Will Luther on Cash, ‘Supernotes,’ and Cryptocurrencies

Will Luther is an assistant professor of economics at Florida Atlantic University and is the director of the Sound Money Project at the American Institute for Economic Research. Will is also an adjunct scholar at the Cato Institute. Will joins the Macro Musings podcast to discuss a recent debate over the future of cash and the current state of cryptocurrencies.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Will, welcome back.

Will Luther: Hey, my pleasure to be here.

Beckworth: It's great to have you back. I understand you are coming to us live from the warm beaches of Miami.

Luther: Yes.

Beckworth: We're up here in D.C. enjoying more West Coast weather, lots of rain, but you're down in Miami enjoying the sunshine. That's great.

Luther: Always sunny.

Beckworth: Always sunny.

Beckworth: So as I mentioned in the introduction, you were recently a part of a conversation. It was an online conversation where a number of essays were posted and replies were made, and it was online at the Cato Unbound series. The title of the debate was Cash, Crime, and the Civil Liberties, where you, J.P. Koning, Josh Hendrickson and James McAndrews participated. The listener to the podcast will recognize J.P. Koning's and Josh Hendrickson's name because they are past guests on the show, and they recognize you as well from your previous appearance, and some might recognize James McAndrews, who's a former New York Fed economist now who's promoting the Narrow Bank. So he's kind of got some recent fame for his attempt to push his bank through. So it's kind of interesting that he was a part of this, but I'm curious, what was the motivation for this debate?

Luther: Well, on the one hand, Ken Rogoff's book The Curse of Cash has definitely got a lot of people thinking about the role of physical, hand to hand currency in the economy. But I think the motivation is just that J.P. is a pretty interesting guy and he has this interesting proposal, and we had the privilege to talk about it a bit.

Beckworth: Yes, and if our listeners haven't seen his blog, please go check it out. I think it's called Moneyness, but J.P. Koning has a really interesting blog. There's a lot of monetary history and institutional detail type analysis on money issues. So definitely check it out. Also, we'll have links to his blog. We'll have a link to this Cato Unbound debate. Again, it's titled Cash, Crime, and Civil Liberties. I want to begin with J.P. Koning's lead essay, and I want to read a few excerpts from it and then I'll turn to you with a question. But these few excerpts kind of highlight where he's taking this debate. So I'm going to just start here.

Beckworth: "Banks and credit card networks are processing a growing proportion of society's transactions. These financial institutions are privy to an ever expanding slice of our lives. Do we trust banks to do a good job guarding this information? Perhaps they may accidentally allow hackers access to it or they may be forced to give government a quick glance of what we've purchased over the last month.

Beckworth: "Cash, on the other hand, leaves no trace of what we've bought or sold. No other payment medium allows us to be 100% sure that our personal information can never be seen." He then goes on to say, "Not only does cash protect our data, it provides us with irrevocable access to a payment system," and he goes on to talk about examples where that's not been the case. He mentions in 2010 Bank of America, Mastercard and Visa embargoed WikiLeaks. They also mentioned another victim of this was a U.K. based NGO Interpal. It was accused of terrorist financing and it was shut down. More recently you can think of PayPal shutting down Alex Jones, the conspiracy theorist online, and also some of the marijuana firms who aren't able to get access to bank financing because of federal laws, and they are resorting to cash. He says, "Cash is decentralized. Banknotes move from hand to hand rather than requiring permission from a central processor."

Beckworth: Finally, he goes on to note that, "U.S. dollars provide a backup to the global monetary system, so in the case in Zimbabwe when their currency succumbed to hyperinflation they turned to dollars." So in a nutshell his argument for cash and why we would want it, is that it provides censorship resistance, data protection, and a global monetary backup system, and it's great to have what he calls a super note, a large bill that people can use in transactions. However, he says that "there's a big, big problem that's been brewing for some time, and that's inflation." Okay, that's a big setup there. But tell us, is this a problem and what would he propose that we do?

Luther: Well, here's the thing, David. Since 1969, the 100 dollar bill has been the largest denomination in circulation in the U.S. That's when the U.S. retired its larger denomination notes. We used to have the 500, the 1,000, the 5,000, even a 10,000 dollar bill. But since July, 1969, the 100 dollar bill is the largest denomination in circulation.

