to cash moolah though.

  6. It’s not just those devious bankers in Frankfurt that believe we should scrap banknotes.
    In a recent NBER paper Kenneth Rogoff argued that paper money has already entered the twilight zone and that we should consider more proactive policies for phasing it out.
    Outside the eurozone, a proposal to ban all cash transactions is being introduced ahead of the Danish election in September, in the hope that cash will be phased out as early as 2016.

  7. In case anyone missed these embedded links in the Martin Sandbu link above.

    http://www.ft.com/intl/cms/s/3/eab39a48-c860-11e5-be0b-b7ece4e953a0.html#axzz40kN4ueoh

    http://positivemoney.org/publications/digital-cash-why-central-banks-should-start-issuing-electronic-money-new-report/

    The rather obvious question that occurs to the non-expert is to ask why the question of the risk assessment associated with the creation of money by commercial banks (via loans crediting bank accounts) is, seemingly, being ignored?

    Would central banks, subject to constant pressure from politicians (assuming that they are independent of them in the first place) be better at it than private banks trying to make a profit for their shareholders?

    The fate of the €500 note is a side-show in the context of this debate. The arguments for dispensing with it, and cash payments in general, are obvious. It is a pity that only the most politically convenient one has been put to use. But this does not invalidate the other arguments.

  8. Bring on the helicopters!
    Loadsamoney for loadsa consumers….get the money go round up to top speeds…consumption…production…jobs…wages….inflation….
    Problems solved!

  9. I think many of us would be terrified at the prospect of an electronic-only currency controlled by the ECB, with it’s record of support for arbitrary policy behaviour. I expect it would give a boost among the general population to non-euro currency holdings, hard-to-trace cryptocurrencies and physical holdings of precious metals.

  10. Interesting headline from Wolfgang Munchau in FT today:

    “Concessions to Britain will create a two-tier Europe”

    …good lord – its been a 2-Tier Europe long before the Brits sought slow down the run away train the EU has become.

  11. May be of interest to some on this thread….

    Tracker Mortgages are back! I had an offer of one last week from BOI in the post. Happy days one would think but we all know 1. ECB rates even if they enter negative territory are unlikely to ever even go -0.5%. 2. Irish mortgage interest rates are about 200% above our European “partners”.

    As such I think it is fair to say this is pure scam territory we are in where BOI are effectively trying to lock customers into fixed rate “trackers” faced with the prospect that competition in retail banking could be about to return again and drive down that gap between European and Irish mortgage rates…..Buyer beware! I would at least have thought they would describe the product as something different but I guess its not a brand that existing holders would have a bad thing to say about it!

  12. Couple of points:

    1. Have the Irish political parties outlined their policies on taxation of negative interest rates yet?

    2. Central banks do not appear to have to tools to clip PHAU etc.

    3. 500 Euro notes are small fry compared to modern art in bonded warehouses.

    4. Gold is heavy, not voluminous.

    5. Of the many asset price valuation metrics widely used both formally via modelling and informally in strategy papers was the yield ratio. It was one of many, and a rival to the yield gap.

    It was so widely applied at one time, correction – for a very long time – that it is effectively part of the market’s subconscious, if there is such a thing.

    For equities you divide either the dividend yield or the index earnings, by the bond redemption yield.

    You pick the maturity depending on what you are focussing on, and you usually refer to government bonds – using corporates to factor in some credit risk was just for proper market geeks.

    I wonder how many current central bank governors have experience of using this metric for making investment decisions.

    Several European 10 year government bonds now have negative redemption yields.

    Yield ratio driven models would have driven many share prices through infinity and beyond.

    There are very significant distorting forces at work. For the moment those applying them can justify their actions by pointing to a mandate. At some point historians may look back at that mandate and wonder whether it was actually necessary or, for a number of years, realistically attainable.

    In Germany the argument is more readily made. They are wondering what eventual costs will have been associated with ECB determination to hit “close to but below 2%”.

  13. @docm

    BoI are cost cutting by making many branches almost devoid of staff and devoid of horizontal surfaces on which bemused customers can write out dockets.

    Its like something from candid camera.

    The expensive customers who cannot use machines are essentially being invited to go elsewhere.

  14. Again, on moving to electronic-only currencies, I don’t think any government has a legitimate interest in creating conditions under which the whole of any person’s transactions can be tracked in detail, whether or not it is the government itself that does it. It is nobody’s business but my own if I buy a case of Tayto crisps, a pregnancy test, a book on mindfulness, or a DVD of American Sniper. Like a perceptive check-out assistant at Tesco once pointed out to me on one of the many occasions when I refused the offer of a loyalty card, they can track me on my credit card anyway.

    I try to make sure I go through a few hundred euros in cash every month as a matter of principle, almost all on small stuff, so that a meaningful share of my spending is not recorded anywhere. It is of great importance to me that I should continue to be free to protect my privacy on day-to-day transactions by using a non-electronic payment technology.

  15. I think NPV doesn’t work near zero. Normally (remember back to normal, where rates were 4% plus?) a higher rate meant more risk and a lower rate meant less because ceteris was paribus and there was n limit to how much money was in the system. \but no rates are around zero and not because there is less risk. Because there is too much money that cannot earn a return.
    And that means increased risk, not reduced risk, So NPV is incoherent these days
    Same as most stock prices which are FAR too high given what bonds are saying.

  16. QE, ZIRP and NIRP all share the same characteristics. Never been tried before and don’t work. Central Bankers can’t reverse incoome inequality which is the driver of deflation.

    I find it amusing when consultants try to convince themselves that negative rates are normal.

  17. This is the best analysis of what is going on , imo . NIRP and ZIRP are just symptoms of a system that is broken.

    http://monthlyreview.org/2014/05/01/stagnation-and-financialization/

    “There is a strong built-in disposition in the system to overaccumulation, inequality, crises, and stagnation
    A kind of vicious circle is generated: (1) The inability to absorb a rising surplus held by corporations and wealthy households lowers growth rates and induces stagnation. (2) The vested interests respond to the slowdown by doing everything they can to increase their shares of the social product so as to maintain the rates of return on their individual capitals. (3) This results in an even greater concentration of surplus at the top of the economic pyramid intensifying the overall problem of surplus absorption”

    I was reading the SBP de Domhnaigh. Didn’t go anywhere near that. Some fund manager got page 27 to insist equities are grand. I don’t see anyone in the private sector looking at US income inequality as the reason why SnP sales have been flat since 2011 and why profits fell by 4.5% in Q4 15.

  18. @ Grumpy

    the discounting implications of NIRP are fascinating.
    We really are in uncharted territory. It is also clear that monetarism is banjaxed. Increasing the money supply does not necessarily generate inflation. I also wonder about all the debt on modern balance sheets.

  19. It isn’t that easy to hide anything over a grand or two in €50 notes, if you fold them into bundles of €500 and keep them in an envelope in the middle of a large stack of paper files, casually like. They form a lump and the experienced eye can spot the secret location at a glance. What you gain in convenience you more than lose in security. A larger amount in €500 notes could, I guess, be slipped unobtrusively between the pages of a novel. Burglars avoid bookshelves, as I know from experience. They probably remind them of school. This is not without risk, however, as a popular book (an autobiography, say, by one of our television personalities) might catch the eye of an idle visitor, or your wife. Something in German, say, or anything about the EU, would be a better choice. But it might get thrown out by mistake.

  20. @Grumpy, @Sarah Carey: “500 Euro notes are small fry compared to modern art in bonded warehouses”.

    True, but what about volatility/capital uncertainty/liquidity? I’d hate to rely on the art market for my pension.

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