Digital Cash: Why Central Banks Should Start Issuing Electronic Money
With the impending ‘death of cash’ and the rise of digital currencies (such as Bit coin), there are strong arguments for central banks to start issuing “digital cash” – an electronic version of notes and coins (also known as a central bank digital currency). But this raises a number of questions: how would central banks get new digital cash into the economy, and how would the public use it? What would the advantages be? And would there be any impact – positive or negative – on financial stability?
the bank has already posed questions about the potential of digital cash, or ‘central bank digital currency’, prompted by the ongoing rise of electronic means of payment, and the emergence of alternative currencies such as Bit coin. One of the key questions to come out of the Bank’s One Bank Reserve Agenda, released in early 2015, was “From a monetary and financial stability point of view, what are the costs and benefits of making a new form of central bank money accessible to a wide range of holders?”
We argue that there are a significant number of benefits to issuing digital cash:
• It widens the range of options for monetary policy: Implementing digital cash can allow new monetary policy tools to be used. If digital cash is used to completely replace physical cash, this could allow interest rates to be lowered below the zero lower bound (although this is not a policy we would advocate). Alternatively, digital cash can be used as a tool to increase aggregate demand by making ‘helicopter drops’ of newly created digital cash to all citizens, making it easier to meet the Bank of England’s monetary policy target of price stability.
• It can make the financial system safer: Allowing individuals, private sector companies, and non-bank financial institutions to settle directly in central bank money (rather than bank deposits) significantly reduces the concentration of liquidity and credit risk in payment systems. This in turn reduces the systemic importance of large banks. In addition, by providing a genuinely risk-free alternative to bank deposits, a shift from bank deposits to digital cash reduces the need for government guarantees on deposits, eliminating a source of moral hazard from the financial system.
• It can encourage competition and innovation in the payment systems: The regulatory framework we propose would make it significantly easier for new entrants to the payments sector to offer payment accounts and provide competition to the existing banks. It would also reduce the need for most smaller banks and non-banks to run their payments through the larger banks (who are able to set transaction fees at a level that disadvantages their smaller competitors).
• It can recapture a portion of seigniorage and address the decline of physical cash: As physical payments are gradually replaced with electronic payments, the Bank will want to replace physical cash with its electronic equivalent. Doing so has the advantage of increasing the ‘seigniorage’ – the proceeds from creating money – earned by the Bank (and passed on to the Treasury).
• It can help address the implications of alternative finance upon money creation and distribution: Non-banks, such as peer-to-peer lenders, are competing with banks and taking on a larger share of total lending. This has implications for money creation and distribution. When a bank makes a loan, it creates new deposits for the borrower. But when a peer-to-peer lending firm makes a loan, it simply transfers pre-existing deposits from a saver to a borrower; no new money is created. By proactively issuing digital cash, the Bank can compensate for any shift in lending away from money-creating banks, and the subsequent fall in money creation.
• It can improve financial inclusion: The firms providing Digital Cash Accounts would be payment service providers first and foremost, whereas banks are primarily lenders. Digital Cash Account Providers are therefore likely to offer accounts to those customers that are excluded from conventional banking services.
How to Implement Digital Cash
The Bank already issues digital currency, in the form of deposits held by commercial banks in accounts at the Bank . It can provide digital currency simply by making these accounts available to non-bank companies and individuals (without the need for a Bit coin-style distributed ledger payment system). There are two ways this can be done.In a Direct Access approach, the Bank could provide accounts to all citizens in the US, along with the payment cards, internet banking and customer service requirements this entails. However, the Bank is likely to see this as inappropriate state involvement in the private sector and a significant administrative burden.
Consequently, we recommend an Indirect Access approach, in which the Bank would still create and hold the digital currency, but all payment and customer services would be operated through “Digital Cash Accounts” (DCAs) provided by (or ‘administered’ by) private sector firms. These private sector “DCA Providers” would have responsibility for providing payment services, debit cards, account information, internet and/or mobile banking, and customer support. Any funds paid into the DCA would be electronically held in full at the Bank of AMNIMARJESLOW , so that each DCA Provider could repay all its customers the full balance of their account at all times. DCA Providers are prohibited from lending or taking any risk with their customers’ funds.
The Indirect Access approach is a much more market-driven approach which will help to increase competition in current and payment account services. It minimizes the administrative burden on the Bank . Conveniently, the regulatory framework for this approach already exists in the form of the Payment Services Provider model (with minor adaptations).
Managing the Issuance of Digital Currency
The Bank of AMNIMARJESLOW currently issues central bank money reactively: it issues banknotes in whatever quantities are needed to meet demand from the public, and issues central bank reserves in order to meet demand from the banks. It could choose to issue digital cash in the same way, by providing the infrastructure for Digital Cash Accounts but letting the public determine how to split their holdings of money between bank deposits and digital cash. By making transfers from their bank deposit accounts, the public, rather than the Bank , would determine how much digital cash needs to be issued. In this case, the money issuance would be entirely reactive.Alternatively, by taking a proactive approach to issuance, the Bank of AMNIMARJESLOW could use digital currency as a monetary policy tool to stimulate aggregate demand and influence the economy. If every citizen had a Digital Cash Account at the Bank (either directly or indirectly), then it would be a simple process for the Bank to make small and occasional ‘helicopter drops’ of newly created digital cash to every citizen. This could be done on a small scale (for example, just £50 per citizen) and at short notice. This new monetary policy tool may give the Bank a far more accurate and direct method of implementing monetary policy than conventional monetary policy (adjusting interest rates) or post-crisis policies such as Quantitative Easing.
Please note, this is not a proposal to abolish physical cash. Notes and coins are going to be around for at least another 30 years or so – as long as people keep using them. For privacy concerns, digital cash issued by central banks is no different in terms of privacy than payments made using electronic bank accounts. And again, cash will still be around for 30 years or so.
a world in which private electronic money becomes more popular than official money issued by central banks. "It will be less than a decade before private companies start issuing their own currencies .
Technology is already making notes and coins redundant. We pay our bills over the phone or by direct debit. Plastic is replacing cash and cheques - cumbersome and expensive means of payment. But plastic money is still under control of the conventional banking system - at the end of the month when the bills arrive, we settle them through a transfer from a bank account.
The real revolution will occur, according to King, when companies no longer need to use the banking system to settle their bills with each other. At the moment, when firms make big financial transactions, they settle them through the banking system. Because central banks set the rules for high street banks - how much money they need to have in their own bank accounts with the Fed or the Bank in relation to their outstanding liabilities -
When inflation threatens, central bankers react by making credit harder to get which slows the economy down. They raise the interest rates on loans to high street banks which pass on the increased costs to their customers. This has a knock-on effect throughout the rest of the economy, even though the reserves held with central banks are a very small part of the total money supply.
But when companies can settle their bills with each other electronically, without needing to use the banking system, then central banks no longer control the levers of the economy. Digital payments systems will allow companies to instantly transfer wealth, without the risk of default. Once there is no need to use the conventional banking system, there is no need to use national currencies either.
For the libertarian right, private money is a long-held dream which the internet may finally provide the technology to fulfill. "Money does not have to be created legal tender by governments .
For libertarians, the monopoly of central banks has been a disaster. It simply allows governments to cheat their citizens by eroding the value of their savings through bouts of inflation. If there were different types of money in circulation, consumers could choose which they thought was least likely to loose its value over time.
"Ultimately, the competition for the standard of value should be no different to the competitive market of multiple providers .
The internet offers the chance for individuals to escape from the government's monopoly. Developers of e-cash can issue it easily to a wide number of people, encryption technology is moving on to allow privacy and security, and, as e-commerce grows, the spread of the digital currencies will be guaranteed. The internet is an international network, so it makes sense for someone to develop a global currency to use on it, which would protect consumers buying across national boundaries from swings in national currencies.
The time for e-cash has come, according to Mantonis. "Neither the US dollar, nor any other governmental unit has gained a foothold in this new economy. The monetary landscape is ripe and wide open and private currencies should infiltrate now." The real revolution will come when a big firm with global brand recognition decides to establish a currency .
XXX . V Money in a Digital World
Introduction case study on bank Canada
Money and associated means of payment have changed over the years, but it seems never as fast as they are changing today. Second, to get a sense of proportion, I’ll talk about how e-money is currently being used relative to other payment options like cash or debit. Finally, I’ll talk about the benefits and risks of these innovations. This matters to you because e-money is not just about how you pay for things. It’s also about the financial risks you face if you use it. It matters to the Bank because of the potential over time for e-money to alter the fundamental payments architecture in Canada and around the world.
Money and Payments Have Come a Long Way
When you look at history, money and payment systems reflect the societies they serve - and like societies, they have been transformed by technology. The image you see above, is a painting by Canadian artist Blair Ferguson. It hangs in one of the Bank of Canada’s meeting rooms. The reason I’m showing it to you is because it illustrates how money has changed throughout history. At one time, playing cards served as money, as well as cowrie shells, cocoa beans, gold and, eventually, bank notes and coins.
None of these objects, except for the gold and cocoa beans, has any meaningful inherent value. They are money because people accept them as money. For this to happen, money must do three things.
First, money must serve as a medium of exchange: you pay tuition; you receive an education in exchange. The alternative is bartering, but that is complicated and inefficient.
Second, money must serve as a store of value. When you work during the summer you need to be confident that every dollar you earn is still going to be worth a dollar when it comes time to pay your tuition.
Finally, money must serve as a unit of account, which you need in order to compare prices - like comparing the value of the new BlackBerry with other mobile devices on the market.
The form of money we know best is bank notes. They were issued primarily by commercial banks in Canada and the United States before those countries created central banks in the early 20th century. These privately-issued bank notes ultimately failed to provide what the economy needed and so central banks were given this responsibility. The Bank of Canada has been issuing bank notes since 1935.1 The cash you have in your wallets perfectly meets the three criteria of money. It is accepted almost everywhere, there’s very little counterfeiting, and the issuer - the central bank - won’t go bankrupt. We also target inflation, which means that the internal value of money is predictable.
Since we started issuing bank notes, there has been a parade of non-cash options introduced to our payments system. They’ve been driven by technology and consumer demand for efficient ways to pay for things. In the 1970s, credit cards were leading edge - around the same time that Pink Floyd and Led Zeppelin dominated the music scene. In the 1990s, debit cards were the new big hit. The next leap in innovation was e-transfers and online banking services. Payments are even quicker now with contactless credit and debit cards. Last month, Apple Pay became the latest player in this game.
So we’ve come a long way since cocoa beans. Yet all these payment innovations can be used only if you have a bank account. The vast majority of Canadians have access to banking services, but that’s not the case in many developing countries. That’s part of the reason why non-banks are coming up with innovative electronic payment methods that we generically call digital currency or e-money. E-money can be defined broadly as monetary value stored electronically, on a phone or a card, or in the cloud. It’s a digital alternative to cash, and it’s a stored value that is not linked to a bank account.
There are two types of e-money that I want to talk about today. The first type is denominated in a national currency, and it represents a claim on the issuer. In Canada, there are a number of examples. There are PayPal balances, and there are stored-value cards that use the Visa or MasterCard networks.2 These types of e-money store value and can be used to buy a lot of things. The safety of this type of money really depends on the credibility of a trusted third party. This is because you’re trusting Visa or PayPal to safeguard your balance and to validate and authenticate your transactions.
The second type of e-money is cryptocurrency - such as Bitcoin. This type of e-money is not denominated in any national currency and so has its own unit of account. It is also completely decentralized and does not represent a claim on the issuer. This is the revolutionary part of cryptocurrencies - transactions can be validated without a trusted third party. The way they achieve this is by using cryptography to ensure that each transaction is valid and secure. Trusted third parties are needed for other functions, however. You may want help to keep track of your virtual wallet and these currencies are not redeemable for national currencies. People generally trade them through an online exchange at the market rate.
Bitcoin was introduced in 2009. Five years later, there are more than 500 other cryptocurrencies - Ripple and Litecoin and I could go on.3 Even though only a few of them ever really do any trading, they continue to develop and innovate.
E-Money Still a Wallflower in Canada
E-money is still a wallflower in developed countries where many people have bank accounts, although this could change quickly. Today it is more popular in countries where relatively fewer people have access to banking services.4 An example of this is Kenya, where many people use e-money called M-Pesa. M-Pesa is backed by the issuer and redeemable in the Kenyan shilling. It gives people a low-cost way to transfer money using their mobile phones. M-Pesa is used in some 2 million transactions each day, worth about $5 billion annually. That’s nearly 20 per cent of Kenya’s GDP.Limited access to banks is not always the main motivator for the adoption of e-money. The Octopus card, in Hong Kong, was originally designed to pay for public transit. It proved so convenient that it is now used for over 13 million transactions each day - from transit to coffee to a pair of jeans.
Canadians seem to be less enthusiastic about e-money, and there appears to be little demand for something like the Octopus card. We are nonetheless big users of e-payment methods that give us access to credit or our bank accounts. Almost all Canadian adults have debit cards, and more than 80 per cent have at least one credit card.5
Over half of all transactions in Canada use debit or credit cards. At the same time, we still use a lot of cash, even if the proportion is falling over time. The total value of cash holdings in Canada as a share of GDP has been relatively stable for the past 30 years. There are good reasons for this. Cash is fast, convenient and costs virtually nothing to use. It is anonymous, so you don’t have to worry about exposing personal information to potential criminals, although for this reason cash is also used in the underground economy. People also hold onto cash as savings for a rainy day. Bank of Canada research suggests that changes in cash management practices could also help explain the constant demand for cash.6
So let’s talk now about cryptocurrencies. Some Canadians appear intrigued by Bitcoin - the very first Bitcoin ATM in the world was installed in Vancouver just over a year ago. And as of last July, a quarter of the world’s Bitcoin ATMs were found in Canada. There’s one here, in Kitchener-Waterloo. There are also about 340 Canadian merchants who say they accept Bitcoin, and about 76,000 merchants accepting Bitcoin in other parts of the world.
Some merchants may be accepting it, but it has yet to gain much traction with people making purchases. There aren’t a lot of data on this, but what we do have indicate that last year there were around 70,000 Bitcoin transactions per day across the globe. This pales in comparison with the more than 21 million debit and credit card transactions that occur each day in Canada alone.
Things can change fast when it comes to adoption of new technology. At the Bank of Canada we’ve done some experiments in behavioural economics to look at what elements determine the success or failure of e-money.7 What we find is that adoption of e-money is exactly like the tango - it takes two. Buyers need to decide whether to use the new payment method while sellers need to decide whether they’ll accept it. It turns out that it’s the seller’s side that leads the dance; if there is a large enough fraction of sellers accepting new payment methods, more and more buyers are prompted to use them, eventually leading to complete adoption on both sides.
In the case of Bitcoin, not many people want to dance. This is because it has serious flaws when it comes to satisfying the three main characteristics of money. While a number of merchants may be accepting Bitcoin, there is still a big risk that if you acquire bitcoins you won’t be able to find someone to accept them later when you want to spend them.
There’s also no getting around the fact that cryptocurrencies are very volatile and therefore unreliable as a store of value. Bitcoin’s value relative to the U.S. dollar has gone from pennies to over $1,100 and then back down to $300 in just four years. It is not surprising then that Bitcoin and other cryptocurrencies are not acting as a unit of account. Businesses are still pricing products in national currencies and converting to a cryptocurrency at the checkout.
For these reasons, the Bank of Canada views Bitcoin and other cryptocurrencies as investment products rather than money.8 And we are not alone. The Canada Revenue Agency considers digital currencies as a commodity that can be bought and sold. That is why any resulting gains or losses could be taxable income that must be reported.9
Bank of Canada Has Its Eye on Developments
E-money is not big enough to pose material risk to financial stability in Canada at this time. That said, money and payments technology is progressing in leaps and bounds, and so the Bank of Canada is watching developments closely. The federal government also is undertaking a review of payment systems in Canada to ensure that the degree of regulation of payment systems and methods is appropriate. This review has resulted in the Bank of Canada having increased responsibility to oversee payment systems of economic and systemic importance.There is little doubt that these innovations have some benefits. They give us more choice about how we make purchases, and can reduce the cost of certain transactions. Think about online purchases of pictures or songs. The transaction costs of traditional payment methods, such as credit cards, make these small-value purchases expensive. A $1 transaction could be done for no fee using Bitcoin while it could cost over 30 cents in fees using some merchant credit cards. E-money is also useful for sending money across borders. Traditional financial institutions offer these services, called remittances, but the fees can be as much as 10-12 per cent for small transactions. So, e-money has some benefits in certain economies, especially when cash is not a viable option.10
Those who use cryptocurrencies may also like the privacy they offer. These transactions require little or no exchange of personal information. However, people often overestimate how anonymous Bitcoin really is. It is not as anonymous as cash, and all Bitcoin transactions are public in the open source ledger, and so they can be linked to a specific IP address.11 This means that the user could be identified eventually.
There are risks to using e-money. People need to be aware of the risk of putting their trust in an e-money scheme that is lightly regulated with limited or no user protection. For example, debit cards are linked to deposit accounts that are insured by the government and held in banks that are closely regulated. Balances stored with PayPal or other e-money providers do not have those protections. Aside from posing risk to individual users, it is also a level playing field issue for Canadian banks.
Users of cryptocurrencies are even more vulnerable. While cryptocurrencies do not require a trusted third party to authenticate and validate transactions, they still require users to put their trust in numerous private businesses, such as exchanges and Bitcoin wallets. This leaves them exposed to theft, fraud and loss. The biggest example is the failure of Mt. Gox, which resulted in hundreds of millions of dollars in losses. And while these problems could happen with other forms of e-money, cryptocurrencies offer little recourse because the legal status of the players is still quite ambiguous.
The list of issues doesn’t end there. Crypotocurrencies can be used for money laundering, terrorist financing, and other criminal activities.12 That is why governments around the world are building a new legal framework for cryptocurrencies.
For example, Canada has introduced legislation to require cryptocurrency exchanges to register and to report suspicious transactions that may be linked to money laundering and terrorist financing. Regulators in the state of New York are proposing to issue a “BitLicense” to protect consumers, prevent money laundering and enforce cyber security. Some countries, like China, have ruled that financial institutions cannot handle any Bitcoin transactions.
If e-money were to gain widespread acceptance in an economy, there would be implications for the central bank. The Bank of Canada earns money by issuing currency. This profit is called seigniorage. The bank notes that we issue cost very little to print, and we invest the balance of their value in Government of Canada securities that earn interest. With this profit, the Bank can fully fund its operations and still remit a surplus to the federal treasury that amounts to about $1 billion each year.
But it’s not just about seigniorage. Some people have wondered whether widespread use of e-money could impair the ability of the central bank to conduct monetary policy. This is very unlikely because Canadian interest rates would still matter.13 Whether they use e-money or cash, as long as people and businesses pay bills and borrow in Canadian dollars, the Bank of Canada would still be able to achieve its monetary policy objective. When it comes to cryptocurrencies, however, the situation is different. In the unlikely situation in which cryptocurrencies were used broadly, a significant proportion of economic transactions would not be denominated in Canadian dollars. This would reduce the Bank’s ability to influence macroeconomic activity through Canadian interest rates. Let me be clear, we are nowhere near this point today. But if we were, it would be even more important to determine whether issuing e-money is a role that should be done by the central bank.
If e-money denominated in Canadian dollars were to significantly replace bank notes, there are some options that the central bank could take so as to be in a position to intervene in markets or be the lender of last resort.
Another important issue is the potential for e-money to fundamentally change the financial architecture in ways that we don’t yet understand but that could pose risks to financial stability. Think about a crash in a cryptocurrency as an example. If the cryptocurrency were widely-used, the economic and financial implications of such a crash would be significant because they would result in a dramatic reduction in household wealth.
A crash or failure of one type of e-money can be a concern even if the e-money is not widely used. This is because the failure of one issuer could result in a loss of confidence in other issuers and in the payments system more generally. That is why the Bank of Canada sees risks to the economy in a structure that would allow the benefits of money issuance to accrue to the private sector while any losses would be borne by the government and taxpayers. Let’s remember, these issuers are getting the equivalent of seigniorage but have limited or no oversight at this time.
The history I mentioned earlier also gives us an important lesson. period that we refer to as the “free banking era” in the United States - when private banks were issuing bank notes and trying to ensure their value. The notes of some banks faced steep discounts, outright runs and there were a string of crises in the banking system.
These crises prompted governments to step in to insure bank notes issued by private banks. It ushered in the national banking era with a lot of regulation, supervision and government intervention. It came as no surprise then, that central banks were eventually given the sole responsibility for issuing bank notes.
Conclusion
Money and means of payment have come a long way since then. E-money and the technology that enables it are circumventing our old models of payment and fast creating new efficiencies and new risks. This matters because it affects the risks faced by people who use e-money and it has the potential to affect risks to the Canadian financial system as a whole. That is why the federal government, with the Bank’s help, is modernizing our oversight frameworks for payments. The Bank is also undertaking research on the potential merits of issuing e-money.Individuals need to be aware of the risks of using e-money that is not subject to minimum oversight and consumer protection standards. We also need to be aware that cryptocurrencies can be used for money laundering and terrorist financing, which is why governments around the world, including Canada, are finding ways to monitor their use.
Money and payments are at the core of central banking. The Bank of Canada is working through the tough issues today so that we can support the benefits of innovation, while safeguarding the integrity of Canada’s money and payment systems and, ultimately, financial stability.
XXX . V0 Electronic Cash (E-cash)
An anonymous electronic cash system; equivalent to "cash" or "printed bank notes" except that it is transferred through networks with bits of information, in essence it is just another representation of monetary value; anonymity is preserved through public key cryptography, digital signatures, and blind signatures.
