In the last year, I have begun to buy things without
using coins, paper money, a credit card, or a checkbook. You may begin
to do likewise next year, or you may have begun a few years ago, though
neither of us could have done it ten years back. I've actually learned
two new ways to pay.
I bought a bag of groceries last week by swiping my
"debit" card (the same card I use at an automatic teller machine, or
ATM) through a small card-reader - mounted right next to the little
check-writing platform for people who still use checks - and keying in
my four-digit PIN (personal identification number). I thereby
electronically authorized a transfer of funds, from my bank account to
the supermarket's, equal to the $25.96 being displayed on the cash
register as my total bill. In a matter of seconds before my groceries
were completely bagged, in fact -the cash register spit out my itemized
receipt to signal that the payment was good. Last summer I used a
service station along the interstate with similar card-readers and
receipt-printers mounted by and wired to its gasoline pumps, allowing
any debit-cardholder to buy gasoline at any hour without any station
employee having to be on duty to process the payment. Before too long,
just about every point of sale that takes credit cards will probably
also take debit cards.
Yesterday I used a second novel way of paying at a
nearby copy shop. The shop's self-service photocopier didn't take coins,
paper money, credit cards, or even a debit card. Instead I put a plastic
card bearing a magnetic strip on its back into a reader, which displayed
in glowing yellow digits how many dollars-worth the card "carried." (On
an earlier occasion I had purchased the card from a nearby machine,
which had "loaded" the card with the dollar amount of paper money and
coins I put into the machine. When the card balance gets low, it can be
topped up at the same machine.) I watched the yellow number go down by
.07 with each copy produced. In the future a single prepaid card,
probably carrying a microchip rather than a magnetic strip, may be
usable in a wide variety of transactions. Imagine the convenience if the
same card were accepted by photocopy machines, soda machines, pay
telephones, and even by the cash registers in ordinary retail shops.
Imagine if the card balance could be topped up at an ATM - or even at
your home computer -by transferring funds from your bank account. Such
"smart cards," as the idea is known, would amount to a bank-issued
currency, a modern equivalent of the private banknotes that circulated
before governments monopolized the issue of currency.
New Ways to Pay: The Advantage
These new payment methods are spreading. Smart card
systems have been introduced in Denmark, Singapore, and
England.1 Here in the United States, retailers are finding
card-readers increasingly cheap to install, and growing numbers of
customers are discovering the advantages of debit and prepaid cards. In
a world where people are increasingly in a hurry, they speed the act of
paying - no need to have the right change or to wait for change in
return, no need to write out a check, no need to stop at the bank
counter or ATM to get more cash. Paying by debit card or smart card will
often be more convenient than paying with cash. A debit card is even
better than cash or a smart card in at least two respects: using a debit
card keeps your money in your bank account, where it is both more secure
from theft and earns interest, right up to the moment it is spent.
Some observers are skeptical that payments methods will
change dramatically any time soon. What happened to the predictions a
decade ago that soon everyone would be banking electronically by home
computer? Actually, home banking is now finally growing in popularity,
for several reasons. Touch-tone phone-banking services, along with ATMs,
have acclimated people to electronic banking; home computers and modems
(devices to transmit computer information over telephone lines) have
gotten cheaper; home banking software has gotten easier to use; and
increasing numbers of households are subscribing to on-line services
like Prodigy that include electronic home banking and bill-paying among
their offerings.2 Hundreds of thousands of people now make
hundreds of millions of dollars worth of monthly payments electronically
by typing and mouse-clicking at their home computers. (I'm not yet one
of those people, but check back with me in a few years.)
An even more dramatic development in the last few
years, with possibly profound implications for the payments system, has
been the growth of the Internet, the decentralized worldwide network of
inter-linked computers across which users send electronic mail
("e-mail"), post messages to "newsgroups" for public discussion, and
browse for and download information. The Internet is estimated to have
had 30 million users at the start of 1995, and to have been growing at
the amazing rate of 10 percent per month.3 Like many in
academia and business, I often spend an hour a day reading and sending
e-mail and newsgroup postings. The Internet was originally
non-commercial, but with tens of thousands of business firms now
connected, plenty of business is already being done by e-mail. Those who
"log on" to the "Net" or "go on-line" daily are natural candidates for
convenient on-line retail shopping, and commercial Internet sites have
begun to appear. On-line catalogs - fast becoming "virtual shopping
malls " - have long been a staple of Prodigy, Compuserve, America On
Line, and the other proprietary networks.
