By MARK BERNKOPF
The Two Revolutions
Is 1996 the Year of Electronic Money?
Electronic Money: Neither New nor Exotic
Central Banks and Electronic Cash
When is an Institution a Bank?
The Effects of an Electronic Currency
Privately-Issued Currencies
Contingency Planning and Maintaining Confidence
Internet Resources on Electronic Cash and Monetary Policy
New payments technologies are heralding what appears to the greatest union of
the disciplines of science and money since Sir Isaac Newton, Master of the
Mint, unwittingly put Great Britain on the gold standard, back in 1720.
Web sites about digital cash and other electronic payment systems have been
proliferating wildly. Moreover, every major newspaper, business magazine, and
evening television news broadcast seems to have featured at least one story
about "electronic money" or "digital cash." There are now about at least four
paperback books on electronic cash, each of similar thickness, appearance, and
price, for sale in North American bookstores. No doubt there are more such
books on the way.
To top it all off, Nicholas Negroponte has called 1996 "the year of
electronic money." Professor Negroponte and other analysts talk about a
revolution transferring power from governments and central banks to investors,
consumers, and entrepreneurs.
Not, perhaps, for everyone. Take, for example, the country where Professor
Negroponte made his declaration - France. The French experience with electronic
commerce via smart cards and minitels dates to the 1980s - ancient history to
most Internet users. Moreover, Japan and much of Western Europe have long used
prepaid telephone cards.
In contrast, it is only now that smart cards and other implements of
electronic commerce being developed for the "Anglo-Saxon" economies [1]. Aside
from Danmont of Denmark and Avant of Finland, developments in electronic
commerce in the non-English-speaking world have not been well reported in the
English-speaking press. At the end of this article, I have listed a couple of
Internet sites that shed more light on these activities.
And what of this new revolution taking power from the hands of politicians,
civil servants, and central bankers, and placing it in the hands of theaverage
citizen?
There are actually two electronic money revolutions underway - an electronic
money revolution and an electronic cash revolution. Let me define the terms:
- "Electronic cash" is the digital replacement for banknotes and coins, in
other words, electronic money for small transactions.
- "Electronic money" includes electronic cash, as well as the immense torrents
of digital funds that zip through international and national payments networks
[
2], such as SWIFT, Fedwire
http://www.ny.frb.org/pihome/fedpoint/fed43.html,and CHIPS
http://www.ny.frb.org/pihome/fedpoint/fed36.html.
The electronic cash revolution is bringing electronic money to the ordinary
consumer and merchant. For the "Anglo-Saxon" economies, this revolution is only
just beginning.
It is the electronic money revolution that has shifted so much economic power
from the State to financial markets. This revolution arrived some years ago. It
has already shaken the landscape, as the European Exchange-Rate Mechanism
crises of 1992 and 1993 attest. Worldwide liberalization of government controls
on capital outflows - combined with new telecommunications and computing
technologies - have enabled huge electronic "hot money" flows to flash around
the globe in search of the highest returns. Nowadays private-sector financial
capital greatly outweighs central bank foreign-exchange reserves and
international trade-related flows, although until a few years ago this was not
the case.
Electronic money is neither new nor all that exotic. According to a U. S.
Treasury official [3], Western Union made the first electronic funds transfer
(EFT) in 1860, the year that Lincoln was first elected President of the United
States. This EFT was made by telegraph, and was an analogue rather than digital
payment, but it was an electronic payment nonetheless [4]. Moreover, the
technology to support this type of EFT dates back to May 1844, when Samuel F.
B. Morse first demonstrated the telegraph. Indeed, Fedwire started as a Federal
Reserve telegraph system as long ago as 1918. And SWIFT and CHIPS date to the
early 1970s.