Luther: Now the problem is that we've experienced inflation over this period, so a 100 dollar bill in 1969 was roughly equivalent to a 700 dollar bill today. And so all of that censorship resistance that J.P. mentions has eroded along with the value of the 100 dollar bill. The ability to hold your wealth if you're in a country like Zimbabwe or more recently Venezuela and you're experiencing, you know your domestic currency is hyper inflating. It's much harder to hold seven 100 dollar bills than it would be to hold one 700 dollar bill. And so J.P. says we need to bolster the dollar's ability to provide these services, and the way to do that is to issue a super note, maybe a 500 dollar bill or a 1,000 dollar bill. That would certainly get us back to where we were when those larger denomination notes were retired, and it would also put us well on our way to maintaining that level of services for cash as we continue to experience inflation into the future.

Beckworth: Okay, now he mentions there's going to be pushback against his idea, particularly from people like Ken Rogoff. So Ken Rogoff, his criticism is that these large bills lead to illicit activity, also tax evasion. So what is J.P.'s response to critics of large notes like that?

Luther: Well, that's right. J.P.'s proposal is actually going in exactly the opposite direction of Rogoff and other demonetization proposals. Whereas they want to eliminate the large denomination notes that we have, J.P. is suggesting that we offer even larger denominations.

Luther: Now like Rogoff, J.P. recognizes that cash can be used for crime and tax evasion, and so he wants to discourage those uses by taxing these super notes. So one way you can go about taxing these super notes is by redeeming them for less than face value at the Central Bank, and if you do that, the argument goes they'll trade at a discount even before they're handed over to Federal Reserve employees.

Beckworth: So the idea is to provide this service that we all recognize these notes provide, the three roles he mentioned, but tax them. And what's the idea behind that tax? Is he implicitly arguing for something like a Pigouvian tax on externality?

Luther: Well, I think that's the basic idea, right? If you have a factory that's polluting, right, there's a negative externality there and so the Pigouvian argument is that you put a tax on that activity and discourage the pollution, but you don't outright ban the activity and so you still get the production associated with the factory. So I think that's his basic idea with imposing a tax on these super notes.

Beckworth: Now he said 5% in the article, and he also mentioned, for those who might find that alarming, now why would you want to tax my note? Notes are already implicitly taxed, is that correct?

Luther: That's right. You know, if you have 2% inflation that means that your, since the nominal interest rate on physical hand to hand currency is zero, that means that those notes lose a little value each period, and so that is tantamount to a tax. It's a tax on money holding.

Beckworth: Okay. So he would just go a little bit beyond, another 3% or so, and somehow tax the bank notes. Now, does he give a good idea of how we would actually do that operationally?

Luther: Yeah, so the idea is that you would, that these notes would be discounted, and so when they are put into circulation, maybe it's a 500 dollar bill, and it has, say it's redeemed in a year. Well, 5% of that 500 dollar bill would be returnable to you from the Federal Reserve in smaller denomination notes if you were to redeem that. And so the idea would be that if everyone knows that this 500 dollar bill is going to lose 5% of its value each year, then at any particular point in time throughout that year it will be discounted accordingly. So that's the way he proposes effectively taxing these super notes.

Beckworth: Okay. So that provides my segue into James McAndrews' reply. He criticizes J.P.'s approach in terms of it being a Pigouvian tax. He contends that it's not quite an externality going on here, is that right?

Luther: It's not so much that he's denying that it's an externality, but he points out that this way of trying to correct the externality is not quite a Pigouvian tax. So if we think back on a polluting factory, right? What you want to do is tax the pollution. But this tax on, so if you think that crime is the externality associated with cash, you're not taxing the noxious activity, as McAndrews calls it. Instead it's a tax on the input to those activities, and so what that means is that you're taxing all uses of cash, not just those that are resulting in illicit activity. So I've likened this to spanking all of your children when one of them misbehaves, so probably not the best way to go about solving this problem.

Beckworth: Yeah, and the Monetarist in me is also a little nervous about taxing not just any asset, but an asset that is money, right? The medium of exchange, the one that facilitates transactions across the entire economy. That has me worried. Of course, as many of the authors point out, a lot of transactions are not done with cash. In fact, most are not done with cash. But still this seems a little more distortionary than if you just tax any other asset at that rate.

Luther: That's right. So there's a, it's kind of an old argument that Milton Friedman put forward that I discuss in my essay called, The Optimum Quantity of Money Argument. Where Friedman basically argues that you want to set the rate of return on money, that is the non interest bearing cash that we're using, equal to the rate of return on comparable assets, like a risk free bond, and the way you go about doing that is by generating a mild deflation. So this suggests that in order to induce people to hold the optimum quantity of money, that is not to economize on their cash holdings by holding bonds and therefore not being able to make some desirable transactions because they're not holding enough cash, you actually want to generate a mild deflation, so that there's a rate of return on cash equal to the rate of return on those bonds. And so that suggests that not only do we not want to tax these super notes, but we might actually want to subsidize the super notes, not by paying an explicit subsidy but by engineering a mild deflation.

