Spending Money Freely; L. White

Yesterday I used a second novel way of paying at a nearby copy shop. The shop's Dr. White teaches economics at the University of Georgia, and is a contributing editor to The Freeman. He is this month's guest editor. self-service photocopier didn't take coins, paper money, credit cards, or even a debit card. Instead I put a plastic card bearing a magnetic strip on its back into a reader, which displayed in glowing yellow digits how many dollars-worth the card "car ried." (On an earlier occasion I had pur chased the card from a nearby machine, which had "loaded" the card with the dollar amount of paper money and coins I put into the machine. When the card balance gets low, it can be topped up at the same ma chine.) I watched the yellow number go down by .07 with each copy produced. In the future a single prepaid card, probably carrying a microchip rather than a magnetic strip, may be usable in a wide variety of transactions. Imagine the convenience if the same card were accepted by photocopy machines, soda machines, pay telephones, and even by the cash registers in ordinary retail shops. Imagine if the card balance could be topped up at an ATM-or even at your home computer-by transferring funds from your bank account. Such "smart cards," as the idea is known, would amount to a bank-issued currency, a modern equiv alent of the private banknotes· that circu lated before governments monopolized the issue of currency.

New Ways to Pay: The Advantage These new payment methods are spread ing. Smart card systems have been intro duced in Denmark, Singapore, and Eng296 land.l Here in the United States, retailers are finding card-readers increasingly cheap to install, and growing numbers of custom ers are discovering the advantages of debit and prepaid cards. In a world where people are increasingly in a hurry, they speed the act of paying-no need to have the right change or to wait for change in return, no need to write out a check, no need to stop at the bank counter or ATM to get more cash. Paying by debit card or smart card willoften be more convenient than paying with cash. A debit card is even better than cash or a smart card in at least two respects: using a debit card keeps your money in your bank account, where it is both more secure from theft and earns interest, right up to the moment it is spent.

Some observers are skeptical that pay ments methods willchange dramatically any time soon. What happened to the predic tions a decade ago that soon everyone would be banking electronically by home com puter? Actually, home banking is now fi nally growing in popularity, for several rea sons. Touch-tone phone-banking services, along with ATMs, have acclimated people to electronic banking; home computers and modems (devices to transmit computer in formation over telephone lines) have gotten cheaper; home banking software has gotten easier to use; and increasing numbers of households are subscribing to on-line ser vices like Prodigy that include electronic home banking and bill-paying among their offerings.2 Hundreds of thousands of people now make hundreds of millions of dollars worth of monthly payments electronically by typing and mouse-clicking at their home computers. (I'm not yet one of those people, but check back with me in a few years.) An even more dramatic development in the last few years, with possibly profound implications for the payments system, has been the growth of the Internet, the decen tralized worldwide network of interlinked computers across which users send elec tronic mail ("e-mail"), post messages to "newsgroups" for public discussion, and browse for and download information. The Internet is estimated to have had 30 million 297 users at the start of 1995, and to have been growingat the amazingrate of 10percent per month.3 Like many in academia and busi ness, I often spend an hour a day reading and sendinge-mailand newsgroup postings. The Internet was originally non-commercial, but with tens of thousands of business firms now connected, plenty of business is al ready beingdone bye-mail. Those who' 'log on" to the "Net" or "go on-line" daily are natural candidates for convenient on-line retail shopping, and commercial Internet sites have begun to appear. On-line cata logs-fast becoming "virtual shopping malls" - have longbeen a staple of Prodigy, Compuserve, America On Line, and the other proprietary networks.

But how to pay for an item selected from your computer screen? For some transac tions, you might want to send a credit card number bye-mail. I have actually renewed a magazine subscription this way, but I had to worry about my number being inter cepted by a computer' 'hacker. " The profit motive is now hurrying to the rescue: Mi crosoft and Visa, the software and credit card giants, have recently announced ajoint project to develop a user-friendly way to encrypt (encode) and decrypt credit-card numbers sent over e-mail to assure security in such transactions. For other transactions, a way to "pay cash" over the Internet would be a winner. Several firms are now developing systems for "digital cash" or "e-money," most notably DigiCash, founded by cryptography (code-making) expert David Chaum. These systems allow an electronic funds transfer to be launched from a personal computer as easily as from a supermarket's debit card-reader.

