The Future of Money in the Information Age edited by James Dorn

Can We Resist the Temptation to Regulate New Forms of Money?

Cato Institute • 1997 • 171 pages • $12.95 paperback

If there’s one lesson that we’ve learned in the computer age, it’s that George Orwell was wrong: technology is not the enemy of liberty, but its friend. It was the personal computer, the fax machine and the telecommunications satellite that were central to the liberation of Eastern Europe and the Soviet Union (and China, to an extent) because they broke down the information barriers that enabled those regimes to continue to lie to their citizens. Because of their economic implications, the latest technologies, advanced personal computers, and the Internet, offer new, and perhaps greater, promises for human freedom, as the papers in this collection make clear.

All but two of the papers in the book were part of the Cato Institute’s annual monetary conference in 1996. They represent a wide range of expertise and perspectives on the set of issues surrounding the implications that modern information and communication technology have for money and its associated institutions. The contributors include academics, traditional bank executives, computer experts, electronic money entrepreneurs, policy analysts, and central bankers. The papers are mostly short and accessible, and the book would make a good supplement for an undergraduate course on money and banking.

Although there are some significant points of disagreement among the authors, two beliefs seem to represent a consensus. First, as more transactions take place over the Internet and as money itself becomes increasingly “digital,” it will be harder for governments across the world to monitor and control both money and the exchanges made with it. Second, this change in the nature of money is more evolutionary than revolutionary. The history of money is the story of the substitution of more abstract forms of money for more concrete ones. In this way, the use of so-called “electronic money” is not fundamentally different from the substitution of paper for commodity money, or checks for currency.

The papers in this book explore a variety of different forms that electronic money might take. The simplest is what is known as “smart cards,” or “stored-value” cards. We can already see an early version of these in the form of prepaid phone cards. Imagine, however, that you had such a card that contained a bank balance and that you could spend it anywhere by swiping it through a store’s or vending machine’s card reader. Imagine further that you could “reload” that balance by inserting the card into an ATM, or your personal computer linked via the Internet to your bank, or through a card reader located at a place of business, or even by a direct hookup with another card user. Such a card could replace currency for almost all uses and would be far safer, as it would require a PIN or an even more advanced security device.

More sophisticated versions of electronic money would include money both created and stored in electronic form over the Internet, and used for transactions made there. Internet banks could give loans in the form of encrypted strings of digits that other computers would recognize as a money balance created by the bank. So to “spend” this money, one could simply send the string of digits to the seller of the product, who would then pass that string on to his bank, who would pass it on to the issuer, who would then verify it and credit the merchant’s bank for the amount. This kind of money would have no physical form (unlike the smart card) and could be quite useful for the booming world of Internet commerce. If the encryption procedures are secure enough, this kind of digital money would be safer than using a standard credit card over the Internet, which is the way most business is done there now.

Aside from the obvious conveniences for consumers, these innovations have significant implications for monetary policy and central banking. Most important, the more these electronic forms of money displace central bank-created currency, the larger will be the proportion of the money supply that is privately created. Smart cards and digital currency are liabilities of the banks that created them, not the Fed. In the extreme, should paper or “analog” currency disappear, the Fed will then only control the supply of bank reserves. That power would still give the Fed the ability to create much mischief, but it would have a few benefits.

As George Selgin’s paper argues, if paper currency disappears, the Fed would no longer have to worry about the degree to which the public wishes to convert its bank deposits into currency. Right now, the Fed needs to estimate that magnitude in order to correctly predict the effects on the money supply when it conducts open-market operations. In a paperless world, the Fed would have much more control over the supply of bank reserves and, as Selgin argues, could much more successfully implement a Friedman-like monetary rule. Even given the existence of a central bank, the advent of electronic currency might usher in a new era of relative monetary stability by making rule-based policies easier to implement.

The move away from paper could also lead to the even more desirable outcome of the eventual fading away of the central bank. Electronic money opens up the market for “hand-to-hand” money by putting the equivalent of a printing press in every bank’s computer. Private banks will likely outcompete the Fed in such a market, further undermining the argument for having a central bank in the first place. As the sophistication of the technology increases, so will the ability of banks to manage their portfolios and so will the ease with which consumers can use progressively more abstract forms of money.

One can easily imagine a world where banks offer balances on the basis of assets such as private-sector bonds and stocks (as mutual funds do now) and customers take those balances in the form of smart cards that can be used in place of currency, checks, and credit cards. In such a world there is no need for a central bank, only a network of institutions that enable the individual banks to clear their balances among themselves. The need for a central source of reserves would disappear, as would the Fed’s lender-of-last-resort function, as mutual funds cannot be “run” on the way banks can. The progress of electronic money is rendering both central banks and the national borders within which they operate increasingly obsolete.

Lest we get too heady about all of this change, it is important to realize that it is evolutionary not revolutionary. First of all, money already exists in electronic form through wire transfers, and secondly, money has been evolving away from the concrete toward the abstract since it was first used. As Larry White’s paper notes, the first time balances were transferred by bookkeeping entries, money was separated from the physical world. That is, in principle, not fundamentally different from the various forms of electronic money this collection explores. The leap from paper to encoded digits is the equivalent of the leap from gold coins to paper.

In addition, there is a certain sense of going back to the future here. As several of the papers in this volume point out, the banking system we will likely end up with in the electronic future will look an awful lot like the U.S. banking system did before the Fed was created. In particular, hand-to-hand money issued by individual banks was commonplace in the nineteenth century, and remains the primary currency in a few countries even today. The natural response to this point is to wonder whether the electronic money future might fall victim to the same problems as the past. After all, the pre-Fed banking system is no longer with us, so it must have ended for a reason.

And this brings up the key issue facing the future: what sorts of regulations, if any, should there be on the production of electronic money? As the papers by Alan Greenspan and R. Alton Gilbert rightly note, recent scholarship on nineteenth-century banking in America and elsewhere has argued that the failures of those systems were largely due to poorly chosen regulations, such as limits on branch banking and the requirement that banks buy bonds as collateral for their currency issues. The history of banking is littered with such examples of often well-intentioned attempts at regulation that wind up creating unintended problems, and create a demand for further intervention. It is just such a process that has brought us the Fed and the numerous problems banks have faced in this century.

Perhaps with the advent of a new century, and new mechanisms for delivering monetary services, we will finally heed the lessons of the past and give these new technologies and institutions the freedom to develop in response to the needs of the market. The Internet and other computer technologies hold open the promise of an era of unimaginable wealth and progress. The question so well addressed by this collection is whether we can learn those lessons of the past and resist the temptation to regulate new forms of money and thereby destroy their enormous promise.

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