Cash and the black economy

As the Australian government and regulators narrow their focus on responsible banking practices, the issue of the “black” economy has once again stepped into the spotlight. The black economy exists in the shadow of the real economy where transactions – usually cash based – are made to avoid tax or fund illicit activities.

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In this year’s Federal Budget, new measures were introduced to target black economy activities, including one which limited cash payments to a business within Australia to AU$10,000 from July 2019. 

"Until the causes are addressed, the symptoms are likely to continue.”

Transactions in excess of this amount would need to be made using electronic payment systems or by cheque.  Paying off cash loans to financial institutions in excess of this amount will still be possible for any individual or business however.

The most recent Black Economy Taskforce report highlights the harm cause by the black economy yet while we better understand the extent of the damage, more needs to be done to reduce it.

Cause and effect

Here’s an analogy: a doctor recently explained to me the difference between the symptoms and the causes of a medical condition.

When I asked her to use a non-medical example, she brought up the proposed building of a wall between the United States and Mexico.

The symptoms which provoked such a suggestion are the heavy use of drugs in the United States, many of which are believed to come in through Mexico. However, she suggested the cause of this situation is not the supply of drugs from Central and South America but the demand for drugs in North America.

Until the causes are addressed, the symptoms are likely to continue.

Judging by a recent report by G4S - a company that manages cash distribution systems globally - the cash economy is seemingly alive and well. The report found there are 500 billion banknotes and trillions of coins in circulation worldwide. Physical money now accounts for 9.6 per cent of global gross domestic product, up from 8.1 per cent in 2011.

Flash your cash

Australia has not been immune to these symptoms. The Reserve Bank of Australia (RBA) recently released a cross-country analysis of high denomination banknotes currently in circulation. The number of such notes in circulation has increased at an above average trend rate in recent years.

It is suggested that increased domestic demand for both transaction and store-of-value purposes may have contributed to the trend, as well as responses to changes in government and central bank policies.

The report also highlighted in Australia the ratio of the value of banknotes in circulation to nominal GDP is currently close to its 50 year peak, at around 4 per cent. The growth has been strongest for the higher denomination notes, in Australia’s case the AU$100 note.

Apparently for every Australian in the current population, there are 14 AU$100 notes… although not all of us suffer from this symptom!

So what are the causes of this proliferation of cash?

Demand is creating some effect, particularly for what is known as ‘cash-intensive’ activities. But in this case there may also be a supply issue. 

The Global Financial Crisis (GFC) required governments and central banks to act in unison to restore confidence and growth in their economies. One widely-adopted policy was ‘Quantitative Easing’ (QE) – essentially flooding economies with more money.

Increasing the money supply would hopefully regenerate economic activity, via more investment and more consumption.

With QE policies in effect for the past decade, could this be a cause of the increase of cash in circulation and the subsequent symptoms of the black economy?

Money under the mattress

The RBA’s report also mentioned the demand for banknotes for ‘store-of-value’ purposes – that’s when citizens keep considerable amounts of cash on hand, rather than depositing it in the banking system.

About 70 per cent of participants in the RBA’s 2016 Consumer Payments Survey, reported holding cash outside of their purses and wallets. When investigating causes of damaged banknote claims,  the RBA has revealed several claims were made for losses in excess of more than AU$20,000 where ‘house fire’ was cited as the cause of damage.

AU$100 banknotes also accounted for about one quarter (by value) of claims of over AU$5,000.

This ‘store-of-value’ function performed by high-denomination banknotes can be particularly important during times of significant financial instability, such as following the GFC.

Could government and central bank interest rate policies post-GFC be causing citizens to hold more cash ‘in-hand’?

Another symptom of the black economy is consumers choosing to pay cash, with the consent of the provider of the goods and services they are purchasing. This sometimes occurs to pay less than the nominal price by avoiding GST.

This behavior is thought to be prevalent in particular situations such as employing tradespeople in domestic repairs and renovations.

ANZ’s recent Financial Wellbeing report revealed 36 per cent of Australians are struggling or just getting by financially, with 25 per cent unable to pay bills or loans, when they get a final reminder.

Some people who fall into this category may be seeking to cut costs wherever possible and paying cash might be the cheapest option.

Financial wellbeing is largely determined by a person’s behavior and attitude towards money, not just their financial knowledge, experience or income.

These findings take us into the realms of behavioral economics.

If someone discovers paying by cash can be less costly and also that other citizens are already doing it, seemingly with impunity, they might begin to think “well if its OK for them and it appears to work, why should I not join in?”. This raises again the question of policy and the black economy. The conundrum is we know this economy is detrimental to the greater good but individual incentives still encourage its use.

The black economy may be caused by more than just cash in circulation and low interest rates, its causes may also be about our own behaviors and attitudes.

Steve Worthington is a Professor at Swinburne Business School.

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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