One of our readers was kind enough to pass on an article that appeared in the Wall Street Journal titled, “The Sinister Side of Cash” by Kenneth S. Rogoff. In sum, the article mentioned various manners in which cash is an enabler of crime. The following are examples of such crimes:
- racketeering – a gang slices car tires on all cars in a neighborhood, the gang then offers protection to the neighborhood residents from the tire slicing for a cash fee of $200. Two crisp $100 bills keep tires inflated.
- extortion – wealthy married woman is seduced by a young charismatic man. The man then requires a $20k payment in order to withhold the information of the illicit affair from the wealthy married woman’s husband.
- money laundering – a drug lord owns a local professional sports team, said drug lord takes all the cash received from illegal drug sales and inflates the number of actual seats sold in the stadium from 45,000 to 55,000 and shows that the additional 10,000 seats were sold for cash. This cash is then deposited into the professional sports team’s bank account and illegitimate funds become legitimate funds. Human trafficking proceeds can be in hidden by similar processes.
- corruption of public officials – the mayor of Whoville receives a bribe of $20,000 in cash to allow, a business owner, the payer of the bribe to receive a public grant of $50,000 to grow their business.
- terrorism – a sleeper cell terrorist quietly makes cash purchases of bomb supplies, black market weapons, and executes a terrorist attack.
- tax evasion – a convenience store chain owner receives over half of all revenues in cash and instead of reporting the entire amount in cash, said owner cuts the cash receipts in half and reports this number to the IRS.
What do all of the above crimes have in common? They don’t really work without cash. Just imagine trying to sell a kilo of cocaine but only accept credit cards. It is clear that such a sales process would quickly raise flags with the authorities and put both the seller and the buyer in a complicated situation of explaining away the records of these transactions.
Rogoff argues that the Federal Reserve should significantly reduce the cash supply in the U.S. economy. He contends that we should first do away with $100 bills and then move to $50s, $20s et cetera. A couple arguments against such measures are the slow pace of non-cash payments and the need for quantitative easing in times of financial crisis. This is where the Central Bank buys government securities or other securities in the market in order to increase the money supply, reduce interest rates, and induce banks to lend more freely. How would a central bank perform this function if we didn’t have cash?
Currently the Federal Reserve is working on an faster payments initiative. Such an initiative seeks to address the slow settlement process of payments based on our financial system’s existing payments infrastructure. Unless you are a merchant of some kind you probably don’t think about how slowly funds move until you try and cash a check. But as a merchant you are subject to these slow payment processes every time a payment is made with a credit card, generally these payments are not received for 2-3 days (when the payments are local). Why so slow you may ask? See the below.
When a cardholder goes to make a payment, from their perspective the payment is made instantly and all is well in the world. But wait, what really happens? What really happens is that the payment card is only pre-authorized for the amount of the purchase. The merchant performs the authorization through the payment card network (the settlement bank) and receives payment days later from the acquiring bank. The acquiring bank represents the merchant in the process while the issuing bank represents the consumer or cardholder. The actual payment is made by the issuing bank to the acquiring bank who ultimately pays the merchant. Let’s break this into steps that follow the numbers in the graphic above:
- The merchant accepts the payment card and swipes it to authorize the payment.
- The authorization request is routed through the payment card network or the settlement bank (e.g., Visa/MasterCard) to the Issuing bank.
- The issuing bank validates availability of funds and responds to the authorization request.
- The merchant records and stores the authorization response from the issuer and later runs a process to request payment from the Issuer.
- The issuer receives a request for payment and directs the funds to the acquiring bank for ultimate payment to the merchant.
The process of moving the money from the Issuer to the Acquirer and ultimately to the merchant is usually done in 1-2 banking business days. Throw a weekend in there and you are at 3-4 total days. Sounds complicated right? Wouldn’t you think you could digitally exchange cash at fiber optic speeds i.e. practically instantaneously?
Venmo, Paypal, and other peer-to-peer payments platforms can speed up the funds transfer process between consumers when there are transferring closed loop value, or payment of value on Venmo to another person receiving value on Venmo but the moment they move the value outside of the Venmo system it is going to take 2-3 days for the value to arrive in an outside account (following a similar process to that above).
What if we don’t need traditional cash at all? What if the Federal Reserve issued authoritative digital cash that is completely trackable and traceable. This type of a bold move would simplify our current payment settlement system, reduce cost and allow un-interrupted flow of digital cash from person to person to business to business. Consumers could make small cash payments at low, perhaps negligible cost and high convenience and would start to build in information for government programs that could assist in banking the unbanked and underbanked. The best part being that we could all simply use our mobile phones to carry this value. In the U.S. we are at 79.3% smartphone penetration. Mobile phone penetration is at 115.7% meaning that many people have more than one connected device. For the small fraction of people that may not have a mobile phone issuance of a feature phone could be a part of our welfare programs. The Fed spends roughly $600,000,000 a year on processing, paying, receiving, verification, destruction, transportation, and non-standard packaging of physical cash. $600mm buys a lot of phones. If the number of people in the U.S. without of mobile feature phone is between 5-10% of the population, the government could do away with physical cash and buy a low end feature phone for everyone who does not currently have one.
Let’s take this a step further. Once the Fed is issuing digital cash, wouldn’t it be nice if they stored the transaction history for the Fed in a blockchain? For those that haven’t previously read this blog, a blockchain is a digital ledger that has inherent controls to keep the history of the ledger from being altered. Imagine how much more comfortable the people of the United States would feel if they could track quantitative easing down to the dollar. Not to suggest that all people using the Fed’s digital cash would have a public transaction history, but a blockchain shows public keys (an alphanumeric identifier) for all users, and if the Fed was regulated to disclose their public key, the collective populace could keep tabs on the Fed and their actions. Also, if we knew that Wells Fargo received a bailout of $25b (circa 2008) and was required to use the digital cash system for use of the bailout funds, we could track the use down to the dollar on the blockchain. This wouldn’t stop a bailed out bank from a “corporate laundering of funds,” (using the bailout funds in the manner intended, i.e. free up credit markets while using corporate funds to pay bloated executive bonuses) but at least the bailout funds would go where they were intended. I digress.
The point is, authoritative issue of digital cash by the Federal Reserve would strangle cash based criminal activity, speed the U.S. payments system, and maintain the power of the Federal Reserve to perform quantitative easing in times of national fiscal duress.