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The British cash gap

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Central banks and criminals are colluding to grow the shadow economy, which seems mad to me, because the seigniorage income from the circulating medium of exchange is a fraction of the tax gap it stimulates. Surely we should have a plan to do something about this?

In my recent book… wait, did I mention that I have a book out? It’s called “Identity is the New Money” and it is available from all good bookstores… I point out that there is a growing “cash gap” in developed economies as the amount of cash in circulation races ahead of economic growth.


In a superb new paper, the economists Jonathan Ashworth and Charles Goodhart delve into the fact that this is also true for the UK.

It is a remarkable fact that the ratio of currency to GDP in the UK has been rising, despite the greater use of card and online payments (see Figure 1). The currency-to-GDP ratio now stands at 16.1%, compared to 13.3% in Q4 2007.

[From Trying to glimpse the ‘grey economy’ | vox]

In their detailed examination of the statistics, the authors make a clear distinction between the “black economy” (e.g., drug dealing and money laundering) and the “grey economy” of activities that are legal but unreported in order to evade taxation. When your builder offers you a discount for cash and you pay him, you are participating in the grey economy. When your builder offers you crystal meth and you pay him, you are participating in the black economy. They define a total “shadow economy” as the sum of the black and grey economies. This shadow economy is growing and is costing billions (which mortgage-paying, PAYE-slaves like me have to make up for with our taxes).

Patrick Stevens, tax policy director of the Chartered Institute of Taxation, said: “These figures suggest that tax evasion and other illegal activity are costing the Exchequer nearly five times as much as tax avoidance”.

[From UK tax gap climbs to £34bn –]

Hence the question as to whether the amount of cash in circulation might be in some way related to the shadow economy and me being taxed up the rear-end to to provide services to self-employed tradespersons whose income comes in just under the income tax threshold? Are there other explanations? The authors note that there was a jump in the amount of cash in circulation around the time of the global financial crisis (which might be expected as the public saw television pictures of customer queuing to withdraw their money from Northern Rock) but that it did not fall back after stabilisation. Thus, they ask, is the amount of cash still high because the general public are concerned about the safety of banks (hint: no) or are there correlating indicators of a growth in the grey economy (hint: yes, ranging from the growth in self-employment to VAT increases and, hence my earlier example, housing repairs).

Just to illustrate what is going on here, I took the latest figures that I could find and made them into a chart similar to the one above but showing the actual figures for the UK. As you can see, the jump that Jonathan and Charles talk about is clearly visible but the decade-long trend lines are the same as for the US: the amount of cash “in circulation” is racing ahead of the growth of the economy.

Relative cash and economic growth, UK

Charles and Jonathan refer to an older paper “Is Cash Becoming Technologically Outmoded? Or Does it Remain Necessary to Facilitate “Bad Behaviour”? An Empirical Investigation into the Determinants of Cash Holdings” (London School of Economics: 2000) that looks in detail at the substitution of cash at retail point of sale (POS) and shows that ATMs and POS terminals have an impact on the demand for small notes but overall, and I think this is a really interesting and important point to bear in mind, the central conclusion is (as they say) “on our evidence, the effects of modern payment technologies on the demand for cash are not that strong”.

Wow. That’s huge. In essence, it means that the demand for cash from central banks is not to support the economy but to support crime. We need to have some joined-up thinking and it is time we tackle the issue of cash and criminality head-on.

Lots of shady activity may also be bad for growth. Shadowy firms find it hard to borrow, which limits their productivity. According to Francesco Pappada of the Einaudi Institute of Economics and Finance many small firms in Greece deliberately avoid taking out loans because it involves being more transparent. Unproductive firms pay low wages.

[From Greece’s shadow economy: The treasures of darkness | The Economist]

But back to the point. Charles and Jonathan’s work (which estimates that the UK economy is significantly bigger than shown in official figures) seems to me to explain the growing tax gap in the UK as well as some other strange economic behaviour around the labour market. Now, in a talk about electronic money that he gave a couple of months ago, Charles was kind enough to refer to some of my thinking around “privacy money” as a way forward so I’m going to promote some ideas around that to our clients in the payments world to see if there is a win-win around the corner.

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