Tag Archives: electronic money

(Revised) Electronic Money: Revisited

In class, Professor Kimball has discussed his strong support for the discontinuation of paper money, and for it to be switched to be electronic. He has written countless blog posts about it. One of which is about the zero lower bound, or ZLB. Along with that, he contributed an article to Slate that made connections to bitcoin. Professor Kimball’s main claim about eliminating the ZLB is that negative interest rates are crucial to the economy’s recovery. Negative interest rates will cause increases in investments. The main function of eliminating the ZLB is to decrease the incentive to save, therefore stimulating consumption. Consumption is important for combatting the recession, and a huge increase in consumption would help raise output.

It seems that this idea has been catching on. An article in the Wall Street Journal, discussed the elimination of paper currency as well. However, this was more from a legal standpoint. According to the article, crime has been declining very quickly since the 1990’s. The article mentions that a possible reason why is that people have been using cash less and less. Cash is very anonymous, which means that it is integral to illegal transactions.

To this day, I have been having trouble completely agreeing with Professor Kimball’s stance on the elimination of paper currency. I agree that the ZLB is created by paper currency. I also believe that this idea could work in theory. When interest rates decrease, consumption and investment go up. This is because the interest rate is the opportunity cost of spending money, as opposed to saving it. A lower interest rate means that by spending, the individual is giving up less than he would if the interest rate was higher. The biggest problem for me is that creditors will disappear. Positive interest rates make creditors want to lend money because the borrower will pay back more money in the future. Nobody would want to lend money at a negative interest rate. Why would somebody want to lend money when he or she knows that the borrower will pay back less money in the future?

I do agree with every legal standpoint in this discussion. Electronic money is very easy to trace. A bank, or the government can know when and where a transaction is made. The same cannot be said about paper currency. If paper money were to be eliminated, how would a drug dealer be able to sell his product? Would the buyer pay him with Square? The answer is “no” because the government would be able to see it.

Electronic Money: Revisited

Professor Miles Kimball of the University of Michigan has proven to be a strong advocate of eliminating paper money and having all monetary transactions be electronic. His main reason for this is that it is a way to eliminate the Zero Lower Bound or ZLB. This can be seen on his blog, Confessions of a Supply-Side Liberal. His also contributed an article to Slate, which brought up similar points. Professor Kimball’s main reason for electronic money is indeed the elimination of the ZLB on nominal interest rates in the short-term. This only exists with paper money because paper money collects zero interest. If banks offered negative interest rates on savings, then people would hold onto cash because zero interest is better than a negative rate. Professor Kimball believes that these negative interest rates are integral to helping the economy recover because they promote investment and consumption, which are parts of GDP, or output.

There is an article in the Wall Street Journal about the elimination of cash, but from a legal standpoint. The article makes light of the fact that crime has gone down dramatically since the 1990’s. It attributes this to the decrease in the use of cash. Cash is crucial to illegal transactions due to the fact that it is not as traceable as electronic money. It is completely anonymous. The article also mentions that payments, such as welfare would be a lot easier if they were made electronically.

With regards to all of this, and one of my previous blogs posts. I am still unsure about the elimination of paper money. Negative interest rates would promote investments. They would promote consumption by creating an incentive against saving. Money in the bank would decrease everyday, so it would make more sense, economical, to spend. One downside is that nobody would want to loan money at a negative interest rate. It would be like the creditor is paying the borrower to borrow money. Positive interest rates create the incentive for a creditor lend money since he or she will be paid more in return.

From a legal standpoint, I think the argument in favor of electronic money is more valid. The credit and debit card purchases are very easily traced. The card company, bank, and/or government can know the exact amount of money transferred and exactly to whom it was going. Black market transactions would be a lot more difficult to make. Somebody buying illegal drugs, such as cocaine, would not be able to make the purchase. What would the dealer do? Use Square? The government would see a Square transaction for a large amount of money, and be able to investigate the transaction.

Another Reason to Put an End to Cash

Throughout this semester Professor Kimball has discussed the possibility of switching over to electronic money completely and getting rid of cash. By this point, the argument he has put forward in terms of how electronic money will benefit the economy is very clear and I think we all know the main idea. In his article on Slate entitled “The Paperless Economy: How Governments Can and Should Beat Bitcoin at its Own Game”, Prof. Kimball lays out the steps that are necessary to switch over to electronic currency. Towards the end of the post, he notes that “Giving electronic money the role that undeserving paper money now holds will only tame the business cycle and end inflation. Fostering long-run economic growth, dealing with inequality, and establishing peace on a war-torn planet will remain just as challenging as they are now.” In general this is absolutely true, but it appears that something along the lines of these other challenges, decreasing the crime rate, may actually come along with putting an end to paper money.

