How does the price increase of commodities lead to the cost increase of cash usage across time?

by Holti Banka 0

The declining use of paper-based payment instruments reflects the greater convenience and lower costs of electronic payments—it is easier for consumers to swipe plastic or touch their phone than to carry cash or write a check, and typically less expensive for businesses to process the electronic transaction. In addition, it turns out that the cost of producing the paper-based payment instruments shows rapid increases across time, reflecting increases in the prices of cotton, energy, and other raw materials used to produce, transport, and safeguard currency and checks. These increases have a meaningful impact in driving the continued shift to electronic payments beyond simply the cost savings of moving away from paper-based payment instruments.

The three main cost components of paper-based payment instruments such as cash and checks are those associated with production, transportation, and secure storage. Chakravorti and Mazzotta (2013) find that the annual cost of cash use in the United States is around $200 billion, most of which is borne by businesses, banks, and government agencies. These costs increase constantly with commodity prices, and the changes of these three cost components add uncertainty and risk that further drive the adoption of electronic payment instruments—the cost of using electronic payment instruments is far more stable than paper-based payment instruments.

Changes in the cost of production and transportation of cash and checks are driven by prices of commodities such as cotton (used in currency) and oil (to transport it), while the cost of storage is driven by rents and property prices. In the United States and other countries, the cost of producing currency varies with the price of the primary materials: 75 percent of a US dollar note consists of cotton fiber while the remaining 25 percent is linen. The price of cotton has increased steeply over the past decade, by almost 106 percent between 2008 and 2011, also driving the increase in the average cost of printing a dollar note by almost 58 percent during the same time period.

To show the relationship between the price of cotton and the cost of printing dollar notes, Graph 1 presents the patterns in the price of cotton and the average production cost per dollar paper note from 2000 to 2013. The cost of production per dollar note is derived by dividing the total production cost by the number of new paper notes produced that year. Data on the amount of currency are from the annual financial statements of the Federal Reserve Board, while cotton prices, which include taxes, come from the National Cotton Council of America. The similar patterns in the values of the two indicators across time show how increases in the cotton prices are associated with increases in the cost of producing cash.

Graph 1: Price of cotton and paper currency production cost over time (adjusted for inflation)

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Sources: National Cotton Council of America ; Annual Financial Statements of the Fed; Bureau of Labor Statistics

Table 1: 2013 real dollar value of cotton price and paper currency production cost over time

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The costs associated with transporting cash are borne by all major actors in the payments chain, from the Fed to commercial banks to large retailers, and ultimately reflected in prices paid by consumers and businesses. Higher payments costs thus effectively impose a tax on an economy, while rapidly changing costs introduce uncertainty that leads businesses to delay investments and hiring. As in the case of cash production, the cost of transporting cash depends on prices of fuel and wages. Given the instability of world fuel prices, cash transportation costs also demonstrate unpredictable patterns, further increasing the cost uncertainty associated with the use of cash and checks.

The relationship between cash transportation costs and the price of gasoline is presented in Graph 2. Gasoline prices are from the Energy Information Administration, for an average of retails prices of all grades of gasoline and on-highway diesel fuel (including taxes), while cash transportation costs are taken from the Fed’s annual reports and include both the cost of shipping new currency from the Bureau of Engraving and Printing (BEP) and handling currency after it becomes unusable.
Indeed, both the price of gasoline and the cost of cash transportation demonstrate increasing patterns across the years. A perfect correlation between the two cannot be expected because there are other factors, not captured here, which affect the cost of cash transportation, such as labor costs.

Graph 2: Price of gasoline and currency transportation cost over time (adjusted for inflation)

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Sources: Energy Information Administration ; Annual Financial Statements of the Fed; Bureau of Labor Statistics

Table 2: 2013 real dollar value of gasoline price and currency transportation cost over time

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Cash requires space for it to be safely stored and people to safeguard it—both, factors that add to the cost. No similarly detailed data are available on the cost related to cash storage and safekeeping to compare the increase of this cost component to that of property prices and rents. However, cash storage related costs likewise change upwards, driven in recent years by the changes in the property market and rents.

What matters is not just the magnitude of the costs associated with cash use, but also the increase of those costs across time, which is considerable because the commodities involved in the process of producing and transporting cash demonstrate upward price trends. Continued progress in moving to electronic payments will thus have benefits in terms of reduced uncertainty and thus a stronger economy, even beyond the cost savings involved with the transition away from paper-based payments instruments.

* Holti Banka is a Ph.D. candidate at the University of Maryland’s School of Public Policy. His research focuses on measuring the costs associated with the use of different payment instruments and the macroeconomic impact of the shift from paper-based to electronic payment instruments.