The Cash Paradox? Is It All About to Change?

Both before, during and since the two years of COVID, the industry has become very aware of what has become known as the cash paradox, identified as the continued growth of cash in circulation compared with a country’s GDP, despite its declining use for payments.

Some central banks have done their best to identify where the cash is but haven’t been able to do so with any degree of certainty.

They do know where it isn’t – ie. in daily use for payments, since there is data on that.

The general view is that the large volume of cash not in daily circulation, ie. that issued but not active, is in store somewhere, held as a reserve for an emergency. The cost of holding cash with very low or even negative interest rates has, up until now, made this an attractive option. As has low inflation.

But with the end of most COVID restrictions and a rebound of economic activity, there have been universal shortages of a wide variety of products and components. With global supply chains disrupted there continues to be a reduction in the output of both industrial and retail products. Chip shortages are having a serious impact across a wide range of industries. Closer to home, higher prices for metals used in coin manufacture has led in some instances to negative seigniorage.

Then Russia invaded Ukraine, which has not only exacerbated shortages of raw materials and food, but also of gas and oil due to sanctions imposed. Most thought the invasion of Ukraine would be over quickly, but four months later the Ukrainians are still mounting a staunch defence.

The fuel crisis has deepened, prices for oil and gas are rocketing, in turn driving up prices. Added to this, Ukraine and Russia are normally major exporters of grain and other food products along fertilizer, glass and metals, all of which will be in seriously short supply.

Sharply rising prices

The result is sharply rising prices with a commensurate reduction in purchasing power, especially for the less well-off. Company values have fallen substantially as investors dump stocks before they fall further (see Industry Watch). Inflation is predicted to exceed 10% in parts of the world that have become accustomed to low inflation. Central banks are reacting by increasing interest rates.

All of this could tip economies into recession – indeed, this is being widely predicted. We are in a period of significant economic uncertainty.

What does this mean for cash?

What does this mean for cash usage and cash in circulation? Will those people having to manage on less money after paying more for essentials such as energy and food turn to cash as a means of budgeting? This is a well-known phenomenon. Credit card interest and borrowing rates are already increasing and credit may not be available or affordable. This could also drive people back to cash.

Furthermore, given the need by some for money to pay the bills and feed the family, will cash held as a reserve now be spent? With interest rates and inflation rising, will people choose to bank their cash reserves to invest them in an attempt to retain their value? What happens if the significant stocks of cash held as a store of value, particularly high denomination notes, swiftly return to central banks and are swapped for lower value denominations? If people move to harder currencies experiencing lower inflation than in their home country, what could be the impact on local currencies?

And in those countries with rapidly depleting bank branches and ATMs, will a return to cash slow down the rationalisation?

COVID accelerated the trend towards digital payments and away from cash. Now we have several factors with the potential to increase the use of cash for transactions but reduce cash held as a store of value.

We have become used to low interest rates and economic growth. But if the economic situation continues to deteriorate, the current norms and assumptions about cash could be overturned.

Time will tell, but it probably won’t be long before we find out.