"Information causes change. If it doesn't, it's not information." --Claude Shannon

One does not usually think of Gertrude Stein in the Pantheon of great economists, but she nevertheless has added her thoughts about money to those of Adam Smith, John Maynard Keynes, Milton Friedman and others. She said: "The money is always there, but the pockets change; it is not in the same pockets after a change; and that's all there is to say about money." All that she said is true, but like many things in our society, money is in a state of flux. The very nature of money, who issues it and how it is used is being transformed and altered by technology.

Few would now deny that we are in the midst of what could be called a sea change in the way the world works, and money and banking are being swept along with all the rest of the artifacts of an industrial society. Whenever the world is in the midst of great social, technological, and political transitions the old order attempts to hold on to its eroding power as new power centers arise. Sometimes this takes the form of denial that real change has occurred, and people stick to the old ways until it is too late to salvage a business.

The marriage of computers with telecommunications has created a truly global market in everything from money to stocks to commodities. The magnitude of the change is illustrated by the fact that today "All the world's businesses spend more on telecommunications each year than they do on oil."[1]  Indeed this capital investment has provided the world with a new kind of energy. These huge networks - public and private - have even created a new kind of an economy, a network economy in which what Brian Arthur calls the law of increasing returns operates: the more people connected to the network or the clearinghouse, or your fax machine, the more valuable it becomes. Indeed some mathematicians have proven, at least to their own satisfaction, the sum of the network increases as the square of the number of members. The old industrial society in which we all grew up is morphing into a new information/network economy which often operates with different rules. The very nature of a network disperses power from the center to the periphery because more and more people have access to information that was once closely held by a few elite. Since a network has no center of control and few if any boundaries, it becomes difficult for the state to exert control. As world communications go more and more digital and the availability of broadband fiber explodes, the cost of transmitting information, including information about money, moves toward zero. This revolution in information technology has helped produce a global economy, because it allows today's enterprises to integrate their activities across the world in a way never before possible. Products may have value added in a dozen countries before being sold in still other nations. Today's balance of trade metrics cannot capture these transactions and thus produce misleading statistics. This phenomenon is not limited to banks and other business enterprises, but all institutions from medical centers to universities can no longer define their scope by national borders. What this means is that the economic map of the world is no longer congruent with that of nation states, but now covers the political map of the world like a huge overlay without regard to political boundaries.

It can be argued that the speed and size of these global markets today have created a difference in kind and not just in degree from markets in the past. After all it is speed alone that transforms a harmless piece of lead into a deadly bullet or a group of still pictures into a motion picture. The speed, size and complexity of the market made possible by the convergence of computers and telecommunications has had and is having a profound effect on the world we live in. Nicholas Negroponte went even further when he opined, "Computing is not about computers any more, it is about living." And certainly markets of all kinds impact all our lives. Since markets are basically driven by information about money or stocks or commodities, the instant and almost universal availability of this information make the modern Reuters or Bloomberg screens light up in a way that is different in kind from smaller, slower and more primitive technologies.

The global market today might be described as the very model of what has become known to scientists as a complex adaptive system. The agents, or people who influence the system, range from learned central bankers to 21-year-old traders at some small merchant bank. The agents in the global market are numbered in the millions, each having his or her own agenda and interacting in ways to produce a result that cannot be predicted. When the pundits on the evening news explain why the dollar is strong or weak, or why the stock market went up or down 120 points, they advance the limits of creative writing but not necessarily our understanding.

These great complex systems are nonlinear and tend to resemble biological rather than mechanical systems. In these systems, chaos theory postulates that small events tend to have large consequences over time. The classic example is that of a butterfly moving its wings over China affecting the weather weeks later in Wisconsin. The global market exhibits some of these characteristics. Despite massive work by the Santa Fe Institute and many others, we do not know just how these complex systems work. As Mitchell Waldrop put it, 'The marketplace responds to changing tastes and lifestyles, immigration, technological developments, shifts in the price of raw materials, and a host of other factors."[2] 

