Evan Soltas has a very good post on the surprisingly low interest rates observed in several European countries. He points out that there are significant costs of holding currency:
But nobody really seems to have a good handle on what the new, negative lower bound might be. So how much would it actually cost, I wondered, to store $10,000 in currency for a year?
This seems to me a decent, and admittedly entertaining, way of getting a rough estimate of a lower bound. I picked $10,000 because it’s about twice the average balance of a savings account in the U.S., giving me a conservative estimate of the average percentage cost.
A safe deposit box at a bank seems to cost around $100 a yearafter insurance. Then the average cost of storing currency is about 1 percent annually — maybe a bit more if you buy a safe.
Yet, rather obviously, having $10,000 in a deposit box is not the same thing as having $10,000 in a bank account. You can spend from your bank account using a credit card, or you can go to an ATM and withdraw cash. You can’t do the same with a safety deposit box.
How much is that convenience worth? It seems like a hard question, but we have a decent proxy for that: credit card fees, counting both those to merchants and to cardholders. That’s because the credit-card company is making exactly the same calculus as we are trying to make — how much can we charge before we make people indifferent between currency and credit cards? The data here suggest a conservative estimate is 2 percent annually.
So my rough guess is that the average depositor is probably better off keeping their money at a bank up to a nominal interest rate of -3 percent annually. (This is also what other people said, in an extremely informal poll, would be the most they would accept.) But, from an economic perspective, what we really care about is the marginal depositor — that is, who has the lowest cost of currency storage?
And here, I am at a loss. Are there are efficiencies of scale in currency storage? What does the marginal cost curve for currency storage look like?
I’ve only seen safety deposit boxes in pictures, but I’d guess they could hold considerably more than $10,000, in packets of crisp $100 bills. Maybe $100,000. On the other hand there are risks such as fire and theft, which don’t occur with T-bills. But even those risks may be fairly low. So I think Evan is correct to emphasize the convenience factor. However, Paul Krugman raises some other good points:
In normal times, we invoke the convenience of money — its extra liquidity — to explain why people hold money at zero or at any rate low interest rates when there are other safe assets offering higher yields. We think of money demand as determined by people increasing their holdings up to the point where the opportunity cost of holding money, the interest rate on other safe assets, equals its utility from increased liquidity.
Once interest rates on safe assets are zero or lower, however, liquidity has no opportunity cost; people will saturate themselves with it. That’s why we call it a liquidity trap! And what this means is that the marginal dollar of money holdings is being held solely as a store of value — the medium of exchange utility is irrelevant.
I like this argument, but I have a nagging feeling that Soltas must be right about the convenience factor. I just can’t think of any other reason for the surprisingly large negative rates in Europe. So let me throw out one other way of thinking about the vague term “convenience.” Here are some things you should know about currency:
1. Bringing more than $10,000 in cash into the US triggers alarm bells at the border.
2. Taking more than $10,000 in cash out of a bank triggers alarm bells. Indeed frequent cash transactions of $5000 can be enough to trigger a report to the government, under the “know your customer” rules.
3. If you are pulled over for a missing taillight and have an envelope with lots of cash in your car, the police in the US can seize the money. If you’ve committed no crime and are willing to spend a lot of money on attorneys and many months of your time, you can eventually get the money back. But it’s very costly to do so.
Just to be clear, there is no law against holding large amounts of cash in the US. But the government considers it to be a sort of quasi-crime, evidence of wrongdoing. They strongly dislike people who deal in large amounts of currency.
Why should it matter if the government is very hostile to your behavior, as long as you’ve committed no crime? It shouldn’t matter, but let’s not be naive. If you are a wealthy person or a business, it’s almost impossible to go through life without breaking laws. The tax code and other regulations are so complex that wealthy people and businesses are easy pickings for any prosecutor that wants to make his name nailing the next Michael Milken. (Disclosure: I’ve gone through life with just one email account, and today I find out that you aren’t supposed to use your job email for personal use. Hillary, I feel your pain.)
I may be totally off base on this, but I’d like to hear from people that work in the investment banking world. How would your boss feel if you suddenly suggested investing billions of dollars or euros or francs in currency, and then storing this currency in hundreds of safety deposit boxes? And suppose you justified this investment on the basis that the return would be higher than you’d earn on government debt? I suspect the idea of all that currency would give most big institutions a queasy feeling, and would make wealthy individuals worry that the government might begin to take a very close look at their books . . . if you know what I mean.
What do you think?
PS. Back in the old days it was acceptable to hold large amounts of currency, indeed banks held $100,000 currency notes. That was before the US government criminalized all sorts of business behavior that used to be acceptable. Perhaps that’s why even during the worst of the Great Depression, the interest rate never went more than one or two basis points negative, if my memory is correct.
PPS. I also recommend Alex Tabarrok’s post on the police in Ferguson, which shows that innocent low-income blacks and Hispanics also have plenty to fear from the police. The people with the least to fear are academics, government bureaucrats, and others of that type. No wonder they are so naive about the downside of big and powerful governments.