The European Union has struck on a plan to crack down on the use of anonymous payments and virtual currencies so that terrorists can't use them. The problem is that terrorists aren't really using them, anyway.
They're using good old cash, though its circulation is already severely limited in countries such as France -- the scene of the most recent Islamic State terror attacks. Instead of taking their anger out on virtual currencies, now is the time for governments to think seriously about the abolition of cash.
Despite the Islamic State's well-known dislike of the U.S., its financial accounts seem to be kept in U.S. dollars. The terror group's revenue comes in greenbacks, whether from old-school oil smuggling, "taxes" on subjugated populations or the trade in stolen artefacts. The expenses -- such as the purchase of weapons, which are also smuggled into traditional markets such as Belgium from the Balkans' former war zones, and the payment of fighters' salaries -- also take the form of cash transactions.
They are made possible by the huge amount of U.S. currency that is held overseas, mostly in $100 and $50 bills. In a 2012 paper for the Federal Reserve Board of Governors, Ruth Judson cited estimates of about 50 percent of all U.S. cash in circulation in 2011. If applied to current data, that suggests $670 billion in U.S. banknotes is being used outside of the U.S. This dwarfs Islamic State's estimated $2 billion asset base. It's also at least 15 times the amount of money moved every year in all kinds of so-called hidden digital payments -- through digital wallets, mobile money and virtual currencies.
If Islamic State moved all its transactions, hundreds of millions of dollars a year, into the bitcoin universe, the virtual currency's rate would spike wildly. Today, only 14.8 million bitcoins have been "mined," for a total of $4.7 billion at the current exchange rate.
Last month, the U.K. government put out a "national risk assessment of money laundering and terrorist financing." The document ranked payment media by the level of risk they represent. Cash was rated a "high" risk for terrorist financing, the traditional banking system a "medium" one, and e-money and virtual currencies a "low" one. "Digital currencies are currently not a method by which terrorists raise or move money out of the U.K. (though they remain a viable method for doing so)," the report said.
Governments are aware that the circulation of cash -- anonymous, untraceable, universally accepted -- poses the greatest danger in feeding all sorts of underground activities, including terrorism. The Bank of England estimates that only about a quarter of the cash in circulation is used to buy things; the rest is hoarded or used in the shadow economy. In France, it's been illegal since September to make cash payments of more than 1,000 euros ($1,070), though the limit is higher for foreign visitors, 10,000 euros. Cash deposits and withdrawals of 10,000 or more are reported to the country's anti-money laundering agency. That, however, is not particularly efficient: In the underground economy, much bigger amounts will keep changing hands, and cash couriers will continue crossing borders, ignoring the financial system that is visible to the authorities.
The crackdown on cash in its current form can perhaps reduce small-time tax dodging. But it won't mop up the hundreds of billions of dollars already circulating in the underground economy -- or in countries with a low uptake of cashless payments. Cash accounts for about 85 percent of consumer transactions worldwide. In the U.S., only 45 percent of such transactions are cashless; in China, just 10 percent.
All kinds of people, not just criminals and tax dodgers, like cash, mainly because it's still more convenient than any other form of payment. It works when power is down, it's not subject to computer glitches, you're lucky if you have it when the government declares a forced bank holiday as it did in Greece last summer (plastic card payments were allowed in that case, though, so holding cash wasn't a huge advantage). Privacy -- the main argument of the intellectual opponents of a cashless society -- is also a concern: Instinctively, people don't want all their transactions to be transparent to governments, even when they're not doing anythi ng illegal.
Consider, however, what would happen if cash were banned but alternative currencies were freely allowed to circulate.
People would be forced to convert their cash savings to bank deposits. In itself, that's a nasty proposition for consumers: It wouldn't just allow governments to monitor all transactions, it would also let them take interest rates below zero, forcing people to pay banks to hold their money. That opportunity is the main reason why some economists are calling for the abolition of cash.
The free circulation of decentralized virtual currencies, however, would put a damper on governments' extortionist moves, letting people exchange their money for what is in effect a virtual commodity that, unlike money, is not state-issued. Interest is an alien concept to the bitcoin world, though there are schemes that allow one to earn it; banks will want to offer depositors something to prevent them from fleeing into the virtual world, and governments will have a reason to back them if they want more control over transactions.
It's likely then that most people will want to keep their savings and borrow in traditional money. Bitcoin and its ilk will only be useful for transactions that require privacy and also as a risky alternative investment: The volatility of bitcoin's exchange rates is far greater than any other currencies or money-like commodity. The blue line on the chart below in the 30-day volatility of Bitcoin's exchange rate to the U.S. dollar, and the green one is gold price volatility:
That volatility, however, would make the alternative system risky for terrorists to use. Groups like Islamic State and their contractors don't want a means of payment that can lose half of its value in a day. They may still want to use bitcoin because it'll always be harder (though not impossible) to trace than the movement of funds in the traditional banking system, but the risks will be much higher than with cash, and the exchange rate will be open to government manipulation ( it is now, though governments don't use the opportunity).
Cash use is shrinking in the developed world, anyway. So perhaps attempts to cut off terrorist funding will usher in a cashless financial system earlier than it would have developed by itself. It's important, though, to give people alternatives, perhaps in the form of virtual currencies. Cracking down on them is not going to be helpful, and it won't hurt terrorists as much as a move away from cash would.
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: Therese Raphael at traphael4@bloomberg.net