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Source: http://www.house.gov/banking/91900rai.htm
STATEMENT OF Dr. RICHARD
W. RAHN ON THE FUTURE OF ELECTRONIC PAYMENTS:
ROADBLOCKS
AND EMERGING
PRACTICES BEFORE THE SUBCOMMITTEE ON DOMESTIC AND INTERNATIONAL MONETARY
POLICY OF THE COMMITTEE ON BANKING AND FINANCIAL SERVICES
SEPTEMBER 19, 2000
{Note from JS: I worked in banking from 1978 -
1985. During that time, banks were acquiring on-line computer systems
with long-range networking capabilities. The financial industry was gearing
up for the cashless society, and some projected full implementation by
1984. At the time, I was pretty busy lecturing in some churches regarding
what I had learned about the planned cashless society. In the following
statement by Dr. Rahn, we find that what was planned 20 years ago is now
a reality.)
Mr. Chairman and Members
of the Committee, thank you for giving me this opportunity to testify
today on the impact of the emerging electronic and digital payment systems
on monetary policy and financial privacy. I am an Adjunct Scholar at the
Cato Institute, a Senior Fellow at the Discovery Institute, and Chairman
of Novecon Financial Ltd. Also, I am the author of the recent book, The
End of Money and the Struggle for Financial Privacy. I will focus my comments
today on the emerging digital money-like products which, I believe, will
supplant most conventional government issued money and existing payments
systems over the next couple of decades.
Introduction
The age of digital money
is upon us. The new technologies of the Internet, digital electronics,
public key encryption, and the rapid price declines of computing power
and telecommunications bandwidth are having a dramatic effect on the financial
world. These new technologies are enabling the development of financial
markets, procedures, and instruments that economists in the past could
only theorize about. Financial transactions can be settled in real time
even though the contracting parties may be thousands of miles apart. Money
and other assets can be moved at almost the speed of light to any point
on the globe for a minuscule cost. Easy to use encryption programs enable
almost anyone to move data or money around the globe with almost complete
security. It is now possible for private digital currency issuers to compete
without the high information and transaction costs that burdened the multiple-issuer
systems in the past. Moreover, new, private monies are emerging, including
"digital gold." The technical barriers have been overcome, as
well as many of the economic challenges.
Digital money is the monetary
value of government- or privately-issued currency units stored in electronic
form in an electronic device. Digital money is one type of a digital financial
instrument that fulfills most or all of the functions of money. The monetary
value stored in the electronic device can be transferred to other such
devices, allowing the users to engage in payment transactions. This is
different from traditional electronic payment systems, such as credit
and debit cards and wire transfers, which usually require online authorization
and may involve debiting and crediting bank accounts for each transaction.
A prepaid monetary value may be stored in a computer chip on a card -
"smart card" - or stored on a computer chip in a wireless device,
or on a computer disk drive. Money transfers with cards are most often
made through card reader/writers, while transfers using computers or wireless
devices are made over wired or wireless communication networks, such as
the Internet. Cards, wireless devices, and computers can also be used
to merely authorize monetary transfers from one account to another. These
accounts may be bank accounts or reserve assets held in non-bank institutions.
Stock, bond, mutual fund, and gold deposit accounts may allow ownership
transfer of assets, even in micro amounts, to be made by computer or wireless
devices. To prevent fraud, all such transfers need to be protected by
cryptographic codes. The technology now exists to make such transfers
anonymous, like paper currency transactions, if the user so chooses.
Financial cryptographers
have developed methods whereby people will be able to securely hold bearer
digital cash, bonds, stock, and even financial derivatives, and make very
low cost and anonymous transactions with them. A US dollar in paper form
is a bearer instrument. That is, the person who holds it is normally considered
to be its lawful owner. There is no list of owners of paper currency (a
registration record); ownership is conveyed by physical possession. (NOTE
- colour coding expresses the emphasis and concerns of BIBLE REVELATIONS
without any intention to digress from the core message of the author).
The advantage of bearer instrument transactions is that settlement is
in real time, and therefore there is no risk of non-payment, as there
is in book entry transactions such as checks and credit cards. There are
no charge backs to the merchant, and the risk of fraud (in the absence
of counterfeiting) is greatly reduced. Bearer instruments are also anonymous,
which can protect the owner from corrupt governments or criminal types.
However, because of this anonymity, many governments do not like or have
prohibited certain types of bearer instruments because they make it hard
for tax officials to collect revenue. Digital monetary and financial products
are "disruptive" technologies, in that their creation upsets
the existing legal and public policy order as to how money and financial
products and institutions are regulated and organized. National borders
are ceasing to have the relevancy they once did.
