Toward a Cashless Society; E. Kolar

Third lesson: Banking is not a natural monopoly. Historical experience shows that there are some tendencies for larger banks to be more efficient, but not beyond a certain size. Nationally branched banks do tend to out compete smaller banks in many areas of the banking business, but not in all areas. Banks must be large enough to diversify their assets and liabilities adequately, but this does not require being large relative to the entire banking market. Recent develop ments in the financial technologies of loan syndication and securitization may have reduced the size at which a bank becomes large enough in this respect. In the absence of government regulations that currently favor the largest banks, particularly the pursuit of the "too big to fail" doctrine by the Federal Reserve and the Federal DeTOWARD A CASHLESS SOCIETY 377 posit Insurance Corporation, a stable and deregulated financial structure would result that would likely include both large and small banks. 0 1. Hans Sennholz, Money and Freedom (Spring Mills, Pa.: Libertarian Press, 1985); Kevin Dowd, Private Money: The Path to Monetary Stability (London: Institute of Economic Affairs, 1988); George A. Selgin, The Theory of Free Banking (Totowa, N.J.: Rowman and Littlefield, 1988); Kevin Dowd, The State and the Monetary System (New York: Philip Allan, 1989); David Glasner, Free Banking and Monetary Reform (Cambridge: Cambridge University Press, 1989);Lawrence H.

White, Competition and Currency (New York: New York University Press, 1989);Richard Salsman, Breaking the Banks: Central Banking Problems and Free Banking Solutions (Great Barrington, Mass.: American Institute for Economic Research, 1990); Steven Horwitz, Monetary Evolution, Free Banking, and Economic Order (Boulder, Colo.: Westview Press, 1992). 2. This statistic, from a study by Andrew J. Economopou los, is cited by Kevin Dowd, "U. S. Banking in the 'Free Banking' Period," in Dowd, ed., The Experience of Free Banking (London: Routledge, 1992),p. 218. Pioneering modem work on the U. S. experience with' 'free banking" laws, which is the source for the information in the next paragraph of the text, has been done by Hugh Rockoff and by Arthur J. Rolnick and Warren E. Weber. TOWARDA CASHLESS SOCIETY by Elizabeth Kolar T he financial system of today's world is the product of centuries of innovation.

What began as a barter economy moved through various incarnations in response to the limitations inherent in the evolving sys terns. Changes will undoubtedly continue to occur in response to social and technologi cal progress. Contemporary discussion of likely changes has focused increasingly on the possibility of a cashless society. The The author is an operations analyst for Diebold, Inc., a banking equipment manufacturer. technology for such a society exists. How ever, the benefits of cashlessness are not yet perceived to outweigh the supposed disadvantages. This article will discuss the progress to ward cashlessness and its relevance to free banking. Free banking historically involved the issuance of bank notes that were re deemable for a "base" money such as gold or silver. Modern proponents of free bank ing such as Lawrence White have continued to think of it in these terms. White's col league at the University of Georgia, George 378 THE FREEMAN • OCTOBER 1993 Selgin, has, on the other hand, envisioned a regime under which the existing (U.S. dol lar) monetary base would be frozen, and banks could then issue notes that would be exchangeable for base dollars. Both writers apparently envision a society that will con tinue to use currency and coin as pervasive media of exchange.

A cashless society would mean, of course, the absence of currency and coin. Therefore, a cashless society could mean a barter society in which commodities were traded for commodities. However, barter would represent a major step backward. The cashless society envisioned and discussed herewith refers instead to the widespread application of computer technology in the financial system. Increasingly, funds are being transferred via an "Electronic Funds Transfer System" (EFTS). The EFTS As it became apparent that electronic banking was here to stay, Congress in 1974 established the National Commission on Electronic Fund Transfers. The commission studied the infant EFTS, and published its recommendations in 1977. The commission concluded that an EFTS developed in an "orderly" manner would be beneficial to consumers of financial services and sug gested that such a system operate outside the public sector. The commission went on to state that "a national EFTS could be supported by as few as 225,000 on-line terminals installed in general merchandise stores. "

