Investment Strategy

Protecting yourself from the war on cash

The war on cash continues. More and more establishment voices can be heard advocating that it’s phased out in Europe and the USA. Earlier in the week we looked at the real reasons for that: mainly government control of the masses. Today we turn to what to do to protect yourself, and even profit.

We tend to take it for granted. It’s easy to forget how handy it is. Even financial experts – or perhaps especially those experts – don’t give it a second thought. But physical, paper cash is useful stuff.

Young kids are taught the benefits of saving and delayed gratification using cash. And grandparents find it an easy way to make gifts.

…cash receipts are eight times cheaper to handle than debit card payments and 30 times cheaper than credit cards.

Small businesses find that cash is a lot cheaper to handle than accepting payment by bank cards, which come with fees attached. A recent survey done by the British Retail Consortium, a trade body, found that cash receipts are eight times cheaper to handle than debit card payments and 30 times cheaper than credit cards.

Seasoned travellers know that cash is always accepted when credit cards fail. In many countries you’ll get a bigger smile when you pull out euro or US dollar bills than the local variety.

And now a quick apology. This is a complex subject, so today’s article is a tad longer than usual. But I think it’s worth it to get to grips with the potential ways to protect yourself and your savings.

Savers in countries with high inflation – which is to say fast depreciating currencies – but without high enough interest rates on deposits to make up the loss of value can turn to foreign paper. Savers in Argentina between 2011 and 2015 – with it’s complex mess of multiple exchange rates and capital controls – turned to US dollar bills to protect their savings. It worked.

Cash can also be good in an emergency. A couple of years ago my father was suddenly taken seriously ill. He’d always dealt with paying most of the bills, and my mother didn’t know what to do. I made a trip to the bank and delivered here a modest stack of notes. Her immediate worries about how to pay for necessities went away.

But paper cash places a limit on government and central bank control. In most places the authorities have a monopoly on issuing the stuff, even if they can’t stop bills of other currencies from creeping in.

Now they also want the power to keep money in bank deposits, which fund the banking system and keep credit creation alive. Desperate times mean desperate measures.

Over-indebted developed countries have more or less reached the zero bound with interest rates. Now they want to fully go for broke and take rates negative. Many trillions of government bonds already trade with negative yields.

The next step in this vain attempt to get growth going is to have negative interest rates on bank deposits. But if they do that, then many deposits will be switched into physical cash. Zero percent is better than minus percent.

So the exit must be blocked for the authorities to get their way. Cash must be phased out, starting with the biggest notes, and eventually could be banned altogether.

If one country gets rid of cash, but there are people that still want to use it to save and transact, the most obvious thing is to simply use another country’s notes. If there are no more physical euros there could still be Swiss francs. Japanese yen could be replaced with Chinese renminbi yuan. US dollars with the Canadian kind.

Obviously this means taking on currency risk, and betting on foreign currencies is not usually a good idea – especially if the issuing country is bankrupt, which is to say most developed countries. But there’s plenty of precedent for using other countries’ money, especially if your own isn’t to be trusted. US dollars are accepted in much of the world.

A better idea could be to get hold of some of your home country’s cash now, before it’s too late (assuming you’re not in a high inflation country with a fast depreciating currency). If it really looks like the US will stop printing 100 dollar bills then get some now. The same for larger denomination euro bills, or the 500 or 200 varieties.

Once these larger bills aren’t printed any more they may even attract a small premium. The supply would slowly shrink as the huge stock of bills get paid into banks and retired from service. But demand could continue to grow, since it’s more convenient to store and transport cash with large denomination bills, which take up less space.

Could the US$100 bill one day be worth US$105? It’s certainly possible. After all, stranger things are happening – such as negative bond yields and the prospect of negative interest on deposits.

Of course, this approach may not work for long. Eventually governments may go beyond simply ceasing to produce notes. Instead they may insist that notes – especially the larger ones – will have a sell-by date. After a certain day, on a certain month, in a certain year they may become worthless.

Even then it’s not clear that they would actually become worthless. A few years ago I remember reading about somewhere in Africa or the Middle East that was still using notes that were long “obsolete” – as in the currency didn’t even officially exist any more. But the paper was still readily accepted in transactions. (Unfortunately I couldn’t work out where it was for this article. If you know then I’d be interested in hearing from you at the email address at the end of this article.)

After all, fiat currencies are already inherently worthless (see here for an explanation). But they have a value in the same way that a messaging app like Whatsapp has value, because of the network effect.

What that means is that the more people use a currency the more useful it becomes to each user. The typical monopoly of one currency within a country’s borders is just a forced network. See here and here for more explanation of the network effect (which may not apply fully to social networks, but definitely does apply to currencies).

