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A Cashless Society Will Be Bad for Personal Finance

Digital wallets may be good for the economy, but they can lead to overspending

When Ben Modica, a 28-year-old database analyst from Minneapolis, wanted to save more money to put toward his loans, he stopped using his credit card and start making all his discretionary purchases with cash. At the beginning of each week, he’d load up his wallet with $100 cash, and that would be his spending money for the week.

“I tried to limit my credit card spending, but it just didn’t work,” he says. By using cash, he carried around a constant, physical reminder of how much he had spent (and how much he had to carry him through the end of the week). “You realize the tradeoffs more [with cash]. If I buy a $6 coffee today, I can’t get a coffee tomorrow. Whereas with credit cards, I’d just buy a coffee every day.

“With cash, the opportunity cost is really present. Credit cards make it seem like you’re not really spending anything.” Simply using cash helped Modica reduce his spending by roughly $100 a week.

The technique is popular among personal finance life-hackers, who say having a tactile relationship with money makes them more conscious about how they spend. And their strategy is backed by research that shows using credit cards induces people to spend more.

But it’s a strategy that seems increasingly outmoded and difficult to maintain as cash becomes less relevant in our economy.

The proliferation of e-commerce, credit cards and digital payment services such as Apple Pay, Google Wallet and Square have it easier to transact, and their use is largely heralded as an economic benefit, especially in developing countries. But while a post-cash world would be great for consumption, it could have a disastrous effect on people’s individual finances.

Last month, India Prime Minister Narenda Modi banned the nation’s two largest bank notes, the 500- and 1,000-rupee bills, (roughly equivalent 7.50 and 15 USD). Those two bills accounted for 23 billion notes, 86 percent of the nation’s currency.

The decision was meant to address rampant tax evasion, and it initially sent the country — where 78 percent of transactions were done in cash — into hysterics. Indians suddenly found themselves unable to buy necessities such as food and fuel. There were hours-long waits at ATMs and banks, and the retail industry came to a halt.

Indian merchants have resorted to using mobile payment software on their phones, and the government has ordered one million more credit and debit card readers added to stores, ushering in one of the largest, most cashless economies in the world.

Techno-utopians, economists and Bitcoin proponents have long dreamed of a world where all transactions occur through our smartphones and credit cards, saying the convenience will increase transactions and strengthen markets. “An easy to use, efficient method of purchasing goods and services is essential to a well-functioning economy,” writes M. Ray Perryman, president of the Perryman Group, an economic research firm based in Waco, Texas. Perryman estimates electronic payments (including mobile payment apps and credit card readers) accounted for a 12 percent increase in the U.S. gross domestic product from 2004 to 2014, and millions of new jobs.

But research has long shown that people spend more money when using a credit card, often to the tune of a 12 to 18 percent increase, and that effect on spending is even more pronounced with digital payment services such as PayPal, Apple Pay or Google Wallet, according to Widener University professor Ross Steinman.

Indeed, a recent study found that people spend more when they see Apple Pay is available at a register. If swiping a credit card makes people less conscious of the money they’re spending, then they’re even less aware when transacting is as easy as thumbing their smartphone.

A similar phenomenon occurs in e-commerce when shoppers save their credit or debit card information to their accounts, making it easier to check out. Garrett Button, a 30-year-old ecommerce executive from Raleigh, North Carolina, blames his old impulsive online shopping habit on Amazon’s one-click payment system, which allowed him to buy items with the touch of a button. “When the price is just a number next to a photo, it’s hard to associate the cost to the actual purchase because it’s just a digital representation,” Button says. “It’s like I’m spending points, not money.”

Button’s spending is now under control; he bought just four items from Amazon in 2016. But he spent frivolously there in past years, wasting money on nonessential goods such as a quad copter drone, video games and a wireless keyboard and mouse.

The tendency to overspend when not using cash is all the more troubling when you consider millennials are saving less than previous generations. It might also explain why savings-conscious millennials are so fond of the “envelope system” to control their spending. With the envelope system, you create an envelope for each of your expenditures (groceries, gas, etc.), fill them with a set amount of cash each month, and only spend the money from those envelopes. No credit cards, no Apple Pay. Just straight cash.

For now, cash is still the preferred transaction method in Western nations, according to a new study conducted by economists from the U.S., Canada, Austria, France, Germany, the Netherlands and Australia. Even in the U.S., where cash was least popular among the countries studied, cash is still used for almost half (46 percent) of transactions. “Reports of the death of cash have been greatly exaggerated,” the authors write.

But cash’s relevance is diminishing. Some prominent economists, including Kenneth Rogoff, former chief economist of the International Monetary Fund, have pushed the U.S. mint to stop printing bills larger than $10.

A cashless U.S. wouldn’t necessarily spell disaster for everyone’s finances. Some consumers have found digital payments actually curb their spending.

“[Electronic payment] definitely encourages spending, which is typically good,” Perryman tells MEL. “I have seen mixed results as far as overspending. The same tools that allow

more efficient transactions also allow more efficient monitoring of balances and amounts spent.”

That was true for Button, who says using Google Wallet helped him realize all the money he was wasting eating out at lunch every day. When he paid with Google Wallet, he’d immediately receive a push notification to his phone and an email about the purchase. He’d then enter the transaction into Mint, a personal finance app, to track his spending. All those reminders added up. “Mentally, I was buying the product three different times,” he says. “It really hammered home how much I spent that day, and made me think more before making a purchase.”

He soon scaled back to eating out for lunch just once a week, and started saving $150 a month.