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There are a lot of ways to pay for things. There are credit cards, wire transfers, frequent
flyer points, sticks of gum, bitcoins, cheques (if they are still a thing) and of course
tried and true CASH.
Physical cash is one of the easiest ways of instantly and reliably transacting money.
In an economy that benefits greatly by people buying and selling and trading items, this
type of simplicity is remarkably beneficial.
It has been well documented that the ease of transactions in a nation is as big of a
determinant of economic success as oil, natural gas or even a well-educated population.
Modern financial systems have made spending money extremely easy, and sometimes that is
by design.
But! Amongst all of this cash is still a staple of regular transactions. So what would happen
if we got rid of it?
This is not some obscure hypothetical, modern economies have been pulling back on the use
of cash in a very big way.
Just think, when was the last time you paid cash for something? For many of you it will
be all the time, but for most, the ease of tapping a credit card or venmoing some money
makes theses paper rectangles all but obsolete.
The decline of cash is not all due to the march of technology either, policies have
been put into place to limit how easy it is to spend your own money.
Many governments around the world have put in place sever limitations on the use of cash.
The Australian government for example has plans to make it illegal for a business to
accept more than $10,000 cash for any single transaction.
Even outside of these stipulations cash is starting to get a reputation. Go into your
local car dealership and try to pay for a brand new pickup with cash.
That is perfectly legal, but you better be prepared to answer a whole lotta questions.
So many questions in fact that most dealers won’t even bother working with it anymore,
which very visually highlights a cashless future edging closer and closer.
So would going completely cashless really be that bad?
Would governments even let it happen?
Has something like this actually happened before?
And in the world of negative interest rates could this hurt people that just want to hold
onto some money without having to pay for the privilege of doing so.
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Now for those of you who don’t remember the last time you paid cash for anything,
it’s logical to think this is just the natural progression of technology.
We don’t use gold coins or goats to trade anymore so if technology has just made it
better and easier to do everything electronically
What is the harm of embracing change?
Cash is great, but from a consumer’s perspective, there are just more compelling options.
Credit cards are the first solution here.
If cash gets lost or stolen or destroyed, it is gone...
On the other hand, if you accidentally put your credit card through the washing machine,
it would most likely still be fine, or worst case scenario you just order another one.
If it gets stolen, you can just reverse all of the fraudulent charges. All while benefiting
from the ability to earn rewards like cash back on purchases, or frequent flyer points,
and being able to pay for things without physically being there to hand over money. Which is particularly
important in this day and age. And very useful for patreon.com slash economics explained
Of course, credit cards have their drawbacks
If these cards are used irresponsibly and not paid off in full they carry extremely
high-interest rates, often well over 30% depending on the provider.
And even for those people that do pay them off in full every month, cards may be hurting
their finances in a less obvious way.
A 2018 paper published by the bank of international settlements found that there was a strong
correlation between someone’s credit card limits and that person’s marginal propensity
to consume.
In plain English this means that people are more likely to spend more of their money if
they have a big credit card, or even worse, lots of credit cards.
One final and very important curiosity about these cards is that they are actually very
difficult to extract cash from.
If you try to take cash out from your American Express, Visa or Mastercard you are going
to get charged with what is called a cash advance fee.
This is typically a very significant upfront charge, sometimes as much as 10% of the cash
withdrawn plus interest will be charged on this from the moment you take that money out
of the ATM. Often times at an even higher rate than the already exorbitant credit card
purchase interest rates.
So what is the problem here?
Well its actually right there in the name, when you pay with a credit card, you are not
paying in cash, physical or otherwise, you are paying in a promise. A promise to the
credit card company that you will pay this all back with actual cash.
Credit and Cash as terms often used pretty interchangeably, but in reality, credit means
that there is cash coming to fill in the hole left by credit.
When someone gets a Cash Advance it means they are trading in that credit for cash in
advance, which means they need to start paying on that promise right away.
Functionally this is very important to banking because free-flowing access to credit can
boost consumption in the short term normally at the expense of growth in the future.
But as for the cashless economy debate, it also shows that credit cards are not necessarily
a direct substitution.
A debit card might instead be a better bet, these cards only let the user access money
they already have and still offer alot of the same functionality of credit cards, without
the nasty side effects like cash advance fee’s, high-interest rates, or a destabilizing impact
on consumer spending in the debt cycle.
This hybrid approach looks like it combines the best of both worlds, the ease and functionality
of a card, with the reliability of cash.
But there is one other thorn in the side of all of these services.