Privacy Concerns There is, however, a potentially large fly in the ointment of these new payments methods. Unlike a paper-money or prepaid card transaction, a credit-card or debit-card transaction typically lacks privacy. Using electronic deposit transfer or a credit card (either in person or via computer), like 298 THE FREEMAN • MAY 1995 writing a check, generates a trail. Your bank's or card company's computer ends up with a list not only of how much you've spent, but of where you spent it. The same list could be constructed by combining the information held by all the vendors from whom you bought. This list is potentially available to the IRS or to other government agencies who may want to commandeer it. If you don't have a contract with your bank and vendors expressly forbidding it, the list is potentially available to credit bureaus or junk-mail firms who may want to buy the information. The privacy issue understand ably concerns many people who are per fectly law-abiding citizens.

Fortunately, computing and crypto graphic experts like Chaum are working to develop methods for anonymous electronic payments. One set of models for anonymous payments uses the "smart card" method (the funds to be transferred have already been downloaded onto a smart card or personal computer); an alternative set uses electronic deposit transfer either by debit card or by personal computer. For an ex ample of the deposit-transfer type, suppose I wish to pay you $100anonymously without using physical currency. (I might be stand ing at your cash register, or I might be home at my computer looking at your invoice on my screen.) By merely typing in my PIN, or clicking on a "pay" button on my computer screen, I send a cryptographically "signed" (or PIN-authorized) and numbered (you have assigned the number) message to my bank that instructs my bank to transfer $100 to an account (whose name is encoded) at your bank. My bank reads the "signature,"

and knows the message is genuine. My bank can't read the recipient account name, so doesn't know to whom the money's going (only to which bank). Your bank can't read my signature (which my bank may have removed), so doesn't know from whom the money came (only from which bank, and in favor of which account). You read the transaction number to know the payment came from me (though you might not know my name).4 You then hand me the goods, or ship them to my private post office box. Are bank customers actually eager to pay cost-covering prices for privacy features of this sort? I don't know. The market will tell us, assuming that government does not interfere. Some federal authorities have sug gested that they would object to a com pletely untraceable version of smart-card or debit-card payment, because it might be used to hide transactions they want to tax or prohibit. To be consistent, such authorities should also object to the availability of untraceable $100 bills. Chillingly, some do.

Keeping the Government Off-Line What role does the government need to play to orchestrate the shift to new pay ments methods? None whatsoever. Govern ments of the past, after all, played no role (or no constructive role) in the transitions from barter to commodity money, from raw me tallic money to coins (though ancient des pots later discovered profits in monopoliz ing the mints and in debasing the coins they produced), from coins to banknotes (though government-sponsored central banks later monopolized their issue and diluted their value as well), from currency to deposit transfer, cash to credit cards, checks to debit cards, or locally to nationally accepted ATM cards. 5 The shift to electronic pay ment methods is taking place already, with out the Federal Reserve having taken any officialposition or promulgated any rules on digital cash or smart cards. Private ATM networks and credit-card networks already exist to set interconnection standards where new standards are needed.

