For example, a million U.S. dollars, made up solely of $ bills, would form a stack measuring approximately 43 inches or 109 centimeters in height and weighing 22 pounds or about 10 kilos. Consequently, currency is inconvenient to use, especially for those who seek to make large investments or payments. Second, currency is subject to theft, requiring a big investment in security and insurance. Third, recounting currency every time it is moved or transferred between people entails time and expense. Finally, currency is subject to degradation, accident, fire, counterfeiting, and other mishaps. Because currency is costly to invest in, then we could refine the proposition we stated earlier to say that a person would invest a dollar in an account or bond that promises to pay back less than a dollar so long as the person could not preserve more of his or her initial wealth by investing in currency, net of its costs. So one might suggest that it is the negative net return on currency that establishes the lower bound to interest rates – zero is only a rough approximation. This formulation is sharper, certainly, but it may also be too blunt for the following reason. Notice that the costs of handling currency vary by the size of the investment one is considering.
Until there are equally secure electronic means of providing that anonymity, eliminating currency is not warranted. Economists have proposed many clever ways to implement the taxation of currency, or, equivalently, the payment of interest on currency holdings. Some of the proposals entail decreasing the value of the currency by imposing a negative rate of interest. This can be likened to making currency out of ice. As you can imagine, such cold currency would slowly disappear as the ice turns into liquid water. (Other proposals would, in effect, attempt to raise or lower the temperature of the air surrounding the ice money.) One might conjecture that the loss of purchasing power is the same whether a person holding a dollar for a period of a year sees the value of that dollar decline owing to inflation of 1 percent, or because he had to pay a penny of interest in an environment of stable prices. However, there is a subtle difference between a negative rate of interest charged on currency, and inflation decreasing the value of currency. With inflation, a dollar remains a dollar, but its purchasing power declines. In contrast, with negative interest rates, the dollar of currency is slowly whittled away as one makes interest payments, even though its purchasing power can remain unchanged (this would be the case if prices fell by the same rate as the negative interest rate). In other words, the value of the unit of account is unchanged when a negative interest rate is charged on currency.