Payment is only one of the functions of cash. A second essential function is to store value.
Banknotes are a financial asset and although they do not bear interest, they offer liquidity and security.
Several studies have measured the share of hoarded banknotes versus transactional banknotes. Helmut Stix has estimated that roughly 10% of cash in circulation was used for transactions in Austria in 200428
. B. Fischer, P. Köhler and F. Seitz29
estimate that around 25 - 35% of all currency in circulation in the euro zone is used for domestic transactions. The remaining 65 - 70% is either hoarded or held abroad.
The mix of denominations in circulation provides a rough assessment of the importance of hoarding. In Switzerland, the CHF 1,000 note, which is one of the highest denominations in the world, represents 61% of the value of notes in circulation30
, but this note is rarely used in daily transactions.
The store of value function also largely explains the international demand for some currencies. Estimates by the US Federal Reserve suggest that as much as 60% of US currency is held overseas31
. In the case of the euro, an estimated 25% of the euro currency and possibly more was circulating outside the euro zone at the end of 201332
. For foreigners, an international currency represents an asset which is liquid, secure and stable in value. These attributes are often not provided by their own currency, particularly after periods of economic instability.
Interest rates are a key factor in explaining currency demand and, in particular, demand for hoarding. Lower interest rates reduce the opportunity cost of holding cash and make it more attractive. Another factor is the level of confidence in the banking and financial system. According to Tom Cusbert and Thomas Rohling33
, currency demand in Australia increased abnormally fast in late 2008, following the collapse of Lehman Brothers, and resulted in a 12% rise in the value of banknotes. Around 20% of this can be attributed to the lowering of interest rates and the increase in income from the government stimulus. The remaining 80% of the rise may be due to an increase in precautionary holdings in response to uncertainty in the financial sector.
Using survey data from ten Central, Eastern and South-Eastern European countries, Helmut Stix has analysed why households in transition economies prefer to hold sizeable shares of their assets in cash at home rather than in banks34
. The paper documents the relevance of this behaviour and shows that cash preferences cannot be fully explained by whether people are banked or unbanked. The analysis reveals that a lack of trust in banks, memories of past banking crisis and weak tax enforcement are important factors. Moreover, cash preferences are stronger in dollarised economies where a “safe” foreign currency serves as a store of value.