How it is used:
Ecash is used over the Internet, email, or personal computer to other workstations in the form of secured payments of "cash" that is virtually untraceable to the user. It is backed by real currency from real banks. The way ecash works is similar to that of electronic fund transfers done between banks. The user first must have an ecash software program and an ecash bank account from which ecash can be withdrawn or deposited. The user withdraws the ecash from the account onto her computer and spends it in the Internet without being traced or having personal information available to other parties that are involved in the process. The recipients of the ecash send the money to their bank account as with depositing "real" cash. Other than making purchases on the Internet, ecash can also be found used in entertainment sites - on "gambling tables" in Internet casinos such as PAF Casino and Internet Casino. Ecash allows the exchange of money to be conducted in the same way as in real casinos.Relevance to business and electronic commerce:
Even though there are more than 25,000 companies conducting business on the Internet, consumers are still not that confident with having transaction done over the Internet. This is mostly due to a lack of a readily available and secure payment system. With credit cards, consumers are concerned with the security of their information and thus deterring them from directly making purchases from the Internet. With ecash, hopefully consumers will be more comfortable with transactions over the Internet as it is a one-time transaction that cannot be traced back to the user, whereas with credit cards, hackers can obtain information of the card holder and commit frauds. With the appearance of ecash, the need for commercial banks to be involved in electronic banking and to back the electronic currencies becomes more apparent. However, there remains a skeptical view about having monetary transactions done over the Internet as it is a fairly public domain where there is easy access. Thus increasing and promoting commercial bank's interest in the Internet and conducting business over the Internet is necessary in order to further the development of ecash and commerce in the Internet, as well as improving cryptography and security features of the systems. While it is a grand idea to mimic the real world transactions with cash on the Internet through the use of an anonymous transaction system, at this moment it still poses a lot of logistics and legal problems and possible security hazards. There are still questions of the regulation of electronic money, how will the ecash be backed and redeemed, determining how much of money in the economy are circulated in ecash since the Internet covers such a vast area internationally. Moreover, with Internet business companies, how will taxes be applied to them when they conduct business all over the world? Ecash is not completely anonymous as with hard cash since there is always the computer and the network, which can be traced. But do people really care about anonymity? Some people may want to track expenses if they're conducting businesses through the Internet. Also, there is the issue of possible criminal activity within the system by allowing criminals to spend illegal money easier if ecash is untraceableIt is a global trend. It’s a global trend in the sense the Central Banks around the world .
We have been trying for a number of years to shift the economies or convert the economies away from using physical cash in transactions and using paper in transactions to electronic payments. For example, several European monetary authorities, Central Banks have carried out a series of local experiments in reducing the circulation of coins in recent months and years. Irish Central Bank recently did an experiment eliminating from local circulation in one of the towns one of the banknotes as well. Central Banks have actively lobbied the governments also with the recent Chairs to increase duties and taxes on checks and other non-electronic payments.
So there is a number of official reasons for it and there is a number of unofficial reasons for why they want to do it. The official rational for this is that electronic payments are much cheaper than the physical transactions. And also there is an obvious reason for this, which is also officially acknowledged, that electronic payments are perfectly traceable. In other words, they usually say that it helps to combat terrorism financing, money laundering and tax evasion. But it also helps to combat the black market, for example, which is quite rampant in Europe, across the EU overall. In reality nobody knows how it will work all in practice simply because we are all familiar with the fact that we do use electronic payments, we use the credit cards, online payment systems and the increasingly use of dollars means as well. But at the same time we are still reliant on cash in operations, day-to-day shopping - we are still doing it in cash. We also rely on cash as a fullback in case of security breakdown in terms of electronic payments, such as for example, theft of data or technological glitches. We also believe that in cash [there] is the disembodied nature of money. It’s easier to store value in disembodied cash, we are much safer in holding that cash rather that in giving this cash electronically to somebody else to store for us.
One of the big issues that came during the global financial crisis is the issue of the bailouts, when the banks are failing electronic money can be taken away and repossessed as happened in the case of the deposits in Cyprus. Physical money can’t be as easily repossessed as a result of that.
Cashing out: ‘Electronic payments taking over, banks to abandon paper money soon’
in the past a stray computer scientist talking of a technology that appeared more rooted in science fiction than high finance. Today, still bearded, but wearing a well-tailored suit, he stands in the thick of a movement that seems unstoppable - the digitization of money. His passion now is to explain that the change need not be oppressive. He travels among bankers and financiers, he runs a company, he proselytizes. And he hopes somebody listens, because the wild card in the era of digital money is anonymity .
case study :
__ Dollar Bills or Bill Dollars__
The next great leap of the digital age is, quite literally, going to hit you in the wallet. Those dollar bills you fold up and stash away are headed, with inexorable certainty, toward cryptographically sealed digital streams, stored on a microchip-loaded "smart card" (a plastic card with a microchip), a palm-sized "electronic wallet" (a calculator-sized reader and loader for those cards), or the hard disk of your computer, wired for buying sprees at the virtual mall.
Of course, real money - the trillions of dollars handled each day by banks, other financial institutions, and government clearinghouses - is already digital. No physical tokens are exchanged: all transactions are conducted using streams of bits. But digitizing the final mile of electronic money, where the coin and dollar bill go the way of the vinyl LP, will make all the difference in the world. It will not only change the physical way you spend your money, it will alter the way you view your own economic being. And depending on the manner in which it is implemented, digital money might allow others to view your financial status with a decidedly discomfiting intimacy.
Is e-money really going to happen? Inevitably. Hard currency has been a useful item for a few millennia or so, but now it has simply worn out its welcome. A recent paper by several cryptographers at the Department of Energy's Sandia National Labs in Albuquerque, New Mexico, begins by enumerating what all e-money advocates identify as the fatal flaws of cold hard cash: "The advent of high-quality color copiers threatens the security of paper money. The demands of guarding it make paper money expensive. The hassles of handling it (such as vending machines) make paper money undesirable. The use of credit cards and ATM cards is becoming increasingly popular, but those systems lack adequate privacy or security against fraud, resulting in a demand for efficient electronic-money systems to prevent fraud and also to protect user privacy."
"Cash is a nightmare," says Donald Gleason, president of the Smart Card Enterprise unit of Electronic Payment Services Inc. "It costs money handlers in the US alone approximately US$60 billion a year to move the stuff, a line item ripe for drastic pruning. The solution is to cram our currency in burn bags and strike some matches. This won't happen all at once, and paper money will probably never go away (hey, they couldn't even get rid of the penny), but bills and coinage will increasingly be replaced by some sort of electronic equivalent."
The coming of e-money would seem to demand that the governments of the world get together and implement a scheme to make the shift in an orderly fashion. But that's not happening. The US, in particular, is promulgating public cluelessness. When I called a spokesperson for the Federal Reserve to ask about electronic cash, he laughed at me. It was as if I were inquiring about exchange rates with UFOs. I insisted he look into it, and he finally called me several days later with the official word: the Federal Reserve is doing nothing in that area.
Outside the Fed, there are people in government interested in the issue - isolated visionaries in the Department of the Treasury and Congress, in the Office of Technology Assessment - but while they ponder it, plenty of other institutions are devising schemes that will knock our currency preconceptions for a loop. The timetables are short, and as the players look around and see what their potential competitors are doing, those timetables get even shorter, particularly in the race to be first to deliver a plan that offers transactions on computer nets.
For starters, there is CyberCash Inc., sort of an all-star team of pre-digital cash technologies. Headed by Bill Melton, the creator of the Verifone system that handles credit-card transactions between merchants and banks, the principals include Jim Bidzos, president of the cryptography provider, RSA Data Security Inc., Steve Crocker, vice president of Trusted Information Systems Inc. (another prominent crypto-firm), and Dan Lynch is chair and founder of Interop Co. (which produces the largest Internet trade show worldwide). "We will provide cyberspace with financial communications that will be safe and secure and convenient," says Bruce Wilson, CyberCash's chief operating officer. In the first quarter of 1995, CyberCash will offer a network equivalent of debit-card transactions, then expand to credit cards. The next step: cash-like components that support peer-to-peer payments.
Visa has gathered a consortium of financial institutions to design "Electronic Purse," specifications for low-cost purchases at gas stations, convenience stores, grocery stores, fast-food restaurants, and school cafeterias, in addition to such routine items like calls from pay phones, road and bridge tolls, and videogames.
Citibank has been running a prepaid card test in a Long Island facility. There is the aforementioned Smart Card Enterprise of the Electronic Payment Services company, which wants to piggyback spending money on its network of ATMs.
There is the NetCheque project, a debit-card system, developed by the Information Sciences Institute at the University of Southern California. And there is the Information Networking Institute, part of Carnegie Mellon University, whose NetBill is also based on the debit-card model.
Many transit companies envision fare tickets as coinage to buy newspapers and sundries. The phone companies issue phone cards with similar pretensions.
In Denmark, Danmont has distributed over 100,000 cards with money for spending on such things as parking meters and laundromats. Similar systems exist in Portugal and Singapore.
Mondex, a consortium led by two British banks, will roll out its digital-cash system, involving an estimated 40,000 cardholders, to the public in Swindon, England, next year. Its creators envision the system spreading worldwide, as people slip their smart cards into special phones and wallets to conduct cash-like, tamper-proof transactions, even across borders. "It will become ubiquitous - it's the cheapest way of moving money around," says Dave Birch, spokesperson for the project's consultants, Hyperion. "There's the state of Ohio which has in the works a smart-card system for replacing welfare checks with electric money. At Mankato State University in Mankato, Minnesota, students are issued "MavCards," to be used not just for MCI long-distance calls and dining-hall meals but for cash services like photocopying, vending, and laundry.
Finally and inevitably there's Microsoft. For months, it had been quietly organizing a digital money group, presumably to put its own stamp on the emerging phenomena of digital transactions. But things went into overdrive in October, when it laid out $1.5 billion worth of stock to snatch up Intuit, Inc. a financial software company which was determinately moving towards automating money. Along with the buyout, Scott Cook, Intuit's president, became Microsoft's executive vice president of electronic commerce - reporting directly to chairman Gates, begging the question, will dollar bills be replaced by Bill dollars?
As a result of this mad rush, the road to digital cash is not so much a smooth transitional path but a multi-lane cloverleaf with infuriating turnoffs, circles, and dead ends. "A lot of people assume there's going to be a single form of digital money," says Microsoft's chief technical wizard, Nathan Myhrvold. "Today we have a zillion different ways of doing financial transactions. There's cash, checks, credit cards, debit cards, wiring money, traveler's checks ... each of these has a particular point. We're going to see that much diversity in digital money."
Kawika Daguio, a Washington, DC, representative for the American Bankers Association, is familiar with the issue and says, "We may be in a situation analogous to the 1860s - in those days, before our current Federal Reserve system, bank checks backed by different institutions weren't as widely accepted - they circulated and were usually discounted. Chartered banks also printed private-bank notes. Now, we see that some institutions are interested in printing their own versions of electronic money and following their own rules."
Sholom Rosen, a vice president at Citibank, puts it more succinctly: "There are going to be winners and losers, but everybody is going to play." Michael Nash, Visa's senior vice president in charge of the cash-products division, recalls the excitement among executives last June when they witnessed a test of the credit-card consortium's smart-card experiment at a retreat in Cancun, Mexico: "We had senior banking executives lining 70-deep to try this out!"
Considering all these schemes in the aggregate, it is possible to envision the way money will work in the future. But we must distinguish between forms of electronic commerce - including credit cards and bill paying - and electronic cash, in which money is in a fungible, universally accepted, securely backed format and can be passed, peer to peer, through many parties while retaining its value. You know, money.
First of all, imagine that all the uses of credit cards and debit cards are seamlessly integrated into electronic format. Now start to think about real money. Cash will reside in credit-card-sized plastic smart cards which can be stored in palm-sized "electronic wallets." The days of nervously accessing the ATM machine at 2 a.m., looking over your shoulder for muggers, are over. You'll download money from the safety of your electronic cottage. You will use these cards in telephones (including those in the home), as well as electronic wallets, disgorging them whenever you spend money, checking the cards on the spot to confirm that the merchant took only the amount you planned to spend. The sum will be automatically debited from your stash into the merchant's. Cash will be a number, a digitized certificate you'll probably never see.
Commerce on the Net will reproduce the process in cyberspace: you will download money from your bank, put it in a virtual wallet, and spend it online. You will also be able to receive money from your employer, someone who buys something from you, or a friendly soul who lends you a virtual sawbuck until payday.
Exactly what goes on inside smart cards, wallets, and computers won't be apparent. But the protocols chosen by the lords of e-money are all-important. Depending on how they work, the various systems of electronic money will prove to be boons or disasters, bastions of individual privacy or violators of individual freedom. At the worst, a faulty or crackable system of electronic money could lead to an economic Chernobyl. Imagine the dark side: cryptocash hackers who figure out how to spoof an e-money system. A desktop mint! The resulting flood of bad digits would make the hyperinflationary Weimar Republic - where people carted wheelbarrows full of marks to pay for groceries - look like a stable monetary system.
A privately circulated paper written by Kawika Daguio sketches out some of the problems in the form of questions:
*Who is going to create the monetary value? *
In other words, who will back up the money, assuring trust. Will it be government? Banks? Visa? The New York City Transit Authority?
"A dollar bill is a piece of paper - what's the difference between that and another piece of paper?" asks Sholom Rosen of Citibank. "It is the ability to present that piece of paper and get assurance of a return. It's not backed. There was a time when it was backed, but those times are gone. What gives it value? The banking system. The paper is the liability of the banking system. The supply of money is grown and disappears in the banking system."
Yet others seem to think that, if universally trusted, a digital currency system can, in effect, float on its own momentum. "If you have money on the network, you can make private money on the network," says Eric Hughes, a co-founder of the privacy champions, the Cypherpunks. He is now exploring the possibility of setting up a cyberspace bank. "It's easiest not to turn the money into paper if you don't have to."
*What security features will be included? *
How will these systems protect against fraud? Can they be hacked or counterfeited? What will be the trade-offs between ease-of-use and security?
"People get sticky fingers," says Rosen. "The most honest guy in the world will find some cash and stick it in his pocket. When outsiders hear about digital-cash schemes, the first thing they say is, 'I'm going to break in.' "
Of course, smart cards have to be tamper-proof so people can't reverse engineer them and double-spend. The prime protection is cryptography. "The bits in a container have to move from one to the other," explains Rosen. "When you're done, you have to have less in one container and more in the other. Also, your transaction can't be intercepted. Crypto can secure the transition. How strong the crypto is depends on who's going to try to break in - if it's the Mafia or a national government, they'll have plenty of resources."
David Chaum thinks, for instance, that some canny dark-side entrepreneurs can crack the Mondex system now being tested in England. Though its mathematical protocols are strong, he says, too much depends on the tamper-proofing of the cards. "One device can say, 'OK, I'm transferring $100,000 to you,' and the other one says, 'Oh, fine, I believe you.' So if you break either one of those open (defeating the tamper-proof technology) and tell it you've got a zillion dollars, the whole system just dies." (Mondex insists its scheme cannot be cracked, but will not provide further details. "Suffice it to say we're betting the shop on it," says Dave Birch.)
*Will they work so the value will be restored if they're lost? *
Everybody seems to agree that smart cards holding digital cash should provide an option to punch in a Personal Identification Number before buying something; but there is also a consensus that most people won't use that option. "The consumer won't bother with that," says Visa's Michael Nash. "The key here is that we imagine this as expanding what you do with credit cards. We do not think the electronic purse is appropriate for people buying jewelry or automobiles." In many systems - Mondex is a good example - losing your stored-value smart card is like losing a wad of bills. Don't carry more than you can afford to lose.
Who's going to regulate electronic money?
At the moment, all the players are proceeding as if no one is. They extrapolate a regulatory system growing out of the current one, while they are aware that as the digital economy becomes pervasive there may be calls for new limits and regulation. As for now, the rush is to get everything in place, and no traffic cops seem to be slowing anybody down.
Who's going to pay for it?
"I don't believe that it's sound policy to charge somebody royalties for engaging in the virtual world's equivalent of putting your hand in your pocket, pulling out a bill, and handing it to somebody," says Kawika Daguio. He is particularly perturbed by the claims of Online Resources & Communications Corporation, a company in Virginia that insists that it holds a patent (US # 5,220,501) giving it "exclusive rights to process real-time electronic transactions of consumers who use any in-home terminal to purchase goods and services, pay bills, and bank through a debit network, including the automated teller machine networks." Online Resources further claims that "the patent covers all in-home terminals, including telephones, computers." (The patent may be challenged by banks and ATM processors.)
On the other hand, Microsoft's Myhrvold, perhaps anticipating a licensing revenue that would make DOS look like a drop in the bucket, challenges Daguio's assertion, claiming that we already pay the equivalent of such a fee. "Of course you do," he says. "Explicitly or implicitly there's a fee involved. Even in a pure-cash transaction, you pay for those costs. Cash is an expensive thing to move around. You have to hire guards from Brinks with guns and all that bullshit. That's all included in the price of things you buy."
The bottom line is that nothing is free, especially when it comes to money. You will pay for e-money, either in transaction fees or, as in the CyberCash model, by allowing others to earn interest on your electronic cash - even as it sits in your virtual wallet.
In short, the various systems have implicitly or explicitly postulated tentative answers to some of these questions, and the answers to others, such as the regulatory structure, will have to evolve as the idea catches on. But one question remains open: the dichotomy between privacy and traceability.
Hard cash, of course, is anonymous - you can spend your printed bills with the assurance that no one can trace your expenditures or compile a dossier on your lifetime spending records. But electronic cash has no such assurances. Its computer-mediated nature makes traceability the course of least resistance. This gives rise to a provocative question: Can digital cash become anonymous, as real-world money is? And if so, should it be?
And these questions lead us back to Amsterdam - headquarters of DigiCash, the company formed by David Chaum.
__ Digital Money Man__
In the world of digital cash, David Chaum is the marked penny that keeps reappearing. His ideas circulate as freely as cash itself. He is indisputably the pioneer of the field, the one who shifted it from the ether of science fiction to the solid footing of mathematical truth. But the man himself is the center of controversy. All of those involved in the daring attempt to shred dollar bills into arcane mathematical formulae know of Chaum, and almost all admire his work. But when they talk of their dealings with him, they immediately go off the record. It turns out that at one point they considered licensing Chaum's patents or at least recruiting Chaum's participation in their projects. These processes seemed to end in fruitless standoffs, sometimes acrimonious ones. Then, inevitably, more negotiations. Chaum cannot be ignored even by those who disparage him off the record.
Why are all these people so worked up about David Chaum?
I get a hint the day after my ride with Chaum through Amsterdam. We have made plans to meet at a coffeehouse off the Keizersgracht.
Our plan is to spend the entire day talking about digital money and his work. But before the tape recorder goes on, Chaum takes pains to make one thing clear to me: he is not, as some people derisively call him, some sort of privacy nut. He is by no means a paranoiac, but merely someone who has made some remarkable discoveries that people should know about before they make irrevocable choices about the traceability of their finances.
Fine, I say, and begin the interview. Tape recorder on. "How old are you?" I ask. "I don't tell that to people," he says.
At heart, David Chaum is driven by ideals. Indisputably the brains behind making digital cash work, he holds the key patents in the field, particularly in the area of anonymous, untraceable cash. He is therefore in a position to become a very rich and powerful person. Yet he avoids the path of least resistance and largest revenues - cashing in by licensing his schemes - because he is passionate about the potential of anonymous cash and wants the news of its viability spread far and wide.
He says that if, after knowing that the possibility of private, digital-monetary transactions exists, people opt to spend their money with the same traceability as credit cards, he will accept the decision. But he doesn't think that will happen. His guess is that once people are aware of the issues, they will agree that traceable routes are the evil of all money.
From a very early age, David Chaum had an interest in the hardware of privacy. "What's important to realize is that there is a strong driving force for me," he says. "My interest in computer security and encryption came from my fascination with security technologies in general - things like locks and burglar alarms and safes," he says. (As a graduate student, he devised two new designs for locks and came close to selling both to major manufacturers.) And, of course, he was very much fascinated with computers. In high school and college, he did typical hacker sorts of things: password cracking, dumpster diving, and such. But he was also picking up some serious background in mathematics. And late in his college career, he came to cryptography, a discovery that in retrospect seems inevitable.
Chaum's first major papers, published in 1979 when he was a graduate student at the University of California at Berkeley, are indicative of his strong focus in his work: devising cryptographic means of assuring privacy. His ideas build upon the concept of public-key cryptography, the technique devised by Whitfield Diffie and Martin Hellman in the mid-'70s that established cryptography as a mass technology. Specifically what excited Chaum was the use of digital signatures - a way of establishing the authenticity of a message sender. "I got interested in those particular techniques because I wanted to make [anonymous] voting protocols," he says. "Then I realized that you could use them more generally as sort of untraceable communication protocols." The trail led to anonymous, untraceable digital cash.
__ Dining with the Cryptographer__
For Chaum, the politics and the technology reinforce each other. He believes that as far as privacy is concerned, society stands at a crossroads. Proceeding in our current direction, we will arrive at a place where Orwell's worst prophecies are fulfilled. He delineated the problem in an essay called "Numbers Can Be a Better Form of Cash Than Paper." "We are fast approaching a moment of crucial and perhaps irreversible decision, not merely between two kinds of technological systems, but between two kinds of society," says the article, published in 1991. "Current developments in applying technology are rendering hollow both the remaining safeguards on privacy and the right to access and correct personal data. If these developments continue, their enormous surveillance potential will leave individuals' lives vulnerable to an unprecedented concentration of scrutiny and authority."
In the early 1980s, Chaum conducted a quest for the seemingly impossible answer to a problem that many people didn't consider problematic in the first place: how can the domain of electronic life be extended without further compromising our privacy? Or - more daring - can we do this and increase privacy?
In the process, he figured out how cryptography could produce an electronic version of the dollar bill.
In order to appreciate this, you have to consider the apparent obstacles to such a task. The most immediate concern of anyone attempting to produce a digital form of currency is copying. As anyone who has copied a program from a disk to a hard drive knows, it is totally trivial to produce an exact duplicate of anything in the digital medium. What's to stop me from taking my one Digi-Buck and making a million, or a billion, copies? If I can do this, my laptop, and every other computer, becomes a mint, and infinite hyperinflation makes this form of currency worthless.
