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Money: Back to the Future?

Wall Street Journal, Nov 23, 1995.

Money: Back to the Future?

By Walter Wriston (Former chairman of Citicorp)

Americans are about to begin using a new kind of money
that may have consequences for the Federal Reserve's
control of the money supply and almost certainly for the
velocity of money.

Over the years, people have used all kinds of things for
money, from the huge immovable stones in the front yards
of the residents of Yap Island to the more familiar
silver and gold. All these various mediums of exchange
will now be joined in our country by the "smart" card --
a piece of plastic embedded with a microchip.

Smart cards combine features of the following: automatic
teller machine cards that let you access your bank
account and draw cash; MasterCard or Visa cards that
permit you to buy now and pay later; and debit cards that
charge an account at the time of purchase. Not only can
smart cards do all of the above but they can also serve
as an "electronic purse" independent of your bank
account. These cards contain real money that can be spent
at stores and restaurants. In effect, the card is an
electronic traveler's check, but one that makes exact
change. In addition, the integrated circuit chip allows
a higher degree of security for the information stored
than do the current magnetic strip cards.

Smart cards are common in Europe and Asia, where some 400
million were shipped last year. The first large-scale use
of smart cards in this country will occur next year at
the Summer Olympics in Atlanta. Plans call for 300,000
rechargeable cards, and 700,000 disposable cards in
denominations of $25, $50 and $100. These cards would fit
nicely into the payment habits of Americans, since in the
U.S. it is estimated that 88% of transactions are done by
cash or check, and of these 83% are for less than $10. In
Atlanta, electronic "purse cards," which contain stored
value, could be spent at pay phones or vending machines.
When their stored value is exhausted, they are thrown
away. The smart cards, by contrast, can be taken back to
the issuer and recharged.

Their broad issuance and use could return America to
something very close to the free banking of the last
century, when every commercial bank issued dollar bills,
backed sometimes by the skill of the management,
sometimes by doubtful state bonds and sometimes by gold
or silver.

We have grown so accustomed to the familiar Federal
Reserve note that many forget that Americans had no
central bank for about 75 years -- from 1836, when
President Jackson vetoed the bill to renew the charter of
the Second Bank of the United States, to the start of
World War I, when the Federal Reserve Act was passed.
After the passage by New York state of the Free Banking
Act in 1838, the idea of state-chartered banks spread
across the country, and each commercial bank issued its
own dollar bills of various shapes and sizes.

This does not mean that the 19th century witnessed
complete currency chaos. In 1863, the National Bank Act
was passed to create a market in the government bonds
needed to finance the Civil War and to bring some order
to the private issuance of currency. The act required
that bank notes issued by commercial banks be uniform in
appearance and that they be backed by collateral
consisting of U.S. Treasury securities. As the old Civil
War bonds were paid off, the currency base of the country
declined some 60% from 1881 to 1890. This inflexible
system led to panics and instability.

To a certain extent, the Treasury Department during this
time assumed some of the functions of a central bank. All
during this period a debate raged, not about whether
America needed a central bank but about "free silver" and
the price at which the Treasury would buy gold and
silver. It was not until the eve of World War I that
passage of the Federal Reserve Act finally gave the U.S.
government a monopoly on the creation of money.

Now we may be going back to the future. The advent of
smart cards means that the Fed will lose its monopoly on
issuing currency, except that this time the new money
will be issued not only by banks but by all kinds of
companies, from convenience stores to telephone
companies. Nor is this the only trend threatening the
Fed's monopoly: Information technology is about to permit
the creation of both electronic token money and cash
money in cyberspace. Already we have Digi Cash in
Amsterdam reviving in modern guise something very close
to the old American free-banking system -- issuing
electronic money (backed by some depository bank holding
collateral in the form of Treasury securities) and
performing the clearing function.

None of this is necessarily a cause for panic. There is
very little, if any, evidence that government has managed
our currency values any better than the commercial banks
did in pre-Fed days. Indeed, the Nobel laureate economist
F.A. Hayek put it more strongly: "The history of
government management of money has, except for a few
short happy periods, been one of incessant fraud and

Still these new trends do present worries for central
bankers. If more and more firms issue cards for cash or
credit, what will be the effect on the velocity of money?
How will central banks form policies on the control of
the money supply if any company can issue electronic
purse cards on credit, with or without collateral? What
will happen if the issuer of the card goes broke?

As smart cards become more visible in America, regulators
and governments will begin to wonder about control of
money and credit. The Eulopean system of central banks
has produced an advisory report outlining a possible
regulatory response, and in this countly some Fed
officials are starting to wonder if their regulations
will be applicable. If one definition of money is an
object that has no use except to be given to someone else
in exchange for goods or services, smart cards are money
-- and they are coming to your neighborhood soon.