The "Cashless Economy" Is A Myth

Via ConvergEx's Nick Colas,

The “Cashless economy” is myth.  Forget what you think you know about credit and debit cards, PayPal, bitcoin, Apple Pay and any other modern conveniences meant to displace physical currency.  The truth is that transactional currency ($1 through $20 bills) in circulation per capita today in America is essentially where it was, inflation adjusted, in 1994: $661 then and $649 today. Moreover, the Federal Reserve’s orders from the U.S. Treasury for small bills have grown faster in the last five years than the 20 year average: 4.5% annually versus a 3.5% long run growth rate.  This year should be no different, with the Fed ordering $49.9 billion of “small bill” currency, the largest amount since 2010. One bit of good economic news in terms of transactions: $1 bills wear out fastest, and the Fed’s 2015 order of 2.5 billion bills is higher than 2014 (2.3 billion) and 2013 (1.8 billion). That’s growth and relevance any startup online payment company would be happy to see. 

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As a New York City resident, the “Fast Cash” button at ATMs in other U.S. cities always amuses me. The most typical offering is $20. That doesn’t even buy you a 7 day unlimited MetroCard in Gotham ($30) or a sandwich at the Carnegie Deli (the Reuben is $29.99).  If you want to see “Fifty Shades of Grey” at the Ziegfeld you’ll get a Lincoln back for your Jackson, but you’ll have to choose between a drink or popcorn. You won’t be able to afford both.
And yet there is actually some good data behind that $20 Fast Cash option.  According to the Diary of Consumer Payment Choice, a 2012 survey done by three regional Federal Reserve branches, the average adult American carries $56 and the median observation is $22. Only 5.2% of Americans carry a $100 bill, and a Boston Fed paper from November 2014 estimated that 65% of those notes actually circulate overseas. So a $20 bill from the ATM in Des Moines or Charlotte is actually enough to replenish the average American’s wallet. Just don’t try that in NYC.
All this got me to thinking about how many small bills - $1 through $20 notes – it takes to keep the U.S. economy in business. The Federal Reserve issues paper money, ordered from the Treasury’s Bureau of Engraving and Printing (BEP), and keeps records of cash in circulation available on their website. With all the fuss about online payments, credit and debit cards, virtual currencies and the like you’d think paper money would be leaving the stage. As it turns out nothing could be further from the truth.
We pulled the circulation statistics from the last 20 years of Fed data, as well as BEP print runs and the U.S. central bank’s 2015 orders for currency, and here’s what we found (several charts included immediately after this note):

The growth of what we will call “Transactional currency” ($1 through $20 bills) has been remarkably stable over the last 20 years.  In 1994 there was $109 billion in such currency outstanding, growing to $207 billion in 2014. There was one hiccup in 1999, as the Fed prepared for worries over Y2K glitches in the banking system, when transactional currency in circulation grew by 15% to $150 billion and shrank by 13% the following year.  On average, however, the balance of such bills has grown by an average of 3.5% annually.



Look at transactional currency per capita, adjusted for inflation, and you’d be hard pressed to find any real change over the last two decades. With 263 million Americans in 1994, per capita transactional cash amounted to $414 back then. That is $661 in today’s money.  Fast forward to 2014, with 319 million Americans, and the per capita number is $649. That’s a compounded rate of change of only 0.1% annually, or 1.8% over the whole period.  Cashless economy indeed!



The most popular transactional note in circulation is the $1 bill, followed by the $20 note. There are some 11 billion of the former in circulation currently and 8.1 billion of the latter. Together they make up 74% of all the transactional currency moving through the U.S. economy.  Interestingly, the ratio of the two notes in circulation hasn’t changed very much since 1994.  Back then, there was 13.2x the amount of $20’s in the system versus $1’s - $80.5 billion versus $6.1 billion.  Now, the ratio is 14.8x - $162.2 billion versus $11.0 billion.