When you think about it, lots of crime related activities have to do with cash. Robbing convenience stores and assaulting someone are just two that quickly come to mind. The reason for this is that cash is so liquid and anonymous in nature, and thus it has long been conjectured that cash has stimulated street crime. While this has not been proven, Erdan Tekin, an economist at Georgia State University, tested the theory by examining the time around Missouri’s implementation of the Electronic Benefit Transfer system such that welfare recipients collected their money in debit card form rather than in cashable checks. The results of this experiment were positive overall, with the crime rate dropping by 9.8%, as well as specifically on three (often financially motivated) types of crime: robbery, assault, and larceny, which were reduced by 7.9%, 12.5%, and 9.6%, respectively. Other tests were run and precautions were taken to ensure that there were not other reasons behind the reduction in crime rates.

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While this may not be proof that getting rid of cash completely will bring down the crime rate further, it is pretty convincing evidence that it will certainly help the cause in a large way. At the end of this WSJ article, the author brings up the fact that there have already been cases of electronic payments being the target of more sophisticated sorts of crime; such as the data hack from Target that resulted in millions of credit and debit cards being compromised. My response to this however, is that things like this can happen while there is a mixture of cash and electronic currency running around in the country and in the world, but if you get rid of cash completely, at least the simpler, street type crime rate should fall, and so the overall crime rate should fall as well. Thus, switching over to electronic currency and putting an end to cash is a plus in more ways than one.

FT Alphaville Addresses the Electronic Currency Idea

For several years I have been an avid reader of the Financial Times, specifically the FT Alphaville blog. They tend to provide great insight and analysis on fairly complex economic and financial topics. Recently, they have posted great pieces related to Bitcoin and cryptocurrencies in general. I came across a post in the Bitcoin series titled “Breaking through the ZLB with virtual currencies” by Izabella Kaminska which featured a discussion that was very similar to Professor Kimball’s electronic money proposal albeit with one key difference. Because nearly all of the exposure I have had to the electronic money idea has come through Professor Kimball or posts he has linked to, I found the outside perspective incredibly interesting and I wanted to explore the key points in a post of my own.

The first point that Kaminska brings up is that there are essentially three options to create negative interest rates (1) banish cash outright and move to a cashless society (2) tax cash reserves or (3) introduce government sponsored virtual currencies. She points out that the first two solutions have too many issues to be successful – the former would likely cause a massive public outcry and the second could be avoided through transfers into foreign currencies or different assets. Virtual currencies, as we are already aware, provide the most promise for a feasible ZLB solution. As Kaminska describes:

Not only might this improve the velocity of money (if the virtual units were well constructed and digitally savvy) it would allow authorities to transcend the zero lower bound by injecting free money into the system without the constraints associated with QE. The free money could be popularised by the perception that its supply was tightly controlled. As long as the unit of account remained the dollar (something which could be assured by tax obligations) it would hopefully broaden the money supply in a way that transferred what would otherwise be hoarded wealth into the wider economy.

The author’s scenario differs from Professor Kimball’s in one very large aspect – the virtual currency would be a synthetic asset separate from the dollar. The Federal Reserve would set the interest rate on the virtual currency but this synthetic asset would remain separate from the dollar, which would remain the unit of account. Essentially this is a call to “Unbundle currency from the unit of account” as the author describes it. So while prices and wages would still be quoted in dollars, the value of a dollar would fluctuate in terms of the currency, effectively abolishing the ZLB.

The idea, as discussed in the FT Alphaville post, seems to grasp the importance of circumventing the ZLB with alternative currency arrangements, however it comes up with a different solution than the electronic currency idea we have been discussing. The idea of abolishing cash, which more closely aligns with Professor Kimball’s proposal is quickly dismissed as politically infeasible, which may be the case unless it’s implementation is forced by strong government measures. In terms of this article’s proposal, I see the benefits of uncoupling the unit of account from the currency but I fear that it would create a too complex of a monetary system to work effectively. Perhaps if virtual currencies like bitcoin catch on, and more price get quoted in terms of organically created virtual currencies, the public could grasp such a system and the government could implement a virtual currency of its own.

Bitcoin Could Hamper a Transition to Electronic Money

In class this week, Professor Kimball has been sharing the rationale for adopting electronic money. The argument is straight forward – monetary policy is currently limited in the extent to which it can stimulate spending by the zero lower bound. Paper money can be withdrawn from a bank and collect zero interest, so if the Fed cannot lower interest rates below this level, hence the zero lower bound. The key note here, however, is that real interest rates are what is important to positive inflation is a workaround to the zero lower bound. As the Professor described, most developed economy central banks have set a constant inflation target at around two percent to give them more room to maneuver near the zero lower bound. As Professor Kimball outlined in his blog post “The Paperless Economy”, abolishing paper money (or at least significantly penalizing holding it) in favor of electronic money could solve the zero lower bound problem by allowing negative interest rates. From a theoretical standpoint, I agree completely with Professor Kimball’s argument. There are, however, a great deal of structural impediments to adopting such a monetary system, which will make it difficult for developed nations to converting to electronic money in the near-term future.