Debit cards, being just a paperless sub stitute for checks, don't raise any important regulatory issues. But won't private banknote-like smart cards, being a new privately issued form of money, need regu lation once they catch on? Don't they threaten an inflationary avalanche of elec tronic money? Absent central bank restric tions, what will limit the quantity of smart card-loaded "dollars" commercial banks can create? The answer to the first two questions is no, because the answer to the third is that a bank's obligation to convert card-balance dollars to scarce reserve dol lars (physical currency or account balances at the clearinghouse) on demand naturally limits the number of card-balance dollars a bank will find it prudent to create given the size of its reserves. 6 There is more at stake for you and me in electronic funds transfer than simply more convenient payment methods. One major potential advantage of electronic funds transfer via personal computer is that it may give ordinary consumers affordable access to offshore banking. With direct deposit of paychecks, and with old-fashioned cash available at ATMs whenever we want it, few of us really need to visit our banks in person anymore. Why not keep your account at a reputable foreign bank (perhaps a branch of a major Swiss bank) in the Bahamas or the Cayman Islands? Such an offshore account is perfectly legal (though a U. S. bank's offshore branch is prohibited from directly doing business with American citizens or firms), but not worth the trouble for most individuals or small businesses today. If an offshore bank were linked to the clearing system and to an onshore ATM·network (or if access to physical cash were irrelevant because all cash-like payments could be made by debit card or smart card), more of us could begin enjoying the advantages of offshore banking that big-money players and large firms have enjoyed for years. Offshore banks pay higher interest on deposits be cause they are free from the taxes on deposit balances that the U.s. government levies in the form of reserve requirements, deposit insurance "premiums," and taxes on bank earnings. Individuals who are concerned SPENDING MONEY FREELY 299 about privacy should also find an offshore foreign bank attractive for its lesser propen sity to surrender its records to domestic authorities.

Just as a variety of old and new forms of payment are available today, old-fashioned payment methods like cash and check writing can be expected to persist well into the twenty-first century. There they will coexist with smart cards, debit cards, per sonal-computer-Iaunched deposit transfer, and perhaps other new electronic methods of payment. If and when Prodigy, Com puserve, and Internet sites begin offering offshore banking services, things should really become interesting. An exodus of retail banking business from the regulated sector to a free banking sector will shrink the fiefdom of federal banking authorities. Let us hope the authorities accept that fate gracefully. 0 1. For an account of recent and possible future develop ments see Steven Levy, "E-Money (That's What I Want)," Wired (December 1994), pp. 174ft'. 2. David C. Churbuck, "Let Your Fingers do the Bank ing," Forbes (19 August 1991), pp. 122-24.

3. "So Much for the Cashless Society," The Economist (26 November 1994), pp. 21-23. 4. In Internet lingo, this method preserves privacy by using the two banks as semi-anonymous "remailers" of different parts of the payment message. Privacy could be increased even further by having a clearinghouse relay the message so that neither bank even knows the identity of the other bank. For an enlightening explanation of how the necessary encryption method works (such that my computer can encode a message that only the intended recipient's computer can decode), see Hal Finney, "Protecting Privacy with Electronic Cash," Ex tropy #10 (Winter/Spring 1993), pp. 8-14. 5. For brief accounts of how these practices emerged in the market see George A. Selgin and Lawrence H. White, "The Evolutionofa Free Banking System," Economic Inquiry, vol. 25, no. 3 (July 1987), pp. 439-57. 6. The theory of the natural limit to banknote volume under "free banking" applies equally to smart-card balances. See George A. Selgin and Lawrence H. White, "How Would the Invisible Hand Handle Money?," Journal ofEconomic Liter ature, vol. 32, no. 4 (December 1994), pp. 1718-49.

Available from FEE. .. Bankers and Regulators T he seventeen essays in this volume, all selected from earlier issues of The Freeman,examine in detail the failure of regulation and offer hope for a return to sound banking, The collection includes, among others, articles by Hans F. Sennholz, Ken S. Ewert, E.C. Pasour, Jr., Kurt Schuler, Richard M. Salsman, and Lawrence H. White. 176 pages, indexed, $14.95 paperback THEFREEMAN IDEASON UBERTY Phonesand Freedom by Marty Mattocks A fter a recent departmental meeting at work, my boss asked a colleague and me to stay and discuss progress on a com mon project. After we had dispensed with the business at hand, the discussion moved on to new topics and an open-ended ques tion and answer period. In this relaxed atmosphere I asked my boss to bring me up to date on what was outlined on the black board behind him: a recent proposal by an alternative long-distance provider for cut ting our telecommunications costs. We are mutually responsible for providing technical support to a relatively large company with its own telephone switch and so I am curious to learn all I can about this dynamic field.