Electronic money (e-money) offers the possibility of
privatizing the currency and making government fiat money disappear.
Competition and falling processing costs will prompt e-money issuers to
pay interest to users, and as people choose to hold that money rather
than non-interest-bearing paper money issued by central banks, there
will be a radical change in economic affairs.
Even central bankers are forecasting the demise of
paper currency. Jerry L. Jordan, president of the Federal Reserve Bank
of Cleveland, predicts that "Just as fiat money replaced specie-backed
paper currencies, electronically initiated debits and credits will
become the dominant payment modes, creating the potential for private
money to compete with government-issued currencies." 1 And
University of Georgia economist Lawrence H. White forecasts, "When
commercial on-line networks and Internet sites begin offering offshore
banking services, with zero or very small fees for transferring funds,
an exodus of retail banking business will begin from the regulated
onshore sector to the untaxed and unregulated offshore sector."
2
The transition from the old monetary universe, with
government at its center, to a new monetary universe, with the private
market at its center, will be a slow process of evolution rather than
revolution. 3 Because of habit and the network effects of
paper currency, it will take time for people to adjust to new ideas and
new technology and to accept digital cash (in the form of portable
"smart cards" as well as Internet accounts) as a new medium of exchange.
4 Thus, the current monetary system will not disappear
overnight.
Transition to a New Monetary Universe
The convenience of e-money, its anonymity, and its
positive yield will make it increasingly attractive as a medium of
exchange in the information age. So, as banks find ways to further
reduce their reserves and clearing balances at the Federal Reserve, the
net effect will be to reduce the demand for central bank money (the
monetary base). The Fed will then have to reduce the supply of base
money to prevent inflation. In the process, the Fed will suffer losses.
(Seigniorage, by which the Fed currently profits through issuing
currency for interest-bearing government bonds, would become negative.)
If the public and banks continue to move out of non-interest-bearing
government fiat money (in the form of currency in circulation and
deposits at the Fed) and into e-money, the central bank will eventually
go out of business. 5
The market will fill the void and provide a new
monetary standard as people demand sound money Private entrepreneurs
will have an incentive to maintain the value of their currencies or be
forced out of business; consumers will unload bad monies and switch to
monies with reliable purchasing power. 6 A market-driven
monetary regime will then emerge in which the monetary unit would be
fixed in value by making it convertible into a basket of commodities or,
more likely, into mutual fund shares. 7 Market forces will
ensure that the supply of money will respond to changes in demand
without experiencing the disrupting effects of monetary disequilibrium
that occur under the current fiat money regime, in which money has no
guaranteed value. 8
The Flexibility to Experiment
In the choice of monetary institutions, F A. Hayek
wrote, "selection by evolution is prevented by government monopolies
that make competitive experimentation impossible." 9 Thus,
the key to whether a new monetary regime evolves is competition - that
is, the freedom to experiment. Will private, profit-seeking
entrepreneurs, operating within the spontaneous market process, be
allowed to discover a new monetary universe or will government planners
and regulators attempt to block that process by protecting the status
quo? Ultimately, the answer to that question may be that the forces of
technology and competition will make it impossible to prevent
private-sector suppliers of e-money from breaking the government's
monopoly on currency.
Financial innovation depends on the freedom to fail, as
well as the right to profit from success. Markets are driven by
individuals who are willing to take risks in search of new opportunities
and profit. In the process, privately sanctioned informal rules often
emerge that later become codified and enforced by government; the market
typically leads the process of innovation, and government follows.
Misguided government intervention would cause more problems than it
cures. If overzealous regulators restrict experimentation and make the
emerging electronic marketplace too costly, they will severely hamper
the development of e-money.
How the Congress, Federal Reserve, and Treasury, in
particular.. view the transition to electronic cash and commerce will
shape the future of the electronic payments system. A laissez-faire
attitude will foster innovation; a protectionist attitude will mean that
special interests will determine the pace of innovation. The challenge
for government will be to provide a legal framework that safeguards
property rights and expands markets so that wealth is created rather
than destroyed. As Federal Reserve Board chairman Alan Greenspan has
noted, "If we wish to foster financial innovation, we must be careful
not to impose rules that inhibit it....[T]he private sector will need
the flexibility to experiment, without broad interference by the
government." 10
Private entrepreneurs, such as David Chaum of DigiCash,
are already developing the technology needed to ensure privacy and
security in the electronic payments system. Chaum, a pioneer in
developing blind-signature technology (the use of encryption to generate
secure digital signatures), is confident that the new technology will
allow electronic cash to come very close to having the attributes of
paper currency without the costs. Moreover, that technology will allow
users of e-cash to "retroactively and irrefutably reveal the recipient
of the funds." Thus, crimes associated with the use of paper currency -
such as extortion and bribery - "are no more likely than they are with
checks today." His goal is to create "a payments system that can be
widely adopted and that will stimulate economic growth ... and act as a
springboard for increasing individual freedom." Chaum believes that goal
is achievable once "consumers realize that the use of electronic
payments media does not have to compromise their privacy, but in fact
can empower them to protect their own interests." 11
Monetary Freedom and Individual Sovereignty
In the new monetary universe, the individual-not the
state-will stand at the center. Market-driven money, not politicized
government fiat money, will be the standard of value. Bill Frezza,
president of Wireless Computing Associates, envisions an enlarged
private space in which "sovereign individuals will have the tools to
construct a practical realization of laissez-faire capitalism." At the
center of that space, "will be new monetary institutions that must
inherently rest on the consent of the participants." 12 In
the new monetary universe, people will benefit from greater competition,
more information, and more freedom.