Both businesses and governments
need to build the appropriate legal order for the digital age and understand
how it should be managed. This will require changes in laws and regulations,
leaving businesses in a thicket of uncertainty during the transition period.
Central bankers, treasury officials, law enforcement authorities, and
intellectual property administrators (patent officials, etc.) will by
necessity have to adjust to a different world. Their challenge will be
to create a new set of rules and procedures that bring the necessary order
without impinging on the rights of privacy of individuals and institutions,
or destroying the economic efficiencies that the new technology is bringing.
Policy Implications of Digital
Payments Systems
Many legal issues will arise
as digital money becomes more prevalent. Given that most digital money
will be global in the sense that the Internet will facilitate its movement
or use outside its issuing jurisdiction, the lack of legal uniformity
between countries raises many policy issues. For instance, who has the
liability if a failure does occur in a particular digital money system
because of fraud or for some other reason? When digital money payments
are made across national borders, who has jurisdiction? Does digital money
violate the monopoly rights of central banks to issue money? May a central
bank issue digital money? Do non-bank issuers of digital money need to
be regulated, and if so, who should the regulator be? Who is going to
determine if the clearing organizations have sufficiently robust and fraud
proof systems?(1)
Given that various digital
money systems are now being developed and offered, the answers to the
above questions will probably slowly evolve over the next few years as
real problems emerge. Already, multilateral financial institutions like
the Bank for International Settlements and the International Monetary
Fund have established working groups to try to develop recommendations
for their members in dealing with the above-mentioned issues. These BIS
and IMF recommendations will be of particular interest to the world's
central bankers who are facing the front line of change. To the extent
people use privately-issued digital money for transactions, the demand
for government money is reduced. If people are willing to hold liquid
balances in the form of digital money, the quantity of demand deposits
(checking accounts) that people need or desire is smaller, thus reducing
the central bank's supply of money. The same principle holds true for
other money substitutes, from very limited money substitutes (i.e., balances
held on telephone cards, or frequent flyer miles) to broad, money-like
products (i.e., digital gold). As these broad and narrow-use money substitutes
grow in popularity because of their ease of use in the digital age, the
amount of money supplied by central banks will decline. Until some non-government
money reaches a critical mass whereby most users and businesses find they
can do a substantial portion of their business in the "new money,"
virtually all digital money and money substitute products will be reconverted
to central-bank-issued money at some point. However, even during this
period of partial and temporary substitution of digital money for central
bank money, the demand for central bank money will gradually decline.
Justifiable concerns have
been raised about the innovations in payments technology and the development
of digital money and their impact on inflation. For monetary systems with
a quantity anchor (such as the US dollar and other fiat currencies), technology
changes resulting in an increase in the money multiplier or a decrease
in money demand will increase the price level unless base money is reduced
by an appropriate amount. If digital money is issued by an institution
other than a bank, which has no reserve requirement, the growth in digital
money will increase the money supply unless the central bank takes corrective
action. The increases in the money supply resulting from the new technologies
will be both gradual and easily recognized, and hence would be neutralized
by the central bank by appropriate reductions in the monetary base.
As with all innovations
with payments technology, the introduction of digital cash has a one-time
effect on the price level. The money multiplier would be larger but stable
at its new level. If digital money is issued by a bank at the expense
of deposits, and is subject to the same reserve requirements as deposits,
the monetary effect would be approximately neutralized. If digital cash
issued by banks is subject to a 100% reserve, or if digital cash is issued
by a non-bank, with a 100% reserve(2), no new money is created. With any
price rule digital money system (i.e. commodity backed systems), inflation
by definition is not a problem.
In general, electronic payments
and digital money systems increase the efficiency by which the existing
money supply can make payments, thus reducing the demand for money. These
improvements tend to take place gradually over time, and are observed
as an increase in the velocity of money, which requires a compensating
adjustment in base money by the Federal Reserve. In sum, I see no reason
for great concern in terms of monetary policy management by central banks
as a result of these new technological innovations. The changes will be
gradual and obvious, giving plenty of time to make policy adjustments
to prevent inflation.
One effect of the decrease
in demand for central bank money will be the disappearance of central
bank seigniorage revenue. At present, the world's central banks obtain
a considerable income from issuing paper banknotes, which are non-interest
bearing central bank liabilities. Among the G-10 countries, seigniorage
as a percent of GDP ranged from a low of .28% in the UK to a high of .65%
in Italy in 1996.(3) This seigniorage not only provides for all of the
central bank operations, but also provides their treasuries with significant
revenue. However, it is also apparent that the efficiency gains for the
economy from digital money swamp any negative effect on government revenue
of the loss of seigniorage revenue, which has been in effect a tax on
the banking system.