So, crazy as it may seem, discontinued paper notes could still have value, just so long as there’s enough demand for them.

An ethereal alternative to paper

Phasing out cash, combined with negative interest on bank deposits, could also provoke an accelerated adoption of “crypto currencies”, such as bitcoin.

Cryptos are exclusively electronic credits, and potentially could become an important part of the internet economy (which itself is still growing rapidly: see here for more). But they have some important differences to electronic fiat money of the government kind.

Bitcoin isn’t issued by governments, but created by privately owned computers. They solve complex problems (algorithms) and are rewarded with bitcoins. The process is called “bitcoin mining”. The bitcoins can then be exchanged for goods and services, or fiat currencies.

A lot of people are sceptical about bitcoin because “it isn’t backed by anything”. But then neither is government fiat currency, most of which also exists in the electronic ether. Fiat currency hasn’t been intrinsically “worth anything” since the end of the gold standard.

Under a gold standard you could convert your money – dollars or pounds or whatever – into ounces of gold. It was gold backed. Those days are long gone, so what’s the difference with bitcoin?

If anything the difference is in bitcoin’s favour. The way it’s set up, according to people that understand these things much better than I, the computers can only create a maximum of 21 million bitcoins. In turn each of those whole bitcoins can be divided into 100 million smaller units. At the time of writing one whole bitcoin is worth US$434 on the online markets.

Currently a little over 15.2 million have been mined, and the rate of production is slowing over time. It gets progressively harder to create new ones as the total reaches its limit. On the other hand, fiat currencies have unlimited potential supply, and are created by central and commercial banks at the mere touch of a button.

The supply limit means that a bitcoin economy has built-in price deflation, assuming more and more people use it. Rising transaction volumes would mean that rising demand ultimately comes head to head with the fixed supply of bitcoins. In other words, the value of bitcoin could rise indefinitely as the bitcoin economy expands, and the bitcoin price of things would come down.

So, given the prospect of losing money on bank deposits with negative rates, or owning an appreciating crypto currency, many would choose the crypto currency. But for that to work adoption has to increase faster than new cryptos are created. If fewer and fewer people use bitcoin – perhaps because something better is invented – then the price will collapse.

Bitcoin is still largely experimental. Cleverer people that myself assure me it’s a secure system, and transactions are anonymous, and transaction fees are low. But the user interfaces are still clunky, few businesses accept it yet, and the price is highly volatile.

The rocky ride is shown in the following chart of the US$ bitcoin price since late 2011, including the bubble and bust of late 2013 / early 2014. The price rocketed above US$1,100 only to fall below US$200 a little over a year later. There now appears to be a rising trend again.

BitcoinPrice2016

Bitcoin and other cryptos could have a bright future, especially if governments try to phase out physical cash in a NIRP world. It’s worth dipping your toe in, or at least keeping tabs on progress. But you should by no means bet the farm. It’s still an experiment.

The solid choice

Finally there are our good old friends the precious metals, which are very firmly rooted in the physical world. By this I mean gold and silver. If physical cash goes by the wayside then gold and silver coins will be in demand as an obvious substitute for transactions, with gold bullion the best choice for the safe keeping of larger amounts.

After all, an ounce of silver is worth just US$14.97 at today’s price. A quarter ounce coin has just US$3.74 of silver value. That kind of small denomination would work for most “cash” transactions.

Gold itself is up 18% since its December low. I’m even wondering if part of the reason it’s being driven up is concern that cash is on the way out. Perhaps the smart money is, well, getting out of money?

Even if that isn’t a factor yet, I’d bet that reduced or no access to physical cash would eventually drive a lot of extra gold and silver demand. It’s yet another reason to own precious metals, on top of insurance against financial distress and the growing gold buying power in China and India.

Owning gold now could amount to front running that big upwards price move, as the war on cash continues. At least until they try to ban gold ownership, but that’s something to worry about much later. OfWealth will be producing a handy guide to the best ways to invest in gold in the near future, so watch this space.

Of course you’ll still want to be invested in lots of other things too: stocks and real estate and so on. But for the assets that you would usually keep as physical cash or liquid bank deposits the time may come when you need to seek alternatives. That time could be soon, so it pays to be prepared. Be ready to beat the rush, in other words.

To recap, here are the potential escape routes a potential future ban on cash and negative interest rates on deposits:

  • Notes of stable foreign currencies
  • Get hold of high denomination notes of your home currency before it’s too late
  • Try out bitcoin
  • Invest in gold and silver (we’ll show you how to soon)

Let me know your thoughts. Are you worried about a ban on cash, or do you think it’s irrelevant?

Stay tuned OfWealthers,

Rob Marstrand

robmarstrand@ofwealth.com

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.