Beckworth: Yeah, and the Friedman rule comes out of a lot of models, right, in macro? It seems to be the case that Friedman rule often is the optimal way to do monetary policy in many macro models. Let's take that to jump right into your reply. Your reply is that, contrary to J.P.'s argument for a tax, you say, "Hey, we should just go ahead and subsidize the super notes. Let's don't tax them."

Luther: That's right. So I would argue that the tax on our existing denominations is already too high. And so we want people to hold the optimum quantity of money. We don't want them to find themselves in situations where they're walking down the hall, they see that delicious Snickers bar in the vending machine and they reach into their pocket and find that it turns out they're just not holding enough cash to make that transaction, so then that transaction doesn't occur, and so the gains from that transaction go unrealized. Those are the kind of situations that Friedman has in mind when he's talking about the optimum quantity of money. You want individuals to be holding sufficient money balances so that they can make transactions and realize the gains from exchange.

Beckworth: Right. Let me push back on that argument a little bit. So I see the argument for money in general, right, but what about cash? I mean, how much of our transactions do we actually use as cash?

Luther: That's a good question. It's difficult to say precisely how much cash is used, in particular by law abiding citizens, and at the same time by criminals. Rogoff tries to make some estimates, or really he surveys the estimates in the literature in his book, The Curse of Cash. And here's how he goes about it. He says roughly 50% of all U.S. currency is held abroad. About 1% is held by banks and 5% is held by firms. So we get pretty good estimates there. So that accounts for about 56% of the currency in circulation.

Luther: Then he looks at surveys of domestic consumers, and those domestic consumers in surveys report that they're holding roughly what amounts to 5 to 10% of the currency in circulation, so that leaves 34 to 49% of the currency in circulation unaccounted for. And so Rogoff concludes that since domestic consumers aren't admitting on surveys that they're holding these cash balances, that must be the fraction of cash balances that's held for illegitimate uses, maybe making illicit transactions or maybe to evade taxes, but that 34 to 49% of all the currency in circulation is held by criminals.

Luther: Now that's kind of a rough approximation, and perhaps not a very good one. For one, it's a pretty big range, right, somewhere between a third and a half of all currency. That's a pretty big difference. But two, you know the approach to making that estimate, you know the assumption that any cash that someone isn't admitting to holding must be held for illicit purposes, strikes me as a bit odd. I could think of a lot of reasons to not report on a survey why, how much cash balances you're holding, especially if you're interested in financial privacy, which is one reason why you might hold cash. The reason that you hold cash, financial privacy, is also a reason why you would not tell people in a survey that you're holding so much cash.

Beckworth: Good point.

Luther: Likewise, if you're concerned about the security of that cash, one way to keep that cash secure is to not go around telling people that you're holding so much cash. So I think that the approach to just assuming that since people aren't fessing up to holding this cash it must be held by criminals, I'm not sure that I would buy that. I think that there are perfectly reasonable explanations for why someone might hold cash and then not say that they're holding that cash in a survey.

Beckworth: So bad statistics by Rogoff might be part of the story. But you argue that even if his stats were correct, some tax evasion might be good, right?

Luther: And some crime.

Beckworth: And some crime, yep.

Luther: Right, so here's the thing. I don't want to defend criminals, but the reality is that not all crimes are created equal. The assumption by Rogoff and others that reducing crime necessarily increases social welfare just doesn't follow. Think about some of the weird conclusions that would lead you to. So take a criminal transaction in some states, like buying pot. So that transaction is illegal in Ohio, where I'm originally from. Perfectly legal in Colorado, though, and so that means that the criminal activity of selling and buying pot in Ohio is reducing social welfare, while those same activities is assumed to be increasing social welfare in Colorado.

Luther: And so that's a little odd. I think we need to make a distinction between types of crimes. There's a difference between victimless crimes where individuals are making transactions that perhaps you or I would find repugnant, maybe morally reprehensible, but we can make a distinction between those kind of transactions and transactions where individuals are actually harming others by those transactions, things like trafficking or murder for hire. And my guess is that most of the crime that's being committed with cash is the kind of crime where people are evading the laws that restrict their choice. Now I don't, I have no interest-

Beckworth: Such as what? Like buying marijuana, prostitution, things like that?

