The financial system of today's world is the product of
centuries of innovation. What began as a barter economy moved through
various incarnations in response to the limitations inherent in the
evolving systems. Changes will undoubtedly continue to occur in response
to social and technological progress. Contemporary discussion of likely
changes has focused increasingly on the possibility of a cash-less
society. The technology for such a society exists. However, the benefits
of cash-less-ness are not yet perceived to outweigh the supposed
disadvantages.
This article will discuss the progress toward
cash-less-ness and its relevance to free banking. Free banking
historically involved the issuance of bank notes that were redeemable
for a "base" money such as gold or silver. Modern proponents of free
banking such as Lawrence White have continued to think of it in these
terms. White's colleague at the University of Georgia, George Selgin,
has, on the other hand, envisioned a regime under which the existing
(U.S. dollar) monetary base would be frozen, and banks could then issue
notes that would be exchangeable for base dollars. Both writers
apparently envision a society that will continue to use currency and
coin as pervasive media of exchange.
A cash-less society would mean, of course, the absence
of currency and coin. Therefore, a cash-less society could mean a barter
society in which commodities were traded for commodities. However,
barter would represent a major step backward. The cash-less society
envisioned and discussed herewith refers instead to the widespread
application of computer technology in the financial system.
Increasingly, funds are being transferred via an "Electronic Funds
Transfer System" (EFTS).
The EFTS
As it became apparent that electronic banking was here
to stay, Congress in 1974 established the National Commission on
Electronic Fund Transfers. The commission studied the infant EFTS, and
published its recommendations in 1977. The commission concluded that an
EFTS developed in an "orderly" manner would be beneficial to consumers
of financial services and suggested that such a system operate outside
the public sector. The commission went on to state that "a national EFTS
could be supported by as few as 225,000 on-line terminals installed in
general merchandise stores."
As the commission completed its research, the Federal
Reserve established "Fed Wire." Fed Wire is a nationwide electronic
communications network that links the 12 Federal Reserve District Banks,
all member commercial banks, and the U.S. Treasury. It represents a
considerable investment on the part of the Federal Reserve, and has been
interpreted by the member banks as Federal Reserve endorsement of a
nationwide EFTS.
Transition to an EFTS involves overcoming structural
barriers such as high start-up costs as well as the establishment of
cooperation and communication among competing banks and retailers. In a
sense, by the creation of Fed Wire, the Federal Reserve has provided not
only an endorsement of EFTS, but a subsidy as well. Large institutions
have capitalized on the Fed's investment, and smaller organizations must
now subscribe to the changes in order to remain competitive.
An EFTS is made up of many components, the most widely
known and accepted being Automated Teller Machines (ATMs). Additional
integral elements are Automated Clearing Houses (ACHs) and Point of Sale
terminals (POSs). As we shall see, the ACHs and POSs, not ATMs, are
probably the keys to further progress toward a cash-less society.
Federal Reserve economist Michael Keeley has argued
that "trends in cash usage and holdings suggest that cold, hard cash is
becoming an even more popular means of payment." He goes on to say that,
"Since most ATMs use $20 bills, it is interesting to note that the
growth in volume of $20 bills has been greater than that of other
denominations since 1977 - about the same time that the number of ATMs
installed started to grow nationwide."
Federal Reserve reports on currency have shown a
significant increase in the number of bills in circulation, and an
increase in the average denomination being used; for example, the number
of $20 bills has increased faster than the number of $10 bills. The
number of checks being written and the average size of each check have
also increased, but at much slower rates.
ATMs
Keeley uses such facts to support his view that a
cash-less society is "far from reality." However, a provocative argument
can be made that the transition to a cash-less society involves an
increase in cash usage prior to its disappearance for all but low-dollar
and "discrete" transactions. Before the spread of ATMs, a greater
percentage of retail transactions involved payment by check.
Because of processing delays, checks present
opportunities for buyers to make purchases prior to the receipt of the
requisite funds in their accounts-i.e., there is a so-called "float."
However, checks also involve a certain amount of time and inconvenience
for the parties to a transaction. Before the spread of ATMs the most
common method of obtaining cash was from tellers at bank branches. With
the limited banking hours of the day and the associated long lines, it
was far more common for consumers to endure the inconveniences
associated with check writing than to visit a bank branch to obtain
cash. ATMs made cash easier to obtain, however, and it increasingly
became the preferred method of payment.
POSs
The use of POSs may displace the use of cash obtained
from ATMs just as the use of ATM cash has displaced checks. POS use
reduces many of the liabilities of cash. For example, crimes such as
mugging and purse-snatching would decrease in the absence of cash, and
the opportunity costs of cash would be eliminated insofar as a
consumer's funds would always be in interest-bearing accounts.
