The ECB would do so at its own peril.

By Don Quijones, Spain & Mexico, editor at WOLF STREET .

Germany loves physical money. According to a Bundesbank study, approximately 80% of payments in Germany are made in cash. Even among millennials, two-thirds say they prefer paying in cash to electronic means, a much higher level than in almost any other advanced economy with the exception of Japan.

This is a big problem for a European establishment that is desperate to consign physical money to the scrap heap. Some countries, including France and Spain, have already set maximum cash limits of €1,000. Greece has dropped its cap for cash transactions from €1,500 to €500.

In January the European Commission telegraphed its intention to implement a mandatory continent-wide limit by 2018, even if it violates the “non-fundamental” rights of over 500 million EU citizens to privacy, anonymity, and personal freedom. The Commission’s plans are likely to meet strong resistance from certain quarters, in particular Germans.

When the Merkel government merely suggested last year that it was considering banning cash payments above €5,000, it triggered a fierce public backlash. The country’s biggest tabloid, Bild, published a scathing open letter titled “Hands Off Our Cash,” while a broad spectrum of political parties condemned the proposed measures as an attack on data protection and privacy.

Even the head of the Bunderbank, Jens Weidmann, criticized the government’s proposals, telling Bild (emphasis added): “It would be fatal if citizens got the impression that cash is being gradually taken away from them.”

Most central bankers do not share Weidmann’s misgivings. On the contrary, most central banks and the big banks whose interests they largely represent are one of three elite groups that are currently waging an existential war against physical money — the other two being the electronic payments industry and government itself.

The main reason for central bankers’ distaste for cash is that it significantly limits their ability to continue conducting arguably the greatest financial heist of the modern age, i.e., negative interest rate policy (NIRP). In a public speech in 2015 Andrew Haldane, chief economist at the Bank of England, admitted as much, arguing that banning cash altogether would give central banks greater “flexibility” in the event of a new crisis.

But the Bundesbank seems to have a very different perspective on the matter, for an obvious reason: it is one of the world’s biggest manufacturers of cash. Since the introduction of the euro in 2002 it has put a net €327 billion into circulation above its on-paper allocation. In total, 592 billion of the 1.1 trillion euros worth of banknotes in circulation at the end of 2016 started life at the Bundesbank.

When contacted by Bloomberg to explain how Germany’s central bank had become the euro area’s most prolific issuer, the European Central Bank said:

“The issuance of euro banknotes is an entirely demand-driven process, and none of the NCBs can control the migration of its issued banknotes. As a result, the number of returned banknotes to NCBs can exceed the number of banknotes issued by them. For example, German tourists travelling to Spain take euro banknotes issued by the Deutsche Bundesbank with them to Spain, which are finally lodged at the Banco de Espana.”

But nonetheless, Germans could be made to pay for their love of cash. As Bloomberg reports, if a national central bank uses more than its allocation of physical cash, it has to pay interest on the overuse, at the ECB’s main refinancing rate. For the moment, the issue is moot since the ECB rate is zero percent, so there is no cost.

But should the ECB, over time, raise benchmark interest rates to, say, 2% (crazier things have happened), that would result in an annual cost of €6.5 billion on the Bundesbank. This would be paid to national central banks such as Spain and Portugal, who are underusing their cash allocation. In other words, the less cash you issue the more you get paid. Luxembourg, too, would have to pay interest to other central banks since it has an allocation of less than €3 billion euros and yet has put over €96 billion into circulation. As Bloomberg notes, in this case holiday makers are probably not to blame.

Perhaps the greatest irony is that for the Bundesbank and the Bank of Luxembourg to be made to pay for their overproduction of cash, the ECB would need to hike interest rates, which defeats the main purpose for which central banks would like to get rid of cash. But still, the ECB will probably find another way of punishing Germany’s hordes of cash lovers.

It does so at its own peril. Already only one in three Germans say they have trust in the ECB. And that was before ECB governor Mario Draghi gave an infamous speech in May last year laying much of the blame for the Eurozone’s weak economy on Germans’ proclivity to save, rather than splash out on foreign imports or invest in the stock market. Once Germans realize that the ECB is considering financially punishing them for their love of cash, their trust in the central bank could also go into negative territory. By Don Quijones.

There’s an air of furtive desperation about the proceedings. Read… Are We About to See a “European Monetary Fund?”

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