Luther: Yeah. So if you take a look, you know I do some work on cryptocurrencies, and if you look at the Silk Road, which was an early website that allowed individuals to purchase illegal goods with Bitcoin, much of those transactions was just marijuana. And the majority of the goods that were posted for sale on the Silk Road were illegal substances. So you know, I don't want to defend heroin dealers or pimps, but those transactions are largely taking place between consenting adults. They're illegal certainly, but it's not clear that stamping them out would necessarily improve social welfare. At a minimum we need to take into account the fact that the individuals participating in those markets are experiencing private benefits, some gains from trade, even if folks like you and me find it repugnant and experience some losses when we have to observe those transactions taking place.

Beckworth: Absolutely. And I think a more general point is, there are always trade offs. You mentioned, some crime is optimal. I used to ask that question when I used to teach my students at the university, I'd say, "What crime rate is the optimal crime rate?" And of course they would all say, "Zero." But then when you explain well, what would it take, what kind of resources would it take to get to zero? Police on every street, a military state? What would you give up? There's trade offs.

Beckworth: So at some level a positive crime rate is actually optimal, given the cost it would take to actually enforce it, and I think that general point applies here, too. There's trade offs involved, as you've spoken to.

Luther: We can think about the trade offs involved with tax evasion, as well. First, we need to recognize that the costs of tax evasion, it's not the loss of revenue to the government. That's just a transfer, right? The tax cheat has a little more income. The government has a little less. The cost to society is the corresponding resource misallocation, and so some firms who are especially adept at evading taxes are going to be able to undercut the prices of those firms that are less adept, and so you're misallocating resources across the economy there. In general we should expect that the cost of those misallocations is less than the transfer of resources from the government to the tax cheats, right? The dead weight loss triangle is typically smaller in area than the Tullock rectangle, if you're familiar with a simple supply and demand framework. And so there's certainly a cost there, but it's smaller than the reduction in revenues.

Luther: But as I point out, there may also be a benefit there, that is if you think that governments set their tax rates with social welfare in mind, then sure, we get the optimal tax rate and the optimal tax scheme. But if instead you're concerned that maybe some governments in some places overtax their citizens, then having access to cash provides a constraint, a potentially desirable constraint, to check that overtaxation. So in thinking about the trade offs we should recognize that tax evasion misallocates resources, but we should also recognize that it provides a constraint on the extent to which governments can overtax their citizens.

Beckworth: So in short, it's complicated.

Luther: It's very complicated.

Beckworth: Right. Not a simple, clearcut case as outlined in the Rogoff book. Okay, so you've made these arguments. I want to go back to James McAndrews' reply, because very similar in spirit, and he concludes though that a, maybe a moderate approach where he wouldn't go for the 500 dollar note, he'd go for a 200 dollar note, no surcharge. What are your thoughts on that?

Luther: That's right. So I think it's, there are pros and cons to that proposal. His argument is basically, look, we have the 100 now, to introduce a 500 or 1000 dollar notes, that would be a big change in the denomination structure. And so maybe a middle ground, like a 200 denomination note, would be better. And so I think that a 200 denomination note would be better than a 100 denomination note being the max, but I'm more keen to see the 500 or the 1000 than McAndrews is.

Luther: At the same time, he gets a little closer to what I think of as the optimal tax on these notes. I want it to be slightly negative deflation. He wants it to be a zero, and so zero is closer than the 5% tax that Koning is proposing, but it still doesn't quite hit my ideal of generating a mild deflation and therefore subsidizing these large denomination notes, and all of the other notes in circulation.

Beckworth: Right. He also makes another interesting argument in his piece that if we were to get rid of all cash, what would likely happen is that the criminals would come up with their own payment system, that you would simply have a substitution from cash into some alternative mechanism. Do you agree with that?

Luther: Well, I definitely think that that's possible. There are close substitutes to cash. Rogoff mentions some in his book, you know gold and diamonds. But also cryptocurrencies. You know, cryptocurrencies might function as close substitutes to cash, and so one of the things we need to think about when we're thinking about banning cash on the one hand or introducing larger denomination notes on the other, is that we have access to close substitutes, and so to the extent that cryptocurrencies act as close substitutes for cash, and I think there are good reasons to think they would, then bans on cash are going to have fewer benefits than proponents suggest unless those bans also prohibit the use of close substitutes like cryptocurrencies.

Beckworth: Yeah. It seems to me at least that if the government could somehow get rid of cash, it would vastly increase the incentives to make cryptocurrencies truly money like. Because right now they're more speculative, right, in terms of assets. But you could see it creating an added reason for truly becoming a medium of exchange.