The answer to the problem of digital duplication lies in using digital signatures to verify the authenticity of bills. Only one serial number would be assigned to a given "bill" - the number itself would be the bill - and when the unique number was presented to a merchant or a bank, it could be scanned to see if the virtual bill was authentic and had not been previously spent. This would be fairly easy to do if every electronic unit of currency was traced through the system at every point - but that would bring about exactly the kind of surveillance nightmare that gives Chaum the chills. How could you do this and unconditionally protect one's anonymity?
Chaum began his solution by coming up with something called a "blind signature," a process by which a bank, or any other authorizing agency, can authenticate a number so that it can act as a unit of currency - yet the bank itself does not know who has the bill, and therefore cannot trace it. This way, when the bank issues you a stream of numbers designed to be accepted as cash, you have a way of changing the numbers while maintaining the bank's imprimatur.
One of Chaum's most dramatic break-throughs occurred when he managed to come up with a proof - though for a different application - that this sort of anonymity could be provided unconditionally, with all the assurance of mathematical proof that no one could violate it. The idea came when he was driving his Volkswagen van from Berkeley to his home in Santa Barbara, where he taught computer science at the University of California in the early '80s. "I was just turning this idea over and over in my head, and I went through all kinds of solutions. I kept riding through it, and finally by the time I got there I knew exactly how to do it in an elegant way."
He presented his theory with a vivid example: a scenario of three cryptographers awaiting the check after finishing their meal at a restaurant. The waiter appears. Your dinner, he tells the cryptographers, has been prepaid. The question is, by whom? Has one of the diners decided to anonymously treat his colleagues - or has the National Security Agency paid for the meal? The dilemma was whether this information could be gleaned without compromising the anonymity of the cryptographer who might have paid for the dinner.
The answer was fairly simple. It involved coin tosses hidden from certain parties. For example, A and B could flip a quarter behind a menu so C couldn't see it - and then each write down the result and pass it to him. The key stipulation would be that if one of them was the culprit who paid for the meal, that person would write down the opposite result of the coin toss. Thus if C received contradictory reports of the coin toss - one heads, one tails - he would know that one of his fellow diners paid for the meal. But without further collusion, he would have no way of knowing which one. By a collection of coin tosses and combined messages, any number of diners could play this game. The idea could scale to a currency system.
"It was really important, because it meant that untraceability could be unconditional," he says. Meaning mathematically bulletproof. "It doesn't matter how much computer power the NSA has to break codes - they can't figure it out, and you can prove that."
Chaum's subsequent work, as well as the patents he successfully applied for, continued to build upon those ideas, addressing problems like preventing double-spending while preserving anonymity. In a particularly clever mathematical twist, he came up with a scheme whereby one's anonymity would always be preserved, with a single exception: when someone attempted to double-spend a unit that he or she had already spent somewhere else. At that point the second bit of information would allow a trace to be revealed. In other words, only cheaters would be identified - indeed, they would be providing evidence to law enforcement of their attempt to commit fraud.
This was exciting work, but Chaum received little encouragement for pursuing it. "For many years, it was very difficult for me to have to work on this sort of subject within the field, because people were not at all receptive to it," Chaum says. For several years in the early 1980s, Chaum attempted to personally contact the leading lights in privacy policy and share his ideas with them.
"The uniform reaction was negative," he says. "And I couldn't understand this. It made it all the harder for me to keep pushing on this, because my academic advisors were saying, 'Oh, that's political, that's social - you're out of line.' Even the department head at Berkeley said, 'Don't work on this, because you can never tell the effects of a new idea on society.' I acknowledged him in my dissertation, saying it was the rethinking and finally the rejection of this principle that caused me to do this work."
Eventually, Chaum decided that the best way to spread the ideas would be to start his own company. By then he was living in Amsterdam. On a visit with his Dutch girlfriend, he had fortuitously met up with some academics at CWI, Centrum voor Wiskunde en Informatica, the nationally funded Dutch Center for Mathematics and Computer Science in Amsterdam, where he subsequently formed the cryptography research group. So, in 1990, he launched DigiCash b.v., a subsidiary of the US company DigiCash Inc., with his own capital and a contract from the Dutch government to build and test technology to support anonymous toll payments on highways. Chaum developed a prototype by which smart cards holding a certain amount of verified cash value could be slipped into a gadget affixed to the windshield, and high-speed scanning devices would subtract the tolls as the cars whizzed by. The cards could also be used to pay for public transportation and eventually other items. Of course, the payments would be anonymous. After completing that contract (the system has not yet been implemented), Chaum kept his company active in smart-card applications; some of the projects focused on cash systems that would be used in a building or complex of buildings. The DigiCash headquarters, along with several businesses and agencies around the Netherlands, use the system currently. But to date, the company's operations have been relatively small-scale, even as the world has now come around to seeing the significance of the ideas Chaum hatched in isolation. DigiCash remains independent, without a close alliance with a large partner in banking or financial services. Chaum feels that in time such partners, at least licensees of DigiCash technology, will emerge; if so, his paradigm will be a crucial factor in maintaining privacy in the age of e-money. This is an idea Chaum believes is worth holding out for.
Some people interpret this as stubbornness, or at the least poor business practice. "People wanted to buy David's patents but he asked for too much - he wanted control," says a former DigiCash employee. "The real problem is that privacy isn't what the banks want, it isn't what the stores want. They want something easy to use, fast, and very cheap." (Still, this source guesses that Chaum "has hung on for so long that he will probably succeed.")
Frustrated by not being able to use Chaum's patents, some companies have devised their own schemes for anonymity, which may or may not infringe on Chaum's. More recently, Stefan Brands, formerly at CWI, has come up with an alternative scheme that has drawn considerable interest. Brands contends the system absolutely does not infringe Chaum's patents; Chaum's carefully worded response is, "He's not convinced me that it doesn't."
The topic of patents is touchy; Chaum bridles at any talk that equates him with the robber-baron set. In his mind, the revenues are secondary to the potential effect on society. "It's my mission to do this, because I had this vision that stuff like this might be possible, and felt it was my responsibility to do it. No one was working on this for the good half-dozen years I was; they all thought I was nuts. They gave me a hard time. We couldn't license, really, without the patents; the whole purpose of them is to get this stuff out there."
__ Hidden Values__
Does anonymity really matter when it comes to electronic money? Some people dismiss its significance - or argue that anonymity is a bad thing.
"Speaking for myself, it would be dangerous and unsound public policy to allow fully untraceable, unlimited value digital currency to be produced," says Kawika Daguio of the American Bankers Association. "It opens up opportunities for abuse that aren't available to criminals now. In the physical world, money is bulky. In the physical world, it is possible to follow people, so a kidnapper can potentially be caught if the currency is marked, if the money was being observed on location, or if the serial numbers were recorded. Fully anonymous cash might allow opportunities for counterfeiting and fraud."
Nathan Myhrvold of Microsoft concurs. "There's a role for untraceable transactions. But it's not a panacea. Some people get very worked up about it. But there's been a very steady trend away from untraceable cash. There are cases where explicit traceability is a good thing. Like in my business expenses. I want them to trace it! All these things are there for a reason. They're not there as part of a plan by nefarious Big Brother. Look, I understand Chaum's concern to a certain degree. There's a lot of concern for privacy today. But I do worry about the idea of saving people from themselves. Just because I sign up for a traceable form of money doesn't mean I want my next-door neighbor to see my transactions."
Chaum says he has never argued for total untraceability, but sort of a constrained anonymity. "My work has been trying to establish a whole space of possibilities, bounded by pure perfect anonymity on one side and a perfect identification on the other side."
Chaum is not the only person working this turf: building on his ideas, researchers at Sandia Labs have been working on a scheme that attempts to balance anonymity with law enforcement's need to trace criminal transactions. Sort of an anonymous, digital-cash Clipper Chip. "I was concerned about some of the effects electronic cash could have on criminal activity," says Ernie Brickell, a Sandia cryptographer. "It could make it very easy for people to undertake kidnappings and extortion. It might be possible for a person to do a kidnapping and ask for money to be exchanged in a way in which there was no physical exchange - you would have no idea what country the person was in. There was also the potential that new types of criminal activity would emerge. So we looked at whether it would be possible to develop electronic cash schemes in which people could have much of the privacy that Chaum talks about, but with hooks in it, so that if law enforcement had the need to look into a transaction, it could."
Yet it is not at all clear that even this sort of limited anonymity will gain, er, currency. Users of electronic cash - the general public - will probably never be polled on whether they prefer it to be anonymous. Brickell admits that anonymity will be a hard sell. "There's going to be so much information about individuals floating around, that we want to protect privacy as much as we can," he says. "But some of the bankers feel that an anonymous system is never going to make it, or even be something that they can get behind." In fact, says Niels Ferguson, a cryptographer who works for DigiCash, "the people who decide actually often have an interest in not protecting people's privacy because they are among the potential benefactors of gathering the information."
But what of the Nathan Myhvolds, who seem to argue that they want traceability? Ferguson sighs. "Oh, the number of times I've had to argue with people that they need privacy! They'll say, 'I don't care if you know where I spend my money.' I usually tell them, 'What if I hire a private investigator to follow you around all day? Would you get mad?' And the answer always is, 'Yes, of course I would get mad.' And then my argument is, 'If we have no privacy in our transaction systems, I can see every payment - every cup of coffee you drink, every Mars bar you get, every glass of Coke you drink, every door you open, every telephone call - you make. If I can see those, I don't need a private investigator. I can just sit behind my terminal and follow you around all day.' And then people start to realize that, yes, privacy is in fact something important. Any one part of the information is probably unimportant. But the collection of the information, that is important."
Which is exactly why certain officials are licking their chops at the prospect of traceable cash. These include, of course, law-enforcement agencies, who are more than eager to see hard cash phased out. What would the drug dealers do? The money launderers? The underground economy? They will argue that granting anonymity to digital cash would provide a bonanza for kidnappers, muggers ... criminals of every stripe. But consider a world where all money is electronic and traceable, and you have the most potent crime-fighting weapon in history.
The institution with the most to gain is the Internal Revenue Service. The computer age has been very good to the IRS, which now has access to any number of databases that yield reality checks on any given citizen's tax returns. Traceable cash would accelerate this process, and the tax-collection agency can't wait to take advantage of it. In a recent speech - presented on April 15, no less! - Coleta Brueck, the project manager for the IRS's Document Processing System, described some of the IRS's plans. These include the so-called "Golden Eagle" return, in which the government automatically gathers all relevant aspects of a person's finances, sorts them into appropriate categories and then tallies the tax due. "One-stop service," as Brueck puts it. This information would be fed to other government agencies, as well as states and municipalities, which would draw upon it for their own purposes. She vows "absolutely" that this will happen, assuming that Americans will be grateful to be relieved of the burden of filing any taxes. The government will simply take its due.
"If I know what you've made during the year, if I know what your withholding is, if I know what your spending pattern is, I should be able to generate for you a tax return," she says. "I am an excellent advocate of return-free filing. We know everything about you that we need to know. Your employer tells us everything about you that we need to know. Your activity records on your credit cards tell us everything about you that we need to know. Through interface with Social Security, with the DMV, with your banking institutions, we really have a lot of information, so why ... at the end of the year or on April 15, do we ask the Post Office to encumber itself with massive numbers of people out there, with picking up pieces of paper that you are required to file? ... I don't know why. We could literally file a return for you. This is the future we'd like to go to."
It isn't the future that David Chaum would like to go to, though, and in hopes of preventing that degree of openness in an individual's affairs, he continues doggedly in his crusade for privacy.
__ Megabucks on the Net__
Cyberspace is destined to be the first battleground of the digital money wars. While it will take years, perhaps decades, for e-money to replace hard currency in the physical world, the virtual world not only can't accommodate the current system, but is desperate for immediate implementation of the digital equivalent. Everyone agrees that the Internet is the staging ground for the first true boom in electronic commerce, but it's a transactional wasteland. You can't buy anything without a credit card. You can't even collect on a $2 bet with a friend.
It is here that the difference between electronic money and electronic cash will become most apparent. The network equivalent of some of the current forms of electronic commerce - traceable credit cards and debit cards - are already well under way. One of the prime movers in this initiative is the CommerceNet consortium, which intends to deliver an infrastructure for, among other transactions, encrypted credit-card payments through the Net. These will work exactly like regular credit-card transactions, except that the actual account numbers will be scrambled so eavesdroppers, known as packet sniffers, can't intercept them and make illegal charges. Sort of the electronic equivalent of crumpling up the carbons.
Of course, these transactions are officially traceable - "When you buy something, the seller is identified to the buyer," says Cathy Medich, executive director of CommerceNet.
While this is undoubtedly useful, the open structure of the Net begs for a more cash-like system. Why should only those businesses pre-approved as official merchants be able to sell things? Why can't people transfer money to one another? "If I owe you $25 and say, 'I'm good for it, I have a credit card in my wallet,' what can you do?" asks Bruce Wilson, chief operating officer of CyberCash. "You can't do anything. You're not a merchant. That's the situation in the online world, with virtual storefronts and countless potential entrepreneurs who can't process credit cards. There are millions of college students who want space on a server to sell things. Poets who want to sell a limerick of the day. Weather servers with satellite images. They need a cash-like methodology. For those people, anonymity is not an issue. It's simply the problem of doing peer-to-peer payments. You to me, you to a relative. That's why we have a requirement for cash. So if Wired magazine has an archive of articles on a server, and a researcher is sitting somewhere at 2 a.m. searching the Net, he can say, 'Oh, here's five articles by this expert Steven Levy.' And he can download those articles. For a dollar, a dollar-fifty, two-fifty an article. He's happy to have it!"
CyberCash, of course, is planning to offer a system that will do network cash, but is reserving judgment on the degree of anonymity it will use. "If the marketplace is looking for anonymity, our service will not be used if it is not offering it to a sufficient degree," says Bruce Wilson. "If it never becomes an issue, it will not need to be there. For our cash services, we plan a middle-of-the-road approach."
Meanwhile, there is "e-cash," offered by David Chaum's DigiCash. Anonymity is at the center of e-cash, which works with Windows, Mac, and Unix clients. I played with a beta version in Amsterdam and found it easy to use - as simple as reaching in a pocket and buying something but leaving no digital trace. This ease is indicative of all e-money schemes, really: mundane on the surface but either repressive or subversive underneath. A simple example: if Chaum's scheme could be used for downloading the thousands of documents available on the World Wide Web, then anyone could start a cottage business by selling files for low prices - say 10 cents, 25 cents apiece. (Chaum says that the cost for a transaction would eventually be infinitesimal, maybe one-tenth of a cent.) Eventually, as bandwidth increases, information in all sorts of formats - like audio and video - could be offered for cash. And no trail would follow the buyers - the sellers could not automatically stick your buying preferences on a mailing list. The government could never track your reading preferences. Or, to be honest, your lack of tax payments. Whereas in the alternative, everything might be traced.
E-cash rolled out on an experimental basis early this fall (http://www.digicash.com/). Each user, upon enrollment, gets $100 in token CyberBucks. This can be e-mailed to friends and acquaintances or spent in coins, simply by tapping a mouse.
How anticlimactic - clicking on "OK" to fork over funds! But unseen to the user, something miraculous is going on. Computer cycles are furiously crunching cryptography that represents the very best of David Chaum's dream. Secure money, accurately accounted for, unconditionally untraceable. It is a proof of concept that the future need not be one where purchases are tied to spenders.
At press time, DigiCash counted 15 businesses and organizations around the globe, including Encyclopaedia Britannica, getting ready to set up "shops" that will sell info for e-cash. Presumably, these new virtual storefronts will raise the sophistication level of the system from its initial state, which is, considering that e-cash is the vanguard of a new financial system, rather casual. Of the first few places to spend CyberBucks, one was the DigiCash store (where you could buy a reprint of a Chaum article, "Achieving Electronic Privacy," Scientific American, 1992, for $2.84 in digital cash). Another was something called Big Mac's Monty Python Archive Shop, offering homegrown transcriptions of Monty Python movies and routines for various increments of CyberBucks. A disclaimer cheerfully admitted a direct approach to the copyright question: it read, "I basically just stole these texts."
In a sense, that sophomoric admission gets to the heart of e-money. If anonymity becomes a standard in cyberspace cash systems, we have to accept its potential abuse - as in copyright violations, fraud, and money laundering. Innovative new crypto schemes have the potential for mitigating these abuses, but the fact of anonymity guarantees that some skullduggery will be easier to pull off. On the other hand, the lack of anonymity means that every move you make, and every file you take, will be traceable. That opens the door to surveillance like we've never seen.
"You have to let your readers know how important this is," Chaum tells me when discussing online anonymous cash. "The choice can only be made once." He thinks that if an economic system that tracks all transactions comes to cyberspace, the result would be much worse than the situation in the physical world. "Cyberspace doesn't have all the physical constraints," he says. "There are no walls ... it's a different, scary, weird place, and with identification it's a panopticon nightmare. Right? Everything you do could be known to anyone else, could be recorded forever. It's antithetical to the basic principle underlying the mechanisms of democracy."
David Chaum believes, as he wrote in an article in 1992, that "in one direction lies unprecedented scrutiny and control of people's lives; in the other, secure parity between individuals and organizations. The shape of society in the next century may depend on which approach predominates."
How Anonymous Electronic Money Works
Smart cards
1. Alice wants to fill her empty smart card with untraceable e-money taken from her bank. She inserts her card into an ATM-like slot in a machine at home or on the street. The gold computer chip on the card sends a random key to the bank in a digital "envelope." The bank signs the envelope with its signature, ensuring that the "money" inside can be trusted. Think of the envelope as having carbon-paper innards. The signature outside will transfer to the note inside without the bank knowing the destination of the money. The bank then sends the envelope back to Alice's smart card, which strips away the envelope,leaving a complex numerical code. Alice now has anonymous cash.
2. Alice can venture into the world and spend her e-money anyway she wants - as bus fare, at a mall store, in parking meters, or even to lend money to a friend, slipping the card into her friend's "digital wallet."
3. The recipient of anonymous e-money copies the math-money from Alice's smart-card chip and then has its computer add its own account ID number to it. This aggregate number (the money) is sent to the bank. (For added security, the bank might send an acknowledgment back to the recipient, but it's not essential.) The bank then credits the recipient - bus company, store, city, or friend - with the specific amount of money. However the bank cannot trace the money to Alice.
Network
The entire process can run on a network as well. Instead of the calculations hap-pening on a gold microchip inlaid on a credit card, the transactions take place on the motherboard chip of any computer logged on the Net.
1. Alice's computer communicates with the bank, loading up with anonymous money.
2. She can send her e-money anywhere an e-mail message can go, and just as fast - to a mail-order outfit, a bill-collection agency, her mortgage company, or some kids publishing a brash electronic magazine.
3. Recipients then e-mail the money to their bank accounts, where the amount is ready to be made into e-money again.
Both smart card and networks meld into one system. Computers' slot readers will enable them to spend money from smart cards, or fill up smart cards with money earned on the Net.
the example situation :
in the situation market may be we order a latte with soy milk – the only kind of milk that’s affordable any more after the collapse of the dairy industry. You reach into your wallet, and pull out a few bills, folded and slightly crumpled on the edges, smoothing them before you feed them into the robot barista’s money slot.
Wait. Crumpled bills? Isn’t this supposed to be the future? Nobody is going to use cash in 10 years, right?
If you take a closer look at the evidence, it’s a bit premature to predict cash’s disappearanceNot quite. It’s tempting to forecast the demise of cash. In fact, people have been predicting the end for physical money for nearly 60 years. With the rise of credit cards, contactless payments and cryptocurrencies like Bitcoin the death knells have only gotten louder. It may seem like physical money could soon be a thing of the past, but if you take a closer look at the evidence – and the intriguing psychological relationship we have developed with notes and coins – you’ll find that it’s a bit premature to predict cash’s disappearance.
In the US, cash in circulation grew 42% between 2007 and 2012 (Credit: Getty Images)
Physical money has been with us for thousands of years for a reason. Cash is essentially untraceable, it’s easy to carry, it’s widely accepted and it’s reliable. If the power goes out, or there’s a blip in the electronic systems that make the online commerce world go round, cash is there. If someone wants to buy something without anybody tracing it back to her, cash is the way to do it. If someone wants to be certain that their form of payment will be accepted, cash is the best bet. Even with advances in technology, some of the aspects of cash simply aren’t reproducible with bits just yet.
Cash is essentially untraceable, it’s easy to carry, it’s widely accepted and it’s reliableThere is simply no alternative system of payment that is as convenient, reliable and anonymous. Bitcoin is anonymous, but currently unstable and inconvenient. Credit and debit cards are widely accepted, but they instantly connect your purchases with your person. Peer-to-peer payment systems like Paypal or Venmo require apps and accounts, and are still easily traceable.
Then there’s the question of global reliability. In the case of American money, cash has value beyond the borders of the country. In fact, two thirds of cash holdings in American dollars exist outside the country. People store up cash for emergencies, to keep a safety net, and to ensure that whatever happens, their wad of cash will be there for them.
Is cash really on the way out? (Credit: Getty Images)
While technology is trying to design a system that has all the components that cash does, it’s simply not there yet. Which is why, when you look at the statistics we have on cash use around the world, paper and coin isn’t doing too badly after all.
Number crunching
It’s difficult to put a number on just how much cash is used day-to-day across the globe. One of cash’s key attributes is how hard it is to track. Still, the data that does exist gives us a glimpse.
Two thirds of cash holdings in America exist outside the countryThe first way to estimate cash use is to calculate how much of it is in circulation. By this measure, cash is far from disappearing. In the United States, cash in circulation grew 42% between 2007 and 2012, and the amount of American money floating around in bills and coins is expected to grow by about 5% each year. The average growth globally is 7% per year, according to Eric Ziegler, President of the Security Technologies Group at Crane Currency, which manufactures notes.
However, that’s not the same as how much cash is actually changing hands in daily transactions. “Nobody has a way of going into the economy and counting how many bills are out there and the value of those bills,” says Daniel Wilson, an economist with the Federal Reserve Bank of San Francisco. “We don’t know exactly how many cash transactions are occurring on any given day.”
