Internet to Create Laissez-Faire Banking

Bankers are concerned that e-cash will prohibit them from setting interest rates or controlling currency

Technologies capable of better securing the transmission of money over the Internet will usher in an era of laissez-faire banking that could end the sovereignty of central bankers in London, Tokyo and Washington, according to senior financial regulators from around the world. But bankers paint an ominous picture of Internet finance, which they say will threaten the safety and soundness of the banking industry.


This electronic money, or e-cash, is being issued by U.S. computer software firms DigiCash, the Netherlands, and CyberCash, Reston, Va., in conjunction with several major regional banks in America. E-cash has policy makers in Asia, Europe and the United States scrambling. These technologies furnish consumers with secure, encrypted credit card and money payment services over the World Wide Web.

Secure payment cards, such as Europe's Mondex, provide similar benefits. Presently, the use of such technologies is small, amounting to tens of millions of dollars in transactions per year. But bankers are concerned that these Internet technologies will lead to a resurgence of privately issued currencies, similar to those dispensed in Hong Kong, and will lessen the banks' ability to set interest rates or control their respective money supplies.

"Electronic money will have the same effect as the end of the Cold War," said Bill Niskanen, a White House economic advisor in the Reagan administration, now in private practice. "It will be less disastrous, but more complex."

At a recent conference on the future of money in the information age, sponsored by the free-market think tank, The Cato Institute, banking industry officials outlined many possibilities in the not-too-distant future wrought by Internet finance.

"Electronic money makes money less subject to government regulations," said Jerry Jordan, president and CEO of the Federal Reserve Bank of Cleveland, a major bank in the U.S. Federal Reserve System. "This outside money has a value not dependent upon anything else. Could a Mondex dollar be de-linked from a Federal Reserve note? It needs to be decided. Whether Mondex has a settlement account with the Federal Reserve has not been decided."

Electronic commerce over the Internet is not likely to be regulated by any government due to its decentralization. All it takes to establish a business presence on-line is to set up a computer server and install Internet software.

Companies such as CyberCash then serve as the intermediary -- similar to banks handling credit cards. But the Internet, unlike banks, is completely anonymous. Financial authorities don't have access, as of yet, to the records.

"China, which wants to police the Internet, will be very frustrated," said John Lopez, chief of staff at the Subcommittee on Domestic and International Monetary Policy in the U.S. House of Representatives. "There are leaks in their monitoring system already. There are compromising Web pages. How can they stop it? There is no way they can monitor that many people."

Officials seem to be split on whether the central banks will disappear or not. "The truth is, we don't know who will replace central banks and other financial regulators. And I don't think they're asking these questions at the Fed," said Jordan of the Federal Reserve Bank in Cleveland.

Federal government control of the money supply is a relatively recent phenomenon in the United States and in other countries with a similar economic model.

Before the American Civil War in the 1860s, state banks and private parties were allowed to issue money. In 1913, the Federal Reserve Bank was formed. By the 1930s, the federal government had taken control of issuing currency and today holds a monopoly on that franchise.

According to George Selgin, a professor at the University of Georgia and one of the leading financial historians in the U.S., "It is a legal way for firms to reprivatize currency. It can strip the Fed and other central banks of the power to inflate. E-cash makes the money less subject to government regulations."

Such thinking is quite attractive to many of the well-educated, affluent devotees of the Internet, according to Bill Frezza, founder of Digital Liberty, a Philadelphia-based cyberspace think tank.

"In our lifetimes, I expect to see the mass exodus of our most productive citizens from around the world," said Frezza. "They will withdraw from society. They will form supranational economic communities. They will conduct transactions, and create and exchange wealth in cyberspace. They will be immune to the sovereignty of governments. If governments can't stop the flow of white powder [drugs] over their borders, how can they stop the flow of digital bits?"

R. Alton Gilbert, vice president of the Federal Reserve Bank of St. Louis, said that the rise of e-cash will have several troubling implications for the safety and soundness of the banking industry.

For example, if e-cash use becomes widespread, and an e-cash provider fails, how would authorities handle the run on the electronic entity? "Should e-cash companies be required to be chartered like a bank?" he asked. "We may get there through planning or crisis. But usually, crises are what lead to changes in banking regulation."

But advocates say the e-cash technology exhibits the three elements required of any currency -- it is verifiable, untraceable and unforgeable.

"It is the same as a dollar or a yen note," said Frezza. "Cyberspace could be the first place in the world where real, laissez-faire capitalism has been tried." Frezza reckons that these international cyberspace citizens can form their own institutions and self-insure their funds.

What implication might that have on, say, taxing authorities around the globe? "Electronic money will make tax evasion much easier," said Richard Rahn, president of the consulting group Novecon and former chief economist of the U.S. Chamber of Commerce.

"You can move monies around the world at the speed of light. Governments are doomed to fail because of this. It is the end of bureaucratic totalitarianism. Some withholding of taxes from payroll checks and some property taxes are still possible. But the present tax codes cannot survive in most industrialized countries. There will be more international competition among tax regimes. People will flee to where the rates are the lowest."

Governments may wish to stanch this outflow of tax revenues -- but that would require police powers "greater than the Stasi or Stalinist regimes to do so," said Rahn.

But Bill Melton, CEO of CyberCash, doesn't think financial and regulatory affairs will decay to that state. He suggests that the model adopted by credit card issuers be emulated on the Internet.

So-called affinity cards are quite popular among credit card issuers today. Members of a group, United Airlines frequent fliers for example, are entered into a database and screened with actuarial tables. Based on their credit history, and membership in a reputable group, they can be given or denied access to on-line cash.

"You could rely on these affinity cards and the co-branding opportunities they offer to screen those who want to do on-line commerce," said Melton. "You could issue digital certificates and easily manage it with the technology to reduce fraud."

In the United States, about 3 percent of the gross national product is needed to maintain the current paper-based money system. A conversion to digital money -- and elimination of the dollar, yen and deutsche mark -- could save that amount for the United States and other nations in a similar situation.

"Laissez-faire banking could emerge spontaneously from the technology," said David Cronin, an economist and member of the Central Bank of Ireland. "Central banks are unlikely to issue e-cash."


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