Cash

Cash is commonly understood to be the physical form of money. While a vast array of physical items has been used in order to physically express money in the past, banknotes and coins are the predominant forms existing today. Bank deposits recorded on the liabilities side of banks' balance sheets are the original form of income that grant purchasing power to their holders. A banknote, on the other hand, is the physical acknowledgment that its holder is the owner of part of the central bank's liabilities. Banknotes therefore do not add to the bank deposits held by the public, but are a claim on existing bank deposits recorded on the liabilities side of central banks, commonly under the title "currency in circulation".

Before the advent of central banking, private banks issued banknotes. Today, central banks issue banknotes, while treasury departments issue coins in several countries. Importantly, central banks do not issue banknotes by purchasing output or financial assets with freshly printed banknotes, as observers sometimes maintain. This is, of course, illegal in any financial system that adheres to the basic principles of banking. Instead, every purchase of the government or the central bank must be financed with income sooner or later. While governments receive their income mainly by means of taxa- tion, central banks earn it for the most part in the form of net interest payments or fees. This income is paid to central banks in exchange for the provision of a variety of services to the wider banking system, such as financial intermediation or the supply of central bank money for settlement purposes between member banks.

In order to receive banknotes from the central bank, a commercial bank must transfer to the central bank equivalent claims on bank deposits. The central bank then physically transfers banknotes, which themselves represent the central bank's acknowledgement of debt. Neither is the central bank's physical currency purchased by the commercial bank, nor is the purely scriptural claim on the commercial bank's deposit purchased by the central bank in this blank operation. Instead, the two banks exchange a scriptural claim on a bank deposit for a physical claim on a bank deposit, leading to a reciprocal indebtedness confined to the banking system. As Rossi (2007, p. 85) points out, "[t]he emissions of bank notes and coins serve merely to allow for the substitution of one [immaterial] form of financial claims for another [material]".

Table 3 illustrates what happens when the commercial bank's client withdraws bank- notes from the automatic teller machine. As soon as the client withdraws banknotes, she transforms "an immaterial claim on income [£x] into a paper-based representation of it [banknotes]" (ibid., p. 87).

The emission of coins works analogously to the emission of banknotes, despite coins being issued by the treasury in many cases (see Gnos and Rochon, 2002, p. 49 or Rossi, 2007, p. 87 for elaboration on this point). In contrast to the popular fiction of "helicop- ter money" (Friedman, 1969, pp. 4-5) and similarly simplistic conceptions of the money creation process that persist despite their open contradiction with reality, the amount of notes and coins in circulation is entirely determined by the public's demand to effect payments using physical representations of income. If the general public chooses, for whatever reasons, to abolish the use of cash in the near future, this would change nothing substantially about the functioning of the financial system.

See also:

Amsterdamse Wisselbank; Bank deposits; Bank run; Central bank money; Money creation; Settlement balances.