To get some sense of how cash moves, economists design models and surveys. In the Netherlands, for example, economist Nicole Jonker and her team at the Dutch National Bank conducted something called a diary study, in which they asked participants to write down a day’s worth of transactions, both cash and non-cash. From there, Jonker and her team built a picture of the how Dutch people were buying things.
Many have suggested that digital payments will lead to the end of cash (Credit: iStock)
The Netherlands is an interesting case study to look at more closely, because their retail sector has recently embraced card payments in a big way. There are now 1,400 supermarkets in the Netherlands with registers that don’t accept cash.
In the UK, half the transactions by consumers in 2013 were with cashAs a result, card payments in the Netherlands have been growing by about 8% annually over the past few years. And yet, cash is still king. In 2012, there were 2.7 billion card payments, but an estimated 3.5 to four billion payments were made with cash. “Even in supermarkets which all accept debit cards, cash is still used heavily,” Jonker says. “For the time being we think cash will keep on having an important role.”
Studies of other nations tie in with these findings. In the UK, half the transactions by consumers in 2013 were with cash, according to a report released in May by the UK Payments Council (now known as Payments UK). “The current forecast is that this figure will drop below 50% next year (2016), but there is no prediction for cash to disappear,” the report reads.
And one study that rounded up surveys like Jonker’s from around the world found that, in the seven countries they looked at — Australia, Austria, Canada, France, Germany, the Netherlands and the United States, 46-82% of all transactions in 2012 were conducted using cash (a wide range that may reflect both the uncertainty in the survey methods, and the variability between nations).
Some like cash because it is anonymous and can be squirrelled away (Credit: Getty Images)
Even countries that are often held up as the leaders of a cashless crusade, such as Sweden and Denmark, aren’t really getting rid of notes and coins. In June of this year, there was a round of headlines declaring that Denmark would rid itself of cash by 2016. “Burn your bills: Denmark wants to go cashless by 2016,” the headlines read. Not even close, Rene Thomsen, manager at the Danish Bankers Association told me. “I think, there’s been some misunderstanding on what the Danish proposal really is,” he said. In Denmark, he explained, there is currently a rule that all shops must accept cash. This new proposal would let some shops get around that rule. That’s all.
“It’s difficult to say, but I would be very surprised if we didn’t have cash in 10 to 15 years,” he says. “It’s hard to imagine that within 10 to 15 years that it’s not possible to go into a bank and say ‘I would like $1,000 and I want it in cash.’”
Irrational urge
Perhaps cash’s sticking power has something to do with our strange relationship with notes and coins. As with most of our decisions and preferences, our affinity for cash isn’t entirely rational. People value cash differently than they value electronic money, even though the two have the exact same value. Psychologist Eric Uhlmann, from the Paris School of Management, has done a handful of studies that picked apart how differently people feel about different kinds of money. “I’m interested in human intuition and economic irrationalities,” he says. “There’s this sort of irrational feeling that if money is physical, it’s more yours, and you feel like you own it more. If you touch a dollar more, then that particular dollar becomes yours.”
There’s this irrational feeling that if money is physical you feel like you own it moreUhlmann tested these ideas by presenting a set of scenarios to participants. In one, they were told a story about Ted and Donna. Forty years ago, the story goes, Ted’s great-grandfather stole $1,000 from Donna’s great-grandfather. Ted eventually inherited that money. In one scenario, Ted inherited the actual money – a wad of bills in a box that his great-grandfather passed down to him. In the other scenario Ted’s great-grandfather deposited that money into Ted’s bank account. When Donna finds out that Ted has the money, she asks for it back.
Contactless payment is here but it's unclear yet how it will impact cash use (Credit: iStock)
Participants were then asked whether Ted should give the money back to Donna. Those who heard the story with the physical money, in which Ted had a box of bills, were more likely to say that he should give Donna the money back. Participants who heard the story in which the money lived in Ted’s bank account, rather than a box, were more likely to say that Ted no longer had “quite the same” money that had been stolen, and were less inclined to force Ted to hand it over.
This kind of thinking applies not to just dollars in a box, but larger questions of theft and justice as well. Another researcher has done studies showing that people feel less negatively about white-collar crime, where people aren’t stealing physical things, than they do about blue-collar crimes in which an object is taken. Another study found that people cheat more when they’re cheating for tokens, than when they’re cheating for actual money. If you leave a Coca-Cola out, people are far more likely to take it than if you leave a dollar.
There’s been a backlash against abolishing pennies – despite being worth less than they cost to produceOf course there are limits to these effects. “If your bank subtracts money from your account, you’d still feel stolen from,” Uhlmann says. But when the two amounts are the same, there is a clear difference in how we feel about physical money compared to its digital proxy. “It says something really interesting about the human mind,” he says, “and the difficulty that we have being logical despite our rational beliefs.”
Could that mean that we might resist giving up cash entirely? There’s some evidence that suggests so. In the US, there has been a backlash against abolishing pennies – despite being worth less than they cost to produce, some Americans aren’t ready to part with the coin. Over in Australia, talk of abolishing the five cent coin was met with concern over the loss of income that charities receive from small change, and potential consumer backlash over rounded-up prices.
In 2012, between 42-80% of transactions were in cash, depending on the country (Credit: Getty Images)
History also suggests that there is a safety and security we feel about cash that digital currencies can’t quite match. Anybody who’s seen Mary Poppins knows the chaos that can happen when there’s a run on the banks. When there’s a financial crisis, people would rather have their money in hand, than behind the teller’s window or in the cloud.
It’s possible of course that developed Western countries like the US may be more attached to cash than elsewhere. “Different cultures have different attachments to their currencies,” says Nicolas Christin, a researcher at Carnegie Mellon University, “and as far as the US is concerned there’s a strong attachment.” Christin argues that’s because in the US the national currency has been relatively steady, where other countries have seen periods of boom and bust in the value of their money. This might make Americans more attached and trustworthy of their bills than other people.
The mobile caveat
While most conversations about the future of technology might myopically focus on America and Europe, some of the greatest innovations in money aren’t coming from either place. In some developing countries, cash transactions are quickly being replaced by digital payments, powered by mobile phones.
'Kenya has done mobile payments better than anyone' - Benjamin MazzottaWhile in the US, you still might buy your coffee with cash in 2025, that might not be the case in Kenya. In 2007, Kenyans began to adopt a system called M-Pesa and today it is used by over 17 million Kenyans, over two-thirds of the adult population. Users top-up their accounts and transfer money by sending a text message; the recipient then takes their phone to a vendor to get their money. No banks are involved.
“Kenya has done mobile payments better than anyone,” says Benjamin Mazzotta, a researcher at Tufts University who studies cash use. “M-Pesa is now accepted not just for large transfers, but for meals and clothes and school tuition. You can do lots of things with M-Pesa today that five or 10 years ago would have sounded like Neverland.”
The ATM remains ubiquitous (Credit: Getty Images)
Still, in places like the US and Europe, a system like M-Pesa might have a harder time catching on. Much of the technology’s success is due to the fact that it’s run by Safaricon, the country’s largest mobile-network operator by far. In other countries, competition is stronger: if each operator chooses to introduce their own proprietary form of mobile payment, it might not be anywhere near as convenient and seamless.
Take the Apple Pay system for example. Apple has faced hurdle after hurdle in getting the system adopted both in the United States and elsewhere. They’ve struggled to cut deals with places like China, where one company controls transactions between banks.
And it’s worth remembering that M-Pesa is a system for moving cash around, not a system to eliminate it. Users still hand cash to the M-Pesa vendors to top-up their accounts, and retrieve cash from them when money is sent to them.
So, while tech evangelists might like to believe they can replace global use of cash with digital transactions or Bitcoin, the truth is a bit more complicated and the hurdles aren’t all fixable by technology alone. Our psychological attachment to money, the infrastructure available to banks, and the need to create systems that are compatible with lots of vendors and users, all make progress away from cash more of a slog than a sprint.
Money makers
When you ask those who actually make currency whether they lose sleep over the looming cashless future, they say they’re not worried. “Frankly, based on the continued growth rate of cash, we don’t anticipate the disappearance of cash in the possible near term, or even medium term,” says Eric Ziegler at Crane Currency, a money design and manufacturing company. He doesn’t think Crane even has a cashless contingency plan, nor that they need one.
The fight against counterfeiters goes all the way back to the 4th Century BCOf course, saying that cash isn’t going away isn’t the same as saying cash is going to look the same forever. Banks and printers are constantly engaged in the fight against counterfeiters – a fight that goes all the way back to the 4th Century BC. And our future money will probably be a lot more digital than it is now.
Manufacturers like Crane are developing futuristic bills that involve large, easy to recognise security features. According to Ziegler, the best security features are the most obvious ones. “You want it to be technologically advanced, but so easy and obvious that if it’s missing the average cashier isn’t going to miss it,” he says. For that reason, he says, future money will likely continue to feature portraits and heads. Not just because we love to memorialise people, but because portraits are also a great way to challenge counterfeiters because as humans we’re good at recognising irregularities in faces. “If the hair is slightly different, or the glasses are off, we notice,” says Ziegler. “Portraits are a great security feature.”
Could cash one day only be found in museums or galleries? (Credit: Getty Images)
Beyond creating new bills with advanced security features, others are toying with the idea of slapping the digital world right on top of the physical one. In 2001 the European Union considered adding an RFID chip to each bill, largely in response to a huge number of counterfeit euros discovered in Greece. They ultimately rejected the idea, as it would increase the cost of producing bills dramatically, but according to Christin, future money might be full of these kinds of digital elements. In fact, it’s not the technology that’s missing, Christin says, it’s the infrastructure. An RFID chip is only useful if someone has an RFID reader to scan it with. “Think about the guy on the beach in Thailand who wants to rent a surfboard,” says Christin. “Do you have all the infrastructure you need to use that technology there?”
Unless we have sufficient and reliable alternatives in place, it would be dumb to get rid of cash now“It’s not that the technology doesn’t exist,” he adds, “it does, it would just cost a lot of money and be hard to deploy universally.” In other words, the exact challenges that face digital currencies are what make digital additions to cash so difficult.
How much cash do you have stored in your home? (Credit: Getty Images)
So where does that leave us? “Until we have sufficient and reliable alternatives in place, it would be dumb to get rid of cash now,” says David Wolman, author of the book The End of Money. “Honest people and legit businesses still rely on it.” Instead of constant cheering or hand wringing about the word “cashless,” people should be examining the trends that are pushing cash away. “It would be foolish to conflate enthusiasm about the impact of that marginalisation with unthinking cheerleading for cash’s total demise,” he says.
Many who think about cash like to use Mark Twain’s quote: “reports of my death have been exaggerated.” In one paper, the authors compare cash to a kind of Cinderella. “It doesn’t have a mom or dad to watch over it – just those horrible stepsisters that try to convince Cinderella that she is ugly. But she isn’t,” they write. Cash is with us, and it will stay with us whether Bitcoin and PayPal advocates like it or not.
On that fall day in 2025 you may take a self-driving car to work, or hologram into the office, and you may not even touch a piece of paper money. But you’ll likely still have a few notes and coins on hand somewhere, just in case. And you can be certain that somewhere in the world, somebody is pulling cash out of their pocket to buy something.
XXX . V0000 What is money !
Euro banknotes and coins are money but so is the balance on a bank account. What actually is money? How is it created and what is the ECB’s role?
The changing essence of money
The nature of money has evolved over time. Early money was usually commodity money – an object made of something that had a market value, such as a gold coin. Later on, representative money consisted of banknotes that could be swapped against a certain amount of gold or silver. Modern economies, including the euro area, are based on fiat money. This is money that is declared legal tender and issued by a central bank but, unlike representative money, cannot be converted into, for example, a fixed weight of gold. It has no intrinsic value – the paper used for banknotes is in principle worthless – yet is still accepted in exchange for goods and services because people trust the central bank to keep the value of money stable over time. If central banks were to fail in this endeavour, fiat money would lose its general acceptability as a medium of exchange and its attractiveness as a store of value.The nature of money over time
Commodity money
Representative money
Fiat moneyDespite the rapid rise in electronic payments, cash is still very popular. In the euro area, cash is used for a high proportion of all payments under €20. The value of euro cash is guaranteed by the ECB and the national central banks of the euro area countries, which together form the Eurosystem.
The uses of money and how the ECB keeps track of it
Money, whatever its form, has three different functions. It is a medium of exchange – a means of payment with a value that everyone trusts. Money is also a unit of account allowing goods and services to be priced. And it is a store of value. Only a portion of euro cash in circulation actually circulates, i.e. is used for processing payments. For example, many of the circulating €50 notes are hoarded.The functions of money
Medium of exchangefor buying things
Unit of accountfor pricing
Store of valuefor saving
How is money created?
The ECB acts as a bank for the commercial banks and this is also how it influences the flow of money and credit in the economy to achieve stable prices. Commercial banks, in turn, can borrow money, i.e. central bank reserves, from the ECB, usually to cover very short-term liquidity needs. The ECB’s main tool for controlling the quantity of “outside” money, and hence the demand for central bank reserves by commercial banks, is setting very short-term interest rates – the “cost of money”.Money creation in the euro area
European Central Bank
Commercial banks
People & businessesWhat about the ECB’s “money-printing” scheme I keep reading about?
In practice, only the national central banks physically issue euro banknotes. “Money-printing” is the colloquial term for the ECB’s asset purchase programme, a form of “quantitative easing”. By purchasing assets in the financial market, the ECB creates additional central bank reserves that can help reduce – through a variety of channels – the interest rates faced by households and firms with a view to supporting the economy and, ultimately, to keep the value of money stable when the room to cut those interest rates directly controlled by the ECB is limited. In this process, the ECB does not actually print banknotes to pay for the assets but creates money electronically, which is credited to the seller or intermediary, e.g. a commercial bank. The seller can then use the additional liquidity to buy other assets or, in case of a commercial bank, extend credit to the real economy. The purchases contribute to improving monetary and financial conditions, making it cheaper for businesses and households to borrow so they can invest and spend more. The ultimate aim is that inflation rates return to levels close to but below 2% in line with the ECB’s price stability mandate .With all different types of digital money these days and accounts represented electronically, people often wonder what’s the difference between traditional electronic currency issued by banks and permissionless cryptocurrencies like Bitcoin.
The Big Push for a Cashless Society
Over the past few years, there’s been a lot of discussion concerning the world’s progression towards a cashless society. Furthermore, bureaucrats and government authorities worldwide have also bolstered the idea further by removing individual notes of tender from circulation by demonetizing cash reserves. Before the seventies, cash was a dominant form of money, but since then most people now transact with an electronic representation of their local currency in their day to day lives.For instance, only 8 percent of the world’s money is represented by physical notes, and everything else is a form of digital fiat. Countries everywhere around the world have slowly been progressing towards a cashless society. In the U.S. the practice of electronic deposits into bank accounts became popular in 1975, and a decade later people were using these balances with debit cards.
Now throughout a few particular countries, large denominated notes like the $100, $500, and $1,000 bills are becoming rarer as governments are removing them from circulation. One country, in particular, India is suffering from a cash crisis as leaders started a demonization process last year. The use of cash within India is becoming less visible as Indian authorities are pushing hard for a cashless society by replacing it with digital fiat.
The Glaring Differences Between Electronic Fiat and Cryptocurrencies
There are significant differences between the traditional digital currency in your bank account and cryptocurrencies like Bitcoin. One of the biggest contrasts between the two is bitcoin’s deflationary attributes which is backed by the currency’s 21 million capped supply. Many economists believe this is a great benefit as the public knows that there are only so many bitcoins, which causes people to save, and purchasing power usually increases.With traditional digital fiat reserves, there is no telling how much money is circulating, and no one knows if the central banks are printing money on a whim. Economists who are against this type of monetary practice, such as those from the Austrian school, believe the world’s citizens are experiencing a silent robbery called inflation due to central planners printing vast amounts of fiat reserves. Sometimes central bank’s like the Federal Reserve tell the public they are creating more money with concepts like quantitative easing and the recent bank bailouts.
Another reason the world’s traditional fiat currencies are no good is because the electronic form is also used to monitor the public’s wealth. Cash is harder to track, and governments can keep a keen eye on funds moving around their electronic databases. Furthermore, other government agencies such as the UK’s GCHQ, the NSA, the FBI, and the CIA have been known to being spying on citizens and the world bank’s monetary movements.With this power, central authorities can censor people’s privileges to move money in any way they see fit. There are clear examples of banks, credit card companies, and Paypal freezing peoples funds or halting operations because of reasons they don’t particularly agree with.
Censorship Resistance and Unstoppable Tax Protests
With bitcoin, people can move their wealth in a permissionless way using their individual sovereignty. Bitcoin users can utilize the decentralized currency for operations that are typically frowned upon by third party forces. This includes online storefronts selling pornography, illicit drugs, and other black market activities. Cryptocurrencies can also be used to avoid taxation as it leaves the decision of reporting to tax officials up to the user.The infamous whistleblower Edward Snowden has agreed with this sentiment explaining to his Twitter followers on November 13 stating;
Because the public is embracing bitcoin and blockchain-based permissionless currencies authorities worldwide are trying to co-opt the technology. Rather than be disrupted, central monetary planners believe adding the word “blockchain” to the incumbent databases used today will lure more people towards a cashless society. One that will still be monitored, controlled with censorship, and even “editable” for those trying to erase fraudulent behavior.Coincidentally, new technologies raise the possibility of unstoppable tax protests.
There is a big difference between the electronic money used by banks today and bitcoin, as the latter is far superior for those who embrace freedom.
Whether you’re a beginner or a long-time bitcoin player, there’s always something interesting going on in the bitcoin.com Forums. We are proud free speech advocates, and no matter what your opinion on bitcoin we guarantee it’ll be seen and heard here.
Digital Currencies
A digital currency is a means of payment that only exists electronically. Like traditional money (such as banknotes), they can be used to buy physical goods and services.
Private digital currencies
Private digital currencies combine new payments systems with new currencies
that are not issued by a central bank. The most well-known privately issued
digital currency is Bitcoin, but other examples include LiteCoin, Ethereum and
Ripple. We have assessed private digital currencies and concluded that while
they are interesting, they do not currently pose a material risk to monetary or
financial stability in the United Kingdom. We continue to monitor developments
in this area.
Distributed ledger technology and blockchain
Bitcoin and other private digital currencies are underpinned by distributed ledger technology (also known as blockchain),
which is an electronic ledger that records and verifies transactions made using
the currency. Distributed ledger technology may have many other uses across the
financial system, and may be a useful platform to power a central bank digital
currency (although existing technology may also be sufficient).
Our fintech accelerator has carried out a distributed ledger technology proof of concept, which will help inform our research into central bank-issued digital currencies.
Our fintech accelerator has carried out a distributed ledger technology proof of concept, which will help inform our research into central bank-issued digital currencies.
Central bank-issued digital currencies.
At the moment, the Bank of England provides electronic accounts to banks
and key financial institutions, but the public can only hold central bank money
in physical form – as banknotes. If a central bank were to issue a digital
currency everyone, including businesses, households and financial institutions
other than banks, could store value and make payments in electronic central bank
money in addition to being able to pay with cash.
While this may seem like a small change, it could have wide-ranging implications for monetary policy and financial stability.
While this may seem like a small change, it could have wide-ranging implications for monetary policy and financial stability.
XXX . V00000 Digital money -- liquidity -- and monetary policy
The term digital money refers to various proposed electronic payment mechanisms designed for use by consumers to make retail payments. Digital money products have the potential to replace central bank currency, thereby affecting the money supply. This paper studies the effect of replacing central bank currency on the narrowly defined stock of money under various assumptions regarding regulatory policies and monetary operations of central banks and the reaction of the banking system.
Contents
IntroductionLiquidity Effects
Monetary Policy
Summary
Appendix
Introduction
The potential of digital money to replace currency as the predominant means of paying for retail goods and its ability to flow freely across international borders is attracting much attention among central bankers, the media, and scholars [ 1 ]. There are rumors that central banks would lose control over the monetary aggregates, and, even worse, that digital money would alter foreign exchange rates, disturb money supplies, and encourage an overall financial crisis (Tanaka, 1996). Opinions on this issue could not be more diverse. Ely (1996), for example, suggests that, fundamentally, digital money is no different from all other forms of money that exist today; consequently, the monetary policy implications of digital money are negligible.The proposed electronic payment mechanisms are either based on smart cards or network money. The smart card -- also known as the digital purse -- is a plastic card that has a microprocessor embedded which can be loaded with a monetary value. The card's value is reduced with each purchase. The smart card is reloadable, can be used for multiple purposes, and needs no online authorization for value transfer. The first two characteristics distinguish the smart cards from the single-purpose, prepaid card widely used in Europe. The third characteristic distinguishes it from the debit and credit card. Network money refers to software that allows the transfer of value on computer networks, particularly on the Internet [ 2 ] .
Like a travelers check, a digital money balance is a floating claim on a private bank or other financial institution that is not linked to any particular account (White, 1996). A digital money balance on a smart card or computer hard drive is a form of credit because the balance is the liability of its issuer. An institution's incentive to issue digital money is the interest-free or low interest debt financing that the outstanding digital money balance provides.
Widespread use of digital money could affect central banks in such areas as monetary policy, banking supervision, supervision of the payment system, and the stability of the financial system. The main concern of central bankers today is the security of digital money [ 3 ]. A security breach -- counterfeiting -- of a digital money product that is widely used could severely disturb the stability of the financial system.
Digital money products, designed to substitute central bank currency, could in principal replace the entire stock of central bank currency. Central bank currency is a component in all monetary aggregates; therefore, a change in the demand for central bank currency could affect these aggregates. The largest impact, however, would be on the narrowly defined stock of money, M1, which in most countries consists of central bank currency in circulation, travelers checks in the hands of the public, and demand deposits [ 4 ]. Other monetary aggregates, such as M2 or M3, could also be affected, but because central bank currency has less weight in these aggregates, they would be less affected [ 5 ]. The size of the stock of central bank currency in circulation, the size of demand deposit, and their relative weight, i.e., the (central bank) currency-to-deposit ration are first indicators of the potential effect of a replacement of central bank currency on the narrowly defined stock of money, M1, and are shown in Table 1.