Electronic money is an old concept; moreover, most money is already
electronic. In the U.S. and other economies, banknotes and coins compose only a
small percentage of what we conventionally define as "the money stock." Only
the narrowest monetary aggregate, M0 - used by few except the British - is
composed chiefly of metallic and paper currency [5]. The narrowest monetary
aggregate into which most conceptions of electronic cash would fall, M1, is
composed of currency, traveler's checks, demand deposits, and other checkable
deposits. In countries that make heavy use of checks, like the United States,
banknotes and coins comprise only a minor share of M1. The broader the
monetary aggregate, the smaller the share of banknotes and coins.
Although the electronic money revolution has made an enormous economic impact,
it is the electronic cash revolution that has captured the imagination,
stimulating new interest in the nature of money.
The first central banks to seriously study electronic cash have been smaller
West European institutions, such as the Nederlandsche Bank and the Bank of
Finland. The Dutch central bank's attention to electronic cash is largely due
to the location of DigiCash and similar ventures and research centers in the
Netherlands. In an interesting instance of socialism or state entrepreneurship
(take your pick), the Bank of Finland actually has a corporate subsidiary,
Avant Finland Ltd., developing that country's Avant cash-card system.
In contrast to the cybersavvy smaller West European central banks, the more
powerful central banks, such as the Federal Reserve and the Bundesbank, have
gotten a relatively late start studying the new technologies. For some time,
the Bundesbank's reactions to electronic cash fell somewhere between suspicion
and disdain. But this past November, it was Bundesbank President Tietmeyer who
convened the Group of Ten central banks to study this issue [6]; the G-10
report should be available in a few months. Top-level American
central bankers have likewise studied the issue only recently. A couple of
years ago, when asked about digital cash, then-Federal Reserve Vice Chairman
Alan S. Blinder replied "Digital what?", adding a few moments later, "It's
literally at the thinking stage [7]."
In the United States, the Domestic and International Monetary Policy
Subcommittee of the House of Representatives Banking Committee has been holding
occasional hearings on "The Future of Money."
http://www.house.gov/castle/banking/money.htm These hearings feature
electronic entrepreneurs, bank executives; university professors; managers of
urban mass-transit authorities using "closed" stored value systems; Federal
law-enforcement officials, the U.S. Treasury executives, and a Vice Chairman of
the Federal Reserve Board.
Aside from the Director of the Mint, who would welcome the opportunity to issue
commemorative cash cards, the U.S. Government has adopted a wait-and-see
attitude toward electronic cash. This results from a reluctance to inhibit
private-sector development of new payment techniques and technologies.
The leading common technical standard for cash cards, EMV, was developed by the
private sector, specifically Europay, MasterCard International, and Visa
International. The private sector is also developing security standards on its
own, even challenging hackers to break their codes for a reward.
Had the U.S. Government wanted to dictate standards, it would have been in a
good position. The U.S. Department of Agriculture is exploring the digitization
of "Food Stamp" coupon for indigent American families. The Department of
Defense's worldwide network of base facilities, including commissaries and
PX's, also could have given the U.S. Government substantial influence over
standards.
In recent years, the Working Group on Payment Systems of the European Union
has presented studies on new payments technologies to the Council of the
European Monetary Institute (EMI)
http://www.kub.nl:2080/library/instructie/eue/24monet.htm, the embryonicEuropean Central Bank. In its May 1994 study on prepaid cards, the WorkingGroup on Payment Systems called for limiting
the issue of electronic cash to "credit institutions," in other words, banks.
This approach would seem instinctive to any central banker, because banks are
already subject to supervision. However, because of the ease with which
nonbanks can now issue money, Dutch central bankers now believe that all
issuers of electronic cash should be regulated, bank and nonbank alike.
When is an Institution a Bank? When is a Prepaid Card Balance E-Cash?
In early April 1996, the Board of Governors of the Federal Reserve System
issued its proposed modernization of Regulation E, the main regulation
governing electronic financial transactions in the United States. The new "Reg
E" would waive paper receipts for small transactions, and for the first time
establishes rules for stored value cards. There have also been several bills
introduced into Congress that substantially rewrite the Electronic Funds
Transfer Act, the legislation that governs "Reg E." Minneapolis attorney Chris
Sand berg discusses the legal issues affecting digital cash in InfoNation
magazine. http://www.info-nation.com/cashlaw.html
Even aside from the inevitable modernization of the laws and regulations
governing "e-cash, [8]" long-established notion are being turned on their head.
