Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Currency in circulation

The Chief Cashier of the Bank of England, Andrew Bailey, gave a
fascinating speech last month on
various aspects of currency in circulation in the UK. The key point is
that while cheques have been in terminal decline in the UK (see this
), cash has in recent years been growing not only in notional
value, but even as a percentage of GDP.

Bailey thinks that people are increasingly using cash as a store of
value (and not just as a medium of exchange) partly because of a lack
of confidence in the banking system and partly because at near zero
interest rates, the opportunity cost of holding cash is negligible. If
people are indeed stuffing cash under their mattresses, it tells us
how harsh the global financial crisis has been.

Another interesting point is about the quality of notes. In India,
ATMs typically give out better notes than the bank branches do, but
Bailey tells us that in the UK, it is the reverse. The new generation
of ATM machines can dispense notes so soiled that a human teller would
regard them as unfit to be dispensed. One almost hopes that India
remains stuck in the old generation of easily jammed ATMs that give
out relatively clean notes.

The most important point that Bailey makes is that “banknotes
are central-bank money in a form that can be held by the public, in
other words the retail equivalent of reserve accounts at the central
bank.” I would like to push this point further – if
technology allows electronic accounts to be maintained at near zero
cost, should not the central banks provide electronic reserve accounts
to all citizens? As India moves toward issuing a unique identity
number to every citizen, would it not be nice for each such number to
be linked to a no frills account at the RBI?

Why in other words should only the rich and powerful institutions
have access to central bank money? When a variety of tax laws and
money laundering laws attempt to prevent the use of central bank money
in the form of cash, should they not then facilitate the use of
central bank money in the form of electronic reserve accounts at the
central bank?

The shocking thing in finance is that financial markets settlements
do not reach the highest standards of DVP (delivery versus payment)
– simultaneous and irrevocable payment in central bank money. If
you go to a grocery shop, pay for your purchases in cash and walk out
with your goods, the transaction conforms to the highest standards of
DVP because cash is central bank money. In most financial markets on
the other hand, we do not get this level of DVP because the settlement
systems do not settle in central bank money. This is a shame.


3 responses to “Currency in circulation

  1. Ted K January 11, 2010 at 5:25 pm

    Like your blog. I especially liked your thoughts about Clearinghouses vs Registered Exchanges. I wish more people would discuss and write about that, because I think it’s only a matter of time before CDS will cause problems again.

  2. Vishnubharath M March 31, 2010 at 4:36 am

    A nice blog. I stumbled upon this when I reached for my mobile in the wee hours of the day during my preparation for the civil services.
    I can’t say(write) much as I am typing on my non-QWERTY mobile. Let us start a blog to bring abt economic equality

  3. Financialspreadbetting May 31, 2010 at 3:06 pm

    I can well believe it is the risk think. There is a surprising number of people without bank account in the UK. I believe (don’t have the stats to hand) that there are over 2 million people who do not have a bank account. That could explain some of it.

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