But how to pay for an item selected from your computer
screen? For some transactions, you might want to send a credit card
number by e-mail. I have actually renewed a magazine subscription this
way, but I had to worry about my number being intercepted by a computer
"hacker." The profit motive is now hurrying to the rescue: Microsoft and
Visa, the software and credit-card giants, have recently announced a
joint project to develop a user-friendly way to encrypt (encode) and
decrypt credit-card numbers sent over e-mail to assure security in such
transactions.
For other transactions, a way to "pay cash" over the
Internet would be a winner. Several firms are now developing systems for
"digital cash" or "e-money," most notably Digi Cash, founded by
cryptography (code-making) expert David Chaum. These systems allow an
electronic funds transfer to be launched from a personal computer as
easily as from a supermarket's debit- card-reader.
Privacy Concerns
There is, however, a potentially large fly in the
ointment of these new payments methods. Unlike a paper-money or prepaid
card transaction, a credit-card or debit-card transaction typically
lacks privacy. Using electronic deposit transfer or a credit card
(either in person or via computer), like writing a check, generates a
trail. Your bank's or card company's computer ends up with a list not
only of how much you've spent, but of where you spent it. The same list
could be constructed by combining the information held by all the
vendors from whom you bought. This list is potentially available to the
IRS or to other government agencies who may want to commandeer it. If
you don't have a contract with your bank and vendors expressly
forbidding it, the list is potentially available to credit bureaus or
junk-mail firms who may want to buy the information. The privacy issue
understandably concerns many people who are perfectly law-abiding
citizens.
Fortunately, computing and cryptographic experts like
Chaum are working to develop methods for anonymous electronic payments.
One set of models for anonymous payments uses the "smart card" method
(the funds to be transferred have already been downloaded onto a smart
card or personal computer); an alternative set uses electronic deposit
transfer either by debit card or by personal computer. For an example of
the deposit-transfer type, suppose I wish to pay you $100 anonymously
without using physical currency. (I might be standing at your cash
register, or I might be home at my computer looking at your invoice on
my screen.) By merely typing in my PIN, or clicking on a "pay" button on
my computer screen, I send a cryptographically "signed" (or PIN -
authorized) and numbered (you have assigned the number) message to my
bank that instructs my bank to transfer $100 to an account (whose name
is encoded) at your bank. My bank reads the "signature," and knows the
message is genuine. My bank can't read the recipient account name, so
doesn't know to whom the money's going (only to which bank). Your bank
can't read my signature (which my bank may have removed), so doesn't
know from whom the money came (only from which bank, and in favor of
which account). You read the transaction number to know the payment came
from me (though you might not know4my name).4 You then hand
me the goods, or ship them to my private post office box.
Are bank customers actually eager to pay cost-covering
prices for privacy features of this sort? I don't know. The market will
tell us, assuming that government does not interfere. Some federal
authorities have suggested that they would object to a completely
untraceable version of smart-card or debit-card payment, because it
might be used to hide transactions they want to tax or prohibit. To be
consistent, such authorities should also object to the availability of
untraceable $100 bills. Chillingly, some do.
Keeping the Government Off-Line
What role does the government need to play to
orchestrate the shift to new payments methods? None whatsoever.
Governments of the past, after all, played no role (or no constructive
role) in the transitions from barter to commodity money, from raw
metallic money to coins (though ancient despots later discovered profits
in monopolizing the mints and in debasing the coins they produced), from
coins to banknotes (though government-sponsored central banks later
monopolized their issue and diluted their value as well), from currency
to deposit transfer, cash to credit cards, checks to debit cards, or
locally to nationally accepted ATM cards.5 The shift to
electronic payment methods is taking place already, without the Federal
Reserve having taken any official position or promulgated any rules on
digital cash or smart cards. Private ATM networks and credit-card
networks already exist to set interconnection standards where new
standards are needed.