Luther: Yeah, so if you think about the characteristics that make cash superior to bank issued money, like deposit balances, one big one is the financial privacy that's afforded by cash. Now, the reason that cash offers more financial privacy is because of the relative clearing mechanisms that bank issued money transactions and cash transactions employ. So with a bank account, if I were to write you a check or swipe my debit card, right, the bank functions as a central clearinghouse and so they debit my account and credit yours. But with a cash transaction, it's a decentralized clearing process, so when I hand you the cash, effectively my account is debited, and when you receive that cash, effectively your account is credited.

Luther: Now cryptocurrencies, they don't rely on a decentralized clearing mechanism, but the clearing mechanism that they employ, a distributed clearing mechanism, also provides more financial privacy than traditional bank issued money. So someone, for example with Bitcoin, someone is processing that transaction, right, the miner who happens to hash the block of transactions that I'm conducting, but that's a random probability of who that will be, and moreover our identities are obscured, we're quasi anonymous because we're only recognized by our public keys, not our personal identities.

Luther: And so this creates the ability for cryptocurrencies to promote quasi anonymous exchange in much the same way as cash does, but there are some trade offs. So Bitcoin is better for long distance transactions. With cash, you know you have to be physically present. But at the same time, cryptocurrencies like Bitcoin have a block chain, a public ledger of all past transactions, and cash doesn't. So if at some point in the future your identity becomes linked with a given account, someone can go back and observe your transactions with Bitcoin in a way that they wouldn't be able to do with cash transactions. So again, there are always trade offs, but those are some of the trade offs we should keep in mind.

Beckworth: So Will, let's go to Josh Hendrickson's essay, his reply. What argument did he make in his piece?

Luther: So Josh raises an interesting point in thinking about whether or not there's an externality here. So Josh points out that, you know, we make a distinction between two types of externalities, typically, technological externalities and pecuniary externalities. So with the technological externality, that's like the pollution case we were talking about earlier, right? There was some technology that's generating some spillover costs or benefits that we either want to discourage or encourage.

Luther: But those are distinct from pecuniary externalities. And so as Josh points out, if I open a coffee shop that out competes your coffee shop, right, I have imposed some costs on you in some sense. You are going to suffer a loss of income. At the same time I'm experiencing an increase in income, and your former consumers and my current consumers are presumably better off, as evidenced by the fact that they are no longer purchasing coffee from you and they're now purchasing coffee from me.

Luther: But those are pecuniary externalities, and we don't typically think about imposing Pigouvian taxes to discourage pecuniary externalities. It's the technological externalities that the Pigouvian approach would suggest we tax. And so the question is whether or not crime and tax evasion, whether these kind of things are more like Pigouvian externalities or more like technological externalities. So when I drive down the street and see a prostitute trying to sell her services, I see that as morally repugnant and I incur some costs of having to witness that, and so is that more like a loss of revenue for me or is it more like pollution? He points out that it's not so clear how we should think about those externalities.

Beckworth: Okay. Now he goes on to argue that even if you can make the case that it's a technological externality, there's a case to be made for J.P.'s solution, is that right?

Luther: Well actually, he goes even further than J.P., I think.

Beckworth: Oh, really?

Luther: He says that what we could do is use this scheme to levy attacks on criminals and then redistribute the revenues of those taxes to law abiding citizens. So basically he has in mind a situation in which only criminals use large denomination notes, and you ramp up the tax on those large denomination notes, and that effectively allows you to tax the criminal behavior, and then you reallocate the revenues there to compensate those of us who are bearing the externality of this crime. So he sees it as a way of taxing crime, but the corollary to that is that in that solution you don't get any of the benefits to law abiding citizens that J.P. mentions at the outset.

Beckworth: So it sounds like we've got two camps here in this debate. We've got the McAndrews Luther camp, much more in favor of promoting and making it easy to have and use cash, and we've got the Koning Hendrickson camp, which they too want to see cash stick around but they're much more cynical, critical of it. Is that a fair representation?

Luther: I think that's one way of characterizing it. You know, in fairness to Josh, he also wants the financial privacy afforded by cash, but the reality is that in that solution where only criminals are using cash and are being taxed accordingly, it's only the criminals who are experiencing the financial privacy that those super notes are affording.

Beckworth: Okay. Well, Josh has been on the show several times, I know him well. He can take a little heat from us today. He'll be fine. Okay, now with this debate all said, interesting essays, again I encourage listeners to take a look at it. What is your sense of the mood towards cash? This was really interesting when Rogoff's book came out. I know in Europe they were trying to get rid of, maybe they have, you can remind me, the 500 Euro note, and some of the Nordic countries have done a really good job of getting rid of cash. But what is the general mood toward cash? Do you sense there's, the general movement is toward less cash or just kind of agnostic right now?