The failure not only to perceive, but to act on this change will cause many firms to fail over time. But the lure of the known and the comfortable is so strong that many people who talk about their future business plans use a straight line projection to foretell tomorrow, and that method almost always produces a bad result. On the other hand, those who correctly predict the future are almost never believed because the future is always unbelievable. Examples abound. Roger Ibbotson, a professor at the University of Chicago, in 1974 when the Dow Jones average had just lost 42% of its value and stood at 850, predicted that by 1988 the Dow would be at 9218 and would cross 10,000 by November 1999. The Dow actually crossed 10,000 in March this year. At the time Professor Ibbotson made his arithmetic calculation in 1974, almost no one believed him. Using a similar mathematical formula, he now predicts that the Dow will be at 100,000 in 2024. It is probably fair to say that few, if anyone in the room, believe this forecast because based on what we are used to, it just seems outlandish. Even so great a forecaster as H. G. Wells missed the boat on the future of radio: "The truth is that I have anticipated its complete disappearance--confident that the unfortunate people, who must now subdue themselves to 'listening in' will soon find a better pastime for their leisure."[3]  We don't have to predict the future for as William Gibson, the science fiction writer, has observed: "The future is already here. It is just unevenly divided." It is not only unevenly divided among various parts of the world, but also between those who believe there is really a new economy and those that don't.

The new information/network economy is now spawning a host of ideas that seem to many today as heretical as the idea of a Dow at 10,000 seemed to analysts in 1974. No less a personage than the Deputy Governor of the Bank of England, Mr. Mervyn King, speaking at the recent conference of Central Bankers held at Jackson Hole mused on the fact that since more and more people have come to believe that the Internet is changing everything, even Central Banks will not be immune from its influence. Indeed he speculated that Central Banks, now at the height of their power may disappear in a few decades. As you can imagine, this was not well received by the audience. "The successors to Bill Gates," he said, will "have put the successors to Alan Greenspan out of business." He argues that the crucial variable is how fast e-commerce will revolutionize the role of money. If enough computing power is brought to bear, it is clear that the Central Banks' clearing function will disappear as sellers will be able to send a direct debit to the buyer's account in real time and eliminate the credit risk. If this all comes to pass, what will happen to the traditional banking system; will it survive in a form we can recognize, or will it mutate into some new unknown form? Whether you agree with the Deputy Governor or not, few would deny that we are moving at flank speed through a period of transition with uncertain outcomes. Almost every major corporation's business plan includes some form of financial service. These myriad companies entering our business can come from around the corner or from around the world as the barriers to entry are falling fast. Examples abound. Today on the streets of Japan there are 300 unmanned automated loan kiosks where anyone with a driver's license can have his or her credit checked, sign a note and get the money within a half an hour. And the owner of these kiosks is not a bank but none other than General Electric Company.[4] 

The erosion of the bank's market share of financial assets has been going on for a long time, but it is accelerating. In 1970 banks had 76% of all short-term business credit in the United States, but by 1997 this had dropped to just over half at 51%.[5]  By now the number is probably under half and still dropping. Even more startling is the fact that banks in this country now hold less than 25% of the national financial assets. Indeed it would be hard to find any industry which has lost that much market share and is still alive.

As we move further into the information/network economy, banks retain some advantages based on the nature of our products. Nicholas Negroponte has pointed out that: "World trade has traditionally consisted of exchanging atoms, not bits. Even digitally recorded music is distributed on plastic CDs with huge packing, shipping and insurance costs."[5]  One advantage that banks enjoy is that financial services are based on bits. Almost all financial services can be expressed as zero and one arranged in a certain way and can and will be transmitted on the Internet or other electronic pathways. Our products require no shipping and handling. Banks don't need warehouses and delivery trucks, and therein lies a huge advantage.

