Here’s a stylized fact that never goes out of style. More than 85% of the value of all circulating currency issued by the United States are $100 bills. And of these, eight out of ten bills circulate outside the United States. This “fact” is based on empirical estimates since it is almost impossible to capture exact data. High-denomination notes from the United States are more useful to foreigners transacting with each other than to US residents. A 1996 research article published in the Federal Reserve Bulletin estimated that between $200 billion and $250 billion of US currency was offshore, of the $375 billion then in circulation outside banks. It was more than half of all currencies. This has steadily increased since then and has also been verified by other researchers. Foreign demand for US currency grew three times faster than domestic demand. This confirms the maxim, “In the almighty dollar we all trust.” The changing geopolitical landscape of the current era and the tendency of central banks to diversify away from the US dollar could change some of the statistics above. Why foreigners continue to trust the dollar or why much global billing is still in US dollars is a topic for another column.
In 2022, the U.S. M2 measure of money supply, i.e. cash in circulation plus checking and savings accounts, is about $22 trillion, twice the figure of 2011. This implies annual growth of 7%, well above US growth in gross domestic product (GDP).
Last month, the United States recorded retail price inflation of 8.3%, the highest in 40 years. High inflation will persist this year, and possibly the next as well. Core inflation, which excludes the volatile fuel and food components, is 6% in the US, more than double the normally accepted figure. This inflation is the result of a massive expansion of the money supply over the past decade and a half. This inflation was not obvious because it was hidden in stock market bubbles and inflated real estate values. But after the pandemic and following the war in Ukraine, inflation has also spread to goods and services, and is now widespread in product and service markets. It will soon lead to demands for wage increases, which could eventually cause a wage-price spiral.
The winners from a rapid expansion of money, especially money in circulation, are the issuers of debt, primarily the federal government of the United States. The seigniorage income from issuing money, that is, the difference between the cost of printing cash and the face value of the money, is quite significant. This could very well be 3-4% of total federal spending. This is therefore a real gain for the federal government.
Another way of apprehending the phenomenon is an erosion of the purchasing power of these famous 100 dollar bills circulating abroad. At America’s current inflation rates, those bills are eroding by about 8% a year. It is a transfer from currency holders to debt issuers. This is called the “inflation tax”, which is a gift to the US government. This tax is even more pernicious than ordinary taxes since it is also paid by non-nationals (i.e. the large number of foreigners holding US currency), which can be considered taxation without representation.
Seigniorage revenues and levies of this implicit inflation tax are always a tempting option for governments, since they do not need to announce a politically unpopular increase in tax rates. It is a silent tax that ripples through all strata of society and inflates the government’s debt burden without any announcement.
In India too, we have witnessed a strong expansion of the money supply in recent years, a consequence of a very accommodative monetary policy. Moreover, remarkably, the currency in circulation has gone from approximately ₹13,000 billion in 2016 for ₹30 trillion in 2022. That’s a shocking 15% growth per year, well above even nominal GDP growth. And this despite the great shock of demonetization and the concomitant growth of digital transactions.
No one can guess to what extent this monetary expansion has led to inflation in India. But no one can say that Indian inflation is not a monetary phenomenon. Since the Union government is the largest borrower and largest indebted entity in the country, it is the primary beneficiary of any inflation tax imposed by a currency expansion. Cash in circulation has grown excessively also due to the Centre’s direct cash transfer mechanism, which now covers more than 50 grant programs. The “rigidity” of cash conservation has translated into 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 affect private sector borrowers like home loan takers, working capital needs and business expansions. ‘factories.
Meanwhile, the demand for precaution and cash transaction has increased, even as the cash in hand erodes in value at the rate of inflation. Companies that handle cash management say the use of cash is growing at a staggering rate, especially in rural areas. Some payment banks have doubled their business and customer base over the past year.
Even as UPI transaction volumes increase and India moves closer to a less liquid society, the lure of cash remains. Not only does it offer anonymity, but it is immune to bandwidth or power issues. Those on the wrong side of the digital divide feel more comfortable with paper notes, whether crusty or dirty, even as they experience value erosion from inflation. Cash is still king. At least for now.
Ajit Ranade is an economist based in Pune