Luther: Well, I'm not sure that I would say there's a general mood one way or the other. I think the reality is that it's only nerdy guys like us who are sitting around thinking about the social welfare of cash.

Beckworth: Fair.

Luther: You're right, there have been some efforts to eliminate large denomination notes. In 2013 the 1,000 Swedish krona note was phased out. They still have the 500 note. That's worth, I think, around 60 dollars. And the 500 Euro note, the last one will be issued, is scheduled to be issued in late 2008. But they are not demonetizing the existing 500 Euro note, so you can continue to use those for, as the ECB put it, "an unlimited period of time." So those notes will eventually wear out and they won't be replaced, but they're not actually demonetizing them.

Luther: So that leaves the 200 Euro note as the largest denomination that will continue to be produced and issued. There are cash restrictions in many countries, especially across Europe. So for example, in Belgium you're not allowed to make transactions in cash for more than 3,000 Euros, and there are similar restrictions in France and Croatia and the Czech Republic. So a lot of countries limit the maximum value of cash transactions.

Luther: There have been two cases in recent years where notes have actually been demonetized, and that's in India and Venezuela. Interestingly, as Rogoff has pointed out, these countries are not good candidates for demonetization schemes. Their notes aren't that large of a denomination in terms of purchasing power to begin with, and they're relatively poor countries, and so they rely much more on hand to hand currencies. So they were never intended to be the kind of countries that Rogoff had in mind for demonetization, and yet they have demonetized their largest denomination notes. Interestingly, in both cases, they ultimately issued even larger denomination notes.

Beckworth: Interesting.

Luther: So the motivations, although in India the explicit motivation was to levy a one time tax on those conducting transactions in the underground economy, and Maduro made similar claims in Venezuela, though frankly in the Venezuelan case it was laughable because the purchasing power of the largest denomination notes was getting pretty close to zero. So the idea that criminals are sitting on large piles of Bolívar Fuertes is just incredible. But in both of those countries the anti crime rhetoric was employed, but no demonetization proposal that I've seen actually thinks that it would be a good idea for India or Venezuela or countries like that to get rid of cash at this point.

Beckworth: So we have a few cases where there's been some notes removed, a couple cases of demonetization, not very successful ones. My sense is, here in the U.S. it would be nearly impossible to do something like that, there'd be so much political backlash. But that's just my sense. I might be wrong.

Luther: Yeah, there's a distinction to make between reductions in the demand for cash because individuals would prefer to use some other payment mechanism. I use very little cash, so a ban on cash is not going to have an effect on me. So I am demonetizing myself in that sense, right? Effectively purging cash from my own life. But that's a very different source of a reduction in currency use than the prohibition that demonetization proposals call for. There, you are effectively arguing that you can make society better off by reducing the choice set.

Luther: At best that's likely to be inconsequential, and at worst you are taking some people who are very concerned with financial privacy or are unbanked, and are unbanked intentionally because for whatever reason they would be subject to large fees in the banking system. Maybe they struggle to keep a minimum balance, or perhaps they're using cash as a sort of mental accounting device. You know, when my wallet gets down to 20 bucks I constrain my spending, or something like that. So these are individuals who are indicating that this is a valuable payment technology for them, and so removing that option is almost certainly going to make those individuals worse off. And so that's really the hurdle that you would have to overcome if you're going to make the case that somehow society is going to be made better off despite the costs imposed on, frankly, some of the least advantaged individuals in society.

Beckworth: So what if we went the other direction and we did introduce a 500 dollar super note to the U.S. economy, what do you think would happen? Would there be some kind of endogenous response, as Josh suggests one with his essays? Would it just displace other notes? Would there be added demand for currency?

Luther: Well, I think it would increase the attractiveness of the dollar as the international reserve currency, and I don't know how big the effect would be but I think best case scenario, it would make it a lot more difficult for some countries around the world to erode the value of their citizens' wealth through the inflation tax. The easier it is to get your hands on large denomination notes, the easier it is to secure your wealth in physical cash. The easier it is for you to get out of your domestic currency, the harder it is for governments around the world who maybe have difficulty raising taxes through traditional channels, resorting to the printing press. So I think that's a step in the right direction in terms of liberalism, and so that's one reason why I think these super notes are a good idea.

Beckworth: Yeah, I agree, I think it's almost like a public good we provide to the world, the U.S. It's a service at least that many people around the world value and cherish, and on the margin it might encourage better behavior by issuing these larger notes.

Luther: Yeah, I mean I think that you can certainly make the case in terms of high inflation countries. But in terms of liberalism we should also think back on that financial privacy angle, right?

