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by Catherine England
George Mason University
Economists generally accept the notion that competition in supplying virtually any good or service will lead to superior results in terms of improved quality and lower prices. Agreement about the benefits of competition has not been as universal, however, when the "good" being supplied is "money." Even among economists debates have raged about whether economic systems in which currencies compete would lead to superior performance or to overissue and runaway inflation. So that there is no "false advertising," I am of the school that believes that users of money would (actually already do) benefit from competition among suppliers of money.
In addressing my assignment for this conference, I will take three steps. I will begin by reviewing the case for currency competition, including a brief discussion of how government policies contributed to many of the observed real world problems. I will then talk about evidence that the information revolution has already increased the competition among government-supplied currencies. To a significant degree, I believe the improved inflation performance among developed countries is a result of the increase in effective competition among national currencies. Finally, I will discuss the future for private suppliers of money. In particular, I want to think about the characteristics that a successful private money might have.
Before beginning this discussion, it is important that we all agree on terminology. The original contributions to the "competing currencies" literature were written at a time when the circulating currency (the pieces of paper we carry in our wallets) was a more important element of the money supply than it is today. It might be easier to think about who will supply the physical pieces of paper that will be used in exchange in the next century. [1] In this paper, however, I have focused on the "credits" that we will use to pay for goods and services. Of course, the vast majority of the money supplies of developed countries today is already in the form of electronic credits in bank accounts that are transferred through checks, debit cards, and electronic funds transfer orders. So as we talk about competing currencies, I am relatively unconcerned about who will print the remaining pieces of circulating paper. Instead, I have addressed questions surrounding (1) who will be the "keepers" of the electronic credits that are used to pay for the transfers of goods and services and (2) who will determine the supply of credits in an economy at any point in time.
A Brief History of Competing Currencies
The arguments in favor of competing currencies are the arguments in favor of competition generally. F.A. Hayek and Roland Vaubel, among many others, have argued that competing suppliers of monies will be required to provide users of money with those characteristics that are most widely desired. It has long been assumed that users desire durable monies that are widely accepted and provide a good store of value. In other words, individuals and businesses free to select among several monies would presumably avoid monies associated with high levels of price inflation.
It is widely accepted, of course, that privately provided currencies did not provide "good" monies that remained stable in value. The term most frequently attached to privately issued bank notes in this country is "wildcat banking," wherein banks located where only the wildcats could find them. This location decision was designed to prevent users of the notes issued by these banks from finding the bank and presenting the notes with a demand for payment in gold. So fraud was sometimes a problem.
The market had a solution, of course. Recognizing that it might be difficult to obtain payment in good funds from lesser-known banks, merchants refused to accept notes from these banks at face value. Some banks' notes were quite heavily discounted. Money brokers arose to buy up bank notes from merchants and return the notes to their issuing banks for payment in gold. These money brokers published lists of bank notes and the percentage of face value they would pay for notes from individual banks. As one might expect discounts depended on the reputation of the bank and the ease with which the notes could be exchanged for gold.
Individuals and businesses accepting payment in notes from an unknown bank did need to invest in information about the market value of those notes. There were no doubt many times when individuals received less "purchasing power" or a poorer store of value than they had expected when they accepted particular notes in payment for some good or service.
From today's perspective, the idea of dollars, all with different pictures and designs issued by individual banks and trading at varying percentages of their face value certainly seems chaotic. It is easy for many observers today to accept, then, the necessity of government intervention into the money markets to provide a single currency, recognized throughout the country. Let us remember, however, that the National Banking Act of 1863 also required banks issuing the new uniform dollars to invest in U.S. government bonds. For a country at war, this was a great fiscal benefit. Any monopoly supplier of a national money supply can reap considerable benefits (widely known as seigniorage), and governments have the legal muscle to enforce their monopoly.
Beginning in the late 1970s, several scholars began to examine more closely the private supply of money historically. [2] These scholars determined that the monetary conditions existing in areas with competitive, private supplies of the circulating medium often were not as chaotic or uncertain as it might appear from our 20th century perspective. Information about the health of individual banks was widely available. Individuals and even businessmen dealt most often with banks they knew and that were known by merchants in the area.
Problems that did arise were frequently the result of government restrictions on private arrangements. For example, as long as banks were allowed to issue distinctive notes, overissue was restricted both because distinctive notes could be returned to the issuing bank more quickly and because there was a real benefit to the bank building "brand name capital" as a supplier of bank notes that were readily redeemed and traded at par. [3] Government-sponsored moves to establish uniform currencies increased banks' ability to overissue their notes because excess supplies of notes were not as readily returned to their issuers.
