Too big to keep.

Photographer: MIGUEL MEDINA/AFP/Getty Images

Hands Off the 500-Euro Banknote

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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The European Central Bank is looking at how it might go about phasing out the 500-euro banknote, the second largest paper store of value in the world after the Swiss 1,000-franc bill. Germany's Bundesbank too is open to the idea. Yet it's hard to see whom the elimination of the purple banknote would benefit, despite its dubious reputation.

The 500-euro ($570) bill is something of a libertarian symbol. In a pre-bitcoin world of state-run currencies, it represented one of the best opportunities for a private citizen to fly beneath government radars. It weighs 1.12 grams, so a million euros comes up to just two kilograms -- a compact, light package to guarantee independence. A million U.S. dollars in $100 bills is a 10-kilo bag.

What people have done with this embodiment of financial freedom is another question. According to Doris Schneeberger, head of the ECB's currency management division, "there is no correlation between the use of cash and the black or grey economy" -- but that seems untrue. I have calculated the correlation using ECB data on the share of cash transactions in European countries and a recent paper on the size of Europe's shadow economies by Friedrich Schneider, the continent's preeminent authority on the subject. It's a staggering 0.72 -- as strong a correlation as can be observed for any real-world phenomena.

In Bulgaria, for example, 95 percent of payments are in cash, and the shadow economy reaches 30.6 percent of gross domestic product, the highest level in the European Union. Large-denomination euro bills are used for illicit or tax-cheating payments in these non-euro countries, too. Yet this is not just a "new" Europe phenomenon. Across the 19 countries that use the euro, the correlation between cash transactions and the estimated size of the shadow economy is 0.74 -- marginally stronger than for the EU as a whole.

Economist Kenneth Rogoff pointed out in 2014 that the euro zone had enough cash to cover 10 percent of its gross domestic product, with about one-third of the value held in 500-euro notes, while the U.S., which doesn't have such a large-denomination bill, only had 7 percent. "Currency should be becoming technologically obsolete," Rogoff wrote. "However, in no small part due to its association with the underground economy, it is not."

There are no data on how various denomination bills are used in illicit transactions; it just seems logical that 500s are more convenient for drug and arms dealers. That makes the purple banknote unpopular with regulators (Giovanni Kessler, head of the EU's anti-fraud office, called for its abolition in January), and with politicians (French Finance Minister Michel Sapin said in February it is used "more to conceal than to purchase").

The ECB also claims the notes' popularity with consumers has been flat in recent years, unlike that of the ubiquitous 50-euro bill.

That doesn't, however, mean the 500-euro bill is unpopular. The more than 600 million bills in circulation as of February 2016 made up 28 percent of the total amount of cash euros out there; only the 50-euro notes -- 8.2 billion of them -- accounted for a larger share, at 39 percent.

Phasing out a bill in which so much value is kept is no trivial task. Assuming the notes' holders want to keep their savings in cash, printing smaller-denominated bills to exchange for the 500s will cost half a billion euros, the Frankfurter Allgemeine Zeitung has calculated. To extent that savers move out of cash, because it becomes inconvenient, the ECB will end up losing seigniorage -- the profit from the difference between the notes' face value and production cost, which was abnormally high for the 500s. People who used 500-euro bills before may switch to commodities such as gold.

The gains from scrapping the biggest-denomination bill are less obvious. The shadow economy would be highly unlikely to shrink -- it's just that large transactions would involve bigger packages of smaller bills. Only the total elimination of cash would force criminals to rethink their payment systems and logistical models. Yet nobody is planning that just yet.

The timing for the planned withdrawal of the 500s is ominous, too. These are the days of negative interest rates. One of the few reasons banks are reluctant to pass them on to depositors is that they might flee to cash. Making that harder and riskier -- who wants to keep bags of cash around the house, rather than a small stack of notes? -- is not quite fair to law-abiding citizens trying to avoid paying interest on their own savings.

The Swiss National Bank has announced it won't touch the 1,000-franc ($1,048) bill, which accounts for more than 60 percent of the total Swiss cash value. The bank knows they are used as a store of value, and it has noted a rise in demand for them since rates have turned negative. That's the only fair approach in a world where central banks and governments are messing with the time value of money to the extent that they're doing now.

I have argued before for the total abolition of cash in favor of the free, officially recognized and sanctioned circulation of cryptocurrencies such as bitcoin. These currencies, though they are relatively hard to trace, still leave an electronic trail and are harder to launder clandestinely. At the same time, they provide people with a way to keep their savings outside government control, an important opportunity for free citizens. Until the parallel existence of state-issued electronic money and decentralized currencies -- also in electronic form -- becomes the norm, taking bills of any denomination out of circulation is an exercise as futile as it is costly.

(Corrects chart to show that figures for 500-euro and 50-euro bills in circulation are in the thousands, and corrects corresponding figures in eighth paragraph.)

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor responsible for this story:
Marc Champion at mchampion7@bloomberg.net