For example, what is a bank? Is it any institution that lends money? That
accepts deposits? That lends money and accepts deposits simultaneously? The
commonly accepted definition of bank is fast becoming outmoded. Many have
observed that it would not take much for Microsoft or AT&T and other large
software and telecommunications firms to expand into the banking business.
What is electronic cash? When does the balance on a multipurpose card become
electronic cash? When does stored value qualify for deposit insurance? When
must stored value card issuers maintain reserve requirements? These questions
raise issues that transcend the academic.
What is and what is not electronic cash - or any other form of money - is not a
simple yes-or-no question, but rather a matter of degree. Money is usually a
liability of its issuer, effectively an interest-free loan to the issuer from
its holder. Nonetheless, precisely because money is a matter of degree, the
definition of money is rather ambiguous.
Let us assume that all the photocopiers in a university library require the use
of a university-issued prepaid card. We would consider this card arrangement a
"closed system."
What if vending machines at the university library are retrofitted to accept
our photocopier card? Our closed system has gotten a tad more open.
Now assume that all the vending machines and photocopiers throughout the campus
accept the library photocopier card.
What to obtain a copy of your transcript? What if the university registrar, and
every university department and instrumentality on campus accepts photocopier
cards?
Now, what if the five colleges and universities in the metropolitan area accept
each other's photocopier cards? What if, soon thereafter, off-campus
laundromats, restaurants, and newsstands at each of these institutions accepts
photocopier cards?
Is the balance on the photocopier card cash? Well, the single-purpose card has
unquestionably become a multipurpose card, a relatively open closed system. But
it is not cash yet, because it is not universally accepted.
Now assume that all the photocopiers and vending machines and off-campus
businesses suddenly accept VisaCash, MasterCard Cash, and Mondex cards. These
would be open systems, presuming that every local establishment has the
equipment to process electronic-cash transactions. The cash cards, if issued by
a bank, would be protected by deposit insurance. Moreover, it is likely that
the Federal Reserve would require some sort of reserves to back the electronic
cash.
Would banks be required to issue electronic cash with the same reserves as
those required for savings and checking accounts? Today, for most banks, the
reserve ratio is a mere three percent. In other words, for every dollar of
electronic cash created by a bank, there need be only three cents in bank
reserves.
Today, under current U.S. law, a nonbank institution is free to issue
multipurpose cards without any reserve requirement. However, these nonbank cash
cards are not be protected by Federal deposit insurance. Hence, Dutch central
bankers recognize that all electronic cash issuers, bank and nonbank alike,
must be monitored by the monetary and banking authorities.
But the existence of multipurpose cards make the issue quite difficult to sort
out. When hotels and gasoline stations accept frequent-flier miles, those miles
become a quasi-currency.
Several weeks ago, a U.S. Government prosecutor asked a Federal court to
confiscate the frequent-flier miles of a captured marijuana smuggler. His home,
financial savings, and other property had already been seized by Federal
authorities. The smuggler had accumulated enough mileage to qualify for three
round-trip visits from the United States to the Bahamas.
In Western Europe, new developments in monetary technology share the headlines
with attempts to establish Economic and Monetary Union (EMU). EMU now seems an
uncertain proposition. Among the signatories to the Maastricht Treaty, only
Luxembourg now meets the convergence criteria for Economic and Monetary Union
(EMU). The political momentum for a single European currency so visible
immediately after the signing of the Maastricht Treaty has dissipated. Although
Tim Jones, CEO of Mondex says that his Mondex card would be an ideal vehicle to
test electronic Euros, others believe that electronic cash, far from aiding the
Euro, could deliver its coup de grace.