I believe the biggest obstacle to electronic money would be public perception of such a monetary regime. Paper currency is an easy form of money to understand. Even electronic payments are currently denominated in dollars and usually paid with a credit card or payment service. Transitioning to a completely new currency that is entirely electronic, for the purpose of easier manipulation by the central bank could be met with extreme opposition.

The best current example of electronic money is bitcoin. As Professor Kimball himself mentions as the subtitle to his blog post linked above, “Governments can and should beat bitcoin at its own game.” bitcoin has created an immensely successful cyrptocurrency, which has established legitimacy and value outside of formal government control. This is essentially the polar opposite to what Professor Kimball advocates, as bitcoin exists outside the government’s control, while electronic money would have to be easily controlled by the central bank. A problem could arise in the switch to electronic money, when individuals who are distrustful of government opt to swap their paper cash for bitcoins or other cryptocurrencies instead of government backed electronic money. Demand for these non-government controlled currencies could skyrocket and while the supply of bitcoins is eventually limited, a work around or substitutes will surely be devised if the switch to electronic money is imminent. In the next century, cryptocurrencies may very well be what gold was in the last. Individuals have flocked to gold when governments used aggressive expansionary policy as it was seen as a hedge against inflation. Bitcoins may serve the same purpose in the future for investors who do not wish to be exposed to negative interest rates.

While the existence of bitcoin may fundamentally hinder the adoption of electronic money, current issues in the bitcoin system and regulatory scrutiny could mean that the threat of cryptocurrencies is minimal. As the Wall Street Journal reports on their Money Beat Blog, just earlier today Mt. Gox, the leading bitcoin exchange, halted service and the price of the currency dropped nearly $200 to $600. Governments around the world, including Russia and China limited the legal status of bitcoin as a currency in their countries, which also an issue for more widespread adoption. Overall, while bitcoin may present a real obstacle for governments to over come in terms of introducing electronic money, bitcoin itself must first overcome the obstacles that currently prevent it from fully competing with government backed currency.

Possible Beginning of the End of the Bitcoin Era?

Last week, Charles Shrem, a large Bitcoin tycoon, was put under house arrest. He was charged with money laundering among other various crimes. He is allegedly connected with a drug scheme that involved Bitcoin as the method of payment. This currency has been booming in recent times, but the decision of Shrem’s trial could have an impact on the future of Bitcoins. Shrem is the founder of a website that was widely used in the exchange of the online currency. According to the Wall Street Journal, Shrem is optimistic about Bitcoin’s future despite his arrest.

To add to the woes of the Bitcoin culture, Apple has been taking down all of the applications on its App Store that allow users to buy and sell Bitcoins. The most recent application to be taken down is called BlockChain. A New York Times Article mentions that the chief executive, Nicolas Cary, of the application describes Apple’s actions as “building a walled garden to interfere with innovation”. (Cary)

Interestingly enough, Bitcoins have inspired the concepts of electronic currencies. Professor Miles Kimball of the University of Michigan wrote his first article for Slate about ending the use of paper currency. He argues that Bitcoin is a great display of electronic money, but it is dubious that governments will give up their control over currency. By adopting an electronic currency, the government would be able to eliminate the zero lower-bound. Professor Kimball has been an advocate of this for a while now.

Bitcoins are a novelty within themselves. Online currency seems to be futuristic. Electronic transactions are easier and faster. The downside is that Bitcoins can be used for illegal transactions. This is because they are unregulated, therefore they are not being traced by a governing entity. It is not illegal to own Bitcoins because there are ways to purchase many legal items and services with them. The government cannot arrest someone for exchanging their dollars for Bitcoins. It would be impossible to prove that a person bought Bitcoins with the intent to be a part of an illegal transaction.

The United States adopting an electronic currency has its ups and downs. Transactions can be made more quickly. We see this with the use of credit and debit cards. A swipe and a signature are enough to make a payment. Another positive to electronic money is that the government can trace money even more than it can now. Money used for illegal transactions is almost always done in paper form because it cannot be tracked. Electronic money would allow the government to know what every dollar, every day, goes towards, thus curbing illegal activity. Professor Kimball is also an advocate of negative interest rates, which are only possible with electronic money. This is where I believe that the downside lies. With negative interest rates, people will be losing money every day unless they spend it. There would be no incentive to save. Furthermore, there would be no incentive to lend money. Creditors would cease to exist if they were to be paid back less money than they loaned.