It can be expected that
the growth of digital money will have a direct and significant impact
on the common measures of the money supply, particularly currency and
demand deposits (M1 and M2). Given that many central bankers target these
monetary aggregates in the conduct of their monetary policy, the focus
of monetary policy may need to change. The growth of digital money could
ultimately cause a substantial drop in banks' demand for settlement balances.
In the major economies, cash is the largest component of central bank
liabilities. Extensive use of digital money is likely to shrink the balance
sheets of the central banks significantly. At some point, the shrinkage
might restrict the central banks' ability to conduct open market operations
or foreign exchange sterilization operations. However, to the extent that
the new digital monies are fully backed by assets such as gold or high-quality
financial instruments, the need to conduct open market operations will
diminish, because the supply of money for transactions should automatically
adjust to demand.
As more and more transactions
are settled on a real time basis, the risk of non-payment and fraud declines,
and hence the need for regulation and monitoring also declines. The role
of the central bank may ultimately shrink to doing little more than defining
the numeraire for the national money. The definition is likely to be a
modern version of the gold standard. Specifically, a national currency
in the future may well be defined as a monetary unit that is equal to
a basket of specified commodities with a one world price, such as gold
and crude oil, and even some services. Any good or service having a one
world price that is set in organized auction markets could be a candidate
for a currency basket that would be used to define the value of the monetary
unit.
Some central banks might
also continue to serve as a lender of last resort to large financial institutions
by using off balance sheet transactions. The need for such a lender of
last resort would seem to diminish in a world of instant information on
almost all activities and institutions, and real time settlements. In
the new century, the kind of financial shocks and surprises experienced
in the past ought to be increasingly rare, unless financial regulators
interfere too much with the market adjustments that will naturally occur
in a world of increasingly perfect information.
The rapidity of adoption
of digital money systems by consumers depends on how their cost, convenience,
and anonymity is perceived in relation to paper currency and coin. Eventually,
electronic transfer and digital money systems will replace paper and coin,
because they can greatly reduce transaction costs and will ultimately
become more convenient. At the current level of technological advance,
it appears that within relatively few years, whether they involve a few
cents or millions of dollars, almost all monetary transactions will move
over the Internet, or by wireless device, or by chip card for small transactions.
The question of anonymity will remain an impediment until policy makers
understand that the fundamental desire and right to personal privacy must
be accommodated with the new technologies, to an extent no less than people
now have with cash. The role of central banks will change, and will likely
shrink, as a result of the new technologies.
One danger to the world
economy is that central banks will try to hold on to their traditional
roles by restricting the new technologies or regulating them in such a
way as to make them non-economic. Regulators should keep a hands-off approach
until a problem has been clearly demonstrated and, at that time, devise
corrective actions to do the least damage to innovation and financial
freedom.
Law enforcement officials
around the world have been concerned about the potential abuse of digital
money systems for the purpose of money laundering, and therefore are trying
to restrict or ban them. Officials in various government and regulatory
agencies, such as the Financial Crimes Enforcement Network, assert that
they should have more power and ability to monitor all transactions. It
is true that digital money systems, particularly anonymous ones, may indeed
make the job of money laundering easier. On the other hand, many government
law enforcement agencies throughout the world have abused basic rights
to financial privacy. The benefits of digital money greatly outweigh the
potential criminal abuses, and hence measures to restrict the use of digital
money should be resisted. Without the availability of anonymous systems
there will be strong resistance on the part of many individuals to fully
move to e-payments systems and digital money.
The existing efforts against
money laundering, primarily by the US and major European governments, have
not proven to be the least bit cost effective. For instance, in the US
in 1998, only 932 people were convicted of money laundering, yet the cost
to the private and public sectors of the anti-money laundering efforts
exceeded 10 billion dollars, which comes out to more than 10 million dollars
per conviction. The distinguished British law professor, Barry Rider,
has calculated that "the British state has been able to take out
0.004 per cent of the criminal money that has flowed through London."(4)
There is no evidence that authorities in the US are having much more success.
Money launderers do not have a statistically significant chance of being
caught and losing the profits from their misdeeds, and therefore the deterrent
effect of such laws is negligible. Privacy advocates have also documented
that the money laundering laws are very arbitrarily enforced in many countries,
including the United States. Money laundering is a crime of motive, rather
than one of specific activity, hence its enforcement, by the very nature
of the crime, is highly subjective. This subjectivity leads to selective
and politically biased enforcement. Because of the constant threat of
the vagueness of the money laundering laws and regulations, constructive
financial innovation has been retarded, particularly in the development
of digital monies.