Giles Keating, chief international economist at CS First Boston in London,
believes that electronic money might derail Economic and Monetary Union (EMU)
in Europe. In a guest column in the November 2, 1995 Financial Times, Keating
reminds readers that many of the electronic cash technologies accommodate
several currencies simultaneously on a home computer or a cash card. Moreover,
the new technologies dramatically reduce foreign-exchange transactions costs. A
resident of a country with a chronically weak currency could easily shift his
savings into stronger ones. Indeed, there could easily be a massive flight of
electronic financial assets from weak currencies to stronger ones, effectively
driving the weaker, less significant currency out of existence - a sort of
Gresham's law in reverse. Ultimately, those European governments with
terminally weak currencies would be able to compel the use of their currencies
for "legal tender transactions" only, such as income taxes and driver's license
fees.
If the electronic cash became widespread, then for every dollar of
banknotes or coins replaced by private-sector electronic cash, the
Federal Reserve System, through its open-market operations trading desk in New
York, would be obliged to sell one dollar of U.S. Government securities.
Moreover, the Federal Reserve, and ultimately the U.S. Treasury, would lose the
interest income that it would have earned otherwise [9].
Note that the electronic cash would not be a private currency. Instead, to be
accepted by the U.S. banking clearing and settlements system, it would have to
be denominated in the official U.S. unit of account, the dollar.
The widespread adoption of electronic cash would deprive Federal authorities of
a substantial amount of "seignorage," the margin between the face value of
currency issued, and the costs of issuing that currency. In 1994, the Federal
Reserve turned about $20 billion in seignorage over to the Treasury.
In his essay "Digital Cash and Monetary Freedom," Jon W. Matonis, an
executive with the digital certificate developer VeriSign, Inc., points out
that the new technology offers the possibility of privately-issued currencies.
Matonis takes his inspiration from the late Professor Friedrich von Hayek,
whose essay "The Denationalisation of Money" includes the following quotation:
Money does not have to be created legal tender by government: like law,
language and morals it can emerge spontaneously. Such private money has often
been preferred to government money, but government has usually soon suppressed
it.
This is a theme that can be traced as far back as the 1851 writings of
Herbert Spencer, the father of "social Darwinism" and a strong opponent of
government intervention in the economy.
Matonis is quite correct that the new technology makes easier the use of
multiple private currencies. There is no reason why Intuit, Meca or Microsoft
cannot develop an intelligent agent to optimize the value of the digital
currencies stored in one's hard-disk drive or PC card. Such an agent would
resemble a foreign-exchange or corporate treasury trading desk. Moreover, any
Internauts are quite enthusiastic about the idea of "currency competition."
But why would anyone want to hold a private currency when there are so many
strong national currencies about? This is not merely a matter of "free
banking," but of the introduction of who new units of account. Despite advanced
technology, dealing with multiple currencies seems unnecessarily confusing. The
whole idea of private currencies seems preposterous. Yet Friedrich von Hayek
was no crank, nor are his followers. In many respects von Hayek was ahead of
his time. At a time when the economic establishment - including Republican and
Conservative leaders - accepted the Phillips curve analysis that a little
inflation was a small price to pay for more employment, it was von Hayek who
condemned inflation because it distorts prices, which serve as essential
information signals in a market economy.
Why use Microsoft dollars or Virgin Atlantic sterling when there already is the
Deutsche mark? If you reply that the D-mark may not be around too much longer,
then why not use the Swiss franc, the New Zealand dollar, or the Japanese yen?
I do not know whether Microsoft will be around in a century to redeem Bill
dollars, but I am relatively certain - the USSR, Yugoslavia and Czechoslovakia
notwithstanding - that the United States will be around.
Why should a private-sector currency be any more stable than a national one?
This seems more an article of theology than of economic logic.
Assume that, for the past century, we all had lived in a world of private
currencies. What if, one day while cleaning out the attic, you suddenly
happened upon Grandpa's stash of Eastern Airlines dollars? Fond memories of
Eddie Rickenbacker and Frank Borman may remain, but Eastern Airlines doesn't.
Gramps' Eastern dollars would be good for wallpaper and birdcages, but not much
more.