Not only is paper currency holding its own in the Internet age, it is actually growing faster than U.S. GDP.  For example, aside from the correction in 2000 to reabsorb bills issued in 1999 for Y2K, transactional money in circulation has risen every year since 1994 – no recessions here. Over the last 4 years, the average growth of $1s through $20 in circulation has been 5.1%.  Look at the Federal Reserve’s currency order from the Bureau of Engraving and Printing for 2015, and you’ll see they are expecting to receive $49.9 billion of new transactional notes.  That’s the largest order since 2007 ($51.4 billion) and 2010 ($50.3 billion).


The $1 bill wears out the fastest of any face value, for the obvious reason that it changes hands the most in small value transactions. On average, a $1 bill circulates for 5.9 years, according to the Federal Reserve. Twenty-dollar bills last an average of 7.7 years.  For reference, $100 bills stay in circulation for 15 years since they are typically more a store of value than a transactional currency.


Despite the half-decade average life, the Federal Reserve has ordered more $1 bills for 2015 than either of the last two years. The amounts are 2.5 billion this year versus 2.3 billion in 2014 and 1.8 billion in 2013. Given that the Federal Reserve bases their orders mostly on how much they need to replace paper money worn out through use, this is a promising sign about economic growth in the U.S.  More money usage should mean more transactions, after all.

So what’s going on here?  After all, the rise of shopping on the Internet, the “App economy”, virtual currencies, incentive program credit and debit cards, and online banking were all supposed to make paper currency obsolete.  Yet the American economy is using more paper currency, even adjusted for inflation, than ever before.  Population growth only takes this calculation to flat, with the net $12/person reduction we noted above but a still-sticky $650/person in circulation today.  And, of course, there is the simple fact that the Federal Reserve is still growing the supply of transactional currency faster than GDP or population growth combined with inflation.
A few possible explanations fall to hand:

The underground economy is growing faster than reported/official economic growth.  Ask any housekeeper or day labor how they would prefer to be paid, and the answer is invariably cash.  There are plenty of good reasons for this response, ranging from tax avoidance and immigration status to the lack of a bank account.  The same goes for a myriad of other workers, from New York City doormen at Christmas to the local automotive repair shop or the burly guy manning the ropes at a hot new club.  Cash talks…  You know the rest.


Cash is still more convenient than many other payment options for small amounts. The Diary of Consumer Payment Choice showed that the typical American uses cash some 50% of the time for transactions less than $50.  It is still the preferred method payment for food and personal expenses (51%) and personal to person gifts and transfers (67%).


Contrary to popular belief, young people (18-24) prefer to use cash more than any other age group.  Fully 40% prefer old school legal tender; their parents (45 to 64) only rate it as the preferred method of payment some 25% to 32% of the time.  Since this age cohort typically has a larger amount of small transactions, this preference does make some sense.  It does, however, present a real challenge for online and app-enabled payment solutions to gather this most tech-savvy group into their fold.


Low inflation and interest rates make holding cash less costly.  After all, if the opportunity cost of holding cash is zero – that’s currently the average interest rate on a bank deposit, after all – then what incentive is there to keep money in the financial system?


The rise of lower income households. Another finding from the “Diary”: households making less than $25,000/year preferred to pay in cash some 55% of the time. That compares to 22% for households with $50-75,000 in income and just 10% for those making more than $200,000 annually. The preferred payment mechanism for those high-earning households is actually credit cards, at 66%, likely due to the various incentive programs on offer.


Everyone uses cash for something. Regardless of income, every household uses cash for approximately 22 transactions per month, again according to the “Diary”. 

The “Cashless Economy” seems very far away indeed, and the demographic targets and use cases for companies seeking to build alternative payment systems are harder to develop than many entrepreneurs likely realize. In the meantime, real cash money continues to grow in relevance and use. They might just be dead presidents and Treasury secretaries, but when it comes to the American economy, they are very much alive and well.