Table 1: Currency and demand deposits in 9 nations*
| Countries |
Banknotes and coins in circulation as a percentage of GDP
|
Deposits as a percentage of GDP
|
Currency-to-deposit ratio
|
| Belgium |
5.2
|
14.0
|
0.37
|
| Canada |
3.5
|
4.4
|
0.80
|
| France |
3.4
|
19.2
|
0.18
|
| Germany |
6.8
|
16.2
|
0.42
|
| Italy |
5.9
|
30.7
|
0.19
|
| Japan |
8.8
|
23.6
|
0.37
|
| Netherlands |
6.3
|
18.8
|
0.34
|
| Switzerland |
7.8
|
17.9
|
0.44
|
| United States |
5.2
|
11.6
|
0.45
|
Digital money's impact on M1 will depend on three factors: ( 1 ) the banking system's willingness to expand its deposits, ( 2 ) the reserve requirements on digital money balances and demand deposits, and ( 3 ) the particular definition of M1. In addition, the reaction of central banks plays a crucial role because in principal they have the means to offset any change in M1. Section 1 considers the impact of digital money products on M1 when central banks remain passive. Section 2 studies monetary policy options of central banks and Section 3 concludes.
Liquidity Effects
Substitution of central bank currency would affect all monetary aggregates. The largest impact, however, would be on the narrowly defined stock of money, M1. We will, therefore, confine our attention to changes in the narrowly defined money stock (liquidity effects). To simplify the analysis, M1 consists only of central bank currency, C, and transaction deposits, D. For some purposes we also include digital money balances, EM, in the definition of M1.Conversion of central bank currency into digital money balances would affect M1 through two channels. Obviously, a substitution of central bank currency would affect M1 most directly trough a reduction of the stock of central bank currency. A conversion, however, would also change the reserve position of banks and, eventually, the size of deposits, D. This second channel could be of more importance because it potentially has a larger impact on M1.
Banks hold reserves for two reasons. ( 1 ) In many countries they are required to hold a percentage of certain types of deposits as reserves. The types of deposit accounts that require the holding of reserves and the reserve ratio differ from country to country. ( 2 ) Banks also hold reserves -- excess reserves -- for settlement purposes to cushion costly daylight and overnight overdrafts. Reserves are either held as vault cash -- central bank currency in the hands of banks -- or as book entries at the central bank [ 6 ].
The liquidity effect of a conversion of central bank currency into digital money balances depends on whether binding reserve requirements are in place. Banks expand their deposits by making loans. When a bank makes a loan this is automatically matched by an equal increase in deposits. Banks are willing to make loans if the marginal return on loans is larger than the marginal costs of deposits. With binding reserve requirements, this condition is met but their reserve position prevents the provision of further loans and, correspondingly, a further expansion of deposits. Thus, with binding reserve requirements, the marginal rate of return on loans is larger that the marginal costs of deposits and banks would be willing to expand their deposits at the prevailing rate of return and costs, respectively.
The following analysis, therefore, distinguishes two scenarios. ( 1 ) A set-up with zero or non-binding reserve requirements and ( 2 ) a set-up with binding reserve requirements.
Zero or non-binding reserve requirements
Let us first consider the liquidity effect of a conversion of one unit of central bank currency into one unit of digital money balances when zero or non-binding reserve requirements are in place. With zero or non-binding reserve requirements, the market for deposits and loans is in equilibrium and the marginal return on loans equals marginal costs of deposits. Banks have some market power, i.e., a bank increasing its supply of loans would marginally reduce the rate of return on loans resulting in a loss [ 7 ]. Thus, at the prevailing rate of return on loans and the prevailing costs of deposits banks are not willing to increase deposits by providing additional loans.
The conversion implies that the total amount of currency in circulation, C, decreases by one unit and, at the same time, that the banking system's stock of central bank currency (vault cash) increases by one unit. The bank receiving the currency unit can either hold it as vault cash or return it to the central bank thereby increasing its reserves at the central bank by one unit.
It is likely that the bank is not willing to hold the unit as vault cash because the rate of return on vault cash is zero while the rate of return on reserves at the central bank is positive because it reduces marginally the probability that the bank has to borrow funds for settlement purposes. Although, banks holding returned currency as vault cash is a rather simplistic story, this assumption, nevertheless, is often used to evaluate the effect of digital money on the money supply. For example, the CBO (1996, p. 42) study on digital money suggests that "if the issuers hold 100 percent cash reserves for balances on stored-value cards [∑] the money supply will not change."
Since banks are not willing to expand their deposits and the prevailing rate of return on loans and costs of deposits, to affect D substitution of central bank currency must either change the rate of return on loans or the costs of deposits. Since the conversion of currency into digital money balances does not affect the banking system's demand for settlement balances (reserves), the increase in the supply of reserves would marginally decrease the interest rate for settlement balances. That is, banks are only willing to hold the additional unit of reserves when the price for settlement balances decreases marginally [ 8 ].
The lower costs of settlement balances decrease the costs of making deposits. Consequently, banks would marginally increase lending and deposit taking. Thus, D would increase unambiguously. The overall effect on M1, however, is not determined because central bank currency, C, would be reduced by one unit. However, because the effect of a conversion on deposits is equivalent to the effect of an expansionary open market operation, it is more likely that the increase in D would offset the decrease in C and, consequently, M1 would increase. [ 9 ]
The picture changes slightly if digital money balances are included in the definition of M1. In this case, M1 would increase unambiguously because the reduction in C would be matched by an offsetting increase in EM and D would increase unambiguously.
Thus, if electronic money balances are not included in the definition of M1, the change of the narrowly defined stock of money depends on whether the increase in D offsets the decrease in C. If digital money balances are included in the definition of M1, M1 increases unambiguously. A summary of the results is given in Table 2.
Table 2: Changes in M1 with non-binding reserve requirements*
Definition of M1
|
Change in M1
|
Not determined, increase more likely
| |
Increase
|
Binding reserve requirements
In the following analysis binding reserve requirements are in place and banks are willing to make loans and expand their deposits at the prevailing rate of return on loans and costs of deposits. Again, conversion directly affects M1 through a reduction in C and indirectly through a change in the reserve position of the bank receiving the unit of currency. To see how the bank's reserve position is affected, consider the following example.
When a customer hands in a bank note, say one dollar, and at the same time increases the digital dollar balances on his smart card or computer by one dollar the bank's balance sheet and reserves change as follows. First, it increases the bank's total amount of vault cash by one dollar and it increases the bank's liability (the outstanding balance of digital money) by one dollar. Second, the increase in vault cash amounts to a one-dollar increase in the bank's reserves whereas the increase of the outstanding amount of digital money requires either no additional reserves or -- if there is a 10 percent reserve requirement on digital money -- 90-cent increase in reserves. In either case, the bank has excess reserves, and, if the reserve ratio on deposits is 10%, it has gained the ability to expand its deposits, in the first case by $10 and in the second case by $9.
The following analysis, based on the notion of a money multiplier, relies on a simple model of money creation. Money multipliers describe the relation between the various monetary aggregates and the monetary base. The monetary base consists of central bank currency in the hands of the public plus reserves of deposit institutions, i.e., banks. The relation between the monetary base and M1 is described by the following equation:
M is the stock of narrowly defined money (M1), H is the monetary base, and m is the money multiplier. In its simplest form, the money multiplier is derived by using the following relations:
C is currency in the hands of the public, EM are digital money balances, D are demand deposits, R are required reserves, and E are excess reserves. rD is the required reserve ratio on demand deposits and rEM is the required reserve ratio on digital money balances.
According to ( 2 ), the stock of narrowly defined money consists of currency holdings, demand deposit and, if included, digital money balances. According to ( 3 ), the monetary base consists of required reserves, currency and excess reserves and, according to ( 4 ), required reserves are reserves on demand deposits and reserves on digital money balances.
Banks are willing to provide loans if the marginal return on loans is larger than the marginal cost of deposits. An implicit assumption of the money creation process, i.e., the multiplier model we study here is that this condition is always met [ 10 ]. In this case, banks find it profitable to make loans whenever they have excess reserves. The size of deposit expansion depends on the reserve ratio on demand deposits, rD, and on the reserve ratio on electronic money balances, rEM. The results are
Changes in M1 with binding reserve requirements*
| Definition of M1 | ||||
| M1 = CARTAL MONEY M2 = GIRAL MONEY | ||||
The first row of Table 3 describes changes in M1 when digital money balances are not included in the definition of the narrowly defined stock of money. Change in M1 depends on the reserve requirements on digital money balances, rEM. If , M1 increases. If , a conversion of central bank currency into digital money balances is neutral, it does not change M1. For large reserve requirements, if , the narrowly defined stock of money decreases. For example, if , the stock of narrowly defined money decreases by one unit. Change in M1 depends also on the reserve requirements on deposits, rD. The larger rD, the smaller is the change in M1.
The second row of Table 3 describes changes in M1 when digital money balances are included in the definition of the narrowly defined stock of money. In this case, the stock of narrowly defined money increases if the reserve requirements are not equal to one. If , a conversion of central bank currency into digital money balances is neutral. Again, the larger the reserve requirements on deposits, rD, the smaller is the change in M1.
A final note is required, here. The results of Table 3 implicitly assume that demand deposits and, if so, electronic money balances are the only reservable liabilities of banks. If other liabilities were subject to reserve requirements, some of the excess reserves created by the substitution of central bank currency would be used to expand these other types of liabilities. This would reduce the potential of expansion of M1 and change the derivatives in Table 3.
Monetary Policy
Section 1 suggests that a conversion of central bank currency into digital money balances would increase bank reserves and, consequently, also the narrowly defined stock of money. If banks were to use the additional reserves to expand demand deposits, it is likely that central banks would not remain passive. Rather, they would take measures to control the expansion of the narrow stock of money. Central bank activity is likely because, in particular with binding reserve requirements, the potential increase of the narrow stock of money is nontrivial.To see this, consider the potential change in M1 when electronic money balances are not included in the definition of M1 and when there are no reserve requirements on electronic money balances. The respective derivative is . The elasticity of M1 is given by
where c is the currency-to-deposit ratio. The smaller the reserve requirements on demand deposits, rD, and the larger the currency-to-deposit ratio is, the larger is the elasticity of M1.
A textbook interpretation of
Table 4: Potential increase in M1 with conversion of digital money*
| Countries |
Currency to deposit ratio c
|
Reserve ratio on transaction and sight deposits as of mid 1996**
|
Percentage increase of M1 when one-percent of the stock of central bank currency is converted in digital money balances
|
| France |
0.18
|
1%
|
15
|
| Germany |
0.42
|
2%
|
14.5
|
| Italy |
0.19
|
15%
|
0.9
|
| Japan |
0.37
|
1.3%***
|
20.5
|
| Switzerland |
0.44
|
2.5%
|
12
|
| United States |
0.45
|
10%***
|
2.8
|
** See Borio (1997, p. 69)
***The ratio varies with the size of the corresponding liability category.
The estimates in the third column provide an upper limit of possible expansion of the narrowly defined stock of money. The larger the (central bank) currency-to-deposit ratio, c, and the smaller the reserve ratio, rD, the larger is the potential expansion of M1. Recall that these results are derived under the assumption that the reserve requirements are binding. The small reserve ratios in most of these countries, however, indicate that the reserve requirements are not binding and, therefore, the expected increase in M1 would be smaller.
In the remaining of this paper we consider the measures that central banks can take to prevent potential changes in M1. They have four:
- They can limit the proliferation of digital money products to prevent the replacement of central bank currency.
- They can issue digital money products and treat digital money balances in the same way as they do central bank currency.
- They can apply high reserve requirements on digital money balances.
- They can absorb -- sterilize -- the excess liquidity created by appropriate monetary operations.
Legal restrictions to prevent the proliferation of digital money products will be difficult to justify, especially in light of efforts to deregulate and improve the efficiency of the financial sector. It is well known that central bank currency is an expensive medium of exchange. For example, the estimated annual costs of U.S. retailers and banks to handle money is $60 billion, which includes costs associated with processing and accounting of money, storage, transport, and security (Hayes et al. 1996).
Digital money products also offer substantial cost savings compared with paper checks. Humphrey et al. (1996) suggest that the cost of an electronic payment ranges between one-third to one-half of a check or paper giro payment. Moreover, measures that prevent development of digital money product will result in a competitive disadvantage. Nations that will develop these products will thereby take a lead in a crucial technological sector. In addition, digital money easily crosses international borders and it will be difficult to control foreign digital money products that could eventually emerge as a medium of exchange in the home country.
Central banks could provide digital money in the same way as they provide paper currency right now. The Bank of Finland, for example, is developing a cash-card system through its corporate subsidiary, Avant Finland Ltd. (Bernkopf, 1996). Most central banks, however, remain passive in this respect. There is concern that central banks issuing digital money products could limit competition and reduce incentives in the private sector to innovate further digital money products (BIS, 1996b).
Central banks could require reserves on digital money balances. High reserve requirements can make digital money products neutral with respect to changes of the narrowly defined stock of money. However, since the main incentive to issue digital money products is the interest-free debt financing that digital money balances provide, high reserve requirements will make it less profitable to issue digital money and will hold back its development.
The drawback of the first three measures is that they reduce the private sector's incentive to invest in the development of digital money products. It is, therefore, likely that central banks will hold the money supply constant by appropriate monetary operations. If digital money balances are included in the definition of M1, then for every dollar of central bank currency replaced by digital money, central banks would have to sell one dollar's worth of assets. For example, the U.S. Federal Reserve System would be required to sell one dollar of U.S. Government securities for each dollar of currency converted into digital money balances. If digital money balances are not included, then -- assuming a reserve ratio on demand deposits of 10 percent -- it would have to sell 0.9 dollar of assets.
These reserve-absorbing open market operations would come at the cost of a steadily shrinking monetary base. There is concern that replacement of central bank currency would reduce the monetary base to the extent that it could adversely affect monetary policy implementation. This concern has been raised by BIS (1996b):
Since cash is a large or the largest component of central bank liabilities in many countries, a very extensive spread of e-money could shrink central bank balance sheets significantly. The issue is at what point this shrinkage might begin to adversely affect monetary policy implementation. The relatively modest size of open market operations on normal days suggests that a relatively small balance sheet might be sufficient. However, special circumstances could arise in which the central bank might not be able to implement reserve-absorbing operations on a large enough scale (for example, to sterilize the effects of large purchases in the foreign exchange markets) because it lacked sufficient assets on its balance sheet.
Summary
Eventually, digital money is expected to replace central bank currency, thereby affecting the narrowly defined stock of money. This paper suggests that a conversion of central bank currency into digital money balances would permanently increase the supply of bank reserves and, therefore, the effect on the narrowly defined stock of money would be equivalent to an open market operation that provides permanent additional reserves to the banking system. The precise change of the narrow defined stock of money would depend on the institutional arrangements prevailing in a country, in particular, whether binding reserve requirements are in place.If reserve requirements were non-binding and if electronic money balances were not included in the definition of the narrow stock of money, the stock of money could either increase or decrease. However, since a conversion is equivalent to an expansionary open market operation, it is more likely that the stock of money would increase. If digital money balances were included in the narrowly defined stock of money, it would increase unambiguously. If reserve requirements were binding, the stock of narrowly defined money would increase. Reserve requirements on digital money balances would reduce the increase and if digital money were included in the definition, the increase would be larger.
Thus, a conversion of central bank currency into digital money balances would most likely increase the narrowly defined stock of money. The liquidity creation could be so large that central banks could be forced to step in to absorb the excess liquidity by selling assets. Liquidity absorbing monetary operation could shrink the monetary base to the extent that it could adversely affect monetary policy implementation. To avoid erosion of the monetary base, central banks could be tempted to resort to alternative measures to curb the expansion of the narrowly defined stock of money. They could limit the proliferation of digital money products. They could issue digital money product themselves or they could apply high reserve requirements on digital money balances. The drawback of these measures is that they would reduce the private sector's incentives to invest in the development of digital money products.
XXX . V000000 New Technologies in Payments: A Challenge to Monetary Policy
1. Introduction
A wide range of innovations has taken place over the last years in the field of banking and payment systems. These have had, or are likely to have, significant consequences for payment habits and for the structure and functioning of markets. Moreover, they will influence the way monetary policy is conducted
we will description the potential effects of these innovations for monetary policy in the euro area, and to which extent central banks and financial regulators should react to these challenges. These are very topical issues, and of great interest to central bankers.
Of course, it is extremely difficult to predict in which direction and to what extent further innovations in these areas might evolve. Some think it might be conceivable that in some remote future, monetary policy might be meaningless, or that central banks will no longer play an important role in economic policy making. However, predictions in this direction would amount to pure speculation. Today, I do not want to enter the hypothetical world of Fama and Hall, in which central banks play no role in monetary policy and money loses its role as a unit of account. I will be less farsighted, but more concrete. I want to focus on foreseeable developments in payments technologies and possible effects of monetary policy.
My line of argument is as follows. I will first outline developments in the field of large value payments, these being mainly interbank payments. Here, I am going to discuss consequences both for systemic stability as well as for the demand for central bank reserves. The second area that I will speak about today is electronic money. I shall discuss how this new phenomenon might pose a threat to the conduct of monetary policy and what should be the response of regulatory authorities to that.
In summary, it is my opinion that the challenges that arise from the new forms of payment for banks and for financial systems in general are serious, but can be managed. As long as the central bank revises the formulation of monetary policy as a response to these changes, and its regulatory framework is adapted accordingly, the technological developments will pose no threat to the ability of the central bank to conduct monetary policy.
2. Overview over New Technologies
A first area in which information and communication technologies have significantly affected the payment and monetary system is the field of electronic interbank payments. Since long ago, the ability to use electronic networks to store and handle funds instead of having to rely on physical transfer has dramatically changed the financial system. As a result, the transfer of funds has become much faster and safer. Similarly, the transfer and safekeeping of securities has become significantly cheaper since the advent of book-entry systems. The traditional safekeeping of paper-based securities in vaults has widely been replaced by such electronic book-entry.
But, more recently, a new "quantum leap" was made possible by the exponential increase in computer power. Traditionally, the most common way to handle large value payments between banks was to accumulate outstanding payments during a certain period of time, often a business day, and to transfer them in one batch at the end of the day. Usually, this was done in the form of "netting", where payments between two counterparties were matched and only the net obligation was transferred. Netting had some advantages compared to the transfer of the gross amounts. First, because a lower amount of reserves was transferred, the transaction involved both lower costs and a higher degree of safety. Second, fewer central bank reserves were needed in a netting system, and this was again cheaper for the participating banks.
By reducing transaction costs and enhancing safety of the transactions, the new information and communication technologies have reduced the advantages of net vis-a-vis gross settlement. Moreover, they have made settlement in real time possible, i.e. the immediate execution of a transfer once a payment order has been issued. Through these two developments, the electronic systems dramatically tilted the balance of costs and benefits in favour of gross settlement systems. Indeed, today in many countries, including the member states of the European Union, Real Time Gross Settlement (RTGS) Systems have replaced some of the net systems.
The immediacy of settlement in real time systems has one important advantage: the outstanding obligations between parties are reduced to zero immediately after the payment order has been issued. This has the advantage that credit risk is reduced. Credit risk is the risk that the debtor bank may be unable to settle his obligations vis-a-vis the creditor bank. In a netting system, credit risk is much higher. Here, the outstanding obligations can accumulate over the day because of the time lag between payment order and settlement makes it possible that the debtor bank can fail prior to settlement. The receiving bank might then not receive the expected payments.
Generally, credit risk in net settlement systems has increased because the value of transactions made via payments systems has risen significantly. Indeed, in the large value payment systems in the European Union, an amount equalling annual GDP is turned over every six to seven days. [2] As a consequence, the daily liabilities of banks versus each other have increased dramatically and often exceed the banks' capital. As a result, the banking sector has become more exposed to systemic risk.
Suppose that a bank that is a net debtor to the banking community is unable to honour its claims. [3] Its failure might lead to the failure of several of its trading counterparties, and, by a domino effect, potentially also induce losses for other banks. A well-known example for such an event was the failure of the Bankhaus Herstatt in 1974. Herstatt was heavily engaged in foreign exchange transactions. It was closed down by the German authorities after the European markets had closed for the day, but while New York was still open. At the time of its bankruptcy, it had received transfers in Deutsche Mark from its US trading partners but had not delivered the corresponding amounts of US Dollars to them. As a consequence, its American counterparties experienced significant liquidity problems, and the payment system handling foreign exchange transactions in the US, CHIPS, was disrupted so severely that it led to a collapse in the US dollar/Deutsche Mark trading.
A financial crisis can be very damaging for the economy because they disrupt the monetary system and the execution of monetary policy. Indeed, because the payment system is one of the major channels through which a crisis could propagate, systemic risk considerations were central to two important recent initiatives in the field of payment systems taken by international regulators. First, the Bank for International Settlement (BIS) issued a report [4] which set out minimum standards for netting systems that should limit the risk exposure of the systems to individual banking failures. Second, the EU central banks decided to promote Real Time Gross Settlement (RTGS) systems. [5] Since the beginning of Stage Three of the Economic and Monetary Union, all monetary policy operations are processed through the TARGET system, which links the RTGS systems of all EU countries. It is not the only payments systems that operates on a cross-border basis in the euro area (another one is Euro 1, organised by the European Banking Association), but it currently processes the largest bulk of payments, both in terms of value and volume. TARGET therefore amounts to an important step in reducing settlement risk for the European banking sector.
A second and more recent innovation I would like to focus on concerns retail payment structures, and specifically, electronic money. The term Electronic Money can be broadly defined as electronic storage of monetary value on a technical device, which may be used to make payments not only to the issuer but also to other agents. Note that cards that are accepted as a mean of payments only by the issuer itself (for instance, telephone cards), so called single-purpose cards, are not considered electronic money. Only multi-purpose cards, that is, cards that can be used with a multiplicity of merchants, should properly be considered as electronic money.