There is no statute prohibiting any U.S. citizen from issuing his own
currency. According to Sir Samuel Brittan of the Financial Times, this is also
more or less the case in the United Kingdom. If, as Professor von Hayek
alleged, privately-issued money can arise as spontaneously as law, language and
morals, why is it not here? In his essay on private currencies, Hayek blamed
capital controls for the failure of private currencies to develop. Yet capital
controls are largely gone, and there are still no private currencies.
There are two answers. First, there really is no demand for any
private-sector form of money other than brand-name traveler's checks and your
own demand-deposit and money-market-fund checks.
Second, there actually is an almost continuous history of private currency
ventures, in the United States and elsewhere. In the old American West, when
the mining companies were low on cash, they would sometimes pay the employees
in company scrip, which was accepted at the local company-owned store. More
recently, in the 1960's and 1970's, American supermarket shoppers would
accumulate "S&H Green Stamps," which were redeemable in special S&H retail
outlets.
But there is no compelling reason for citizens and businessmen to accept
private scrip. If banks refuse to accept private currencies, and the country's
clearing and settlement systems refuse to accept private currencies, then why
should anyone else?
Perhaps there might someday be demand for such a currency in a land where
hyperinflation is rampant, and local currency has lost all meaning. But even
here, I would think that dollarization would be a simpler, easier solution.
Would a private currency ever acquire as much trust as the dollar or the
Deutsche mark or the Swiss franc or the yen? I strongly doubt it.
This past autumn, National Westminster Bank PLC encountered a problem with its
credit-card authorization network. NatWest blamed the equipment's supplier,
British Telecommunications PLC. BT blamed NatWest for overburdening the
computer system.
NatWest and BT are also collaborators on Mondex. Suppose that Mondex' security
were breached, and NatWest and BT engaged in another round of fingerpointing?
At the end of the day, money is about confidence. Public recriminations can
easily be as devastating to confidence in an e-cash product as an actual breach
of security. The development of contingency plans and crisis-management skills
do not receive much public attention. Perhaps, to some extent, effective
contingency planning requires some discretion. Nonetheless, this seems an issue
that merits attention from central banks and other banking authorities.
Hearings on "The Future of Money" by the Subcommittee on Domestic and
International Monetary Policy, Committee on Banking and Financial Services,
United States House of Representatives, 104th Congress, Washington, D. C.
URL: http://www.house.gov/castle/banking/money.htm
To read about U.S. Treasury and Federal Reserve System policy toward electronic
cash, please consult the October 11, 1995 testimony of Comptroller of the
Currency Eugene A. Ludwig and then-Federal Reserve Board Vice Chairman Alan S.
Blinder.
To obtain hard copies of the Subcommittee "Future of Money" hearing transcripts
for July 25 and October 11, 1995, telephone +1-202-226-0473. A paper transcript
of the February 27, 1996 hearing was not yet available when this paper was
written.
"The Electronic Purse," by John Wenninger and David Laster, in Current Issues
in Economics and Finance, April 1995, Federal Reserve Bank of New York, New
York.
URL: http://www.ny.frb.org/rmaghome/curr_iss/ci1-1.html
To obtain a free copy of this article via snail mail, telephone the New
York Fed's Public Information Department at +1-212-720-6134. Laster and
Wenninger serve in the Payment System Studies Staff of the New York Fed.
"Policy Issues Raised by Electronic Money," by David Laster and John
Wenninger, Federal Reserve Bank of New York.
URL: http://www.ctr.columbia.edu/citi/emon.html
This paper was presented at the Conference on Digital Cash and Electronic
Money, Columbia Institute for Tele-Information, Columbia Business School,
Columbia University, New York, 21 April 1995.
"Electronic money in a race with Emu," by Giles Keating, Head Economist of CS
First Boston in London, Financial Times, November 2, 1995, p. 15.
http://icg.stwing.upenn.edu/hypermail/cis899/0123.html
"Showdown over E-cash," by Howard Anderson, Upside, January 1996.
http://www.upside.com/resource/print/9601/ecash.html
Anderson is Managing Director of The Yankee Group, a Boston consultancy. He is
also a founder of Battery Venture, a Boston venture capital firm. He has a
reputation as something of a contrarian when viewing long-term technology
trends.
