Monetary policy, or primarily the manipulation of Interest Rates, is the framework by which Central Banks target economic growth and inflation. In order to reverse the 2008 credit crisis of the Great Recession, central banks have cut interest rate policies to unprecedented historic depths.
As the Fed has attempted to restore interest rates closer to pre-Crisis levels, stock markets have trembled. In an economic downturn, Central Banks attempt to revive credit paralysis by cutting interest rates. According to the International Monetary Fund, “Severe recessions have historically required 3–6 percentage points cut in policy rates.”
With the highest major central bank interest rate being the Federal Reserve at a mere 2.5%, and despite being ten years into an equity bull run, traditional Monetary Policy will inevitably struggle in the event of another severe recession. As rate cuts alone were insufficient to reverse 2008’s Great Financial Crisis, central banks of the world devised new forms of Unconventional Monetary Policy.
Alongside Quantitative Easing, multiple central banks set Interest Rates into negative territory, for the first time in history. In such a world of Negative Interest Rates, citizens who save are penalized heavily. While inflation itself is considered a penalty for saving cash, negative interest rates harm savers even further. Advocates suggest that in a severe credit crisis when spending is utterly paralyzed, negative interest rates are the only way to discourage hoarding and spur investment. In the event of a economic downturn, Federal Reserve officials have even discussed its possible implementation in the United States:
Can you imagine a world where, in addition to inflation, your Savings Account depreciates an extra 2–4%?
Decades of easy Monetary Policy by global central banks may have made such a future inevitable when the next recession hits. Failure to raise rates above the 3–6% percent rate necessary to cut to fight recession, has sabotaged the traditional toolbox of central banks. Economic institutions such as the IMF are actively preparing for such a future by drafting extensive policy research for this future economic scenario.
One of the concerns with negative interest rates, is of course, how would states enforce it? If your bank account is taxed an extra 2–4%, wouldn’t you just convert entirely to cold hard cash- where you can avoid the state’s surveillance and no one would ever know? Sweden, a world leader in negative interest rate policy (having held at nearly -2% for years) is naturally also the world leader in transitioning to a cashless society.
The research proposal by the IMF accounts for such a loophole when citizens convert to cash in a negative interest rate environment. In fact, the IMF proposes a so-called “dual currency” system in which physical cash and e-money are separated. Cash conversions would be heavily penalized, and physical cash would depreciate against e-money at the same annual rate as negative interest rate bank deposits.
As Sweden is the pioneer toward this strange economic future, it is fascinating to consider this interview on the effects of Sweden’s Cashless Experiment, hosted by UPenn:
An advantage of a cashless society is that it will be easier to trace criminal activities and we might be able to block some of them. The disadvantage is that everyone can be traced. We will be more traced than we are today. We will lose our privacy.
As citizens transition entirely to digital bank accounts directly administered by the state, a true surveillance society will result. Physical cash has countless privacy advantages and is the criminal’s tool of choice for bribery, laundering, tax evasion, and drug running. In unison with a negative interest rate environment, a cashless world will be a drastic societal change. For better or for worse.
What will be most fascinating is to see how such a world affects Bitcoin: the so-called “Peer-to-Peer Electronic Cash” that was borne from the ashes of Unconventional Monetary Policy in 2009.
If inflation, state surveillance, and negative interest rates make sovereign currency holders suffer, there will likely be an increasing incentive toward the ideals of Bitcoin. Peer-to-Peer Electronic Cash that is many ways outside of the realm of state control will become more appealing to citizens in an oppressive economic environment, naturally. And in spite of its major current technological limitations.
If a severe recession does occur to incite such drastic economic measures, and Bitcoin’s popularity, technology, and privacy capabilities increase, sovereigns will inevitably invent new mechanisms for capital control. Bitcoin exchange, or at least legal exchange, will be taxed heavily at an equal or greater rate than negative interest bank accounts or physical cash. Yet it is a certainty that in the event of drastic economic environments such as described above, citizens will search with determination for any possible alternative store of value. Or better yet, they may search with greater determination for tools that support Bitcoin as a truly permissionless, peer-to-peer currency.
So it will be fascinating to watch how central banks respond in the face of the next financial crisis. Even more important will be how citizens respond.