Back to cash?

Paper or plastic? No, we’re not talking about how to package your groceries. With continuing financial woes, growing consumer debt and new credit card company policies, more people are embracing cash and leaving the credit cards at home.

In fact, more people paid cash this past holiday season to keep spending on track and reduce (or avoid) post-holiday debt, according to recent surveys. In major markets like the U.S. and Australia, people are spending less on their plastic.

“Consumers are looking for discipline in their spending levels that they can achieve from using cash,” said Bryan Eshelman, managing director at AlixPartners (a consulting company) in an article from the Associated Press.

While “cut up the credit cards and pay cash” is traditional advice for people struggling with serious consumer debt, the strategy is becoming more widespread. The “credit card versus cash” debate has been a popular topic in the media and personal finance blogosphere. Self-help financial experts like Dave Ramsey and Gail Vaz-Oxlade often recommend a more tactile method of budgeting using envelopes or jars so people can literally see what they are spending.

Now, Suze Orman is the latest financial guru adding her voice to the trend with the launch of her “Back to Cash Movement”. On her television show, she urged viewers to only pay cash (for a week, a month or more) and get “connected” with their finances again. (Watch her announcement here.)

The advantages of cash

Why the outcry? The thinking behind the strategy is simple: living beyond our means is a recipe for financial disaster, and credit cards make it too easy to spend. After all, research has shown than parting with cold, hard cash in our hands is harder to do, and this visual reminder makes us think about our purchases more carefully. Though many people still report the “burning a hole in my pocket” syndrome, the general consensus is that people spend more when they use credit. Besides, debt doesn’t seem so bad when it’s spread across numerous accounts.

And the situation in the U.S. (where a lot of the financial advice and news comes from) has become a little more complicated. Lately, credit card companies there have been accused of some questionable tactics ahead of new legislation coming into effect this winter. Many people have seen their credit card limits slashed — or their accounts cancelled — or their fees increase. According to a quiz on Orman’s website, more than half of Americans in a recent survey reported seeing their rates and fees rise. Even long-standing customers who always pay their bills on time have seen their single-digit interest rates jump. For people carrying large balances, these extra costs simply pile on the debt.

Worse yet, some companies are now interpreting a customer’s spending habits — like shopping at discount stores — as a sign of financial trouble and using that as the basis to make cuts on spending limits. It’s not surprising that many consumers want to boycott their banks and credit card companies.

Canadians may not be subject to the same problems — after all, our financial system is different — but we certainly aren’t immune to some questionable practices. New regulations, in force as of January 1, 2010 will prohibit practices like raising a customer’s credit limit without their consent, and require better transparency — such as informing customers how long it will take to pay off a balance if only the minimum payment is made. (Read the press release here.)

Add in the worries about having your credit card number or identity stolen, and it’s not hard to see some distinct advantages of using cash. After all, if you really want to keep your purchases private, cash is the only way to go.

Is cash-only the way to go?

So should we swear off plastic and return to the payment options that previous generations relied on? Not so fast, say advocates on the other side of the debate. For example, it’s hard to make an online purchase with that wad of bills in your pocket (not all retailers accept debit cards or PayPal) — so credit cards get the nod for convenience.

And credit cards offer other advantages — like rewards points or cash back, consumer protection and perks like extended warranties and rental car insurance. They’re helpful for large purchases where cash wouldn’t be practical and debit cards have daily limits.

In addition, many people use their credit card statements as a way to track their spending. Keeping track of the cash in your hand requires a little more organization and vigilance because it isn’t automatic.

And while identity theft is a threat for plastic, old-fashioned theft is a risk for people who carry cash. You can cancel a stolen credit card and not be responsible for someone else’s spending — but when cash disappears, it’s gone.

Another point on the pro-credit card side of the debate: credit cards help build a credit history — which is especially important for people just starting out.

However, many of these advantages only apply if you don’t pay annual fees and you don’t carry a balance. Even credit card proponents note that they’re helpful IF they are used responsibly.

The bottom line

Neither experts nor consumers are going to unanimously agree that either cash or credit cards are better — especially when some people include debit cards under the “cash” category while others lump them in with “plastic”. (Cheques are often left out of the debate altogether.) The best advice? If your current strategies are working for you, there’s no need to change simply because it’s “the” thing to do. If, on the other hand, your approach hasn’t been successful, you may want to try something new. For example, if plastic invites higher spending and impulse purchases, give the cash-only trick a try — even for a short period of time.

It isn’t necessary to adopt one strategy over the other in every circumstance. For example, many find that the “envelope system” is a great way to control spending on vacation — especially if your destination is a cash-only economy and you have to handle local currency. And automatic billing to credit cards or debit cards can save money for people prone to missing or late payments.

Regardless of how people choose to pay, the tried-and-true advice still remains: if you don’t have the money in the bank, you can’t afford it.

Photo © Denis Pepin