Home / Opinion / Columns /  Excess cash in circulation has both winners and losers

Here is a stylized fact that never goes out of fashion. More than 85% of the value of all currency in circulation issued by the US is in $100 bills. And of those, eight out of ten bills circulate outside the US. This ‘fact’ is based on empirical estimates since exact data is almost impossible to capture. High-denomination notes of the US are more useful to foreigners transacting among themselves than to residents of America. A 1996 research paper published in the Federal Reserve Bulletin estimated that between $200 billion and $250 billion of US currency was abroad, out of $375 billion then in circulation outside banks. That was more than half of all currency. This has been steadily rising since then and has been verified by other researchers as well. Foreign demand for US currency has grown three times faster than domestic demand. This confirms the maxim, “In the almighty dollar we all trust." The changing geopolitical landscape of present times and tendency of central banks to diversify away from the US dollar might change some of the above statistics. Why foreigners continue to trust the dollar or why much of all global invoicing is still in US dollars is a topic for another column.

In 2022, America’s M2 measure of money supply, i.e. cash in circulation plus current and savings accounts, is roughly $22 trillion, twice that of 2011’s figure. That implies an annual growth of 7%, much higher than US growth in gross domestic product (GDP).

Last month, the US recorded retail inflation of 8.3%, its highest in the past 40 years. High inflation will persist this year, and possibly next as well. Core inflation, which excludes volatile components of fuel and food, is at 6% in the US, more than double the normally accepted number. This inflation is the result of a massive expansion in money supply over last decade-and-a-half. This inflation was not manifest because it lay hidden in stock market bubbles and in inflated housing values. But after the pandemic, and in the wake of the war in Ukraine, inflation has spilt into goods and services as well, and is now generalized across product and service markets. It will soon lead to demands for pay increases, which could possibly cause a wage-price spiral.

The gainers from a rapid expansion of money, especially currency in circulation, are issuers of debt, mainly the federal government of the US. The seigniorage income from the issue of currency, i.e. the difference between the cost of printing cash and the face value of currency, is quite significant. It might very well be 3-4% of total federal spending. This is thus a real gain to the federal government.

Another way to understand the phenomenon is as an erosion in the purchasing power of those infamous $100 bills circulating abroad. At America’s current inflation rates, those bills are eroding at about 8% per annum. That is a transfer from currency holders to debt issuers. This is called the ‘inflation tax’, which is a freebie for the US government. This tax is even more pernicious than regular taxes since it is also paid by non-citizens (i.e. the large number of foreigners holding US currency), which can be seen as taxation without representation.

Seigniorage income and collections of this implicit inflation tax are always a tempting option for governments, since they don’t need to announce a politically unpopular increase in tax rates. It is a silent tax that is diffused across all sections of society and inflates away the government’s debt burden without any announcement.

In India, too, we have seen a big expansion in money supply in the past few years, as a consequence of very accommodative monetary policy. Also, remarkably, the currency in circulation has gone from roughly 13 trillion in 2016 to 30 trillion in 2022. That is a shocking 15% growth per annum, much higher than even nominal GDP growth. And this has happened despite the big shock of demonetization and the attendant growth in digital transactions.

How much of this money expansion has led to inflation in India is anybody’s guess. But it can be nobody’s case that Indian inflation is not a monetary phenomenon. Since the Union government is the country’s biggest borrower and largest indebted entity, it is the predominant beneficiary of any inflation tax imposed by an expansion of currency. Cash in circulation has seen excessive growth also because of the Centre’s direct cash transfer mechanism, which now covers more than 50 subsidy schemes. The ‘stickiness’ of holding onto cash has meant a slower growth in bank deposits, leaving less room for credit expansion. Now that the interest rate cycle has turned and we are in a tightening phase, rate hikes will bite private sector borrowers like home-loan takers, working capital requirements and factory expansions.

Meanwhile, precautionary and transaction demand for cash has gone up, even though cash in one’s pocket experiences value erosion at the rate of inflation. Companies that handle cash management say that cash usage is growing at a staggering pace, especially in rural areas. Some payment banks have doubled their business and client base over the past year.

Even as UPI transaction volumes rise and India inches towards a less-cash society, the lure of cash remains. It not only offers anonymity, it is immune to bandwidth or electricity problems. Those on the wrong side of the digital divide feel more comfortable with paper notes, be they crisp or soiled, even though they suffer the value erosion of inflation. Cash is still king. At least for now.

Ajit Ranade is a Pune-based economist

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