I recently wrote two posts for the Sound Money Project about Swedish monetary
innovation. The first is about an effort by the Swedish central bank—the
Riksbank—to force
retailers to accept cash, and the other is about the
e-Krona, a potential Riksbank-issued digital currency.
This post covers a third topic. For many years now those of us who are
interested in cash, privacy, and payments have had our eye on Swedish
banknote demand. The amount of paper kronor in circulation has been declining
at a rapid pace. Many commentators are convinced that this is due to the rise
of digital payments. Since Sweden is at the vanguard of this trend, it is
believed that other nation's will eventually experience similar declines in
cash demand too.
But I disagree. While digital payments share some of the blame for the
obsolescence of paper kronor, the Riksbank is also responsible. The Riksbank
betrayed the Swedish cash-using public this decade by embarking on an
aggressive note switch. Had it chosen a more customer friendly
approach, Swedes would be holding a much larger stock of banknotes than they
are now. As long as other countries don't enact the same policies as Sweden,
they needn't worry about precipitous declines in cash demand.
Banknotes are dead, long live banknotes
Across the globe, an odd pattern has played out over the last decade. The
proportion of payments that are being made with cash has been rapidly
declining thanks to the popularity of card payments. Sweden is no different
in this respect, although it may be further along than most:
Oddly, even as developed countries are seeing fewer transactions completed
using cash, the quantity of banknotes outstanding has jumped. This increase
in cash outstanding, which generally exceeds GDP growth, is mostly due to an
increase in demand for large-value denominations, as the chart below
illustrates:
The BIS has a good
explanation for this seemingly contradictory pattern. The demand for cash
can be split into two buckets: means-of-payment and store-of-value.
Banknotes earmarked as a means of payment are generally spent over the next
few days. Demand for this type of cash is stagnating thanks to increased card
usage. Not so the former. The demand to store $100 bills under mattresses and
in safety deposit boxes in anticipation of some sort of disaster is booming.
According to the BIS, this is due in part to low interest rates, which makes
banknotes more attractive relative to a bank deposit or government bond.
The number of banknotes held as a store-of-value demand accounts for quite a
large proportion of total cash in circulation. In a
recent paper, Reserve Bank of Australia researchers estimated that 50% to
75% of Australian banknotes are hoarded as a store of value. Keep in mind
that these sorts of calculations are subject to all sorts of assumptions. Australia's
experience with cash probably applies to most other developed nations.
Sweden, a sign of what's to come?
Which gets us back to Sweden. Sweden differs from all other nations because
of what is happening with its banknote count. The quantity of paper kronor
outstanding has been consistently plummeting for a decade now, and currently
clocks in at just half its 2008 tally:
Surprising, but for the first time in years,
the number of Swedish krona banknotes in circulation is growing.
Has Sweden's push to become a cashless society come to an end? pic.twitter.com/T6l1q40Ssu
— JP Koning (@jp_koning) November
6, 2018
Even Norway, which has probably proceeded further
along the path of digital payments than Sweden, has experienced only a
small decline in notes outstanding, nothing akin to Sweden's white-knuckled
collapse. The key question is this: why have most developed nations
experienced digital payments renaissances along with stability in cash
demand, whereas Sweden's own renaissance has been twinned with a seismic drop
in cash demand?
The answer to the question is important. Many commentators (including Ken
Rogoff) are convinced that the rest of the world's nations will eventually
find themselves in the same situation as Sweden. The allure of digital
payments will inevitably lead to an all-out Swedish-style desertion of cash.
I'm not convinced. As I mentioned at the outset of this post, the Riksbank
shot itself in the foot by carrying out an aggressive currency swap between
2012-2017. This swap did incredible damage to the paper kronor "user
experience", or UX. In response, discouraged Swedes fled from cash and
substituted into less awkward alternatives like bank deposits. Let's take a
closer look at Sweden's 'great note switch'.
The 'great' note switch
Every decade or two central banks will roll out new banknotes with updated
designs and anti-counterfeiting measures. This is good policy since it cuts
down on fake notes. These switches are generally carried out in a way that ensures
that the public's user experience with cash remains a good one throughout.
The best way to maintain cash's UX during a changeover period is to allow for
long, or indefinite periods of concurrent circulation between old and new
notes. Concurrent circulation cuts down on confusion and hassle endured by
note users.
Let me explain with an example. Up here in Canada, the Bank of Canada
introduced polymer banknotes between 2011 and 2013. But no time frame was
placed on the demonetization, or cancellation, of previous paper $5, $10,
$20, $50, and $100 notes. Since we all knew from the get-go that we would be
free to spend or deposit old Canadian banknotes whenever we got around to it,
we didn't have to go through the hassle of rounding up old notes stored under
our mattresses and bringing them in for new ones. Apart from the novelty of
polymer notes, we hardly noticed the switch to polymer.