Beckworth: Right.

Luther: If you're using your bank account to finance some political activity in opposition to the Maduro regime in Venezuela, things might end very badly for you. Your identity is visible. And so I think that it's a great thing that individuals who, by the unlucky circumstances of birth have found themselves trapped in places like that, that they're able to access dollars and use those dollars to express their disappointment in what I think many people around the world recognize as a reprehensible regime.

Beckworth: Yeah. So in short, if President Trump issued a 500 dollar note, it'd be a nice way of doing foreign policy with many troubled states in the world. Okay, let's move on to cryptocurrencies. We've touched on them already, but it's been a hot topic. We discussed it last time you were on the show, but what is the current state of cryptocurrencies right now?

Luther: Well, so right now the price of Bitcoin has fallen to just over 6,000 dollars. I think it's around 6,300 dollars at the moment. So that makes the market cap somewhere in the neighborhood of 110 billion dollars.

Beckworth: Where was it before at its peak?

Luther: I don't remember what it was at its peak in terms of the market cap, but the price shot up really high, getting as high as 20,000 dollars for a Bitcoin in December of 2017. So that's a big decline in price in a relatively short period of time. And of course the price of Bitcoin and all cryptocurrencies have bounced around quite a bit from year to year and month to month and even day to day, so a pretty volatile market.

Beckworth: So one of the newish things in cryptocurrencies that I hear about a lot are stable coins. What are stable coins and what do they do?

Luther: A stable coin, the basic idea is that, one difficulty of using cryptocurrencies is that their purchasing power in terms of dollars or Euros or rindinby bounces around quite a bit, and so if you had a cryptocurrency that had a stable purchasing power in terms of one of those currencies, then it would be easier to use that cryptocurrency to make transactions. And so there are some stablecoins like Tether. SagaCoin, recently Basis was proposed. These attempt to stabilize the purchasing power of their respective coins, typically with respect to the dollar.

Luther: So you can think of it, well actually you know Barry Eichengreen has an article at Project Syndicate, I think it was about a week ago, where he likens it essentially to a currency board. So you can issue the Beckworth coin and promise that it's going to be, you know it's going to trade at a dollar. And so if I want to buy a Beckworth coin from you, I give you a dollar, and you hold that dollar. So if at any point in the future I no longer want to hold this Beckworth coin or I spend it to someone else and they don't want to hold it, they can come back to you and you will be able to give them a dollar in exchange for that coin. So essentially, by doing something like that, you can ensure that the purchasing power of the coins you issue are stable in terms of the dollar.

Beckworth: Has the volume of stablecoins grown, are they really popular?

Luther: Well, certainly we've seen a few attempts. I mentioned Tether and SagaCoin and Basis. There was a cryptocurrency, NewBits, which also attempted to offer a stable coin. But you know these projects, they face a problem that Eichengreen points out in his article. He goes through three scenarios which are helpful. The first is essentially the scenario that I just presented to you, where the cryptocurrency issuer maintains 100% dollar backing for the coins that are in circulation.

Luther: Now if they do that, that is if they're functioning as an effective currency board, they will always be in a position to redeem those coins or exchange those coins, that's probably the better term there, to exchange those coins for a dollar, and so they can make sure that the value doesn't change and they are also not subject to a speculative attack because everyone knows that they're holding sufficient dollar backing to redeem all of the coins in circulation. So they can maintain a stable purchasing power. But here's the problem. In order to do that, they have to hold 100% dollar backing.

Beckworth: Right.

Luther: So that means they're not earning interest on the float. You know, maybe they would like to use some of their dollar reserves to purchase some securities that would return a higher interest rate, right? Except they can't do that while holding 100% dollar reserves. That also makes it difficult for them to attract customers, right? They can't offer a competitive return to customers because they aren't earning any interest on their 100% dollar reserves. So that makes it a challenge for them to expand their network.

Luther: Now the second scenario which Eichengreen considers, he says okay, well the solution there is for them to hold something less than 100% of its circulation in reserves. That makes it more profitable. They can hold some securities and pay a competitive return, and therefore attract depositors. But in doing so, it's also increased the risk of, that it will be unable to satisfy its depositors, and so it's possible that holders of those coins will initiate a speculative attack, either because they're convinced that the issuer is unable to redeem or because they're convinced that other people are convinced that the issuer is unable to redeem, and so they could push those issuers into trouble.

Beckworth: What about Central Bank involvement with cryptocurrencies? There was much talk about this over the past few years of Fed coin. Where does that now stand?