"Electronic Cash: two sides to the story," by Dimitrios Kyriakou, Institute for
Prospective Technological Studies, Seville, Spain.
http://www.jrc.es/reports/vol00/dkelecca.htm
"So much for the cashless society," The Economist, 26 November 1994, p. 21.
http://www.ios.com/~lroth/clips/emoney.html
This was the first article to outline the challenges that electronic cash
would face central bankers and other policymakers.
"Digital Cash & Monetary Freedom," by Jon W. Matonis, April 1995.
http://www.isoc.org/in95prc/HMP/PAPER/136/html/paper.html
http://www.interfinance.com/digicash.html
http://www.publitronix.com/digital_cash/home.html
http://www.eff.org/pub/Privacy/Anonymity/Digital_money/matonis_on_dig_cash.paper
Matonis is a longtime libertarian, currency and futures trader, founder of the
Institute for Monetary Freedom, and executive with VeriSign Inc. of Mountain
View, California, a developer of digital-certificate products and services.
"Electronic Commerce and the Banking Industry: The Requirement and
Opportunities for New Payment Systems Using the Internet," by Andreas Crede,
University of Sussex, Science Policy Research Unit, in Journal of
Computer-Mediated Communication, Special Issue on Electronic Commerce, December
1995.
http://www.usc.edu/dept/annenberg/vol1/issue3/crede.html
Smart Cards and Systems Newsletter
http://www.cardshow.com/scs-secure/i10/country_news.html
Discusses several cash and multipurpose card projects.
A Panorama of the Electronic Purse Around The World
http://www.cardshow.com/applications/EP/contents.html
The above two sites are presented by the Smart Card Cyber Show.
Mark Bernkopf has served at the Open Market Operations Department of the
Federal Reserve Bank of New York and in the research unit of the White House
Office of Communications. He is now an independent consultant in Arlington,
Virginia, just outside Washington, D.C. Toward the end of last year, Bernkopf
prepared two in-depth studies on electronic cash for overseas clients. He can
be contacted by e-mail at markb@erols.com and by snail mail at:
4001 North 9th Street, Suite 1110, Arlington, Virginia 22203-1964 USA
1. By "Anglo-Saxon," I mean the U.K., U.S., Canada, Australia, New Zealand, and
Ireland.
2. Fedwire is the wire transfer facility operated by the Federal Reserve System
for the purchase and sale of excess reserves among American banks. CHIPS, the
Clearing House Interbank Payment System, is a privately-owned network for
transfers in the millions or billions of dollars by banks and large
corporations in the U. S. SWIFT, the Society for Worldwide Interbank Financial
Telecommunication, is an international payments network headquartered in
Brussels. Technically, SWIFT is a messaging system rather than a payments
system, but the distinction need not concern us.
3. Gary R. Garner, Financial Management Service, speech at "Stored Value Cards"
conference, organized by the Center for Business Intelligence, Washington, D.
C. September 1995.
4. In this age of digitized payments, the words "digital" and "electronic" can
be used more or less interchangeably.
5. M0 is pronounced "em naught."
6. There are actually eleven member economies in the Group of Ten.
7. See BusinessWeek, June 12, 1995, "E-cash could transfer the world's
financial life,"
8. ecash(tm) (without a hyphen) is trademarked by DigiCash. However, "e-cash"
(with a hyphen) is generic shorthand for electronic cash. This suggests that
DigiCash will have an interesting time fighting to retain its trademark in the
years ahead, as "e-cash" becomes a household word. One solution to DigiCash's
troubles would be the popularization of the Japanglish term "d-cash" as the
everyday parlance for digital cash. Presumably we need not fear anyone
confusing d-cash with the D-mark.
9. The Federal Reserve generally turns interest income over to the Treasury.