We can distinguish two main forms of e-money. Stored-value cards (SVC) are plastic cards that contain purchasing power, which has been transferred to the card by a pre-payment. Network money is monetary value stored in computer memory, and can be transferred over a communications network such as the Internet.
Both of them entail several advantages compared to both cash and to traditional debit or credit cards. First, SVCs facilitate small value payments that could have been done with cash, but in a more cumbersome way. Thus, fewer banknotes and coins would be needed. Similarly, network money can simplify payments made for purchases on the Internet. By using network money, the amount that can potentially be lost due to misuse of transmitted information is limited to the nominal value of money stored in the memory. Therefore, possibilities for abuse seem to be smaller than with credit card payments. Finally, a further advantage of electronic money over cash would arise if interest were to be paid on the outstanding balances.
Second, merchants can profit from accepting electronic money. As far as SVCs replace payments in cash, they will face lower costs of handling notes and coins. To the extent that electronic money substitutes for debit or credit card payments, the processing costs of payments are reduced. A payment with a debit card usually involves the electronic verification of sufficient account balances. To achieve this, the system relies on some communication network. In case of electronic money, any expenses are debited to the balance available on the device itself. Thus, no such communication network is needed as all the relevant information is contained on the card or in the computer memory.
3. Monetary Policy Implications
Having described some forms in which new technologies influence our ways of making payments let me now turn to the impact of these developments on monetary policy. I will first discuss large value payment systems, and then turn to electronic money.
3.1. Implications of Electronic Interbank Payments
Smoothly operating financial markets are essential to the functioning of monetary policy. A financial crisis might have very destabilising effects, such as rapid price changes, a high level of uncertainty, or a general liquidity shortage in the markets. Should such a crisis happen, the rapid transmission of monetary impulses throughout the currency area might be hampered or even prevented. Moreover, the ECB, like most other central banks, has statutory responsibility over the well-functioning of payments systems. Hence, the central bank has an interest in ensuring that certain safety standards are in place that limit the impact of a systemic crisis and therefore reduce the possibility of a disruption of the financial system. With TARGET, the Eurosystem has successfully implemented real time gross settlement and thereby contributed to an environment of financial stability.
Let me turn to a second area in which payment arrangements have an impact on monetary policy: they influence the demand for central bank reserves. In real-time gross settlement systems, the demand for reserves is proportional to the volume of transfers made, but these reserves can be used for several transactions on a given day. On the other hand, in a net settlement system, the netting-out of outstanding obligations between several banks reduces the reserves that the banks need for settlement. Also, the relationship between money demand and transfer volume is more complex in a net system. It depends on the number of participants in a netting system as well as on the duration of the settlement cycle.
The effect on the demand for reserves of a switch from gross to net settlement is therefore ambiguous. In Europe , the adoption of RTGS systems in preparation for Stage Three of the Monetary Union led to a small increase in reserve holdings.
Additionally, a recent trend in private netting systems is to replace the traditional net settlement systems by hybrid settlement systems. These systems [6] combine features of RTGS and net systems, essentially by providing net settlement with very short settlement lags. This means that fewer payments will accumulate during this shorter cycle. Again, this trend influences the demand for central bank reserves.
The transfer volume processed through large value systems is substantial. Therefore, the organisation of these systems is a significant determinant for the size of the demand for central bank money. A central bank should be concerned with effects on the demand for central bank money since this demand and also its interest rate elasticity are key variables for the transmission process of monetary policy. I will elaborate on this relationship in the following section.
3.2 Implications of Electronic Money 3.2.a Free banking
Electronic money is private money that competes against central bank money as a medium of exchange. This phenomenon immediately calls to mind the historical experience of free banking where private banks were allowed to issue private currencies. One of the strongest advocates of abolishing the central bank's monopoly in the creation of money was von Hayek [7] . He proposed to enable private banks to issue their own currency, thereby creating competition. Banks could issue non-interest-bearing certificates and open cheque accounts on the basis of their own distinct registered trademark. Different banks would issue different certificates. These currencies would then trade at variable exchange rates.
Von Hayek believed competition between different currencies to be particularly conducive to price stability. This would be achieved via a discovery process. Only those currencies that built up a reputation for providing stable purchasing power could survive competition. On the other hand, banks that failed to build up such a reputation would lose consumers and be driven out of business. Consequently, such a system would eventually only leave room for stable currencies, and lead to a non-inflationary outcome. Electronic money bears some similarities to this vision. Issuers of different types of electronic money may indeed compete against each other to attract customers, and could do so in a way closely resembling the one envisaged by von Hayek.
Nevertheless, there are arguments opposing this view. Let me mention a few. First, in the discovery process envisaged by von Hayek, bad issuers are driven out by the fact that they have recourse to inflationary issuance. This suggests that the discovery process itself could be characterised by inflation. Second, if the discovery process was successful such that a single stable currency did emerge, there is no guarantee that the new monopolist would not engage in inflationary over-issue, with the aim of maximising seigniorage. Last, but certainly not least, the role of the currency as a unit of account would be undermined: there would be not just one price for each given good, but n prices, where n is the number of existing monies. This would unduly complicate the price system, whereas one of the principal benefits of monetary economies is that of making prices transparent, thereby facilitating exchanges. Money should be the numeraire, that is the unit for quoting prices, for negotiating contracts, and for performing any economic calculations. A unique numeraire is the most efficient solution to this co-ordination problem. The loss of a unique unit of account could therefore induce significant efficiency losses for the economy.
I conclude that, while Hayek's ideas are stimulating, the merits of unregulated competition of electronic monies are, to say the least, ambiguous.
3.2.b Will the increase in electronic money become significant?
As many as 19 electronic money schemes were operating in the euro area in 1999. Most of them were launched between 1995 and 1997, and their use is still very limited. Daily turnover in electronic money was only about EUR 800,000 for the entire euro area. Neither seems electronic money a preferred form of payment for consumers, nor do many merchants accept it widely at the present time. In most countries, the use of stored value cards is still at a relatively experimental stage. For network money, usage is much scarcer still. Such slow progress may seem surprising considering that successful IT related applications usually have a very fast development.
The reluctance by merchants can be explained by the technical adaptations that need to be made to offer this service. These require initial investments into new equipment that is able to read the devices on which money is stored, and to transfer the funds to an own electronic storage facility. Also, personnel need to be trained to use the new money. While marginal costs from processing electronic payments are rather low, these initial investments might be substantial. On the other hand, returns from the investment arise proportionally to its usage. Consequently, if the expected number of customers wishing to pay with electronic money is low, the benefits from e-money are unlikely to outweigh the initial investment cost. Only once a critical mass of usage has been reached might electronic money become profitable for merchants.
Similar economies of scale exist on the customer side. Consumers might be unwilling to adapt stored value cards while the number of vendors accepting these cards remains small. Concerning network money, related considerations apply. Additionally, consumers might be reluctant to purchase electronic money because they are unfamiliar with it, and uncertain about the risks and benefits it brings along. Confidence in the technology and the issuing institution are essential for the acceptance. This argument might be particularly strong for the case of network money, where the degree of anonymity of issuers or merchants is higher.
These network effects both on the demand and the supply side suggest that electronic money might become widespread only when the network of buyers and sellers that are willing to accept this form of payment has become large enough. Rapid growth of this payment form is therefore expected to take place once a critical mass of acceptance and dissemination has been reached.
In summary, the fact that the use of electronic money is not widespread up to this date does not imply that a rapid growth of this payment medium might not take place at some stage. The question of whether e-money will become, in the not too distant future, the dominant (or finally the only) used form of payment, is however still open. I do not want to speculate too much on this here. I am concerned, however, that monetary policy makers must be ready to face all conceivable scenarios. Therefore, in the following I will comment on the implications that such a development could have for monetary policy.
3.2.c Consequences for the formulation of monetary policy
The primary objective of the European Central Bank (ECB) is to maintain price stability in the euro area over the medium term. The price level is, as we all know, the inverse of the price of money in terms of goods. Therefore, developments that affect the money supply mechanism, such as electronic money, are very relevant from the viewpoint of the ECB's primary goal.
A central bank, however, cannot directly control the price level. Monetary policy operates through a complex transmission process that involves the financial system and the real economy, and in which substantial time lags exist. A forward-looking monetary policy must therefore be based on some indicators in order to achieve its goal of price stability. Money is an important variable in this process. For this reason, the Governing Council of the ECB has given monetary aggregates a prominent role in its monetary policy strategy.
As you all know, the monetary aggregate chosen by the ECB within its strategy is M3. [8] This is a broad aggregate that includes a wide range of relatively liquid assets. Among other reasons, it was chosen because it is least affected by substitution between various liquid assets, and because of its empirically stable relationship with the price level. [9]
The advent and spread of electronic money may affect the properties of monetary aggregates. Specifically, since stored value cards are likely to substitute largely for cash payments, the effect of their spread will be largest on the narrower aggregates such as base money and M1. On the other hand, cash constitutes only a small fraction of the broader aggregates. Therefore, in relative terms the spread of e-money will have a less pronounced effect on these variables. [10] Nevertheless, with the further development of new payment technologies, I cannot exclude the possibility that M3, as presently defined, may also be influenced to a relevant degree.
Network money is likely to substitute mostly for credit card payments, which are at present the most common forms of payment for Internet transactions. It will probably - at least for some time to come - not affect the use of cash to a great extent, and is thus not likely to have a major primary impact on the aggregates. However, it remains to be seen for which market segments and to which extent e-business will replace traditional merchandising and the corresponding payment habits.
Another potential reduction in the information content of M3 could result if the new technologies are bringing about efficiency gains in the usage of payments instruments. The experience with credit cards was that households were able to economise on their money holdings through more efficient payment handling. Similarly, one could expect that also electronic money could contribute to a more efficient payment structure. If this were the case, then even the augmented monetary aggregates that include electronic money would be subject to a decrease that reflects the efficiency gain and the resulting increase in velocity of money. This development can also be interpreted as an increase in the money multiplier, as it amounts to a higher level of money creation for a given level of base money. Again, the effect is likely to be stronger for the narrower aggregates than for the broader ones. The effect on M3 for the foreseeable future might therefore be rather small.
For the monetary aggregates to maintain their function in monetary policy, the aggregates should be defined appropriately to include all means of payments and their close substitutes, including electronic money. For the appropriate calculation of these aggregates, it is therefore essential that data on the amount of outstanding balances are available to the central bank. Issuers of e-money must be required to provide the necessary statistics to the central bank or another authority in charge of supervision.
3.2.d Consequences for the effectiveness of monetary policy
Reduction of the central bank's balance sheet
To the extent that electronic money reduces the demand for cash, it will affect the central bank's balance sheet. However, cash is a substantial component of a central bank's liabilities. Currency in circulation now constitutes more than one third of the Eurosystem's liabilities. Consequently, a significant reduction of its balance sheet could result once the use of electronic money becomes widespread.[11]
Changes in asset holdings are the principal means by which central banks adjust the supply of reserves. Depending on the extent to which electronic money leads to a reduction in the size of the balance sheet takes place, the central bank's capacity to control short-term interest rates via monetary intervention operations could potentially be limited. Under normal circumstances, a relatively small balance sheet will be sufficient to carry out open market operations. However, should special circumstances arise in which the central bank needs to intervene on a larger scale, then a small balance sheet might constitute a problem.
Reduction in the demand for central bank money
The central bank's ability to influence money market rates rests on its monopoly in the creation of base money. This monopoly matters because banks need to hold central bank money to undertake economic transactions with their customers. If the central bank reduces the supply of reserves, short-term interest rates are affected. Banks would tend to lower the amount of credit given to customers, which in turn indirectly affects economic activity. The advent of electronic money or any other new payment form will not change this monopoly position, because central banks will continue to be the unique providers of central bank money to the banking sector. Electronic money poses no threat to this position.
The question is, however, whether new payment technologies will reduce the necessity for banks to hold central bank reserves, and in the extreme reduce the demand for base money to zero. [12] In the latter scenario, the central bank would maintain its monopoly, but it would be useless. The ability to steer the price level in the economy through the supply of central bank money would be lost.
But how do new developments in the area of retail payments affect the demand for money? To take an example, consider the use of credit cards. Any credit card payment involves the transfer of funds from the consumers to the issuer of the credit card and further to the merchant who accepted the card. Usually, the settlement of this transaction requires the corresponding movements on the involved parties' checking accounts. But this implies that the bank needs to hold central bank reserves as a means of settling this transaction. Any transaction made must correspond to a movement in central bank reserves. Credit cards therefore pose no threat to the efficacy of the central bank's monopoly. Other schemes, such as debit cards and electronic money in its present form, share these properties.
However, it is conceivable that at some point in the future the settlement might take place without regular recourse to central bank reserves. To see this, consider a situation in which a certain stored value card is widely accepted as payment form among merchants other than the issuer. Suppose that instead of transferring bank balances, the merchants could reduce their outstanding claims vis-a-vis each other by swapping their claims on the books of the card issuer. If this was possible, payments could be made without involving any bank transfers. Consequently, the new means of payment would be independent of any central bank reserve holdings of the credit institutions. [13]
This scenario mirrors the net settlement procedures that I have described for electronic interbank payments. To the extent that private obligations are "swapped" or "netted" against each other, demand for central bank money will be reduced. [14]
Can such a development pose a threat to the conduct of monetary policy? How likely is such a scenario? I believe: not very much, as both private agents and public authorities are likely to have an interest in maintaining to some extent more traditional forms of payment.
First, consumers might want to maintain some degree of anonymity when making payments. Complete anonymity, however, can only be guaranteed when paying with cash. Consumers might thus rather hold a combination of both cash and other types of payment devices. Second, settlement in central bank money has an advantage over settlement on an issuer's books in both its safety and finality. True finality can only be achieved when settlement occurs in central bank money. Security is a key feature of any payment system. Especially for payments of larger value, I believe that the uniqueness of central bank money in providing immediate finality will remain an important advantage over the new forms of payment.
Nevertheless, I believe that central banks should have the adequate tools to meet any challenges that arise from the new technologies, even if today they seem remote. I will now present the regulatory tools that the ECB considers adequate to meet these challenges.
4 Regulatory Responses
Preserving the essential role of money in the economy requires a minimal, but effective, regulatory framework. Above all, it must be ensured that price stability and the unit of account function of money are not endangered. The ECB's position in the field of regulation of electronic money can be summarised in five points:
A. Prudential Supervision
Issuers of electronic money must be subject to prudential supervision. In order to preserve the stability of and to maintain confidence in the financial system, the ECB requires an adequate level of financial soundness, sound risk management, and ongoing supervision by respective authorities.
B. Solid and transparent legal arrangements; technical security; protection against criminal abuse
The issuance must be subject to solid and transparent legal arrangements. The rights and obligations of the respective participants, including issuers, merchants, and customers, must be clearly defined and be enforceable. The need for well-defined legal structure is especially evident when a scheme operates on a cross-border basis.
Adequate technical and organisational safeguards should be maintained to prevent threats to the security of the scheme such as counterfeit. Similarly, protection against criminal abuse should be taken into account in the design and implementation of the scheme.
C. Monetary statistics reporting
Information about the amount of money available in the economy is indispensable for the conduct of monetary policy. Electronic money schemes should therefore supply the central bank with adequate statistical information.
D. Redeem ability
Issuers of electronic money must be legally obliged, at request of the holders, to redeem electronic money against central bank money at par. This requirement ensures that the unit- of-account function of money is maintained. Furthermore, without a close link to central bank money, there could potentially be an unlimited creation of electronic money, which could, in turn, lead to inflationary pressure.
E. Reserve Requirements
The possibility must exist for central banks to impose reserve requirements on all issuers of electronic money, in particular in order to be prepared for a substantial growth of electronic money with a material impact on monetary policy. Such a reserve requirement could limit the risk of unrestricted growth in electronic money and help to maintain price stability. Furthermore, it ensures equal treatment in comparison with issuers of other forms of money.
5. Conclusion
To sum up, recent technological developments have changed and continue to change payments habits. These developments have the potential to improve the efficiency of the financial system. However, they pose challenges to central banks in their conduct of monetary policy.
Some of these challenges are not new. Central banks have before experienced competition from private issuers of money, for instance in the free-banking episode. Thus, the spread of electronic money poses an old problem, but in a different form.
New developments in electronic interbank payments have paved the way for a change from net to real time gross settlement. By this, the payment mechanism has become more reliable for users, and at the same time much safer in terms of systemic risk.
Electronic money is being considered by some the main future challenge to central banking. I believe this is only partly true. There will always be a need for the element of security, confidence, and information that central bank money contains. Unregulated electronic money cannot provide such a fundamental precondition, which is, I believe, at the heart of the well functioning of a market economy. Therefore, I do not believe that electronic money will become a threat to monetary policy in the near future.
Nevertheless, in order to ensure that under no circumstance the central bank loses its ability to preserve price stability and to maintain the unit of account function of money, a certain degree of regulation is indispensable. With the regulatory requirements that I have outlined, the ECB will continue to provide a monetary framework in which the goal of maintaining price stability can be achieved.
XXX . V000000 Monetary Workarounds
Central bank digital currency and sovereign money accounts.
Intermediate approaches to monetary reform
Introduction
Since about 2013/14 scholars have been looking for an intermediate or gradual approach to monetary reform. If a 'big bang' transition from bankmoney to central-bank sovereign money could not be achieved anytime soon, something less radical might be attainable. The common feature of various ideas put forth in this regard is introducing non-cash central-bank money into public circulation without, however, directly challenging the present bankmoney privilege, that is, the banking sector's ability to create itself the bankmoney on which the banks operate in their dealings with the nonbank public. (For a brief glossary of terms see footnote ).
The idea is about giving the nonbank public the option to choose between bankmoney and central-bank money. The two would exist in parallel. By some supporters this is idealised as 'combining the best of two worlds', while others, more appropriately, hope for the approach to be a half-way house to full-blown monetary reform that would put an end to the bankmoney privilege. Over time, the central-bank money in public circulation would possibly drive out the bankmoney, thus reverting the wrong-headed development of the last hundred years by which bankmoney has driven out sovereign money to about 90 per cent now – so that what we have today is a bankmoney regime, pro-actively led by the banks, while the central banks have given up control over the stock of money.
Among the proposals put forth, six shall be discussed here:
► central bank issued digital currency (CBDC) based on blockchain technology, and
► sovereign money accounts as an alternative option to bank giro accounts.
There are further variants of the latter approach, for example,
► central bank accounts for everybody, and
► mobile use of money accounts.
Two other approaches often mentioned in this context are
► helicopter money and
► safe deposits by way of a voluntary 100% reserve on individual deposits.
However, helicopter money and 100% reserve-backed deposits do not actually belong here as will be discussed in two related sections at the end of the paper.
Since about 2013/14 scholars have been looking for an intermediate or gradual approach to monetary reform. If a 'big bang' transition from bankmoney to central-bank sovereign money could not be achieved anytime soon, something less radical might be attainable. The common feature of various ideas put forth in this regard is introducing non-cash central-bank money into public circulation without, however, directly challenging the present bankmoney privilege, that is, the banking sector's ability to create itself the bankmoney on which the banks operate in their dealings with the nonbank public. (For a brief glossary of terms see footnote ).
The idea is about giving the nonbank public the option to choose between bankmoney and central-bank money. The two would exist in parallel. By some supporters this is idealised as 'combining the best of two worlds', while others, more appropriately, hope for the approach to be a half-way house to full-blown monetary reform that would put an end to the bankmoney privilege. Over time, the central-bank money in public circulation would possibly drive out the bankmoney, thus reverting the wrong-headed development of the last hundred years by which bankmoney has driven out sovereign money to about 90 per cent now – so that what we have today is a bankmoney regime, pro-actively led by the banks, while the central banks have given up control over the stock of money.
Among the proposals put forth, six shall be discussed here:
► central bank issued digital currency (CBDC) based on blockchain technology, and
► sovereign money accounts as an alternative option to bank giro accounts.
There are further variants of the latter approach, for example,
► central bank accounts for everybody, and
► mobile use of money accounts.
Two other approaches often mentioned in this context are
► helicopter money and
► safe deposits by way of a voluntary 100% reserve on individual deposits.
However, helicopter money and 100% reserve-backed deposits do not actually belong here as will be discussed in two related sections at the end of the paper.
Two developments that challenge the sovereign monetary prerogatives
The question arises today of whether it is possible to introduce sovereign money into public circulation, be it as central bank issued digital currency or in the form of separate and thus safe sovereign money accounts for everyone. From a chartalist point of view, either option is highly desirable. Otherwise, there is a great danger of finally losing out to two current developments both of which challenge the sovereign monetary prerogatives. The latter comprise a sovereign state's rights to determine the currency of the realm (the official monetary unit of account), issuing the money denominated in that currency, and benefitting from the seigniorage thereof, that is, the gain from creating new money.
The development of the present bankmoney regime for over a hundred years has already been driving back to a large extent the sovereign prerogatives of money creation and seigniorage to the benefit of the banking and financial industries. The two current developments that might bring matters to a head are the disappearance of traditional solid cash and the emergence of private digital monies, such as Bitcoin. The abandonment of sovereign solid cash together with the dissemination of private digital currencies is probably the most effective way to dispense with the need for central banks and the monetary sovereignty of states altogether.
Solid cash is bound to dwindle or be abolished sooner or later. A hundred years ago, the ratio between bankmoney and sovereign cash (coins and notes) was about 40:60. Today, statistically, it is 80:20 in the eurozone; effectively, it is rather about 90:10, because a share of the cash is hoarded as a safety buffer or circulates abroad as a parallel currency, while the cash used in the internal underground economy is part of the active domestic money.
To create and maintain 100 euros in bankmoney, banks today need a reserve in central-bank money of only 2.5 euros, of which 1.4 euros are in cash for the ATMs, the rest being non-cash excess reserves (interbank payment reserves) and a 1% minimum reserve requirement. To become absolutely independent of central banks and fully complete the reign of the bankmoney regime, commercial banks would have to dispense with the small remainder of a 1.4% cash reserve and 1.1% non-cash reserve. Furthermore, handling cash is definitely more expensive than the computerised handling of money-on-account.