The money laundering laws
have propelled the US to adopt attitudes insensitive to foreign countries'
rights to self-determination, and to violate the sovereignty of foreign
states. The US tries to impose policies on foreign states and businesses
that the US would never accept if the situation were reversed. The US
and the European Union have no business telling smaller developing nations
that they are involved in "harmful tax competition," or that
they should abolish bank and corporate secrecy laws. Small nations have
a need and a right to attract foreign capital, and it is perfectly legitimate
for them to compete against harmful tax, regulatory, and privacy policies
that larger nations impose on their own citizens.
Anti-money laundering legislation
has not only proven to be ineffective and counterproductive, but greatly
undermines the financial privacy rights of individuals. Such laws require
widespread reporting on the financial activities of bank customers by
bank employees to their governments, thus undermining the separation of
business from law enforcement, and ultimately the financial privacy necessary
for civil society. The fact is, the new technologies of various forms
of encrypted e-payments will make the task of enforcing the money laundering
laws even greater, unless governments are permitted a level of financial
privacy intrusion that most civilized people will find unacceptable. However,
widespread adoption of digital money will actually reduce the number of
crimes most people care about, such as murders, thefts, and robberies.
In 1998, there were approximately 18,000 murders in the US, and a substantial
number involved people trying to take someone else's physical money. A
move to digital money would reduce the murder, theft, and robbery rates.
Stealing digital money is a much more complex undertaking than stealing
paper currency, and will be beyond the capabilities of most common criminals.
If there is no physical money to steal, the incentive for criminals to
steal and kill people for money will be greatly reduced. Abolishing the
anti-money laundering laws is likely to speed up the use of digital money,
resulting in less total crime, and less wasted money by governments, even
though it will make life slightly easier for money launderers. Eventually,
knowledgeable people are likely to conclude that the "war on money
laundering" is going to be no more successful than was liquor prohibition
in the United States during the 1920s. It will become increasingly obvious
that the resources utilized in the "war on money laundering"
could be better spent attacking the underlying crimes. The knowledge of
how to utilize high levels of encryption is now widespread. This knowledge,
coupled with the Internet, smart cards, and related technology, ultimately
means that it is almost futile to try to prohibit the hard-to-define crime
of money laundering.
Conclusion and Recommendations
Digital payments and monetary
systems are coming of age, and will replace most existing money and payments
systems over the next couple of decades. These changes will bring enormous
economic benefits by greatly increasing the efficiency and reducing the
costs of our payments systems. In addition, the absence of paper currency
and coin, which is readily subject to theft or loss, should greatly reduce
crime. The US government has a choice of either embracing the new technologies
and helping them along (mainly by getting out of the way), or taking a
"Luddite" approach and attempting to restrict and deny the inevitable.
A civil society depends on a government that does not unduly restrict
liberty and economic opportunity.
The following recommendations,
I expect, will seem radical and frightening to those who do not understand
the new technologies and where we are headed. However, I expect that those
who do understand the new technologies, and desire a civil society that
provides liberty, privacy, and economic opportunity, will see these recommendations
as desirable and necessary.
Recommendations
1. Remove all restrictions
on issuing digital bearer financial instruments, including stocks and
bonds. Financial cryptographers have already figured out how to issue
such instruments in cyberspace, and many feel that they do not need government's
permission. Rather than create a new class of cybercriminals, governments
should recognize the reality, and do something that is both good for the
economy and that supports civil liberties.
2. Remove the capital gains
tax from trading in commodities and private currencies, in order to allow
the full development of commodity backed digital currencies (such as gold)
and other digital currencies. The capital gains tax on commodities does
not bring any revenue over the long run to government, given that losses
and gains offset each other. In the real world it is probably a net loss
for government since people will be more prone to report their losses
rather than their gains, and it reduces the efficiency of the commodities
markets. Over the long run, "capital gains" from currency trades
are most often created when a government has debased its own currency.
3. Remove all restrictions
on anonymous digital money and payments systems.
Restrictions are almost
impossible to enforce, and privacy is a basic human right.
4. Repeal the Bank Secrecy
Act and the subsequent related anti-money laundering legislation. The
existing legislation and implementation is not cost effective, is subject
to abuse, interferes with basic civil liberties to an unacceptable degree,
and actually results in higher levels of crime.
Thank you Mr. Chairman.
I would be pleased to answer any of your questions.
_____________________
1. Bank for International
Settlements, "Implications for Central Banks of the
Development of Electronic
Money," Basle: October
1996, pp. 9.
2. E-gold, a digital gold
product that is already available, is an example of a
100% backed digital money
product.
3. Bank for International
Settlements, "Implications for Central Banks of the
Development of Electronic
Money," Basle: October 1996, pp. 8.
4. Barry Rider, "The
Crusade Against Money Laundering--Time to Think!" European Journal
of Law Review, vol. 1, no.4 (1999), pp. 515.
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