Q&A: Professor: Rely on Market to Regulate Electronic Currency Issuance

Many banking and payments industry observers are wondering about the potential impact of electronic forms of currency on the nation's monetary system. Some academics look back to the 19th century, when it was common for banks to issue private currency.

University of Georgia Prof. Lawrence H. White, who has written several books on the subject, spoke in this interview about the parallels between digital currency and bank issues of paper money.

u

What can the experience of free banking teach us about the emerging electronic world?

WHITE: The main lesson from the historical research is that we don't have to worry about wildcat banking. In the United States, wildcat banking was an unintended consequence of certain regulatory regimes, and it wasn't a free market outcome.

We need to rely on market competition to tell us which of these technologies is the least costly or the most convenient for consumers. Because we don't know, we can't centrally plan these things. We need to let different models contend with one another and not preempt competition or have it foreclosed by regulatory fiat.

What has your work shown about the free banking era in this country and elsewhere?

WHITE: The main theoretical result is that even in the absence of regulations like reserve requirements, there is an economic limit to the amount of money that banks want to create. There is a strong market mechanism that keeps banks from over-issuing-at least in a system where bank notes are redeemable for some more basic money.

When the topic of banks' issuing currency in the form of smart cards or digital currency comes up, people refer back to the 19th century experience with banks issuing currency. And if they think the result was a disaster, then they become fearful of allowing banks to do that.

How will banks be affected by electronic currency?

WHITE: It is an opportunity for banks to get back in the business of issuing bearer claims that are spent a lot like paper currency.

A lot of what people are calling smart cards act in the manner of debit cards. They just give people a way of accessing deposits.

But under the Mondex system, they act like currency-transactions take place without being cleared through the bank. Funds can be transferred from card to card, so like historical bank notes, they circulate outside the bank.

The real important issues are how much anonymity and traceability these transactions have. You can provide them with anonymity either in the currency form or in the debit form, or you can undo the anonymity and make the bearer known to the recipient using either form.

Why is anonymity important?

WHITE: You might be concerned with a debit-type card, that your bank is compiling a list of everything you bought and where you bought it. If you are concerned about your own privacy, then you would want some assurance that wasn't happening.

The question in the market is how much anonymity people are willing to pay for.

There has been some uncertainty about demand for digital cash. How can financial institutions increase customer interest?

WHITE: It is most likely that new developments are going to take place as financial institutions offer payment instruments to their customers in a way that doesn't require their customers to learn any new techniques. You expect new payment institutions to look like familiar models, and that way it is easy to get people accustomed to them.

How can card issuers make money?

WHITE: If you are trying to introduce something like Visa Cash as a substitute for pocket change, people are not likely to want to pay a transaction fee. It is going to have to be seigniorage, the float, or the fact that you are getting an interest-free loan from the holders of these cards.

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER