Money: back to the future?

Wriston, Walter B.


Money: back to the future?

Money: back to the future?


Americans are about to begin using a new kind of money that may have consequences for the Federal Reserve's control of the money supply and almost certainly for the velocity of money.

Over the years, people have used all kinds of things for money, from the huge immovable stones in the front yards of the residents of Yap Island to the more familiar silver and gold. All these various mediums of exchange will now be joined in our country by the "smart" card -- a piece of plastic embedded with a microchip.

Smart cards combine features of the following: automatic teller machine cards that let you access your bank account and draw cash; MasterCard or Visa cards that permit you to buy now and pay later; and debit cards that charge an account at the time of purchase. Not only can smart cards do all of the above but they can also serve as an "electronic purse" independent of your bank account. These cards contain real money that can be spent at stores and restaurants. In effect, the card is an electronic traveler's check, but one that makes exact change. In addition, the integrated circuit chip allows a higher degree of security for the information stored than do the current magnetic strip cards.

Smart cards are common in Europe and Asia, where some 400 million were shipped last year. The first large-scale use of smart cards in this country will occur next year at the Summer Olympics in Atlanta. Plans call for 300,000 rechargeable cards, and 700,000 disposable cards in denominations of $25, $50 and $100. These cards would fit nicely into the payment habits of Americans, since in the U.S. it is estimated that 88% of transactions are done by cash or check, and of these 83% are for less than $10. In Atlanta, electronic "purse cards," which contain stored value, could be spent at pay phones or vending machines. When their stored value is exhausted, they are thrown away. The smart cards, by contrast, can be taken back to the issuer and recharged.

Their broad issuance and use could return America to something very close to the free banking of the last century, when every commercial bank issued dollar bills, backed sometimes by the skill of the management, sometimes by doubtful state bonds and sometimes by gold or silver.

We have grown so accustomed to the familiar Federal Reserve note that many forget that Americans had no central bank for about 75 years -- from 1836, when President Jackson vetoed the bill to renew the charter of the Second Bank of the United States, to the start of World War I, when the Federal Reserve Act was passed. After the passage by New York state of the Free Banking Act in 1838, the idea of state-chartered banks spread across the country, and each commercial bank issued its own dollar bills of various shapes and sizes.

This does not mean that the 19th century witnessed complete currency chaos. In 1863, the National Bank Act was passed to create a market in the government bonds needed to finance the Civil War and to bring some order to the private issuance of currency. The act required that bank notes issued by commercial banks be uniform in appearance and that they be backed by collateral consisting of U.S. Treasury securities. As the old Civil War bonds were paid off, the currency base of the country declined some 60% from 1881 to 1890. This inflexible system led to panics and instability.

To a certain extent, the Treasury Department during this time assumed some of the functions of a central bank. All during this period a debate raged, not about whether America needed a central bank but about "free silver" and the price at which the Treasury would buy gold and silver. It was not until the eve of World War I that passage of the Federal Reserve Act finally gave the U.S. government a monopoly on the creation of money.

Now we may be going back to the future. The advent of smart cards means that the Fed will lose its monopoly on issuing currency, except that this time the new money will be issued not only by banks but by all kinds of companies, from convenience stores to telephone companies. Nor is this the only trend threatening the Fed's monopoly: Information technology is about to permit the creation of both electronic token money and cash money in cyberspace. Already we have Digi Cash in Amsterdam reviving in modern guise something very close to the old American free-banking system -- issuing electronic money (backed by some depository bank holding collateral in the form of Treasury securities) and performing the clearing function.

None of this is necessarily a cause for panic. There is very little, if any, evidence that government has managed our currency values any better than the commercial banks did in pre-Fed days. Indeed, the Nobel laureate economist F.A. Hayek put it more strongly: "The history of government management of money has, except for a few short happy periods, been one of incessant fraud and deception."

Still these new trends do present worries for central bankers. If more and more firms issue cards for cash or credit, what will be the effect on the velocity of money? How will central banks form policies on the control of the money supply if any company can issue electronic purse cards on credit, with or without collateral? What will happen if the issuer of the card goes broke?

As smart cards become more visible in America, regulators and governments will begin to wonder about control of money and credit. The European system of central banks has produced an advisory report outlining a possible regulatory response, and in this country some Fed officials are starting to wonder if their regulations will be applicable. If one definition of money is an object that has no use except to be given to someone else in exchange for goods or services, smart cards are money -- and they are coming to your neighborhood soon.

Mr. Wriston is a former chairman of Citicorp.