Despite this advantage, banks need to do more to survive in the new millennium. The only way to survive in this new economy is by innovation, not by refining the old. It is counter intuitive for most of us to throw away a great product at the peak of its popularity and go with something new. But in the new economy with the barriers to entry falling fast, if we don't innovate, new small firms will and our market share will fall further. The future belongs to the quick and the agile, not to the slow and ponderous. Often the failure to see opportunity is more a marketing failure than a technological one. Examples abound. The banks should have invented the credit card and the money market fund, two innovations that changed our industry, but they did not. They both came from small new companies who understood people's needs and found a way to satisfy them. Sears was an American institution, a retail giant but stuck to its proven ways while Sam Walton and Wal-Mart created a whole new way to serve the retail customer and took their business away. The saga continues as Sam Walton took 12 years and 78 stores to generate $150 million of sales for Wal-Mart, while Amazon.com did it with a website and a warehouse in three years. It is usually a new small company that comes up with the blockbuster idea, because a new company has no intellectual or money capital invested in the old product. In the words of William Perry: "A major company that is a leader in a given field has a very difficult time embracing a discontinuous technology that can lead to a product that has the potential of killing off the product that is yielding most of its earnings."[7]  The Citibank's invention of the CD was greeted by others in the industry as a disaster as institutions that were getting interest-free money would now have to pay for funds. But it was the CD that allowed banks to fund themselves as their demand deposits drained away to money market and mutual funds. Every day the papers are full of stories of great companies trying to deal with the conflict between the new Internet-based business versus their tried and true traditional delivery systems. The brokerage business is right now in the midst of this dilemma as high-paid brokers view online trading as a threat to their existence. But with online trading growing by leaps and bounds, no company can afford to stay aloof.

The introduction of what Clayton Christensen has aptly named "destructive technology" has been and is often the catalyst for change. Often new rather simple technology first captures the low end least profitable part of a market that is ignored by established companies trying to protect their margins. Having once established a market position, the technology usually continues to improve and products and services it produces become more upscale until they threaten the existence of established firms. All of this progression in technology from maverick to mainstream is made more complicated and dangerous to your health by the fact that today everything is moving more quickly than ever before in history. It is becoming in Charles Fine's words "a world of temporary advantage."[8]  As transparency replaces secrecy and data becomes both cheap and ubiquitous, it becomes harder and harder to leverage proprietary information.

Today the average life of a corporation is about 35 years and indeed there is only one company in the Dow Jones Average that was there when it was started. Today life cycles are even faster. In any given week I get at least one proposal for a novel financial service product from some young entrepreneur who has been unable to interest a bank. Some of these ideas, like the money market funds, will one day change our industry and many will fail, but none has been launched by a bank. When IBM invented the personal computer it created a special group that reported directly to the Chairman, otherwise the advocates of the heavy iron of the mainframes would have blocked the project. For years Lockheed has had its so-called skunk works, a group outside of, and resented by, the bureaucracy who have produced many of the innovations in aviation. Perhaps banks need a skunk works of some kind to canvas the young entrepreneurs and to find out what people need and want. Quicken is a great financial product, and it too should have been invented by a bank, but it was not. There are at least a dozen websites that make one's life easier and make E-commerce work better. So far, few if any, are operated by banks.

All businesses are built on the old concept of comparative advantage. The banks' edge was that they used to be able to obtain more information about a customer than could other people and thus could make better credit judgments than could others. That advantage is fast disappearing as the almost billion Web pages can be accessed by anyone. Merchants, large and small, now have more information about people's wants and desires and financial plans and capacity than did the best bankers just ten years ago. When an industry loses its comparative advantage it is in danger of extinction unless it changes and innovates with a new business plan.

The information/network economy will present new and novel credit problems for all banks. It is a truism that what gets measured is what gets done, and we have very few measurements in the new economy that mean very much. Indeed there is a clear disconnect between what is traditionally measured and what is important. In the public sector some of the methodology dates back to the 1930s which is like trying to describe a computer mother board by revolutions per minute or pounds per square inch, both of which were useful in the Industrial Age. That Age had hard assets--things that you could feel and touch and count like buildings, factories and inventory. In the new economy, intellectual capital is far more important than money capital, but so far it goes mostly uncounted in the balance sheet of our customers because it is largely ignored by the writers of accounting standards. Today there is a debate about how to handle "goodwill" among the various accounting authorities of the world. One school holds that it should be written off against earnings, which is another way of saying intellectual capital or the worth of a brand name like Citibank or Coca-Cola has no value. On the other side of the debate is the marketplace. Microsoft, for example, which has trivial fixed assets, has a market cap exceeding that of the big three automobile companies put together. This being so, it becomes increasingly hard to argue that intellectual capital has no value. The old guard will say that this view is just a way of measuring hot air and not real assets, even though many of the so- called real assets are rusted hulks in the scrap yards of history, while the firms based on intellectual capital like AOL are propelling companies into the new economy. Bad data produces bad results, and both the public and the private sector are in need of new metrics for a new economy. So far there has been little progress in this direction as there is a huge vested interest in the familiar and the known.

