The Surprising Popularity of Paper Currency

• Author: Kenneth S. Rogoff
• Position: IMF Economic Counsellor and Director of the IMF's Research Department

Will the global underground economy be the prime destination for those large euro notes?

The introduction of shiny new euro notes and coins at the beginning of this year was indeed an exciting event. But one has to wonder. Why hasn't paper and metal currency already gone the way of the horse and buggy? With credit and debit cards, online banking, and so on, why isn't the demand for currency steadily shrinking to zero?

Curiously, all prognostications about Internet money to the contrary, there is not a shred of evidence that the public is about to give up currency in the United States, Europe, or Japan. Indeed, evidence of the reverse is stunning.

Let's start with the United States. At the end of 2001, currency per capita (held by the public) exceeded $620 billion, or roughly $2,200 for every man, woman, and child. I don't know about you, but I usually don't carry one-tenth that much currency in my wallet, nor does my brother Harry. Moreover, over 65 percent of it was held in $100 bills (the largest denomination), which means that the typical American family should be holding sixty $100 bills. Yet Federal Reserve Board surveys find that, on average, the typical American family does not hold even a single $100 bill!

Where is the missing money? Some of it can be found in obvious places like supermarket cash registers, but only a very little, according to extensive government surveys. In fact, surveys of domestic households and businesses can account for only 5 percent of the U.S. currency in circulation. Where is the rest, the other 95 percent? A big chunk is probably held abroad, though estimates vary wildly from 30 percent to 75 percent (my 1998 Economic Policy article estimated 50 percent). Even if the number is at the high end, say, 75 percent, that still leaves $2,200, held domestically within the United States, for every family of four. Economists presume that most of this cash can be found in the "underground economy." The term brings to mind gangsters and drug dealers, but, quantitatively, the underground economy consists mostly of small businesses and entrepreneurs (and their customers) who are avoiding various forms of taxation.

The mystery only deepens when one turns to the other industrial countries. Currency per capita is significantly larger in Japan (more than $4,000 a person) than in the United States, even though most studies suggest that holdings of yen outside Japan are relatively small. Moreover, over 85...