How to reduce reliance on cash

October 10, 2011
Mohamed El-Erian:

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When the financial crisis hit, the smart money went to cash. Literally, in the case of Mohamed El-Erian:

On the Wednesday and Thursday after Lehman filed for Chapter 11, I asked my wife to please go to the ATM and take as much cash as she could. When she asked why, I said it was because I didn’t know whether there was a chance that banks might not open. I remember my wife sort of pausing and saying, “Are you serious?” And I said, “Yes, I am.”

It turns out that this was a worldwide phenomenon. Here’s Ravi Menon, the managing director of the Monetary Authority of Singapore, in a speech last week (HT IK):

Physical cash commands a premium during times of uncertainty. We saw this during the 2008 global financial crisis. Within the first month of the collapse of Lehman Brothers, there was an exceptionally large withdrawal of high denomination notes by banks in Singapore. Typically, 90 per cent or more of the high-denomination notes withdrawn from banks are re- deposited within the month. During the initial months of the 2008 crisis, only 70 per cent of the $100, $1,000 and $10,000 notes withdrawn were returned.

This is understandable. But the fact is that cash is a very expensive payments mechanism:

Handling cash is costly. According to a 2010 study by Retail Banking Research, the cost of distributing, managing, handling, processing and recycling cash in Europe is estimated at €84 billion. This is equal to 0.6 per cent of Europe’s GDP.

For individuals, cash clears at par: if you give me a $100 bill, then I’m $100 richer and you’re $100 poorer. No one’s going to jump in and charge a fee for facilitating the transaction. And if I then deposit the $100 bill into my checking account, once again I see the full amount appear on my statement.

But the fact that most people never get charged for cash transactions is corrosive, in its own way: it helps to impede the inevitable-yet-glacial move away from cash and towards more secure, easier, and cheaper forms of payments.

Which is one reason why Bank of America’s $5 charge for debit transactions is so mindblowingly stupid. The more that people use their debit cards, the less they’ll use cash. And Bank of America spends billions of dollars every year processing heavy, dirty cash flowing in and out of its branches. If banks can persuade people to move to weightless forms of payment like debit, it will save them enormous amounts of money. After all, most of that 0.6%-of-GDP cost of processing cash is borne by retail banks.

And much of the rest is borne by the government. Minting physical currency is expensive! And wasteful! (Menon reveals, in his speech, that those charity-donation buckets in airports are placed there largely at the behest of the monetary authority, to try to stop local coins from leaving the country and having to be re-minted.)

Which means there’s a massive public-interest argument in favor of slowly phasing out cash in favor of other kind of payments. That’s never going to be easy, but it’s going to be pretty much impossible if the alternative payment mechanisms don’t clear at par.

I don’t know what kind of payment mechanism the world will ultimately alight on; I suspect however that it will use NFC technology in cellphones, and that it will be owned and run by a consortium of large retail banks. In the meantime, however, it behooves everybody, from the government to the banks, to do everything they can to wean people slowly off cash. If cash transactions cost the US 0.5% of GDP each year, that’s $70 billion a year at stake — significantly more than all credit and debit interchange fees combined. Don’t any of our greedy banks see the opportunity here?


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