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  • Mathieu Provencher

Cash vs. Debit

(picture from Wix's library)

Hi everyone! For the first post of the year, I decided to write about what most people think Economics is about: Money!!!!!!!

Now… for those that had the great ‘displeasure’ of being my student, you MUST remember at least that: Economics is NOT about money, it’s about maximising social welfare.

This being said, let take a few lines to share with all of you (millions and millions of you no doubt) that I am now at a crossroad for my mobile class Microeconomics. I am probably going to finish next week with the recording, which means I could publish my product next month or so! BUT, I am also making great progress in preparing exercises related to each class, which would, I hope, help students even more. I’m not too sure yet but I think I may push back the publishing date a bit more to have a more complete product.

OK, enough self-publicity and inner-doubt on what to do next! Let’s get to the fun part…

I said I wanted to write about money this time around. More precisely, I want to talk about physical cash! For many years, a number of Economists have been debating on the future of hard cash. The two sides of the coin (hey I think I just made a pun… this article is just getting better and better) are the following: Some have predicted the end of physical money, to be replaced almost entirely by debit and credit; while others have argued that hard cash is never going away (in the foreseeable future).

Arguments on both sides have been pushed by slogans such as “the death of money” versus “cash is king”. For this article, I’m not going to take a side (yes, you all know it… it depends on the situation) but I’m going to give you guys a few ideas of the advantages and disadvantages of both physical and virtual money.

Before I begin, note that I’m taking about the most liquid of assets. In other words, our analysis focuses on financial assets that can be used immediately to purchase goods and services. This normally means currency notes (paper and coins in our pockets) versus debit and credit cards.

I’m leaving the comparison of other physical and virtual assets (such as art, property development, commodities, and others) to another day.

OK, here we go:

Using physical cash (currencies) can have a few advantages for the economy. Cash is often trusted much more than debit and credit. Most people have more confidence in the pieces of paper than the money they are supposed to have in their accounts. This is particularly true for lower income and lower education individuals that may not have easy access to cash machines and bank branches.

When economic agents have higher confidence in the financial system (in the case of physical money because they have it in their hands), they tend to trade more with each other. This can bring more economic activity and more wealth for the country.

However, an economy based on hard cash can have a lot of problems. In times of high inflation, it becomes very unpractical to carry around large number of bills. The more difficult it is to trade, the less trade there tends to be. Also, physical money is difficult to track, which is great for corruption and the black economy. Corrupt individuals can receive payments without reporting them to anyone, thus reducing the risk of such activities. Black markets (for both legal and illegal products) can also operate without reporting their activities to the relevant authorities.

Finally, when an economy is highly reliant on physical money, changing that money can be very disruptive for the country. India has recently gone through a very painful transition when the government decided to remove relatively high value bills from circulation (to fight corruption and black markets). The country lost most of its physical cash while people were trying to change their high value bills for newer notes. Without cash and without a proper banking system, most people (including tourists) struggled with even the most basic transactions. Venezuela tried to implement a somewhat similar policy (with what seemed to be bills of much lower value). The government was forced to postpone this change multiple times because of social pressures opposing the policy.

Using virtual money also has its advantages and disadvantages. An economy mostly based on virtual cash can avoid most problems related with physical money. Depending on how it is implemented, debit and credit cards can help reduce corruption and black markets. If few physical bills (of relatively low values) are available, it becomes very difficult to exchange large amount of money by hand. In addition, virtual money tends to be much easier to track, especially if it goes through the banking sector (BitCoin was an exception to this rule at the beginning but it is now arguably easier to track).

Changing the country’s currency is obviously very easy with virtual money. The central bank of the country can simply order all banks to change the name or value of their local currency accounts. The change can be implemented in a fraction of a second across the whole country. The few physical bills still in use can then be exchanged within a certain period of time, with no economic disruption at all.

Virtual money unfortunately brings some problems of its own. Some parts of society can be locked out of the financing system if they don’t easily have access to banks. This is again especially true for individuals with low income and low education. These same groups may lack trust towards the banking sector, perceiving them as part of the government (which is often not the case).

Another problem that comes with virtual currency is to remove people from the concept of money. This is related to research from the sub-field of Behavioural Economics. It would seem that people tend to act in more dishonest ways when they don’t see money directly. When using debit or credit cards for example, there is a risk that economic agents cheat and steal more readily. We don’t know how much of that effect is responsible for dishonesty in the economy in general but it may lead to more corrupted practices in key industries (banks for example).

Also, virtual cash may be more prone to large scale theft. Electronic money can disappear because of mistakes or bad programming and it can also be hacked away. BitCoin had its share of scandals in which money simply disappeared. Perhaps the most famous case was with the Japanese office (MtGox) a few years ago (these hacks happen quite often). Also, virtual money allows for high frequency trading to exist, which brings trading to a whole new level. Using mathematical models, computers are now able to trade thousands of times per second. When a mistake happen, the virtual wallet of many people can empty in the blink of an eye.

There it is people! I hope you learnt something and, perhaps more importantly, enjoyed yourselves a bit!

Take care everyone and write to you soon.

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