As the commission completed its re search, the Federal Reserve established "Fed Wire." Fed Wire is a nationwide electronic communications network that links the 12 Federal Reserve District Banks, all member commercial banks, and the U.S. Treasury. It represents a considerable in vestment on the part of the Federal Reserve, and has been interpreted by the member banks as Federal Reserve endorsement of a nationwide EFTS. Transition to an EFTS involves overcom ing structural barriers such as high start-up costs as well as the establishment of co operation and communication among com peting banks and retailers. In a sense, by the creation of Fed Wire, the Federal Reserve has provided not only an endorsement of EFTS, but a subsidy as well. Large institu tions have capitalized on the Fed's invest ment, and smaller organizations must now subscribe to the changes in order to remain competitive.

An EFTS is made up of many compo nents, the most widely known and accepted being Automated Teller Machines (ATMs). Additional integral elements are Automated Clearing Houses (ACHs) and Point of Sale terminals (POSs). As we shall see, the ACHs and POSs, not ATMs, are probably the keys to further progress toward a cash less society. Federal Reserve economist Michael Keeley has argued that "trends in cash usage and holdings suggest that cold, hard cash is becoming an even more popular means of payment." He goes on to say that, "Since most ATMs use $20 bills, it is interesting to note that the growth in volume of $20 bills has been greater than that of other denominations since 1977-about the same time that the number of ATMs in stalled started to grow nationwide." Federal Reserve reports on currency have shown a significant increase in the number of bills in circulation, and an increase in the average denomination being used; for ex ample, the number of $20bills has increased faster than the number of $10 bills. The number of checks being written and the average size of each check have also in creased, but at much slower rates.

ATMs Keeley uses such facts to support his view that a cashless society is "far from reality. " However, a provocative argument can be made that the transition to a cashless society involves an increase in cash usage prior to its disappearance for all but low-dollar and "discrete" transactions. Before the spread of ATMs, a greater percentage of retail transactions involved payment by check.

Because of processing delays, checks present opportunities for buyers to make purchases prior to the receipt of the requi site funds in their accounts-Le., there is a so-called "float." However, checks also involve a certain amount of time and incon venience for the parties to a transaction. Before the spread of ATMs the most com mbn method of obtaining cash was from tellers at bank branches. With the limited ban\kinghours of the day and the associated long lines, it was far more common for consumers to endure the inconveniences associated with check writing than to visit a bank branch to obtain cash. ATMs made cash easier to obtain, however, and it in creasingly became the preferred method of payment. POSs The use of pass may displace the use of cash obtained from ATMs just as the use of ATM cash has displaced checks. pas use reduces many of the liabilities of cash. For example, crimes such as muggingand purse snatching would decrease in the absence of cash, and the opportunity costs of cash would be eliminated insofar as a consumer's funds would always be in interest-bearing accounts.

The shift away from cash and toward pass may be obscured for a time by the use of currency to engage in tax evasion or illegal activities such as drug dealing. Progress toward cashlessness may also be obscured by the use of U.S. dollar bills in the former Soviet Union and elsewhere. But as such areas stabilize and adopt more sophis ticated technology, their payments prac tices will probably start to resemble those in the United States. Transition Problems The transition to a fully electronic transfer of funds system will not be impeded by households; through the use of debit cards they are already in the process of becoming comfortable with the advantages of EFTS. Rather, some of the parties engaging in high TOWARD A CASHLESS SOCIETY 379 dollar transactions will provide resistance until the issue of float costs and benefits is resolved. Insofar as there are delays in processing checks, there is a float cost to the businesses getting paid. This cost is equiv alent to a working capital expense for re ceivables. There is a corresponding benefit to payees who can continue earning interest until their checking accounts are finally debited. Elimination of this float would result in a significant redistribution of in come among businesses, and this may ex plain some of the present resistance to EFTS conversion. The amount of interest earned via check float is now estimated to be between 40 and 50 billion dollars annually.

