The demonetisation of cash

Good news on the Brexit front. Britain’s economy hasn’t imploded.

UK unemployment from March to May was actually down 54,000 compared to the previous quarter, according to data released this morning by the Office for National Statistics (ONS). A record 74.4% of Britons are in the workforce. But are they making more money?

The ONS says earnings – not adjusted for inflation and excluding bonuses, mind you – were up 2.2% compared to last year. Chuck in a low level of inflation and a lot of earnings growth vanishes. Still, on the bright side, there are 23.19 million British souls toiling away, day by day, for the chance to improve their lives.

This data is all pre-Brexit of course. Long-term uncertainty about Britain’s trade relations with the EU and the rest of the world may lead some firms to freeze hiring. We just don’t know yet. But we do know that all the threats of an immediate and dire collapse should Leave win were… empty.

The cash exchange

International and government agencies that predicted Armageddon have begun licking their wounds publicly. I’m talking about the Bank of England and the International Monetary Fund. Both delivered their first “after action” reports on Brexit earlier today. I’ll get to them in just a second.

But first a note I ran across this morning on whether (and how) the Swiss might “demonetise” the thousand-franc note. Such a process, in addition to banning new notes of that size, would require you to come in and exchange your old cash for new cash (with smaller notes). The Swiss could also make a “windfall gain” of about 5% of GDP by extinguishing the liability represented by the notes. Professor Jayanth Varma explains (emphasis added is mine):

After falling for decades, Swiss currency in circulation started rising after the global financial crisis and is now higher than at any time in the last 35 years. Notes in circulation are now well above 10% of GDP and the 1000 franc note accounts for 62% of this or over 6% of GDP.

As Swiss interest rates remain in highly negative territory (-0.75% at the short end and negative all the way to 30 years), the extremely high denomination of 1000 franc note has become very attractive to investors. It is conceivable that if this environment persists, Swiss currency might approach 15% of GDP and the 1000 franc note might by itself edge close to 10% of GDP.

Unlike the ECB which retained the existing notes as legal tender, the Swiss could require holders of the 1000 franc note to exchange them for lower denomination notes or bank deposits. I am not talking about an outright default. The Swiss could start by citing the decision of the European Central Bank (ECB) last month to ‘permanently stop producing the €500 banknote … taking into account concerns that this banknote could facilitate illicit activities’.

They could say that in accordance with global best practices, they too are abolishing the 1000 franc note. Unlike the ECB which retained the existing notes as legal tender, the Swiss could require holders of the 1000 franc note to exchange them for lower-denomination notes or bank deposits.

Fascinating, isn’t it? The war on cash has proven unpopular with the public. Governments have had to start with large denomination notes and equate their use with criminal activity. It’s a beachhead. But if the professor is right, what’s to prevent any government or central bank from requiring you to exchange “old” cash for “new” cash?

The war on savers

Since I’m in a martial frame of mind today, let’s talk about yet another clandestine war. Or is it a casualty? A kind of collateral damage deemed acceptable in yet another war; the war on deflation.

I’m talking about paltry yields on high street savings accounts. Some British investors are getting 0% interest on their savings, according to a report released yesterday by the Financial Conduct Authority. You can see the grim facts below, courtesy of the FCA’s report.

Source: Financial Conduct Authority

You can blame the banks if you like. But don’t forget to blame the central banks too. Since 8 June, when its corporate bond buying programme began, the European Central Bank has purchased more than €10.54 billion worth of investment grade corporate debt. The result?

Falling yields! Income investors looking for a yield – a yield, a yield, my portfolio for a yield! – are getting hammered. Central bank bond buying drives bond prices up. But it puts investors in the position of having to become speculators to find an income. And the last thing you want to do, if you’re investing to generate an income, is put more of your capital at risk.

A discussion of the moral perfidy of central banks is beyond the scope of today’s letter. But let’s just say I could write a novel about it. Instead, I’ll write to you tomorrow about what you can actually do to find an income.

BoE on Brexit

Finally, the Bank of England has an actual report it calls the “Agents’ Summary of Business Conditions.” It’s a survey conducted by the bank’s not-so-secret agents to see how things are going in the real world. You have to come down from the ivory tower once in a while, don’t you? The bank’s latest summary concluded this (emphasis added is mine):
Following the EU referendum, business uncertainty had risen markedly. Many firms had only just begun to formulate new business strategies in response to the vote and, for the time being, were seeking to maintain ‘business as usual’. A majority of firms spoken with did not expect a near-term impact from the result on their investment or staff hiring plans. But around a third of contacts thought there would be some negative impact on those plans over the next twelve months. As yet, there was no clear evidence of a sharp general slowing in activity.

There you have it. Uncertainty, yes. Calamity, no. The long-term awaits.

Category: Market updates