Monetary policy makers, too, want to eliminate cash, since it is still a hurdle to imposing negative interest rates on the deposits of bank customers.[2] People can circumvent negative interest by holding their money in cash. If too many people try to do so at once, this would be a bank run straightaway – a disaster in-built in fractional reserve banking that policy makers will not want to provoke wilfully. Ironically, it is governments today that are most keen on abolishing sovereign cash, fostering the illusion that this would drain the swamp of underground money foregone to the revenue office.
The second current development challenging the sovereign monetary prerogatives extends even further than abolishing solid cash. The emergence of private digital currencies based on blockchain technology challenges central banks and banks alike. Bitcoin, Litecoin, Peercoin, Nxt and dozens more crypto-currencies need neither of the two.
The question arises today of whether it is possible to introduce sovereign money into public circulation, be it as central bank issued digital currency or in the form of separate and thus safe sovereign money accounts for everyone. From a chartalist point of view, either option is highly desirable. Otherwise, there is a great danger of finally losing out to two current developments both of which challenge the sovereign monetary prerogatives. The latter comprise a sovereign state's rights to determine the currency of the realm (the official monetary unit of account), issuing the money denominated in that currency, and benefitting from the seigniorage thereof, that is, the gain from creating new money.
The development of the present bankmoney regime for over a hundred years has already been driving back to a large extent the sovereign prerogatives of money creation and seigniorage to the benefit of the banking and financial industries. The two current developments that might bring matters to a head are the disappearance of traditional solid cash and the emergence of private digital monies, such as Bitcoin. The abandonment of sovereign solid cash together with the dissemination of private digital currencies is probably the most effective way to dispense with the need for central banks and the monetary sovereignty of states altogether.
Solid cash is bound to dwindle or be abolished sooner or later. A hundred years ago, the ratio between bankmoney and sovereign cash (coins and notes) was about 40:60. Today, statistically, it is 80:20 in the eurozone; effectively, it is rather about 90:10, because a share of the cash is hoarded as a safety buffer or circulates abroad as a parallel currency, while the cash used in the internal underground economy is part of the active domestic money.
To create and maintain 100 euros in bankmoney, banks today need a reserve in central-bank money of only 2.5 euros, of which 1.4 euros are in cash for the ATMs, the rest being non-cash excess reserves (interbank payment reserves) and a 1% minimum reserve requirement. To become absolutely independent of central banks and fully complete the reign of the bankmoney regime, commercial banks would have to dispense with the small remainder of a 1.4% cash reserve and 1.1% non-cash reserve. Furthermore, handling cash is definitely more expensive than the computerised handling of money-on-account.
Monetary policy makers, too, want to eliminate cash, since it is still a hurdle to imposing negative interest rates on the deposits of bank customers.[2] People can circumvent negative interest by holding their money in cash. If too many people try to do so at once, this would be a bank run straightaway – a disaster in-built in fractional reserve banking that policy makers will not want to provoke wilfully. Ironically, it is governments today that are most keen on abolishing sovereign cash, fostering the illusion that this would drain the swamp of underground money foregone to the revenue office.
The second current development challenging the sovereign monetary prerogatives extends even further than abolishing solid cash. The emergence of private digital currencies based on blockchain technology challenges central banks and banks alike. Bitcoin, Litecoin, Peercoin, Nxt and dozens more crypto-currencies need neither of the two.
Central bank issued digital currency (CBDC)
Having taken a wait-and-see stance for a while, central bankers have started to think about confronting the new challengers by creating a digital currency of their own, thus trying to continue the traditional sovereign monopoly on solid cash in a modern way by implementing sovereign digital money.
A. Haldane, chief economist of the Bank of England, and other staff of the Bank were among the first to reflect on central bank issued digital currency (CBDC).[3] D. Andolfatto, vice president of the St. Louis Federal Reserve, also proposed 'Fedcoins' for public use.[4] The Basel Bank for International Settlements, the Swedish Riksbank and the central bank of Denmark as well as Chinas central bank followed suit.[5] Singapore and Canada are reported to have already tested a blockchain-based currency for internet business.[6] Furthermore, a number of scholars within the international monetary reform movement had started to look into central bank digital money.[7]
Introducing CBDC could be a substantial and perhaps even decisive step towards restoring the sovereign monetary prerogatives. Digital currency issued by a central bank is not intended to be an alternative to the national currency in place, rather, a cash-like legal-tender alternative to commercial digital currencies as well as bankmoney, with the potential to drive out the former soon and push back the latter again in the longer term.
Strictly speaking, CBDC is of course not about cash or currency in a traditional sense, something solid to touch and carry around. Rather, it is about another kind of money-on-account, whereby an account in the blockchain context is not a conventional bank account, but is called a 'wallet', a digital wallet. Direct transfer of CBDC-units between digital wallets is possible without monetary intermediation by a bank or the central bank. CBDC-units and central-bank money-on-account can be exchanged for one another, analogous to an exchange between solid cash and bankmoney (on account).
Rather than being 'minted' by an opaque stand-alone algorithm with no reference to the real world, the only 'miner' to insert digital money into the blockchain would be the central bank, following its own discretionary policy specifications. Processing the distributed ledger would need to be much less energy-intensive than is the case now and much faster, allowing for many thousand transactions in a second rather than only seven as is presently the case with Bitcoin.[8]
According to a model by Barrdear and Kumhof of the Bank of England, a central bank issuing digital currency would be 'granting universal, electronic, 24x7, national-currency-denominated and interest-bearing access to its balance sheet'. This can be seen as a modern variant of 'Tobin’s 1987 proposal for deposited currency accounts'. CBDC would be 'implemented via distributed ledgers and competes with bank deposits as a medium of exchange'.
The authors consider a pre-crisis setting 'in which an initial stock of CBDC equal to 30% of GDP is issued against an equal amount of government debt, and is then, subject to countercyclical variations over the business cycle, maintained at that level. We choose 30% because this is an amount loosely similar to the magnitudes of QE conducted by various central banks over the last decade.' According to the authors' DSGE model, this 'could permanently raise GDP by as much as 3%, due to reductions in real interest rates, distortionary taxes, and monetary transaction costs. Countercyclical CBDC price or quantity rules, as a second monetary policy instrument, could substantially improve the central bank's ability to stabilize the business cycle.'[9]
Being interest-bearing for the holder underpins the cash-like nature of CBDC. Early banknotes were interest-bearing too. The digital currency would be issued exclusively in exchange for sovereign bonds purchased by a central bank on the open market. The quantity of CBDC in circulation can thus be dispensed in a measured way and kept under control. A hypothetical landslide migration from bank deposits (bankmoney, in fact a money surrogate) to CBDC (the high-powered 'real thing') can also be prevented in this way. The government would redeem the bonds upon maturity, but the CBDC-units would continue to exist until used in a payment to the central bank (upon which act the central bank liability would be deleted).
One might ask whether Gresham's law might apply to the relation between CBDC and bankmoney, expecting the 'high-powered' and safe CBDC to drive out the not-that-trustworthy bankmoney. The question will be resumed in the next section.
The question of why sovereign fiat money should be 'secured' by collateral at all may be raised on this occasion. Why could it not be accounted for as an addition to a central bank's equity, adding to a nation's monetary endowment, rather than adding to the sovereign issuer's liabilities? As the authors themselves observe, the arrangement of their plan creates increased and direct interdependence of monetary and fiscal policy. This can be seen as a problematic feature of the plan.
Having taken a wait-and-see stance for a while, central bankers have started to think about confronting the new challengers by creating a digital currency of their own, thus trying to continue the traditional sovereign monopoly on solid cash in a modern way by implementing sovereign digital money.
A. Haldane, chief economist of the Bank of England, and other staff of the Bank were among the first to reflect on central bank issued digital currency (CBDC).[3] D. Andolfatto, vice president of the St. Louis Federal Reserve, also proposed 'Fedcoins' for public use.[4] The Basel Bank for International Settlements, the Swedish Riksbank and the central bank of Denmark as well as Chinas central bank followed suit.[5] Singapore and Canada are reported to have already tested a blockchain-based currency for internet business.[6] Furthermore, a number of scholars within the international monetary reform movement had started to look into central bank digital money.[7]
Introducing CBDC could be a substantial and perhaps even decisive step towards restoring the sovereign monetary prerogatives. Digital currency issued by a central bank is not intended to be an alternative to the national currency in place, rather, a cash-like legal-tender alternative to commercial digital currencies as well as bankmoney, with the potential to drive out the former soon and push back the latter again in the longer term.
Strictly speaking, CBDC is of course not about cash or currency in a traditional sense, something solid to touch and carry around. Rather, it is about another kind of money-on-account, whereby an account in the blockchain context is not a conventional bank account, but is called a 'wallet', a digital wallet. Direct transfer of CBDC-units between digital wallets is possible without monetary intermediation by a bank or the central bank. CBDC-units and central-bank money-on-account can be exchanged for one another, analogous to an exchange between solid cash and bankmoney (on account).
Rather than being 'minted' by an opaque stand-alone algorithm with no reference to the real world, the only 'miner' to insert digital money into the blockchain would be the central bank, following its own discretionary policy specifications. Processing the distributed ledger would need to be much less energy-intensive than is the case now and much faster, allowing for many thousand transactions in a second rather than only seven as is presently the case with Bitcoin.[8]
According to a model by Barrdear and Kumhof of the Bank of England, a central bank issuing digital currency would be 'granting universal, electronic, 24x7, national-currency-denominated and interest-bearing access to its balance sheet'. This can be seen as a modern variant of 'Tobin’s 1987 proposal for deposited currency accounts'. CBDC would be 'implemented via distributed ledgers and competes with bank deposits as a medium of exchange'.
The authors consider a pre-crisis setting 'in which an initial stock of CBDC equal to 30% of GDP is issued against an equal amount of government debt, and is then, subject to countercyclical variations over the business cycle, maintained at that level. We choose 30% because this is an amount loosely similar to the magnitudes of QE conducted by various central banks over the last decade.' According to the authors' DSGE model, this 'could permanently raise GDP by as much as 3%, due to reductions in real interest rates, distortionary taxes, and monetary transaction costs. Countercyclical CBDC price or quantity rules, as a second monetary policy instrument, could substantially improve the central bank's ability to stabilize the business cycle.'[9]
Being interest-bearing for the holder underpins the cash-like nature of CBDC. Early banknotes were interest-bearing too. The digital currency would be issued exclusively in exchange for sovereign bonds purchased by a central bank on the open market. The quantity of CBDC in circulation can thus be dispensed in a measured way and kept under control. A hypothetical landslide migration from bank deposits (bankmoney, in fact a money surrogate) to CBDC (the high-powered 'real thing') can also be prevented in this way. The government would redeem the bonds upon maturity, but the CBDC-units would continue to exist until used in a payment to the central bank (upon which act the central bank liability would be deleted).
One might ask whether Gresham's law might apply to the relation between CBDC and bankmoney, expecting the 'high-powered' and safe CBDC to drive out the not-that-trustworthy bankmoney. The question will be resumed in the next section.
The question of why sovereign fiat money should be 'secured' by collateral at all may be raised on this occasion. Why could it not be accounted for as an addition to a central bank's equity, adding to a nation's monetary endowment, rather than adding to the sovereign issuer's liabilities? As the authors themselves observe, the arrangement of their plan creates increased and direct interdependence of monetary and fiscal policy. This can be seen as a problematic feature of the plan.
Sovereign money accounts as an alternative option to bank giro accounts
In some of the working papers on CBDC, it is not entirely clear whether the issue concerns central-bank money in digital wallets, liquid reserves in central bank accounts or even 'e-cash' related to a central bank account. For example, the Fedcoin idea was portrayed as 'Fedwire for all', and CBDC was said not necessarily to require a distributed ledger. Apparently there are still some 'details' to be clarified.
The desirable effects of a CBDC can in fact also be achieved by introducing a new type of current account – sovereign money accounts, or money accounts for short – as an alternative to the present bank giro accounts containing bankmoney.[10] Money accounts would offer nonbanks (firms, households, government bodies without a central bank account and non-monetary financial institutions) the option of reserves-on-account, just like banks and government bodies with a central bank account have, rather than having bankmoney-on-account, as is the case today. Such money accounts would also be an answer to the question of safe deposits, which regularly resurfaces in banking crises.
Money accounts can be managed by banks or other payment service providers. The money would be kept in a separate central bank account in the form of a customer transaction omnibus account of a bank or other payment provider. That transaction account would have its own address in the respective electronic payment system so that money could be transferred directly among money accounts without monetary intermediation by the banks. Therefore, a customer transaction money account ought to be an off-balance item, separate from a bank's own reserves, analogous to customer securities accounts. Money then is the property of the customer and is neither an asset nor a liability on a bank's or other payment provider's balance sheet. The proposal could thus also be referred to as an approach of separate accounts.[11]
Introducing money accounts means the separation of a bank's proprietary means from the means of the bank's customers. Non-segregation of a bank's proprietary means and customer means is a core feature of the present bankmoney regime on the basis of fractional reserves. The split-circuit reserve system (split between the interbank reserve circuit and the public bankmoney circuit) would still exist, but customers would have the choice between bankmoney and central-bank money (= reserves = sovereign money). All nonbanks could in fact maintain both types of account.
Offering money accounts to customers could be optional or made compulsory for the providers. As soon as such an offer exists, many customers will not hesitate to make use of it. Firms and people would decide which kind of account they prefer. Indirect transfers between money accounts and giro accounts would be possible, in the same way as it is possible today to transfer an amount of money from a government central bank account to any bank giro account (by way of the recipient bank crediting the respective customer account), and, in the opposite direction, to transfer an amount of money from a bank giro account to a government central bank account (by way of the remitting bank deleting the bankmoney and transferring the respective amount of reserves to the government account). The banks as monetary intermediaries receive and pay out transfers in liquid reserves anyway.
Reserves would enter public circulation in that the government or the banks would make payments to customers in reserves into such money accounts. The government would obtain the money in its central-bank accounts in much the same way as it does now (by receiving bank payments), and the banks would continue to receive the reserves from the central bank.
Operating the two types of accounts in parallel and in mutual exchange would not pose a problem. For a bank, no disadvantage or advantage would arise (in contrast to QE4P or monetary financing without money accounts, as discussed below, in which banks are free riders of the arrangement). The reason is that payments within and between customers omnibus accounts are neutral for the banks, meaning that in this case a bank will not have to use its own money, nor will that bank receive additional reserves.
In a payment from a money account to a giro account, the recipient customer's bank will obtain the reserves, whereas the customer will receive a demand deposit (bankmoney) in the giro account. The reserves obtained in this way, however, are in fact not discretionary for the banks but will largely be committed to payments in the reverse direction, when the giro customers of that bank make payments into money accounts. On balance of all the payments in and out, larger surpluses or deficits are unlikely; should they occur, they can be offset on the interbank money market.
In this way money accounts could be a meaningful start of a gradual transition from the present bankmoney regime to a full-blown sovereign money system, depending on the market decision of money users regarding which type of account they would prefer to use. The more the use of money accounts would propagate, the bigger the shift in payment volumes from giro to money accounts would be. As a result, the extremely low fraction to which banks refinance today would increase.
This would induce higher, though distributed, refinancing costs for the banking sector. The actual refinancing costs of banks can be expected to be about the same as if people made more payments in cash again rather than using cashless transfer of bankmoney via giro accounts. Around 1900, banks in Europe actually had no problem with a cash-to-bankmoney ratio of about 60:40. Until the 1950–60s, the ratio was still about 50:50. In the eurozone today, it is currently about 20:80, statistically. Why should the banking industry have problems with a money-to-giro account ratio coming closer again to 50:50?
Upon the introduction of money accounts, one might at first glance expect a landslide shift from giro accounts to money accounts. However, running giro and money accounts at the same time raises the question of whether Gresham's law would apply again. With regard to traditional coin currencies, that law stated that bad coins (with lower silver content) were driving out good coins, as people tried to dispose of bad coins while preferring to obtain and keep the good ones for themselves. As regards safety, giro accounts are the bad ones in comparison with money accounts containing high-powered central-bank money. Consequently, people might try to be paid into a money account, while making payments from a giro to another giro account. At the same time, keeping a money account might cost a little more. The safety of money is a hot issue only in times of crisis, while in normal times people pay more attention to the costs of banking.
In view of the cost issue and the Gresham situation, the option of money accounts will not automatically result in an immediate mass migration away from giro accounts. This renders obsolete another concern, which is how banks could provide enough acceptable collateral to take up the additional reserves at the central bank in a landslide shift from giro to money accounts.
In some of the working papers on CBDC, it is not entirely clear whether the issue concerns central-bank money in digital wallets, liquid reserves in central bank accounts or even 'e-cash' related to a central bank account. For example, the Fedcoin idea was portrayed as 'Fedwire for all', and CBDC was said not necessarily to require a distributed ledger. Apparently there are still some 'details' to be clarified.
The desirable effects of a CBDC can in fact also be achieved by introducing a new type of current account – sovereign money accounts, or money accounts for short – as an alternative to the present bank giro accounts containing bankmoney.[10] Money accounts would offer nonbanks (firms, households, government bodies without a central bank account and non-monetary financial institutions) the option of reserves-on-account, just like banks and government bodies with a central bank account have, rather than having bankmoney-on-account, as is the case today. Such money accounts would also be an answer to the question of safe deposits, which regularly resurfaces in banking crises.
Money accounts can be managed by banks or other payment service providers. The money would be kept in a separate central bank account in the form of a customer transaction omnibus account of a bank or other payment provider. That transaction account would have its own address in the respective electronic payment system so that money could be transferred directly among money accounts without monetary intermediation by the banks. Therefore, a customer transaction money account ought to be an off-balance item, separate from a bank's own reserves, analogous to customer securities accounts. Money then is the property of the customer and is neither an asset nor a liability on a bank's or other payment provider's balance sheet. The proposal could thus also be referred to as an approach of separate accounts.[11]
Introducing money accounts means the separation of a bank's proprietary means from the means of the bank's customers. Non-segregation of a bank's proprietary means and customer means is a core feature of the present bankmoney regime on the basis of fractional reserves. The split-circuit reserve system (split between the interbank reserve circuit and the public bankmoney circuit) would still exist, but customers would have the choice between bankmoney and central-bank money (= reserves = sovereign money). All nonbanks could in fact maintain both types of account.
Offering money accounts to customers could be optional or made compulsory for the providers. As soon as such an offer exists, many customers will not hesitate to make use of it. Firms and people would decide which kind of account they prefer. Indirect transfers between money accounts and giro accounts would be possible, in the same way as it is possible today to transfer an amount of money from a government central bank account to any bank giro account (by way of the recipient bank crediting the respective customer account), and, in the opposite direction, to transfer an amount of money from a bank giro account to a government central bank account (by way of the remitting bank deleting the bankmoney and transferring the respective amount of reserves to the government account). The banks as monetary intermediaries receive and pay out transfers in liquid reserves anyway.
Reserves would enter public circulation in that the government or the banks would make payments to customers in reserves into such money accounts. The government would obtain the money in its central-bank accounts in much the same way as it does now (by receiving bank payments), and the banks would continue to receive the reserves from the central bank.
Operating the two types of accounts in parallel and in mutual exchange would not pose a problem. For a bank, no disadvantage or advantage would arise (in contrast to QE4P or monetary financing without money accounts, as discussed below, in which banks are free riders of the arrangement). The reason is that payments within and between customers omnibus accounts are neutral for the banks, meaning that in this case a bank will not have to use its own money, nor will that bank receive additional reserves.
In a payment from a money account to a giro account, the recipient customer's bank will obtain the reserves, whereas the customer will receive a demand deposit (bankmoney) in the giro account. The reserves obtained in this way, however, are in fact not discretionary for the banks but will largely be committed to payments in the reverse direction, when the giro customers of that bank make payments into money accounts. On balance of all the payments in and out, larger surpluses or deficits are unlikely; should they occur, they can be offset on the interbank money market.
In this way money accounts could be a meaningful start of a gradual transition from the present bankmoney regime to a full-blown sovereign money system, depending on the market decision of money users regarding which type of account they would prefer to use. The more the use of money accounts would propagate, the bigger the shift in payment volumes from giro to money accounts would be. As a result, the extremely low fraction to which banks refinance today would increase.
This would induce higher, though distributed, refinancing costs for the banking sector. The actual refinancing costs of banks can be expected to be about the same as if people made more payments in cash again rather than using cashless transfer of bankmoney via giro accounts. Around 1900, banks in Europe actually had no problem with a cash-to-bankmoney ratio of about 60:40. Until the 1950–60s, the ratio was still about 50:50. In the eurozone today, it is currently about 20:80, statistically. Why should the banking industry have problems with a money-to-giro account ratio coming closer again to 50:50?
Upon the introduction of money accounts, one might at first glance expect a landslide shift from giro accounts to money accounts. However, running giro and money accounts at the same time raises the question of whether Gresham's law would apply again. With regard to traditional coin currencies, that law stated that bad coins (with lower silver content) were driving out good coins, as people tried to dispose of bad coins while preferring to obtain and keep the good ones for themselves. As regards safety, giro accounts are the bad ones in comparison with money accounts containing high-powered central-bank money. Consequently, people might try to be paid into a money account, while making payments from a giro to another giro account. At the same time, keeping a money account might cost a little more. The safety of money is a hot issue only in times of crisis, while in normal times people pay more attention to the costs of banking.
In view of the cost issue and the Gresham situation, the option of money accounts will not automatically result in an immediate mass migration away from giro accounts. This renders obsolete another concern, which is how banks could provide enough acceptable collateral to take up the additional reserves at the central bank in a landslide shift from giro to money accounts.
Central bank accounts for everyone?