Merchant fee’s
So far we have only been considering a cashless economy from the perspective of the consumer,
but of course, the supplier is a very important part of this equation as well.
Almost all credit card providers make a good portion of their revenue from merchant fee’s.
That is they will charge the business taking payment via credit or debit card a small portion
of the sale.
And by small we mean about 1-2% depending on a variety of factors, which to many businesses
is not that small at all.
Low-profit margin businesses like groceries or cafe’s can really suffer under these
fee’s because remember this is not 1-2% of profit, it is 1-2% of sales!
This means the business still needs to consider the cost of the goods they are selling plus
all of their expenses like store rent, staff wages, and utilities.
The only solution most businesses have to this is to pass this expense along to consumers.
Sometimes this is done through a credit card surcharge, but credit card companies don’t
like this and often dictate that businesses can’t do this.
This leaves them no option but to pass this surcharge onto everybody, in the form of higher
uniform prices.
In many ways, this is credit card companies saying to their users, it’s ok, you can
borrow money interest-free for 55 days, and we will actually reward you for doing so.
but we are going to pass that expense onto everybody else so that we still make a profit.
This is a negative externality, where otherwise innocent and uninvolved consumers who want
to pay in fair-dinkum cash, are forced to pay more to cover the expenses of those who
are paying on cards.
Thought of another way, this is socializing interest and rewards expenses.
If a nation was to uniformly adopt a cash free economy, these merchant fee’s would
not only be more pervasive, but also more expensive as these companies would control
an oligopoly on exchange.
Sure there would be wire transfers and bank cheques, but those are slow and cumbersome
and these days they often have fees of their own.
But since technology has been the driving force behind the demise of cash, perhaps
Technology is the solution
WeChat is one of the most ubiquitous apps in mainland China,
This is an app that was primarily used as an alternative social media source, having
very similar functionality to Facebook, Messenger, and instagram more or less rolled into one.
But it added a feature which took this platform to a completely new level of economic influence.
WeChat Pay.
Last year WeChat facilitated 277 TRILLION RMB in transactions. That is the equivalent
of around 41 trillion USD’s.
For reference credit cards totaled around 4 trillion dollars in the US in the same year.
Obviously china has a larger population than the US which naturally leads to more transactions
but this still does not detract from the scale of this payment system.
Magnitude aside, one of the reasons it is very interesting is because it breaks down
alot of the barriers that would hold back a cashless economy.
For starters transaction fee’s are pretty much non-existent and setting up the infrastructure
for accepting payments doesn’t mean spending tens of thousands of dollars on credit card
terminals and payment support, it just means downloading an app.
A real-world example of just how easy this can be, is that beggars in chana accept WeChat
Pay.
Of course the logical question is where is the money coming from for this service? Tencent,
the company that owns and operates wechat is not a public company or a non-profit, they
have shareholders that want a return.
This is where it can get a little bit, hmm dicey.
The first strategy is the most benign and that is by making payments so easy over the
wechat platform they make payments especially easy to their own businesses like mobile games,
music, and media productions as well as their advertiser partners.
But of course, it is no big secret that the Chinese Government maintains strict controls
over data collection and usage even in a company like Tencent which is supposedly non-state-owned.
They would be more than happy to pay for the vast piles of individualized data pertaining
to how their people are spending all of their newfound wealth.
Of course, this is scary because the Chinese government is scary... but it all highlights
perhaps the biggest problem with a cashless society it gives too much
Power to the providers
WeChat pay is unlikely to ever take off in the western world because most nations have
a relatively justified suspicion of giving too much information to companies located
in china. Just look at the recent drama with TikTok.
But a cashless society would genuinely run into this problem in one way or another.
Money is designed to dictate what is produced in a society by letting people vote with their
wallets for products they want more of, and decide on products that are not deemed to
be worth the resources they require.
Cash, as in those paper rectangles are one of the only truely anonymous ways of casting
this transactional vote.
Everything else, be it a credit card a wire transfer, a buy now pay later app or even
a WeChat is handled by a private institution. A private institution with a profit motive.
Now some of these are better than others, but they do ultimately have the power to sway
the outcome of productional elections.
What’s more is that they have the ability to completely deny service to any business
or individual they choose. They are a private company so they are under no obligation to
make sure you can use your visa.
Now this might all sound a bit “tinfoil hatty” because there wouldn’t necessarily
be a reason to limit anyone in particular. At the end of the day the more people they
have using money through them the more profits they make, but it still isn’t something
that should be possible, if there is no public alternative.
