Credit Is Dead. Long Live Cash!

Article excerpt

Byline: Daniel Gross

Why the return of a cash economy is good for consumers and businesses alike.

Cheap and plentiful credit has powered the U.S. economy for decades. But since the financial crisis of 2008, America has gone on a drastic debt diet. Just as families are paying down credit-card debt and building up cash reserves, businesses large and small are learning to operate in an environment where cash once again is king.

The economic shift has been dramatic; bank lending has dropped at a frightening rate. In 2009 the banking system notched the largest decline in loans in the history of the Federal Deposit Insurance Corporation. Meanwhile, the amount of commercial and industrial loans outstanding has fallen 19 percent since the fall of 2008--back to the level of late 2006. Even the financial sector, which shoveled debt into the economy the way foie gras farmers funnel food into the mouths of geese, has cut way back on debt. Since mid-2007, investment bank Morgan Stanley has reduced its leverage ratio by half.

During the late, lamented credit bubble, both companies and individuals spent and invested based on expectations of what they could borrow. Now they're hoarding cash. The savings rate, near zero in 2007, rose to 3.3 percent in January. At the end of last September, the 376 members of the S&P 500 that aren't utilities or financial firms had a record $820abillion in cash in their coffers, up more than 20 percent from the year before, according to Standard & Poor's.

The conventional wisdom holds that the pullback in credit is a hindrance to recovery. And for many businesses, especially small ones, the inability to roll over old debt or open new lines of credit can put a crimp in expansion plans. But the economy isn't fueled by debt alone. After all, last year the economy experienced a sharp turn, from shrinking at a rate of 6.4 percent in the first quarter to growing at a rate of 5.9 percent in the fourth quarter--all while private-sector credit shriveled. More broadly, the embrace of cash (and the shunning of debt) could be beneficial. During the go-go years, it was common to hear theorists talk about the "discipline of debt." On paper, high debt loads force managers (and homeowners) to make tough, swift decisions to stay solvent. Default, and you lose the company (or the house). In reality, rather than scrimp, overextended borrowers are more likely to walk away from mortgages, or push companies into Chapter 11 bankruptcy protection. Americans are now discovering that cash exerts a superior discipline. The real discipline of cash may be that it causes executives, consumers, and investors to think twice--and to think about the long-term consequences--before spending. The need for instant gratification is part of what created the current mess.

The ability to adapt rapidly remains one of America's competitive advantages. And since the onset of the financial crisis, both consumers and businesses have embraced the new reality. After digging themselves out of $20,000 in debt in 2007, Susannah Fater, her husband, David--a district manager at Staples--and their four children did something radical: they became an all-cash household. "Bills like groceries, gas, and allowance are taken out every month and put into envelopes so that we know exactly where we are financially," says Susannah.

Consumer-oriented firms have pivoted rapidly to service new pay-as-you-go consumers like the Faters. ELayaway.com, based in Tallahassee, Fla., and founded in 2005, offers its 75,000 customers the ability to buy products on installment plans (up to 13 months) from 1,000 merchants, including Apple and Amazon.com. The typical purchase is an electronics item with an average cost of $440 and a four-month payment term. Cofounder Sergio Pinon notes the rise of a category of customers eLayaway calls "planners," who pay for next winter's snowblowers this summer.

Texas electricity provider First Choice Power in January launched a prepaid service called Control First. …