Will a financial crisis increase the use of cash?

Will a financial crisis increase the use of cash?

The current economic climate that we find ourselves living in is one of great uncertainty. The coronavirus pandemic has seen an unprecedented rise in unemployment figures. As of May 2020, there were over 40 million Americans who had filed for unemployment, pushing the country’s unemployment rate to almost 24%. This will have a profound effect on how people use cash, as an increasing number of people will likely max out their credit cards and will look to jobs that pay in cash as banks impose stricter rules around accessing credit. This article will look at two common methods of payment - cash and card, and how these are affected by the financial crisis, problems with credit cards, and the benefits that come with using cash.

Although the current COVID-19 pandemic is compounding unemployment levels across the country, this is not the first financial crisis that America has been hit by, with many people still recovering from the financial crisis of 2008. There is a noticeable trend among Americans to rely on credit cards during periods of prolonged financial difficulty, and in doing so accumulate large amounts of debt. In the period preceding the Great Recession credit card debt rose to $121 billion. This also coincided with a period that saw the unemployment rate double from 5% to 10% between 2008 and 2009. However, some studies have shown that when unemployed, people were less likely to use credit cards as a method of payment.

Unfortunately, periods of financial uncertainty are often accompanied by layoffs or being furloughed. This may very often force people to reach their credit limit with no idea of when or how they will pay back their debt. Times of financial crises also result in banks enforcing stricter lending standards. Similar to the financial crisis of 2008, banks are once again tightening their credit lending standards to both households and businesses. Credit cards in particular are being targeted because of their lack of security, unlike immovable assets such as homes that may be repossessed. This makes credit cards high-risk for lenders. In just a few months, credit limits have been drastically lowered while minimum credit score requirements have increased. This is bad news for those who do not have a good credit history. Introducing these strict standards during times of financial upheaval and uncertainty harms those who are seeking extra credit to make up for their loss of income.

As an increasing number of people move toward cashless payment methods, where does this leave cash? A Federal Reserve survey conducted in 2018 showed that debit cards beat cash as the preferred payment method. The popularity of cash may see a further dip as people are becoming increasingly vigilant about the spread of COVID-19 and are moving toward contactless payments. Although there might be an economic downturn, commitments such as rent and student loans do not disappear. Thus, it is important to save in anticipation of a possible financial crisis.

One of the main cash benefits is that it allows you to monitor exactly how much you are spending and how much is left, curbing the chances of making impulse purchases. The same can be said for paying with a credit card, however, it is more likely for consumers to let their guard down when making purchases on credit. Paying with cash also avoids the necessity of paying annual credit card fees that will appear on your credit card bill. Cash also does not come with the series of obligations that credit cards do, such as having to make monthly payments. If you default on those payments, you are obligated to pay interest and late payment fees. Using cash only may also prevent you from being in a bind if you enter a store that does not accept credit cards. Paying with cash will ensure that the person to whom the money is paid will receive the cash instantly, unlike paying with a credit card, which may take a few days for the amount to clear. Cash also saves the vendor money, as they are charged a fee every time they swipe a customer’s card. Consumers may also reap the benefits of choosing to pay with cash in the form of discounts offered by stores for cash payments. Like all payment methods, there are pros and cons of cash. 

The effects of any financial crisis are far-reaching. Very often they affect the poor and vulnerable of society, who may not have the savings in place to help them weather such a crisis, the most. Consumer debt in America was always high. However, the economic downturn brought about by the recession saw an unprecedented number of Americans forced to declare bankruptcy as they could no longer honor their obligations. The second quarter of 2019 saw consumer debt hit an astonishing $14 trillion. Credit card balances amounted to a total of $1.08 trillion in the third quarter.

Debt assistance programs are available for those who need it. These programs come in two forms: 

Debt management program - this allows you to make monthly payments to a credit counseling agency who will then pay your creditors. The monthly amount is usually less than what is required to pay off your credit card. These programs also include other resources, such as counseling, advice on how to make a budget, and educational courses and materials.

Debt reduction service - unlike the above option, this alternative attempts to reach a settlement with your creditors in which they agree to reduce the overall amount of your debt. This option is not recommended as there are no guarantees that the creditors will agree to such an arrangement. Choosing this option harms your credit score and may affect tax filings. It is also considered a last resort before bankruptcy. 

The ever-present possibility of a financial crisis occurring again, and the fact that the crisis of 2008 is still fresh in many people’s memories, has brought about reforms to deal with similar future crises. It is no longer as easy as it once was for consumers with poor credit ratings to take out credit and make long term purchases, such as cars and homes. Hopefully, it has also shown the majority of consumers the importance of saving however much they can and maintaining a good credit record to mitigate the damage of future financial crises.

The financial crisis of 2008 was not a once-off occurrence. The United States’ economy will be one of the big casualties of the COVID-19 pandemic, setting into motion a series of events that are all too familiar. Although consumers cannot control when a financial crisis might hit, they do have the power to make informed decisions regarding their spending power and habits, to ensure that they are still able to provide for themselves and their families during hard times. Spending methods, such as cash and credit cards, each have their pros and cons. Whilst cash may be an attractive option for those who need help living within their means and saving for a rainy day, it is ultimately a personal decision which payment method you choose to use.

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