In our business, the role of money itself has been called into question by various students of the new economy. Richard Rahn has written a book called The End of Money, detailing how he imagines this will happen. Others have postulated different scenarios.

Over the years, as barter gave way to money and credit, people have used all kinds of things for money ranging from the huge immovable stones in the front yards of the residents of Yap Island, to salt in Upper Niger, from furs in Siberia which were called "soft gold," to the colored shells called wampum used by native Americans. Although much has been made of fraud on the Internet, scoundrels were at work in former times, Fernand Braudel tells us that "The production of counterfeit wampum in glass paste in the nineteenth century by European workshops led to the total disappearance of the old money."[9]  Then as now, Gresham's Law that bad money drives out good, at a fixed exchange rate, prevailed. The theft of personal identification numbers at ATMs and on the Internet is only a modern manifestation of a problem as old as money itself.

The government monopoly on issuing money, which we tend to take for granted, did not always exist - indeed the early mints were all privately founded and owned by merchants who stamped out standard coins that eliminated the need to weigh the precious metal each time a transaction took place. These standard coins commanded a premium over raw metal which gave the private mints an earning stream. At that time taxation was rudimentary, and Governments were quick to notice the earnings and then as now wanted it for themselves. As David Glasner has pointed out, "Besides the attraction any revenue source has for a sovereign, the monopoly over coinage had a particular advantage the ancient state was loath to relinquish. Because the monopoly over coinage could be exploited quickly in an emergency, it was a welcome source of funds in wartime when other revenue sources could not generate additional funds as quickly."[10]  It is still a welcome source of funds, and it is no accident that the Federal Reserve is the most profitable organization in the world.

Today when money laundering is a major activity for drug lords, and it is said for some political contributions, some forms of E- cash present major problems for both banks and law enforcement officers. Governments will want audit trails, but individuals may want privacy. The legal situation of venue is also murky. No consensus has emerged as to what nation's laws would apply for transactions in cyberspace. As a recent U. S. Treasury study dryly put it: "Nation states may find unilateral enforcement of electronic money related rules difficult."[11]  Since any product of the mind can be communicated as a stream of digital bits, the situation grows more complex. One thing is certain: At the end of the day the value of a currency rests on the productive capacity of the people who use it. In today's world that productive capacity rests, to a large extent, upon the fact that information applied to work is creating wealth. As Bill A. Frezza has pointed out, if ordinary people are able to create and exchange wealth on the Net "...The underlying products of their creative output upon which the value of money will be based - may never exist in the physical world. And since that wealth may not have to be exchanged for government fiat currency in order to be useful, there may be scant opportunity to seize it."[12]  It is not beyond the realm of possibility that counterfeiters of E-cash could create their own mints, that hackers can and will break encryption systems said to be secure, and tax collectors will be frustrated as they attempt to move through cyberspace.

Technology has always moved faster than governments and technology as it affects money is no exception. The private issuance of things that have the appearance of being money is accelerating, and public policy issues will grow along with that phenomenon. Today business to business commerce on the Net will exceed $100 billion this year, and growing exponentially. What kind of money will be used, who will issue it, who will redeem it are all open questions.

