We hear it in the media all the time: cash is dying (or should be killed off). We’re headed into a highly digitized world of payments where soon we’ll be paying for everything with just the touch of a fingertip. And it makes sense – the rise of electronic payment methods both inside and outside of the mainstream financial system are on the rise. Some smaller countries have made it a mission to eradicate cash. There are certainly benefits to be touted of going cashless. Even Kocherlakota has recently argued that abolishing cash could improve economic conditions. Most commonly, fans of the cashless society highlight the following:
- Paper currency facilitates the elicit underground economy
- Paper currency enables the Effective Lower Bound
- Paper currency is less secure than other payment instruments, at least when it comes to risk of theft
There is indeed a very strong intellectual argument to be made for eliminating cash, in my opinion. Cash isn’t efficient. It has high transactions costs and causes frictions that are not present with electronic payment methods.
The fact of the matter is though, it’s not going anywhere. Despite that this argument continues to come up year after year and make traction, it’s just not in the data. Pretty much every study that tracks cash usage shows that it has either remained steady or increased over the past decade.
First, let’s take a look at the international stage. According to a MasterCard Advisors report entitled “Cashless Journey,” cash still accounts for about 85% of global consumer transactions. This is based on a study of 33 countries of mixed levels of development. On the home front, the San Francisco Fed’s Cash Payment Office put out a study based on the Boston Fed’s Diary of Consumer Payment Choice, which tracked consumer payment behavior in the U.S. from 2011-2012. The data from the diary clearly demonstrates that cash is still a huge player in the U.S. Although their metric, that 40% of payments are made in cash differs significantly from the MasterCard study, which says that 55% of payments are made in cash in the U.S. (oh the joys of finding consistent data), this is still pretty large percentage.
There are some key takeaways from the data:
- Cash is mostly used for small-value transactions – By value, cash makes up only 14% of transactions. The average cash transaction is $21, compared to $44 for debit cards and $168 for checks. On a similar note…
- Cash is the most common choice for most everyday expenditures – These include gifts and other transfers between people, food and personal care supplies, entertainment, and transportation. However, debit cards also play a large role in these categories, indicating that cash is not the choice due to issues of financial inclusion. And this is pretty true across different groups because…
- Cash preference is ubiquitous among age demographics – My gut said that cash usage should be lowest among younger generations, but I was wrong. Among 18-24 year olds, 40% said cash was their first choice. This is the highest among any age group. Preference for cash actually declined with age, as older groups were more in favor of credit cards, likely due to correlation with higher income. 18-24 year olds were most likely to favor debit cards, with 51% stating this as their first choice, but when asked what they actually used, cash is more prevalent. When looking at transactions, use of cash was pretty even across age groups, despite the stated preferences. All of this is a clear indication of the role of income in payment choice. As people tend to make less money when they’re young, they’re more attached to cash, even if the stated preference is another method. Which leads nicely into my next point…
- Income plays a big role. Other than the age data discussed above, the data also show that those with low household income (under $25,000) have a strong preference for cash. This preference drops off significantly when an individual lives in a household with greater than $25,000 in income. Those with high household income (greater than $200,000) have a strong preference for credit. Debit is the preference for those in between the two extremes. Interestingly, when we look at actual payments made, all incomes levels use cash about the same number of times (not by %- richer households make more payments). So, although richer households do use credit more often, likely due to ease of access, they still also use cash just as frequently as those with lower income. This makes sense because…
- Lower income households use cash differently. Households with income less than $25,000 use cash for a wider variety of transactions and also spend more cash than others, even though the number of payments is on average, the same. In these instances, cash is used is for higher-valued transactions than it is by their richer counterparts. These households use cash more often for larger payments, like housing, likely due to lack of access to alternative options. These are the unbanked/underbanked population that I referenced earlier . But, regardless of income…
- Cash is the best back up. Even among those who state debit or credit cards as their first choice, cash is overwhelmingly the next choice when the first isn’t available. For example, in P2P transactions, cash was used much more often (66% of all transactions). This is likely because there isn’t always an easy alternative to give money directly to another individual. Additionally, 60% of people who stated debit cards as their first choice also stated cash as their second option. I suspect that this is likely due to merchant acceptance, indicating the U.S. is lagging in the infrastructure/technology department (ie. if a merchant doesn’t accept a credit card, he probably doesn’t accept debit cards either, so cash is the only real option).
So, what does it all mean? The most salient conclusion that I can draw is that the main reasons for cash usage still being so prevalent are due to income and financial inclusion. People use cash if they’re unable to use credit cards or debit cards either because they don’t have them or because they try to use them sparingly. This is supported by the age trends as well as the income trends. We see from the data that every age group has a higher frequency of stated preference for debit cards than cash, yet cash is still used more frequently. What’s difficult to ascertain is that if this discrepancy is more because of the income and/or financial constraints or it’s a social convention thing.
I want to believe that, from a cultural stand point, people are comfortable with not using cash and would easily switch over to electronic methods as long as they had access to those tools. I’m not convinced that’s the case though. The arguments for dropping cash make sense cerebrally, but there’s hesitancy. People just aren’t as comfortable with going “on the grid” as they claim. Several things come into play – convenience, acceptance, security, for example. Carin van der Cruijen as the Dutch National Bank has done some interesting work looking into how social conventions and norms affect payment behavior. I think this is a huge part of the equation in addition to quelling concerns about security. People like the idea of actually being able to hold their money and not having it all be stored within a bank’s computer system. As I’ve said before, people aren’t super trusting of banks.
Moving toward a more electronic system that relies less on cash (which I think is optimal) will require better understanding of why people are still attached to paper money. I suspect that trust, security, anonymity, and more widespread social acceptance are the most likely explanations.