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Weak inflation could consign the €500 note to the shredder

On a busy street in Rome a few years ago, I spotted a purple piece of paper – rectangular – on the sidewalk. I picked it up and realized it was a €500 banknote. Or I thought it was; it could have been a forgery. I had never seen a banknote of such value. At the exchange rate at the time, it was worth about $700 – more than the price of my first rust-bucket car.

Being a Boy Scout Canadian, I stood there for a good 45 minutes, waiting for the note's rightful owner to return. No one with a distressed look on his or her face came by, so I went to the bank. The teller put the note through a scanner, smiled and said, "Lei é fortunato" – you are lucky.

She presumed that I wanted to deposit the note in my bank account, and that was the point. A note of that denomination is entirely useless as walking-around money. Shop owners would never accept it as payment because they could never make change for it, or they would assume it was a forgery. But as a store of value, it does the trick.

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Perhaps I should have kept it for its rarity value, for the €500 note might soon join the lira, deutschmark and franc on the European extinction list.

The European Commission is probing the links between the note and criminal activity such as money laundering and the sale of illicit drugs and weapons.

Early this week, Peter Sands, former chief executive officer of Standard Chartered PLC, called for the elimination of the €500 note along with the 1,000 Swiss franc note, even the £50 British note. The main use of the £50 note is to pay tradesmen such as plumbers, he said: "The incentive is tax evasion, since payment in cash makes it easier for the individual to avoid VAT [value-added tax] of 20 per cent," he said.

True, but the campaign to kill high-denomination notes in Europe – they are long gone in the United States and Canada – is probably more about fighting deflation and knocking down the value of the euro than it is with making life (slightly) less convenient for your neighbourhood money launderer.

The European Central Bank does not overtly endorse the death of high-denomination notes. But you can bet that ECB president Mario Draghi, who is fighting a losing war against falling inflation, would welcome it.

Since Mr. Draghi joined the ECB at the height of the euro-zone crisis in late 2011, he has been busy trying to keep the region intact (success) and fighting disinflation (little to no success). Despite the launch of a €60-billion-a-month quantitative easing program, bank-support measures to encourage lending and dropping the ECB's deposit rate into negative territory, the 2 per cent inflation target has proved elusive, partly because of falling oil prices. In January, consumer prices were up only 0.4 per cent over the same month a year earlier. The rate in December was 0.2 per cent and, at one point, inflation was negative.

Sending the €500 note to the shredder probably would weaken the currency, stimulating both exports and inflation (since the cost of imported goods would rise). About 30 per cent of the €1.1-trillion in cash held across the euro zone is hoarded in €500 notes. If that note were eliminated, depositors would be tempted to find another store of wealth. Euros would be sold in favour of the Swiss franc or the U.S. dollar, weakening the euro. The ECB does not specifically target exchange rates, but everyone knows that Mr. Draghi is thrilled that his quantitative easing program has taken the punch out of the euro.

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If the ECB pushes interest rates deeper into negative territory, as it is expected to do as early as next month, following the Swedish central bank's move this week, banks will remove some of their money out of the ECB's deposit account. But where to put the loot?

It costs money for banks and for bank clients to store notes of any denomination in a vault or a safe deposit box. Storing, say, €1-million in small-denomination notes would cost a lot more than doing so in big-denomination notes. If the €500 note is killed off, more money might be put into circulation.

I suspect that the battle to destroy big-denomination notes will succeed and may help Mr. Draghi's inflation crusade, if only a little. Then what? Will the central bankers and regulators then go after smaller notes, leaving the €20 note as the lone biggie?

Europeans in general and southern Europeans in particular like the convenience of cash (and its VAT-evading potential). It makes for lightning-quick payments at shops, bars and restaurants – note how efficient an Italian coffee bar is compared with an American Starbucks. Cash means no services charges associated with debit and credit cards.

It means anyone who is worried about a bank collapse can take out a wad of notes and stuff it in the mattress.

And it means that every transaction you make, from buying cigarettes to paying a university student to paint your fence, is not recorded in a database that can be hacked. Cash is freedom.

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By the way, I donated the €500 I found on the street in Rome to charity.

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About the Author
European Columnist

Eric Reguly is the European columnist for The Globe and Mail and is based in Rome. Since 2007, when he moved to Europe, he has primarily covered economic and financial stories, ranging from the euro zone crisis and the bank bailouts to the rise and fall of Russia's oligarchs and the merger of Fiat and Chrysler. More


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