We have grown so accustomed to the familiar Federal Reserve note, many forget that Americans had no central bank for about 75 years, from 1836, after President Jackson vetoed the bill to renew the charter of the Second Bank of the United States, to the start of World War I. Indeed, many believed that the Constitution left authority over banking to the states, and the Federal Government's bank was unconstitutional. After the passage by New York State of the Free Banking Act, the idea of state chartered banks spread across the country, and each commercial bank issued its own dollar bills of various shapes, sizes and quality. By some estimates, at the outbreak of the Civil War, about 10,000 kinds of paper money were circulating.[13]  The general perception has been that free banking was a disaster, but recent research has proved otherwise. It was not problem free, but as Gerald Dwyer of the Federal Reserve Bank of Atlanta has concluded "There is little evidence supporting a generalization that these free banks were imprudent, let along financially reckless."[14]  Sometimes, as in the private sector today, states competed with each other as when Ohio in May 1854 passed a bill making it illegal for anyone in Ohio to use small bank notes issued by banks in other states. A somewhat similar situation to 19th century free banking may soon exist with smart cards, and cybercash, except that this time these new kinds of money will be, and are now, being issued not only by banks, but by all kinds of companies from 7-11 stores to telephone companies. Today instead of the government decreeing that dollar bills must be of a standard shape, color and size, the private sector is trying to work out the modern equivalent of uniformity which we now call "standards" so that cards can communicate with machines, and machines with each other.

As the monetary system of the world has evolved, we have arrived at the point where for the first time in history, no major currency is tied directly to a commodity like gold or silver. In 1911, long before the advent of information technology, Irving Fisher opined that "irredeemable paper money has almost invariably proved a curse to the country employing it." The advent of the Gold Standard and the Gold Exchange Standard furnished for a time a discipline on the creation of money, but now with the uncoupling of money from any commodity, those old arrangements have been replaced by an even more draconian device which I call the Information Standard. This new discipline is being administered by a completely new system of international finance. Unlike all prior arrangements, this new system was not built by politicians, economists, central bankers, or finance ministers. No high-level international conference produced a master plan. The new system was built by technology. The new world's financial market is not found on a map, but consists of more than 200 thousand electronic monitors in trading rooms all over the world linked together, and the value of our currency is determined by the price that the market will pay for an American dollar in exchange for yens, marks, or pounds. Whatever the price, it is almost constantly being condemned by someone somewhere as too high and by someone somewhere else as too low. Few governments are entirely satisfied with the value the market places on their currency. Someone is always demanding that governments do something to push the value of its currency up or down, depending on how one's interests are affected. But the market is so huge that intervention by central banks has become an expensive exercise in futility. Indeed, Peter Drucker has written: "Control over money was at the very center of what came to be called 'sovereignty'. But money has slipped the leash...It cannot be controlled any longer by national states, not even by their acting together."[15] 

So we arrive back to the wisdom of Gertrude Stein - the money will always be there, but it is not clear whose pocket it will be in, or what it will look like or who will issue it. For clues we can look to one of the inventors of the microchip, Carver Mead, who advises us to "Listen to the technology. Find out what it is telling you." It is advice we can ignore at our peril, but if we listen carefully, we will be able to survive and prosper in the new economy.

[1] Maass, P., "Welcome to Silicone Valley", Wired, Sept. '97. p 134

[2] Waldrop, M. Complexity, Simon & Schuster, p 11

[3] Cerf, Christopher and Navasky, Victor, The Experts Speak. Pantheon Books, 1984, p 207

[4] "The Economist" September 18, 1999, p 24

[5] Figures from The Federal Reserve Bank of New York

[5] Negroponte, Nicholas, Being Digital, Alfred A.Knopf, 1995, p 4

[7] Perry, William, "Cultivating Technological Innovation," The Positive Sum Strategy, National Academy Press, 1986. p 450

[8] See Fine, Charles H., Clock Speed, Perseus Books, 1998

[9] Braudel, Fernand, The Structures of Everyday Life, Harper & Row, p 444

[10] Glasner, David, Free Banking and Monetary Reform, Cambridge University Press, p 30

[11] U.S. Dept. of Treasury, op cit, p 33

[12] Frezza, Bill A., Cato Policy Report, July/August 1996, p 11

[13] Gleick, James, The New York Times Magazine, June 16, 1996, p 30

[14] Dwyer, Jr., Gerald P., Wildcat Banking, Banking Panics, and Free Banking in the United States, p 22

[15] Drucker, Peter, Post Capitalist Society, Harper Collins, p 142-3