The danger, of course, is that government may try to
stifle competition, control information, and constrain freedom.
Special-interest groups that benefit from a paper-based monetary system
should not be allowed to maintain what Milton Friedman has called the
"tyranny of the status quo." The challenge is to develop an
institutional framework that provides transparent rules for the
electronic payments system, safeguards the value of money, and protects
individual freedom. Then we will have better money, greater wealth, and
more liberty as a result of the information revolution.
At the time of the original publication, James Dorn
was vice president for academic affairs at the Cato Institute and
professor of economics at Towson University and he was the editor of
The
Future of Money in the Information Age (Cato Institute).
1. Jerry L. Jordan, "Governments and Money," Cato
Journal, Fall/Winter 1995/96, p. 176.
2. Lawrence IT White, "The Technology Revolution and
Monetary Evolution," in James A. Dorm, ed.. The Future of Money in the
Information Age (Washington, D.C.: Cato Institute, 1997), p. 20.
3. Ibid., pp. 15-16.
4. Lawrence H. White, "Thoughts on the Economics of
'Digital Currency'," Extropy, 2nd-3rd Quarter 1995, p. 18.
5. A more detailed scenario of this transition process
is found in Kevin Dowd, "Monetary Policy in the 21st Century: An
Impossible Task?" Cato Journal, Winter 1998, pp. 327-3 1.
6. For a fuller discussion of why private enterprise
will produce money of superior purchasing power, see F. A. Hayek,
"Toward a Free-Market Monetary System," in James A. Dorm and Anna J.
Schwartz, eds., The Search for Stable Money (Chicago: University of
Chicago Press, 1987), p. 383. Also, more generally, see Hayek,
Denationalisation of Money - The Argument Refined, 2d (extended) ed.,
Hobart Paper 70 (London: Institute of Economic Affairs, 1978).
7. In this "defined-value" monetary regime, the
monetary unit would be defined by a basket of goods and services.
Banknotes and bank accounts denominated in the unit would be maintained
at their defined values by redeernability in equivalent amounts of some
convenient redemption medium, perhaps mutual fund shares. Kevin Dowd has
proposed a convertibility rule that is designed "to achieve price
stability by pegging the prices of index-based financial derivatives."
See Dowd, "Monetary Policy," p. 330, especially footnote 6.
8. For an excellent discussion of how to avoid monetary
disequilibrium, see part four of Leland B. Yeager, The Fluttering Veil:
Essays on Monetary Disequilibrium (Indianapolis: Liberty Fund, 1997),
edited and with an introduction by George Selgin. Also see F. X. Browne
and David Cronin, "Payment Technologies, Financial Innovation, and
Laissez-Faire Banking: A Further Discussion of the Issues," in The
Future of Money, chap. 19. They explain how a laissez-faire banking
system based on electronic payments and deposits held in the form of
highly liquid and divisible mutual fund shares that are "marked to
market" and used as exchange media could eliminate the problem of
monetary disequilibrium,
9. F. A. Hayek, The Fatal Conceit: The Errors of
Socialism, vol. I of The Collected Works of F A. Hayek, edited by W. W.
Bartley III (Chicago: University of Chicago Press, 1989), p. 103.
10. Alan Greenspan, "Fostering Financial Innovation:
The Role of Government," in The Future of Money, p. 48.
11. David Chaum, "Privacy and Social Protection in
Electronic Payment Systems," in The Future of Money, p. 94.
12. Bill Frezza, "The Internet and the End of Monetary
Sovereignty," in The Future of Money, p. 33.
Reprinted with permission from The
Freeman, a publication of The Foundation for Economic Education, Inc.,
November 1998, Vol. 48, No. 11.
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