Luther: Well, you can think about the pros and cons of a Central Bank issued cryptocurrency. So on the one hand, if the Fed were to issue a digital token, which is equal in value to the dollar, that is if the Fed were to issue a stablecoin, it's in a much better position to do that than private banks because it has the ability to create and destroy dollars. So it can basically take in your dollars when you want to access the coin, or if demand for the coins increases relative to say currency or reserves, it can adjust all three of those assets, because it is the issuer of all three of those assets. And so that's really the up side of Central Bank, or the advantage of a Central Bank issued cryptocurrency.

Luther: The downside gets us back to the issues we were talking about earlier, which is that it's not so clear that a Central Bank issued cryptocurrency would be able to offer the same degree of financial privacy that existing cryptocurrencies do. That is, there are some political economy considerations to keep in mind here. Now, the argument against that is that governments around the world do issue cash and cash promotes financial privacy, but it's not so clear that they would be wiling to issue digital assets that provide that degree of financial privacy. Instead, the Financial Crimes Enforcement Network requires that Bitcoin exchanges register as a money service business and you have to comply with know your customer laws, so that suggests that a Fed coin would not have the same degree of financial privacy that private cryptocurrencies would.

Beckworth: Okay. So a Fed cryptocurrency would be like the ultimate stablecoin, which would be a plus, but the minus would be you'd forgo privacy, and that's what a lot of people are after with cryptocurrencies.

Luther: Yeah, I think that's a fair assessment.

Beckworth: Okay. Well, talking about the Fed coin, I mean really what you'd be doing in a sense is getting access to the Fed's balance sheet just through a newer form of money, and this kind of gets us back to James McAndrews. I want to just briefly touch on him. He, you know, is now pushing the Narrow Bank, which would allow big institutional money account holders to have direct access to the Fed's balance sheet, similar in spirit I think in some ways to a Fed coin. And then I recently had on the show Morgan Ricks. Morgan Ricks would say, "Hey, let's open up the floodgates to everyone. Let's have banking accounts for individuals like you and myself, for Amazon and everything in between." Do you have any thoughts on this general movement in this direction towards opening up the Fed's balance sheet?

Luther: Well, I mean, the big reason why folks are interested in opening up a narrow bank that is an institution that basically just holds federal reserves, is because the Fed is paying interest on those reserves. So I personally would prefer that the Fed would return to a corridor system where it's not paying a rate of interest on reserves that is above the market rate for assets of similar risk and duration.

Luther: That is, earlier we were talking about the optimum quantity of money and not taxing monies too much. Well, we also don't want to subsidize those monies too much, and I think that's what the Fed's doing with its current interests on reserves policy, that is, paying banks to not let go of those reserves and therefore push up inflation. So I would prefer to return to a system, a corridor system where the interest on reserves is more in line with market rates, and in that world I think there's much less incentive to have institutions like the Narrow Bank, which really just take advantage of that subsidy on holding reserves at the Fed. So I think that largely goes away if you return to normalcy.

Beckworth: Yeah, and even now we've seen that spread narrow quite a bit, so it will be interesting to see what happens to McAndrews' Narrow Bank plans going forward. I know he's still waiting for approval from the Feds to actually get an account at the Fed. They haven't rejected him, but they haven't said yes either.

Beckworth: But I'm curious though, more generally speaking, about opening up the Fed's balance sheet, and I ask this because to go back to the original point of discussion, that's cash. Cash does open the Fed's balance sheet to you and me, right? I mean when I hold that 100 dollar bill I have access to the liability side of the Fed's balance sheet, but I don't have access to it electronically. So my question to you is, do you see any costs, any dangers? I mean, Morgan Ricks makes a very convincing case on the benefits side. I would love to hear if you have any concerns of any costs that could arise from doing that.

Luther: Yeah. The concern is that banks, private banks, are really good at financial intermediation, that is, taking in our deposits and channeling those deposits into productive loans. And if we're opening up the Fed's balance sheet to folks like you and me, that means instead of depositing our cash into private banks, we're inclined just to deposit it at the Fed, and that financial intermediation still needs to take place. I don't want to see the Fed engaged in that financial intermediation. I think that it's engaged in credit allocation too much already, given the size of its balance sheet. So I think that what goes underappreciated in this conversation about opening up the Fed's balance sheet is the extent to which that would affect the private allocation of credit in the economy.

Luther: You know if we look across the world, places that are financially deeper, they channel savings into an investment more effectively and they have higher economic growth rates as a result, and so we don't want to kill the goose that lays the golden egg just to have an account at the Fed.

Beckworth: Okay. Well on that note, our time is up. Our guest today has been Will Luther. Will, thank you for coming on the show.

Luther: My pleasure.