Debit cards, being just a paperless substitute for
checks, don't raise any important regulatory issues. But won't private
banknote-like smart cards, being a new privately issued form of money,
need regulation once they catch on? Don't they threaten an inflationary
avalanche of electronic money? Absent central bank restrictions, what
will limit the quantity of smart card-loaded "dollars" commercial banks
can create? The answer to the first two questions is no, because the
answer to the third is that a bank's obligation to convert card-balance
dollars to scarce reserve dollars (physical currency or account balances
at the clearinghouse) on demand naturally limits the number of
card-balance dollars a bank will find it prudent to create given the
size of its reserves. 6
There is more at stake for you and me in electronic
funds transfer than simply more convenient payment methods. One major
potential advantage of electronic funds transfer via personal computer
is that it may give ordinary consumers affordable access to offshore
banking. With direct deposit of paychecks, and with old-fashioned cash
available at ATMs whenever we want it, few of us really need to visit
our banks in person anymore. Why not keep your account at a reputable
foreign bank (perhaps a branch of a major Swiss bank) in the Bahamas or
the Cayman Islands? Such an offshore account is perfectly legal (though
a U.S. bank's offshore branch is prohibited from directly doing business
with American citizens or firms), but not worth the trouble for most
individuals or small businesses today. If an offshore bank were linked
to the clearing system and to an onshore ATM network (or if access to
physical cash were irrelevant because all cash-like payments could be
made by debit card or smart card), more of us could begin enjoying the
advantages of offshore banking that big-money players and large firms
have enjoyed for years. Offshore banks pay higher interest on deposits
because they are free from the taxes on deposit balances that the U.S.
government levies in the form of reserve requirements, deposit insurance
"premiums," and taxes on bank earnings. Individuals who are concerned
about privacy should also find an offshore foreign bank attractive for
its lesser propensity to surrender its records to domestic authorities.
Just as a variety of old and new forms of payment are
available today, old-fashioned payment methods like cash and check-
writing can be expected to persist well into the twenty-first century.
There they will coexist with smart cards, debit cards,
per-sonal-computer-launched deposit transfer, and perhaps other new
electronic methods of payment. If and when Prodigy, Com- puserve, and
Internet sites begin offering offshore banking services, things should
really become interesting. An exodus of retail banking business from the
regulated sector to a free banking sector will shrink the fiefdom of
federal banking authorities. Let us hope the authorities accept that
fate gracefully.
At the time of the original publication, Dr. White
taught economics at the University of Georgia, and was a contributing
editor to The Freeman. He was that month's guest editor.
1. For an account of recent and possible future
developments see Steven Levy, "E-Money (That's What I Want), Wired
(December 1994), pp. 174ff.
2. David C. Churbuck, "Let Your Fingers do the
Banking," Forbes (19 August 1991), pp. 122-24.
3. "So Much for the Cashless Society," The Economist
(26 November 1994), pp. 21-23.
4. In Internet lingo, this method preserves privacy by
using the two banks as semi-anonymous "remailers" of different parts of
the payment message. Privacy could be increased even further by having a
clearinghouse relay the message so that neither bank even knows the
identity of the other bank. For an enlightening explanation of how the
necessary encryption method works (such that my computer can encode a
message that only the intended recipient's computer can decode), see Hal
Finney, "Protecting Privacy with Electronic Cash," Extropy #10
(Winter/Spring 1993), pp. 8-14.
5. For brief accounts of how these practices emerged in
the market see George A. Selgin and Lawrence H. White, "The Evolution of
a Free Banking System," Economic Inquiry, vol. 25, no. 3 (July 1987),
pp. 439-57.
6. The theory of the natural limit to banknote volume
under "free banking" applies equally to smart-card balances. See George
A. Selgin and Lawrence H. White, "How Would the Invisible Hand Handle
Money?," Journal of Economic Literature, vol. 32, no. 4 (December 1994),
pp. 1718-49.
Reprinted with permission from The
Freeman, a publication of the Foundation for Economic Education, Inc.,
May 1995, Vol. 45, No. 5.
Yourname@libertyhaven.com