Not so with Sweden's rollout of new banknotes. Rather than allowing for a
long period of concurrent circulation between old and new notes, the Riksbank
announced a shot-gun one-year conversion window for legacy notes. After that
point, all old notes would be declared invalid.
For instance, the new 20, 50, and 1000-krona notes were all introduced on
October 1, 2015. Swedes had until June 30, 2016—a mere 273 days later—to
spend the old notes at retail outlets, after which it was prohibited for
retailers accept old notes. If they had missed that window, the Swedish
public then had another 62 days—till August 31—to deposit them in banks.
After that, all old 20, 50, and 1000 notes would invalid. Owners of invalid
banknotes could bring them to the Riksbank, fill out a form explaining why
the due date had been ignored, and for a fee get valid ones.
The same shot-gun approach characterized the rollout of the new 100 and 500
the following year. Swedes had 273-days to spend old 100 and 500-krona notes,
and another 365 days to deposit them at banks.
I've pasted the time frame for the entire conversion below:
The October 2015 and 2016 switches were preceded by a
preparatory demonetization in 2012. At the time, Sweden had two types of
1000-krona note in circulation. The version that had been introduced in 2006
had a special foil strip to combat counterfeiters, but the 1989 version did
not. In November 2012 the Riksbank announced that Swedes would have 418
days—till Dec 31, 2013—to use old 1000 notes without foil strips. After that
date the notes would be invalid.
That outlines Sweden's hectic changeover timeline. Now, let's go back to 2012
and put ourselves in the shoes of Hakan, a Swede who has stashed a few
1000-krona banknotes in anticipation of emergencies or other exigencies. In
2012, Hakan would have learnt that all of his 1000-krona notes without foil
strips would have to be replaced or declared invalid.
How to deal with this annoyance? Hakan could have replaced them with
1000-krona notes with foil strips, but the Riksbank had also communicated
that notes with strips were to be invalidated by 2016. Replacing them with
500 notes would be equally inconvenient, since these were scheduled to be
replaced in 2017. Rather than committing himself to a string of inconvenient
switches, Hakan may have simply given up and deposited his notes in a bank.
Below I've charted the evolution of Sweden's notes-in-circulation by
denomination:
Note the massive 50% decline in 1000-krona notes outstanding between the end
of 2012 and 2013. Granted, the 1000-krona was already in decline prior to
then. But without the aggressive 2012-13 demonetization, this decline would
have been much less precipitous.
Even more glaring is the drop in the number of 500-krona notes beginning in
2015 as the conversion period approached. Rather than swapping old 500-krona
notes for new ones, or 1000-krona notes, Swedes instead choose to deposit
them in the bank. After enduring a stream of inconvenient note exchanges,
were cash users like Hakan simply sick of their product expiring on
them?
A natural experiment: Norway v Sweden
Neighbouring Norway serves as a good control or benchmark for studying
Sweden. Both nations have similar tastes for digital payments and cash,
identical banknote denomination structures, and their currencies trade close
to par. But unlike Sweden, Norway did not implement a massive note
replacement effort. This gives us some clues into how Sweden's switch may
have affected demand for the paper kronor.
Below I've separately charted the evolution in the value of each nation's
stock of 500 and 1000 notes, and the combined large denomination note stock
(1000s + 500s).
During the 2015-2017 changeover period, demand for Sweden's 500-krona note
plummeted, but uptake of the Norway's 500-krone note continued to grow nicely
(first chart). The aggressive demonetization of 2012-13 coincided with a big
drop in the quantity of Swedish 1000-krona notes. Meanwhile, the rate of
decline in the quantity of Norwegian 1000-krone notes continued as before
(second chart). What message do I take from these two charts? Given two
otherwise equal nations, the one that subjects its citizens to an aggressive
note swap will experience a large decline in the popularity of the targeted
note.
As for the last chart, the total value of Swedish high denomination banknotes
was once twice that of Norway's count. But it is now equal to that of Norway,
despite the fact that Sweden has twice the population. My guess is that if
the Riksbank hadn't inflicted a series of aggressive demonetizations on
Swedes, folks like Hakan could have blissfully ignored the entire changeover,
and Sweden would still have a much bigger note count than Norway. The black
dotted line gives a hint of where Sweden might be now if the pre-changeover
trend in kronor banknote demand had continued.
Why did the Riksbank betray the Swedish public?
Why didn't the Riksbank adopt the same policy as the Bank of Canada during
its own massive note switch? In the charts above its quite easy to point out
when the 500-krona and 1000-krona notes were replaced. But try spotting when
Canada switched from paper to polymer banknotes:
You can't, because it was a gentle switch, one that didn't hurt cash's UX.