The shift away from cash and toward POSs may be
obscured for a time by the use of currency to engage in tax evasion or
illegal activities such as drug dealing. Progress toward cash-less-ness
may also be obscured by the use of U. S. dollar bills in the former
Soviet Union and elsewhere. But as such areas stabilize and adopt more
sophisticated technology, their payments practices will probably start
to resemble those in the United States.
Transition Problems
The transition to a fully electronic transfer of funds
system will not be impeded by households; through the use of debit cards
they are already in the process of becoming comfortable with the
advantages of EFTS. Rather, some of the parties engaging in high dollar
transactions will provide resistance until the issue of float costs and
benefits is resolved. Insofar as there are delays in processing checks,
there is a float cost to the businesses getting paid. This cost is
equivalent to a working capital expense for receivables. There is a
corresponding benefit to payees who can continue earning interest until
their checking accounts are finally debited. Elimination of this float
would result in a significant redistribution of income among businesses,
and this may explain some of the present resistance to EFTS conversion.
The amount of interest earned via check float is now estimated to be
between 40 and 50 billion dollars annually. Understandably, the
recipients of this interest will resist its disappearance.
Canada has addressed the float issue by way of a
banking industry and central bank accord that provides for same-day
accounting of checks presented for payment. The float has been
significantly reduced by the implementation of a retroactive inter-bank
settlement process. This innovation has removed the float associated
with the check clearing process, but not that which occurs when a payee
holds a check for a period of time before processing it.
In order for the U.S. to overcome the barriers to an
EFTS created by the float, it appears that voluntary conversion on the
part of businesses, rather than regulation, is the answer. The U.S.
Treasury has already reduced check use and shifted many government
payments to electronic transfer. Among these are Social Security,
federal payroll, and even large federal contract payments. It can be
expected that the spread of electronic transfer practices will continue
in the private sector as well, with the loss of float costs and benefits
being considered in the terms on which parties are willing to do
business with another.
Free Banking
The progress toward an EFTS could further complicate
the Federal Reserve's attempts to manage the U.S. money supply. As
economists are well aware, the public's demand for cash influences the
quantity of money in circulation. Perhaps more serious is the
internationalization of money flows and the proliferation of new types
of accounts. With electronic systems shifting funds from one type of
account to another, and from one country to another, it has become
difficult or perhaps impossible to say what "the" money supply is.
Part of the appeal of free banking is that it makes
such issues moot. Financial institutions and customers could pursue
their interests independently with their actions being coordinated by
the invisible hand of the market. A cash-less society would pose no
special problems in this context. The 12 Federal Reserve District Banks
could be privatized in the form of Automated Clearing Houses; the
district bank stock to which member banks subscribe upon joining the
Federal Reserve System could be converted into transferable shares in
the ACHs. The newly privatized ACHs would presumably play a major role
in inter-bank lending and reserve settlements.
In the case of either a gold-based or
paper-dollar-based free banking system, base money could be kept at the
ACHs, but it need not be. As long as all claims and settlements were
continuously recorded, base money would only have to be available at
ACHs or member banks to meet occasional customer requests.
In conclusion, the movement toward a cash-less society
is proceeding incrementally. Cash may continue to be useful for some
time, especially for discrete transactions, but even these may become
increasingly automated. Given the rapid growth in technology (e.g.,
pocket-sized cellular telephones), it is not difficult to imagine
devices whereby even the most informal purchases could be automatically
debited from the buyer's bank account.
EFTS is likely to have a profound and visible impact on
everyday decision-making. Some of the more obvious benefits are
reductions in financial transaction time and cost, and a reduced need
for cash which would, in turn, decrease the amount of interest forgone.
The opposition to a cash-less society is likely to become increasingly
silent as it is defeated by subtle economic pressures exerted by the
federal government and financial industry giants; they continue to
realize the benefits of the transition to an EFT system. As this
transition continues, the issue of float is likely to fade as well.
While we may not see a completely cash-less society in
the immediate future, the foundation has been laid, and the available
evidence indicates that we are indeed moving in that direction. The fate
of the Federal Reserve depends, of course, on political considerations,
but the progress toward EFTS could ultimately prove to be a key factor
leading to its replacement by free banking.
At the time of the original publication, The author
was an operations analyst for Diebold, Inc., a banking equipment
manufacturer.
Reprinted with permission from The
Freeman, a publication of the Foundation for Economic Education, Inc.,
October 1993, Vol. 43, No. 10.
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