Understandably, the recipients of this inter est will resist its disappearance. Canada has addressed the float issue by way of a banking industry and central bank accord that provides for same-day account ing of checks presented for payment. The float has been significantly reduced by the implementation of a retroactive interbank settlement process. This innovation has re moved the float associated with the check clearing process, but not that which occurs when a payee holds a check for a period of time before processing it. In order for the U.S. to overcome the barriers to an EFTS created by the float, it appears that voluntary conversion on the part of businesses, rather than regulation, is the answer. The U.S. Treasury has already reduced check use and shifted many gov ernment payments to electronic transfer. Among these are Social Security, federal payroll, and even large federal contract payments. It can be expected that the spread of electronic transfer practices will continue in the private sector as well, with the loss of float costs and benefits being considered in the terms on which parties are willing to do businesswith another.

Free Banking The progress toward an EFTS could fur ther complicate the Federal Reserve's at tempts to manage the U.S. money supply. As economists are well aware, the public's 380 THE FREEMAN • OCTOBER 1993 "Cash may continue to be useful for some time, especially for discrete trans actions, but even these may become in creasingly automated. Given the rapid growth in technology, it is not difficult to imagine devices whereby even the most informal purchases could be automati cally debited from the buyer's bank account." demand for cash influences the quantity of money in circulation. Perhaps more serious is the internationalization of money flows and the proliferation of new types of ac counts. With electronic systems shifting funds from one type of account to another, and from one country to another, it has become difficult or perhaps impossible to say what "the" money supply is. Part of the appeal of free banking is that it makes such issues moot. Financial insti tutions and customers could pursue their interests independently with their actions being coordinated by the invisible hand of the market. A cashless society would pose no special problems in this context. The 12 Federal Reserve District Banks could be privatized in the form of Automated Clear ing Houses; the district bank stock to which member banks subscribe upon joining the Federal Reserve System could be converted into transferable shares in the ACHs. The newly privatized ACHs would presumably playa major role in interbank lending and reserve settlements.

In the case of either a gold-based or paper-dollar-based free banking system, base money could be kept at the ACHs, but it need not be. As long as all claims and settlements were continuously recorded, base money would only have to be available at ACHs or member banks to meet occa sional customer requests. In conclusion, the movement toward a cashless society is proceeding incremen tally. Cash may continue to be useful for some time, especially for discrete transac tions, but even these may become increas ingly automated. Given the rapid growth in technology (e.g., pocket-sized cellular tele phones), it is not difficultto imagine devices whereby even the most informal purchases could be automatically debited from the buyer's bank account. EFTS is likely to have a profound and visible impact on everyday decision-mak ing. Some of the more obvious benefits are reductions in financial transaction time and cost, and a reduced need for cash which would, in turn, decrease the amount of interest forgone. The opposition to a cash less society is likely to become increasingly silent as it is defeated by subtle economic pressures exerted by the federal government and financialindustry giants; they continue to realize the benefitsof the transition to an EFf system. As this transition continues, the issue of float is likely to fade as well.

While we may not see a completely cash less society in the immediate future, the foundation has been laid, and the available evidence indicates that we are indeed mov ing in that direction. The fate of the Federal Reserve depends, of course, on political considerations, but the progress toward EFTS could ultimately prove to be a key factor leading to its replacement by free b~~q. D THEFREEMAN IDEASON LIBERTY WHY FREE MARKETS .ARE DIFFICULT TO DEFEND by D. Eric Schansberg W hen posed as a general question, most people are inclined to support free markets and capitalism rather than govern ment control and socialism. They have seen the fruits of "free market" economies and the failures of socialism. They support free dom as a principle and generally dislike the intrusions and bureaucracy of government. Yet when it comes to specific government programs, the public is frequently enthusi astic about them. And whenever the econ omy is not running smoothly, the public demands action from the President and the Congress to "do something." By giving explicit or tacit approval to such programs, people reveal that they think government can solve problems better than the market. Thus, people support free markets in general, but support government intervention on particu lar issues. The free market is difficult to defend against calls for government activism.