Some Federal Reserve economists are pouring intellectual cold water on smart cards.
They are not contradicting the central bank's light regulatory touch on stored-value cards and other emerging forms of electronic money. These are products of financial innovation, Fed Chairman Alan Greenspan has said, and "we must be careful not to impose rules that inhibit it."
But two increasingly outspoken Federal Reserve officials-one a regional Fed president-are questioning at least the near-term prospect that cards with computer chips will significantly displace coins and currency.
A big reason for their skepticism is the central bank itself and its efficiency in managing today's money and clearing checks.
Harvey Rosenblum, senior vice president and director of research at the Dallas Federal Reserve Bank, allows that electronic money may be "better, faster, and more convenient" but asks "how much better does it have to be to succeed?"
At least 10 times better, he says, according to a rule of thumb of venture capital investing-a hurdle that might stop today's smart card propositions in their tracks.
"The current paper-based system doesn't have much to recommend it, other than that it works great, is cheap, reliable, and we trust it," Mr. Rosenblum said last week in a speech to the annual conference of the NYCE electronic banking network.
"The real danger," he said, "is modernizing too far, too fast," and getting stuck with a technology that becomes outmoded before being fully rolled out.
From a monetary perspective, Thomas C. Melzer, president of the Federal Reserve Bank of St. Louis, said that the closer the country gets to zero inflation and long-term price stability, the less incentive the private sector will have to develop alternative forms of money.
"I applaud efficiency-enhancing innovations, even if they reduce the relative importance of the monetary base," Mr. Melzer said, referring to the basic stock of money for which the Fed is responsible.
"But the monetary base does constitute an extremely efficient class of monetary assets, considering it costs us a lot less than half a cent to keep a dollar of base money circulating for a year," Mr. Melzer said during an April 25 seminar at Murray State University in Kentucky. "Accordingly, I am concerned when an external force such as inflation drives banks and their customers to economize on their use of the monetary base."
One example, Mr. Melzer said, is sweep accounts, which move idle transaction balances into higher-earning instruments-benefiting the account holder and the bank that lessens its reserve requirements as a result.
Mr. Melzer said he is not overly concerned about the monetary policy implications of lower reserve balances. (A recent Federal Reserve Bank of New York study, not mentioned in the speech text, concluded that the rise of sweep accounts had not harmed the Fed's monetary maneuverability.) More crucial to his point, "these accounts represent a real cost to society with no net gain."
The banks may save money, but at the expense of Federal Reserve System earnings that are annually turned back to the U.S. Treasury. "Were it not for sweep accounts," Mr. Melzer said, "the talented people who design and operate them could be applying their skills to more productive activities."
Inflation is "the real villain in this scenario," Mr. Melzer added. Under "price stability," the 2% or less differential between money-market investments and zero-interest reserves would provide far less incentive to circumvent reserving.
Likewise with stored-value cards.
Issuers, he said, "would probably consider themselves lucky to earn the 1% of value that is typical of traditional travelers checks." He estimated per-transaction costs could exceed that issuing premium plus any small merchant fees the market might bear.
"Given that the stored-value liabilities themselves will probably pay no interest to the cardholders, the possibility for profit arises solely from sufficiently high nominal interest rates," Mr. Melzer said.
Under his assumptions, "if $100 of stored value were spent steadily over a period of three months, the card issuer could earn enough at a 6% interest rate for the system to break even. If the interest rate were lower, issuing cards would not be profitable."
What appears profitable "in the current environment of 3% inflation and relatively high nominal interest rates" loses its attractiveness in the price-stability regime for which Mr. Melzer and others in the Fed are crusading.
Mr. Rosenblum, a self-described monetarist and supply sider, goes well beyond the economic realm to debunk what he calls "electronic money hype." While financial incentives to move to new forms of money, such as interest on idle funds, have not been thought through, there are also social, cultural, and institutional factors that are not likely to change overnight.
"Build it, and they will come," the motto of the movie "Field of Dreams" and the hope of some payment-system visionaries, "is not a sound foundation for a business strategy," Mr. Rosenblum told the NYCE conference in Boston.
He said, "E-money is an important technological and financial innovation. It will happen," but he stressed that it would be evolutionary, not revolutionary.
The Dallas-based economist, a former Chicago Fed researcher who unveiled his contrarian views in the Bank Administration Institute's Banking Strategies magazine last November, saw parallels between telecommunications and payments. Just as new technologies like cellular phones and electronic mail coexist with plain old telephone service and snail-mail, smart cards will likely carve out their roles in and around what currency, checks, and credit cards do and will continue to do.
On a matrix of capabilities comparing those payment methods, Mr. Rosenblum gave smart cards mostly question marks: "We don't have a lot of experience with them," he said. "We just don't know."
He said that if half the U.S. population above age 14 carried a smart card with $100 of stored value, the asset would total about $10 billion- about the same as travelers checks and a small fraction of the $1 trillion M1 money supply. The income on those funds would be perhaps $500 million at today's interest rates, a modest business proposition at best.
Contrast that, he said, with the $254 million-about $1 per U.S. citizen- that the Fed spends annually to process and distribute currency. And for banks to make money on stored-value cards, they would have to drive currency out of the market. Driving out checking accounts, on which they earn significant revenues, would be shooting themselves in the feet.
A member of the NYCE audience asked Mr. Rosenblum if he were part of a disinformation campaign to preserve the Fed's central role in payment systems. He denied any profit motive, saying the Fed does not make itself or its employees rich and returns its surpluses to the taxpayers.
Mr. Rosenblum accused "people who want to engage in social engineering" of spreading the false word that the check collection system eats up 3% to 4% of the gross domestic product. The cost is more like 0.1%, and continual improvements in old payment methods-checks are at 62 billion a year and still growing, he noted-make it harder for newer products to compete.
"A payment system invented from scratch would look very different," he said. "That is a useful thought experiment for China or Poland, but not the U.S."
Fed Chairman Greenspan, in a speech to a Treasury conference last September, likened the proposed electronic money to the private-sector issues of the last century, before the government centralized currency creation. He said the new money "is likely to spread only gradually and play a much smaller role in our economy than private currency did historically."