What’s more, is that money in the system, is at the mercy of the system.
The Australian government has recently announced plans to make it illegal for businesses to
accept more than $10,000 in cash.
The primary motivator of this was that it would limit money laundering of ill-gotten
gains, which in fairness is actually a major point for a cashless economy, in the sense
that it makes these naughty activities a lot harder, or at least a lot easier to track.
The problem is that a lot of people are seeing this as a first step in the widespread limitation
on the use of cash.
Pretty much nobody in Australia is paying $10,000 cash for anything, but it would be
nice to have the ability to.
If for example negative interest rates were widely adopted in response to, oh I dunno
the largest economic decline in recorded history.
Then it might actually cost people money to keep cash in a bank account making that mattress
the fiscally conservative depository institution.
If there were legal limitations on cash, then people might just have to suck it up and pay
for the privilege of having money.
What’s more is that this might not even be a win for the government long term and
if such a large change was to happen, then it is going to be driven by those who have
their
Finger on the printer
A cashless society would impact the black market, and not even the typical black market
you might think about filled with underground casinos and mafia kingpins but rather the
whole shadow economy that we have explored in-depth in a recent video.
This would be a win for a government in a few big ways. Firstly it may help slow down
serious criminal activities but it will also stop a lot of more benign crimes.
Things like cash in hand jobs to avoid taxes, or even paying people off the books would
all be almost impossible without cash. This will help increase government tax revenue
from those that should be paying it, easing the net burden on those who are honest.
Realistically when there is a will there is a way, if people want to trade in nasty products
or do work under the table that badly, the might just turn to alternatives like foreign
currencies, crypto currencies, or even gold. Which would be kinda cool, have a black market
filled with pirates…. Yarrrr!
The robustness of the underground market aside.
This would also mean giving up seigniorage…
Seigniorage is a fancy word that describes the profit that a government makes by printing
money.
A standard $100 US banknote costs about cost about 20 cents to produce according to the
US federal reserve bank.
That means for every time that money printer goes BRR and a physical note is printed, the
government is making $99.80.
In 2018 the US government profited about 80 billion dollars by just printing money, which
on the scale of the US budget is admittedly pretty insignificant, but it is still not
something they are going to be too keen to give up, unless there is a big benefit.
Which so far we have seen, there probably isn’t.
Now a question for you all to fight to the death about in the comment section below.
A sheet of paper or more specifically a sheet of cotton might be worth only a few cents
before it goes through the money printers at the federal reserve, but when it gets spat
out the other side it can have a value of thousands of dollars.
So is this genuine value-adding manufacturing?
Final thoughts
The march towards a future where cash becomes a thing of the past is something that has
people genuinely concerned for alot of very valid reasons.
We have gone from a civilisation that trades in gold, to trading in notes backed by gold
to trading in notes backed by nothing, to trading in digits backed by notes backed by
nothing.
There were concerns and drawbacks to every step of this process but it is possible that
eventually, the ease of a purely digital financial landscape will outweigh the burdens.
For now at least, it seems like mo money less problems is the status quo.
Even if it is only a hypothetical for now, it is still really important to explore, not
only because it may by more than a hypothetical in the not to distant future, but because
it reveals a lot about the financial mechanics of the world we live in.
References
KPMG China. 2019 “The Rise of the Tech Giants” market report
Scott L. Fulford and Scott Schuh. 2018. “Credit Cards and Consumption” Bank for International
Settlements.
Agarwal, Sumit, Souphala Chomsisengphet, Neale Mahoney, and Johannes Stroebel. 2015. “DoBanks
Pass Through Credit Expansions? The Marginal Profitability of Consumer Lending During the
Great Recession.”
Aiyagari, S. Rao. 1994. “Uninsured Idiosyncratic Risk and Aggregate Saving.” Quarterly Journal
of Economics
Athreya, Kartik B. 2008. “Default, Insurance, and Debt over the Life-Cycle.” Journal of
Monetary Economics
Mankiw, N.G., 1987. The optimal collection of seigniorage: Theory and evidence. Journal
of Monetary economics
Hendrickson, J.R. and Luther, W.J., 2019. Cash, crime, and cryptocurrencies. AIER Sound
Money Project Working Paper
Wallace, N., 2005. Central-Bank Interest-Rate Control in a Cashless, Arrow-Debreu Economy.
In Essays in Dynamic General Equilibrium Theory. Springer, Berlin, Heidelberg.