Patriotic Swedes might counter that Sweden isn't Canada, it has its own way
of doing things. But during previous Swedish note introductions, long windows
of concurrent circulation were the standard. For instance, when the
1000-krona note that was printed from 1952-1973 was
replaced by a new 1000 note in 1976, the legacy note remained valid for
more than ten years after that, until Dec 31, 1987. And when the next series
of 1000-krona notes was
rolled out in 1989, the legacy note was accepted until December 1998.
Long windows, not short ones, is the Swedish tradition.
A March
2018 report from the Riksbank entitled Banknote and coin changeover in
Sweden: Summary and evaluation gives some insights into why a shot-gun
switch was chosen instead of a user-friendly approach. Very early on the
process, the Riksbank began to consult with firms involved in the movement of
cash including the BDB Bankernas Depå AB (a bank-owned cash depot operator),
the Swedish Bankers’ Association, the larger banks, ATM operators, and
others. One of the questions that was discussed was how long the old
banknotes should remain valid. In April 2012, these market participants
submitted their preferred timetable for the changeover. One of their
preferences was for:
"...the old banknotes and coins to become invalid
after a relatively short period so that they could avoid having to manage
double versions of the banknotes and coins for an extended period."
These same market participants also requested that the Riksbank demonetize
the old 1000-krona notes without foil strips. Removal of this older series
meant one less version to manage once the new 1000-krona note was debuted in
2015. Market participants also hoped that the old banknotes wouldn't be
exchanged for new ones, thus reducing the total amount in circulation. If you
are wondering why bankers might want fewer banknotes outstanding, go read my
'conflict of interest' section a few paragraphs below.
The timetable that ended up being adopted by the Riksbank in May 2012 was
basically the same one proposed by industry. So there you go. The Riksbank
introduced a shot-gun approach because that's what Swedish bankers wanted.
But in designing the changeover to be convenient for banks, the Riksbank
threw the Swedish public under the bus. Nor was it unaware of the
inconvenience it was imposing on Swedes. According to the March 2018 report:
"The Riksbank was aware that the timetable would lead
to complications for the general public in that there would be a number of different
dates to keep track of. The need for information activities would be
increased. However, the Riksbank considered that the interests of the cash
market were more important..."
Now, if the Riksbank had justified the shot-gun switch as a way to flush tax
cheats out, I might be more sympathetic. At least an argument could be made
that the public's welfare was being served by imposing a series of
inconveniences on them. But as the above quote indicates, the motivations for
quickly invalidating old notes was much less nuanced than this. The Riksbank
deemed that the 'complications' that the general public had to endure simply
weren't as important as the 'interests' of the banks. Full stop.
There is a huge conflict of interest involved in consulting with banks about
cash's future. Sweden's bankers would have been quite pleased to provide the
most awkward timetable imaginable. After all, they would have been the main
beneficiaries. The more Swedes who forsake cash to pay with cards, the more
fees banks earn. Furthermore, each kronor that is held in the form of cash is
a kronor that isn't held at a bank in the form of a deposit. Banks lust after
consumer deposits because they are a low-cost source of funding. One wonders
if the Riksbank fully understood this conflict of interest.
Notes for the future
The decline in the kronor count has finally been reversed. In the tweet I
embedded above, the amount of paper kronor in circulation rose in 2018, the
first increase in many years. The impositions on the the kronor's UX over the
last five years are finally drawing to a close. Now that they no longer have
to worry about timetables and expiry dates, are Swedes like Hakan finally
returning to the market?
The great irony is that the Riksbank, having caused a big chunk of the
decline in 1000 and 500-krona note usage, is suddenly getting quite worried
about this trend. Earlier this year, Riksbank governor Stefan Ingves lamented
that
"There are those who think we have nothing to fear in
a world where public means of payment have been replaced completely by
private alternatives. They are wrong, in my opinion. In times of crisis, the
general public has always sought refuge in risk-free assets, such as cash,
that are guaranteed by the state. The idea of commercial agents shouldering
the responsibility to satisfy public demand for safe payments at all times is
unlikely."
The Riksbank may even roll out an e-Krona, a digital
currency designed to meet Swede's desire for "continued access to a
means of payment that is risk-free and guaranteed by the state." Odd
that Ingves is now so concerned about Swedish access to a risk-free payments
medium when he was so willing to ignore the interests of Swedish cash owners
just a few years before.
Sweden will probably have to go through another note switch sometime in the
late 2020s. I hope that when it comes, Swedish bankers will get a little bit
less representation at the table and the Swedish public a bit more.
As for concerned citizens and central bankers in other countries that are
planning to introduce new notes, we can all learn some lessons from Sweden's
2012-2017 changeover. Aggressive note switches may be good for private
bankers, but they hurt cash-using citizens. The long-window approach to
note switches, not Sweden's shot-gun method, is the customer-friendly
approach.