An even simpler proposal than separate accounts is to call for a central bank account for everyone, as put forth, for example, by Schemmann and Andresen.[12] Gocht, a former member of the Bundesbank board of governors, suggested in 1975 assigning all regular payment functions to the postal giro office to separate the payment functions from the credit and investment business of banks.[13]
The proposal sounds plausible, but most national giro offices no longer exist. They have been incorporated into the commercial banking industry, been successfully contained by the improved giro and payment systems of the banks, or suffered from a low image as 'poor people's banking' because a considerable proportion of their customers were or are welfare clients. As a result, the crux of the matter today is that a central bank would have to make a huge effort to build up the respective infrastructure almost from scratch, while the banks would have to bear huge sunk costs and lay off employees.
Independently, one may ask whether mass management of accounts is a reasonable task for the national monetary authority. Some companies, concerned about the safety of their bankmoney at the height of the crisis, wanted to open a central bank account but were repelled, in a few cases even by a court decision. A central bank today acts primarily as the bank of the banks, residually as a manager of government transaction accounts, while no longer conducting business with the public. Money accounts for firms and households, however, can be run perfectly well by the banks themselves or by other payment service providers, as described above: by way of separate customer transaction omnibus accounts, as a sub-account or additional account of a bank or another payment service provider with the central bank, managed by the banks or other providers.
An even simpler proposal than separate accounts is to call for a central bank account for everyone, as put forth, for example, by Schemmann and Andresen.[12] Gocht, a former member of the Bundesbank board of governors, suggested in 1975 assigning all regular payment functions to the postal giro office to separate the payment functions from the credit and investment business of banks.[13]
The proposal sounds plausible, but most national giro offices no longer exist. They have been incorporated into the commercial banking industry, been successfully contained by the improved giro and payment systems of the banks, or suffered from a low image as 'poor people's banking' because a considerable proportion of their customers were or are welfare clients. As a result, the crux of the matter today is that a central bank would have to make a huge effort to build up the respective infrastructure almost from scratch, while the banks would have to bear huge sunk costs and lay off employees.
Independently, one may ask whether mass management of accounts is a reasonable task for the national monetary authority. Some companies, concerned about the safety of their bankmoney at the height of the crisis, wanted to open a central bank account but were repelled, in a few cases even by a court decision. A central bank today acts primarily as the bank of the banks, residually as a manager of government transaction accounts, while no longer conducting business with the public. Money accounts for firms and households, however, can be run perfectly well by the banks themselves or by other payment service providers, as described above: by way of separate customer transaction omnibus accounts, as a sub-account or additional account of a bank or another payment service provider with the central bank, managed by the banks or other providers.
Mobile use of money accounts
Sovereign money accounts in whichever form can be equipped with today's transfer tools, for example credit cards, so-called cash cards or, which are the same, e-cash cards, as well as the corresponding pay-as-you-go functions implemented in mobile phones.
Activation of a money transfer by making use of such a card or mobile-phone function results in the transfer of money-on-account, today normally from a bank giro account into another such account. The term 'cash' or 'e-cash' is thus misleading, because there is no money on the magnetic strip or chip of such cards or phones, either e-cash or money-on-account. Instead, the strip or chip stores the information about a respective amount (an account balance). The information has been downloaded from a bank giro account onto the device, upon which act that individual giro account is debited and the amount transferred (credited) to a bank's e-cash omnibus account, from where the bankmoney is then transferred to a recipient when a customer 'pays' – more precisely, triggers a payment from a bank's e-cash omnibus account to an individual bank giro another – with a cash card or phone.
With sovereign money accounts, in which ever form, the procedure would be analogous. The cards themselves would not carry 'sovereign cash' but represent a balance of money-on-account, and using such cards would trigger a money transfer from a money account to some other account.
Sovereign money accounts in whichever form can be equipped with today's transfer tools, for example credit cards, so-called cash cards or, which are the same, e-cash cards, as well as the corresponding pay-as-you-go functions implemented in mobile phones.
Activation of a money transfer by making use of such a card or mobile-phone function results in the transfer of money-on-account, today normally from a bank giro account into another such account. The term 'cash' or 'e-cash' is thus misleading, because there is no money on the magnetic strip or chip of such cards or phones, either e-cash or money-on-account. Instead, the strip or chip stores the information about a respective amount (an account balance). The information has been downloaded from a bank giro account onto the device, upon which act that individual giro account is debited and the amount transferred (credited) to a bank's e-cash omnibus account, from where the bankmoney is then transferred to a recipient when a customer 'pays' – more precisely, triggers a payment from a bank's e-cash omnibus account to an individual bank giro another – with a cash card or phone.
With sovereign money accounts, in which ever form, the procedure would be analogous. The cards themselves would not carry 'sovereign cash' but represent a balance of money-on-account, and using such cards would trigger a money transfer from a money account to some other account.
Helicopter money
Helicopter money is also known as QE4P (Quantitative Easing for People) and as monetary financing.[14] The different terms have the same meaning, that is, direct central-bank funding of government expenditure. Helicopter money is often seen as a first step towards sovereign money reform, which however it is not, because helicopter money is not about introducing non-cash central-bank money into public circulation. Instead, it might contribute to a permanent mix-up of monetary and fiscal responsibilities.
Technically, today's money system is no longer based on cash nor dominated by it, as was the case with the Greenbacks, the US Treasury notes, in the 19th century, when strongboxes were shipped across the country. In today's basically cashless monetary and banking system, when the government spends reserves from its central-bank account, firms and people get a deposit entry (bankmoney), while the banks obtain the reserves for free. The banks would thus be free riders of the arrangement. The more extensive monetary financing would be, the less the banks would still have to refinance at a cost. If traditional solid coins and notes, which banks still have to refinance to 100%, are then replaced with still more bankmoney and 'e-cash' originated by the banks themselves, any of the existing monetary policy instruments will ultimately be pointless.
Helicopter money could be helpful to a degree as an economic stimulus when there is a pronounced lack of effective demand. But a first step towards monetary reform it is not, for it does not create a cashless public circuit based on central-bank money. Apart from this, the legal admissibility of helicopter money under EU law – Art. 123 (1) TFEU – is questionable, which represents an additional hurdle.
Helicopter money is also known as QE4P (Quantitative Easing for People) and as monetary financing.[14] The different terms have the same meaning, that is, direct central-bank funding of government expenditure. Helicopter money is often seen as a first step towards sovereign money reform, which however it is not, because helicopter money is not about introducing non-cash central-bank money into public circulation. Instead, it might contribute to a permanent mix-up of monetary and fiscal responsibilities.
Technically, today's money system is no longer based on cash nor dominated by it, as was the case with the Greenbacks, the US Treasury notes, in the 19th century, when strongboxes were shipped across the country. In today's basically cashless monetary and banking system, when the government spends reserves from its central-bank account, firms and people get a deposit entry (bankmoney), while the banks obtain the reserves for free. The banks would thus be free riders of the arrangement. The more extensive monetary financing would be, the less the banks would still have to refinance at a cost. If traditional solid coins and notes, which banks still have to refinance to 100%, are then replaced with still more bankmoney and 'e-cash' originated by the banks themselves, any of the existing monetary policy instruments will ultimately be pointless.
Helicopter money could be helpful to a degree as an economic stimulus when there is a pronounced lack of effective demand. But a first step towards monetary reform it is not, for it does not create a cashless public circuit based on central-bank money. Apart from this, the legal admissibility of helicopter money under EU law – Art. 123 (1) TFEU – is questionable, which represents an additional hurdle.
Safe deposits by way of a voluntary 100% reserve
In the aftermath of the banking crises in 2008–12, a number of scholars, as well as bankers managing the accounts of companies or wealthy individuals who were scared about the safety of their deposits, produced the idea of backing up the deposits in bank giro accounts by way of a voluntary 100% reserve on such deposits.[15] This would certainly create safe deposits, but the idea is very unlikely to succeed and to create a public circuit based on those reserves.
There are a number of reasons for this, starting with the fact that implementing a 100% reserve on deposits, in lieu of the existing 1% minimum reserve requirement, is costly for a single bank. A bank pioneering the idea would suffer a significant disadvantage in cost competition. Ultimately it would be the respective customers who would have to bear the additional costs. Most customers would not be prepared to accept the additional costs – which makes the idea appear to be another kind of safe haven for the rich only. Furthermore, in a mixed setting of 100%-reserve banks and fractional-reserve banks side by side, it would be next to impossible to make sure that the reserves accompanying customer payments stay attached to the deposits, even more so under the present condition of non-segregation of customer money from a bank's own means. In comparison with 100%-banking, the approaches of CBDCs as well as safe and separate money accounts are clearly preferable.
In the aftermath of the banking crises in 2008–12, a number of scholars, as well as bankers managing the accounts of companies or wealthy individuals who were scared about the safety of their deposits, produced the idea of backing up the deposits in bank giro accounts by way of a voluntary 100% reserve on such deposits.[15] This would certainly create safe deposits, but the idea is very unlikely to succeed and to create a public circuit based on those reserves.
There are a number of reasons for this, starting with the fact that implementing a 100% reserve on deposits, in lieu of the existing 1% minimum reserve requirement, is costly for a single bank. A bank pioneering the idea would suffer a significant disadvantage in cost competition. Ultimately it would be the respective customers who would have to bear the additional costs. Most customers would not be prepared to accept the additional costs – which makes the idea appear to be another kind of safe haven for the rich only. Furthermore, in a mixed setting of 100%-reserve banks and fractional-reserve banks side by side, it would be next to impossible to make sure that the reserves accompanying customer payments stay attached to the deposits, even more so under the present condition of non-segregation of customer money from a bank's own means. In comparison with 100%-banking, the approaches of CBDCs as well as safe and separate money accounts are clearly preferable.
Final remarks
CBDCs and money accounts can be promising contributions to modernising money, and they can be an additional and perhaps decisive method of monetary reform by increasingly re-expanding the role of sovereign money while diminishing the share of bankmoney and pre-empting a general take-off of private digital currencies. However, this cannot be taken for granted. Using CBDCs or money accounts in parallel with bankmoney and private digital currencies might equally contribute to stabilising and even strengthening the latter. We cannot be sure about the final outcome. In any event, however, CBDCs as well as money accounts will be a positive element in the entire picture, contributing to the safety of money and, up to a point, a higher degree of effectiveness of monetary policy.
Notwithstanding, it should be pointed out that all these considerations do not mean that introducing central-bank money into public circulation, in whichever form, would provide an easier and better method of monetary reform than a full-blown sovereign money reform. The latter is designed to become effective on a set conversion day, but phasing out bankmoney is also a gradual process also in a conversion-day scenario, stretching over a number of years. In both cases the political, financial and operational disputes and collision of diverging interests are unavoidably about the same. Moreover, CBDCs or separate accounts will not by themselves change the dysfunctions of pro-active bankmoney creation by way of primary bank credit. Ultimately, a full conversion-day scenario remains the more consistent approach to sovereign money reform.
CBDCs and money accounts can be promising contributions to modernising money, and they can be an additional and perhaps decisive method of monetary reform by increasingly re-expanding the role of sovereign money while diminishing the share of bankmoney and pre-empting a general take-off of private digital currencies. However, this cannot be taken for granted. Using CBDCs or money accounts in parallel with bankmoney and private digital currencies might equally contribute to stabilising and even strengthening the latter. We cannot be sure about the final outcome. In any event, however, CBDCs as well as money accounts will be a positive element in the entire picture, contributing to the safety of money and, up to a point, a higher degree of effectiveness of monetary policy.
Notwithstanding, it should be pointed out that all these considerations do not mean that introducing central-bank money into public circulation, in whichever form, would provide an easier and better method of monetary reform than a full-blown sovereign money reform. The latter is designed to become effective on a set conversion day, but phasing out bankmoney is also a gradual process also in a conversion-day scenario, stretching over a number of years. In both cases the political, financial and operational disputes and collision of diverging interests are unavoidably about the same. Moreover, CBDCs or separate accounts will not by themselves change the dysfunctions of pro-active bankmoney creation by way of primary bank credit. Ultimately, a full conversion-day scenario remains the more consistent approach to sovereign money reform.
XXX . V0000000 A fluid concept
LIQUIDITY is everywhere. Depending on what you read, you may learn that the world's financial markets are awash with it, that there is a glut of it or even that there is a wall of it. But what exactly is it? Again depending on what you read, you may be told that “it is one of the most mentioned, but least understood, concepts in the financial market debate today” or that “there is rarely much clarity about what ‘buoyant liquidity' actually means.” An economics textbook may bring you clarity—or confusion. It is likely to define liquidity as the ease with which assets can be converted into money. Fine: but that is scarcely the stuff of dramatic metaphors. Liquidity thus defined is surely to be welcomed; floods, gluts and walls of water surely not.
Helpfully, Martin Barnes, of BCA Research, an economic research firm, has laid out three ways of looking at liquidity. The first has to do with overall monetary conditions: money supply, official interest rates and the price of credit. The second is the state of balance sheets—the share of money, or things that can be exchanged for it in a hurry, in the assets of firms, households and financial institutions. The third, financial-market liquidity, is close to the textbook definition: the ability to buy and sell securities without triggering big changes in prices.
Bath time
When people worry about a glut of liquidity, they are thinking of the first of these concepts. If money is too abundant or too cheap, inflationary pressures may build up or bubbles may appear in financial markets—until central banks tighten policy or market opinion suddenly changes. A slackening of economic activity or a drop in asset prices can leave households, businesses and financial institutions in trouble if their balance sheets are not liquid enough (the second concept) or if they cannot find a buyer for assets (the third).In principle, you can view the first concept through prices or quantities. Stephen Roach, of Morgan Stanley, suggests that for emerging markets, quantities (monetary aggregates, volumes of credit and foreign-exchange reserves) matter more; price signals (interest rates, credit spreads and so forth) are a better guide in developed economies, where capital markets are deeper and more liquid. In practice, it is usual to look at quantities.
Often, says Mr Barnes, it is assumed that the monetary environment is determined by central banks. But he thinks this too simplistic. Of course, by setting short-term interest rates they affect banks' reserves and lending, and the willingness of consumers and firms to spend or invest. They can still squeeze liquidity out of the economy, as the Federal Reserve did in the early 1980s, or create a deluge, as it did earlier in this decade. But America's bank reserves, at $47 billion, amount to only 6% of the country's monetary base and only 0.7% of the broad M2 measure of money supply. And the growth rates of both the monetary base and M2 have slowed in recent years, to below that of nominal GDP (see left-hand chart, above). From this, you might conclude that liquidity in America was not especially abundant.
However, that would be to ignore several important developments. A huge amount of credit is created outside banks and through clever instruments. Banks are increasingly able to securitise loans and get them off their balance sheets. The ratio of financial-sector to non-financial-sector debt, reckons Mr Barnes, has climbed from around 10% to 50% in the past 30 years. Financial innovation and deregulation have both helped these trends and aided international flows of credit. Looking at domestic numbers is no longer enough: you need to see the global picture.
Globally, money looks plentiful. In the euro area and Britain, broad money growth is running well ahead of nominal GDP. Or take the global supply of dollars, fuelled by America's large current-account deficit, the accumulation of reserves by foreign governments and their recycling back to the United States. A common measure of this, says Mr Barnes, is the American monetary base plus United States securities held by the Fed for foreign countries. Its annual growth rate peaked in 2004, at more than 20%. But because those securities have continued to pile up, this measure of liquidity is still growing at a rate of around 10% (see right-hand chart, above). Another gauge, combining all foreign-exchange reserves with America's monetary base, has risen at an average rate of perhaps 18% in the past four years. And this omits the contribution to global liquidity of the Bank of Japan, whose low interest rates are fuelling the “carry trade”.
All this is reflected in financial markets for everything from developing-country debt to corporate junk, commodities and art. Global willingness to save and lend is running ahead of investment. Ben Bernanke, chairman of the Fed, has spoken of a savings glut. Then again, the real puzzle could be companies' “investment restraint”, according to Raghuram Rajan, of the University of Chicago's business school (and until recently chief economist at the IMF). Maybe, he suggests, investment is becoming more centred on people and less on physical capital; maybe physical investment is being switched to emerging economies; maybe uncertainty still holds back investment abroad—as it does not, say, investment in property at home. Whatever the cause, a shortage of investment in fixed assets implies a shortage of debt collateralised on them. The financing glut has thus spilled over into markets for existing assets.
So what are central banks to do? Mr Rajan does not think that easy financing conditions can be laid mainly at their door. Still, he thinks that they may face an awkward dilemma. Tighter policy may push down long-term interest rates, boosting some asset markets further. Easier policy, however, would let inflationary pressures build. Mr Barnes concludes that it is too early to worry about liquidity: with inflation low, there is little prospect of a monetary squeeze; and American households and businesses' balance sheets (but not those of pension funds and mutual funds) are fairly liquid. Were there a market scare, he thinks, central banks would ease policy. One day, they may be tested
XXX . V0000000 Velocity of money
The term "velocity of money" (also "The velocity of circulation of money") refers to how fast money passes from one holder to the next. It can refer to the income velocity of money, which is the frequency at which the average same unit of currency is used to purchase newly domestically-produced goods and services within a given time period.[3] In other words, it is the number of times one unit of money is spent to buy goods and services per unit of time.[3] Alternatively and less frequently, it can refer to the transactions velocity of money, which is the frequency with which the average unit of currency is used in any kind of transaction in which it changes possession—not only the purchase of newly produced goods, but also the purchase of financial assets and other items."
If the velocity of money is increasing, then transactions are occurring between individuals more frequently.[3] Although once thought to be constant, it is now understood that the velocity of money changes over time and is influenced by a variety of factors .
Chart showing the log of US M2 money velocity (green), calculated by dividing nominal GDP by M2 stock, M1 plus time deposits 1959–2010. Employment-to-population ratio is displayed in blue, and periods of recession are represented with gray bars).
Similar chart showing the velocity of a slightly narrower measure of money consisting of currency and liquid deposits M1 1959–2010
Illustration
If, for example, in a very small economy, a farmer and a mechanic, with just $50 between them, buy new goods and services from each other in just three transactions over the course of a year- Farmer spends $50 on tractor repair from mechanic.
- Mechanic buys $40 of corn from farmer.
- Mechanic spends $10 on barn cats from farmer.
Relation to money demand
The velocity of money provides another perspective on money demand. Given the nominal flow of transactions using money, if the interest rate on alternative financial assets is high, people will not want to hold much money relative to the quantity of their transactions—they try to exchange it fast for goods or other financial assets, and money is said to "burn a hole in their pocket" and velocity is high. This situation is precisely one of money demand being low. Conversely, with a low opportunity cost velocity is low and money demand is high. In money market equilibrium, some economic variables (interest rates, income, or the price level) have adjusted to equate money demand and money supply.Indirect measurement
In practice, attempts to measure the velocity of money are usually indirect. The transactions velocity can be computed as
- is the velocity of money for all transactions in a given time frame;
- is the price level;
- is the aggregate real value of transactions in a given time frame; and
- is the total nominal amount of money in circulation on average in the economy (see “Money supply” for details).
Values of and permit calculation of .
Similarly, the income velocity of money may be written as
- is the velocity for transactions counting towards national or domestic product; and
- is nominal national or domestic product.
Determination
The determinants and consequent stability of the velocity of money are a subject of controversy across and within schools of economic thought. Those favoring a quantity theory of money have tended to believe that, in the absence of inflationary or deflationary expectations, velocity will be technologically determined and stable, and that such expectations will not generally arise without a signal that overall prices have changed or will change.Criticism
Ludwig von Mises said "The main deficiency of the velocity of circulation concept is that it does not start from the actions of individuals but looks at the problem from the angle of the whole economic system. This concept in itself is a vicious mode of approaching the problem of prices and purchasing power. It is assumed that, other things being equal, prices must change in proportion to the changes occurring in the total supply of money available. This is not true."[5]Back to basics. “Money” is — and has always been — nothing more nor less than a promise between people: a token of value, mutually agreed to. I give you dollar bills, copper pennies, cowrie shells, tally sticks, whales’ teeth, twisted strips of metal — they’re all just IOUs. That is, they’re promises that the token will be exchangeable for something else. To the extent that everyone believes in the token, it has value. To the extent that the belief erodes, so does the value. Hence: “credit” comes from the Latin “credere” — to believe.
The two main forms of money created by the U.S. government are currency — about a trillion dollar’s worth out there at the moment — and “Federal Reserves:” electronic blips on the books of financial institutions — mainly banks. The Fed does indeed create these so-called reserves “out of thin air,” as you put it, when it buys securities to increase the money supply.
But so what? It’s no different than minting more currency. That too is “fiat” money, from the Latin “Fiat” — “let it be done” — as in God’s “Fiat lux” (let there be light) or Italy’s Fiat Punto (let there be a really small car).
Look, someone has to create money, right? If the federal government doesn’t do it, rest assured private interests will, like the “barkeepers, barbers and innkeepers” and state-chartered banks whose printed notes led to such inflation after the War of 1812 that even President James Madison, long an opponent of federal monetary control, felt obliged to create the Second Bank of the United States in 1816.
And when Andrew Jackson, who hated paper money, famously destroyed the bank a generation later, one result was an explosion of state banks, issuing state money that helped fuel an economic boom.
XXX . V00000000 Global Currency
A single form of currency is accepted universally worldwide, regardless of political, social, or technological differences. No matter whether you're dealing with cavemen who speak in broken English or beings from another planet, your money is always good at face value. An almost ubiquitous trope in RPGs and in most other games involving some kind of economy.
The currency in question often has a generic name that implies no place of origin (often just "gold" in fantasy and almost always "credits" in science fiction) and as far as is observable by the player, is spontaneously generated in indefinite quantities within the game world rather than being minted or printed by a bank or government. Despite the fluid nature of this currency, it is seemingly immune to basic economic forces like inflation, supply and demand, devaluation, and Gresham's Law
note . Also, when the currency is gold, people will have absolutely no problem carrying a large amount of it with them, even when the gold would be heavier than themselves. The primary Global Currency Exception is when the designers will insert a region where it isn't accepted in to add difficulty to the later parts of the game.
This is an Acceptable Break From Reality and is often a key part of Easy Logistics—imagine how taxing it would be to spend time in video games changing from currency to currency. It can be justified by an Energy Economy, or coins minted out of valuable metal.
== MA THEOREMA MONETARY FUND ON E-CASH CREATE GOOD WEALTH MATIC ==
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