Cashless Paradox: How Paper Money can prompt post-COVID Economic Rise

The economic downturn during the COVID-19 pandemic revealed the paradox of cash: in times of crisis, people are more likely to withdraw their savings from deposits and keep money at home. It seems unwise since a deposit gives at least a minimum return and other financial instruments may significantly increase amount of investment. But so is the mass pattern of behavior, and it turns out that it may contribute to the further economic growth. “Cash will always be useful”, says Jeffrey Goh, head of regional payment company Grablink, and many people stick to the same thinking.

Bank of England Governor Andrew Bailey called the phenomenon “the paradox of banknotes“. At the end of 2020, there were over €1.4 trillion worth of banknotes in circulation in the EU, up 11% from a year earlier. “Europeans are using cash for savings,” the ECB report claims.

The main psychological explanation here is so-called hoarding behavior. We inherited this concept from our distant ancestors: anticipating a crisis, humans try to create a safety net. And while the rational part of our psyche strives to prove that investments in shares or bank deposits are a good enough piggy bank, the subconscious part of our brain forces us to accumulate funds in something more tangible.

Cash is a fairly compelling medium: you can touch it, you can hide it, and a pile of cash that grows as notes are added to it is a real pleasure. Just think, which looks more impressive: five thousand in the form of a wad of notes or five thousand in the form of numbers in a bank statement?

Cautious behavior is a natural reaction to the unprecedented uncertainty associated with both the pandemic and its aftermath, researchers Charles Goodhart and Jonathan Ashworth note: “While the economic shutdowns and increased use of online retailing are currently diminishing cash’s traditional function as a medium of exchange, it seems that this is being more than offset by panic driven hoarding of banknotes.”

So, the availability of cash prompts people to make savings. In turn, the very fact that households have savings provides a fairly good safety net for the economy.

How banknotes can come in handy in the cashless world

Savings symbolize people’s promise to spend more in the future. At first this seems like another paradox: it is obvious that people do not save money just to spend it once the horizon is clear. However, this idea is erroneous, because it does not take into account all the properties of money. And money, as we know, is not only a means of saving, but also a means of exchange.

Being not only an element of the economy, but also a psychological factor, cash is accumulated in times of uncertainty, and is spent when that uncertainty is gone. History has already seen such an example: during the Second World War, the US economy was booming on military orders. People were earning very decent money, making ships, planes, cars, weapons and food for the army. However, their opportunities to spend that money were quite limited as the markets for food, luxuries and other goods were restricted at the legislative level. A huge pent-up consumer demand was formed during the war years since production of cars and many appliances was banned, and housing construction was severely restricted. But people still got their money and kept it in the form of savings.

It was precisely this kind of pent-up consumer demand (backed by citizens’ savings, i.e., solvent demand) that played a major positive role in the post-war economic boom in the US. Now a similar situation is unfolding in European countries that accumulate savings in cash: at first, lockdown restrictions curbed consumer spending as people could not go out and travel. As a result, the figures showed a significant drop at the peak of the restrictions, but consumer confidence is now slowly recovering. This pent-up demand is expected to be unlocked once the lockdown restrictions are lifted in full, promising a surge for the economy.

The sheer number of people with substantial savings is a ‘seller’s paradise’ (and therefore a producer’s paradise) for goods and services. And undoubtedly, the increase in the savings contributes to a favorable climate for the economy. Moreover, it is the existence of demand that is the most important condition for business development and investment, the most important component of a “good business climate”. And if there is no demand, no other factors, such as low interest rates on loans or anything else, will help.

Apart from savings, cash may be used as an additional fiscal stimulus to prompt up the economic growth. A recent example here is the situation in India, which is currently teetering on the brink of a new crisis. There, cash may become a new savior for those who experience financial difficulties, says one of the country’s leading bankers Uday Kotak: “This is the time to expand the balance sheet of the government, duly supported by the RBI… for monetary expansion or printing of money.” Cash printing, according to Nobel laureate Abhijit Banerjee and former finance minister P. Chidamabaram, is an ideal strategy for the country to sustain spending amid the ongoing spread of COVID-19.

Generally, the position of cash, although slightly tilted, is still stable in most countries around the globe. According to a recent household survey by the ECB, individuals’ total cash transactions in 2019 totaled €1,993 billion, indicating that cash remains the most widely used method of retail payment. As shown above, cash and cash savings not only promise a rise in these retail payments, but also serve as an important psychological factor during periods in economic uncertainty, as well as prove that the world still needs bills and coins.

Show More