Similarly, government restrictions on the contract terms between banks and their customers also served to undermine the stability of these earlier financial markets. Efforts to force bank notes issued by all banks to trade at par effectively reduced the market's discipline of less financially stable banks, for example.
In short, there is ample historical evidence that private, competitive note issues did provide a stable source of money in many different economic settings. Competition among nationally provided currencies is certainly increasing, and the pressure this competition is applying to national monetary authorities seems to be adding to economic stability in both developed and many developing markets.
Competition among Government-Supplied Currencies
Observers of international money markets are remarking with increasing frequency about the growing competition among the world's national monies. Most financial writers do not talk about currency competition as such, of course. But when financial reporters describe increasingly mobile financial capital, and the constraints such capital mobility places on national policymakers, they are describing a world in which national currencies (and economies) are increasingly in competition with one another for financial resources. [4]
In a survey article on "The World Economy," the October 7, 1995 issue of The Economist describes how changes during the past 20 years have altered international capital markets. As telecommunications technology has advanced, The Economist argues, the world's financial markets are rapidly evolving from a collection of individual domestic markets to a single massive global capital market. In this global capital market, investors shop any number of countries for desirable additions to their securities portfolios. The value of a security is clearly influenced by the stability of the currency in which the security is denominated.
In an article appearing in the March/April 1995 Harvard Business Review, Richard O'Brien, an economist at Global Business Network, describes the increasing constraints facing
policymakers. Governments that attempt to tax too heavily (either explicitly or implicitly) see businesses shift their production to other countries. Governments that attempt to borrow too much or that allow their currencies to be devalued through inflation see investors flee with their funds looking for safer financial havens. The growing amount of financial capital that responds decisively to unsound government policy initiatives has forced government decisionmakers to consider the reactions of financial markets before introducing major new policy initiatives. The Economist article on world financial markets quoted James Carville, one of President Clinton's advisers: "I used to think that if there was reincarnation, I wanted to come back as the president or the pope. But now I want to be the bond market: you can intimidate everybody."
The transition to a single capital market is not complete, but it is far enough advanced that government decisionmakers are bemoaning their loss of control over their domestic economies. [5] Furthermore, we must assume that capital will become increasingly mobile as the information age advances. As electronic banking becomes more widespread (as it almost certainly will), practical barriers to individuals and businesses maintaining accounts with institutions in other countries will be dramatically reduced. Why would I not store my wealth in a currency that retains (or increases) its value if moving funds to another location is simplified to require only a few instructions delivered over my computer anytime during the day or night? Indeed, it is possible to imagine the development of a worldwide bank offering accounts and loans in a variety of currencies. The physical offices of such a bank could exist almost anywhere -- or nowhere if employees of the bank telecommute from locations in different countries around the world.
Enter Private Monies?
There are those who argue that U.S. bankers' already supply private money. The vast majority of the U.S. money supply is not in the form of currency printed by the government. The money supply is to be found in the electronic account balances on the books of the nations' banks. But banks are regulated by the federal government, and they must keep their reserves with the central bank.
The question on everyone's mind is the extent to which nonbank financial institutions--or other organizations--will provide "money" in new forms. We are already seeing a number of prepaid debit cards issued by a wide range of providers. (Telephone cards seem to be the most popular at the moment.) How long will it take, say, for a company like American Express to offer to parents of college students a prepaid debit card that can be used for everything from telephone cards to gasoline charges to tuition and books? If American Express takes the balances it receives up front from college parents and invests those balances in loans to businesses, has American Express (a nonbank institution) created money? The college students and their parents certainly view the balances on their debit cards as "money." So does the business receiving the loan.
There are many other potential ways in which private monies might develop as entrepreneurs look for ways to provide payment services on-line and as home-based computer banking continues to develop. The development of these financial services have led to a number of interesting questions about the form(s) electronic payment services might take. I will identify a few of these issues. I am certain there are many more.
There is some debate about whether private money will be denominated in something other than dollars or yen or pounds, for example. We may come up with some new "cyberspace credit" denomination, but I do not believe every privately issued money will be denominated differently. I would suspect many will be denominated in the same terms, and my guess is that we are a long way from giving up the national currency designations we have dealt with so long.
Key to any monetary system is trust. Private (and public) issuers of money in the future will be required to establish their reliability in delivering payment services through mechanisms that meet the needs of users. This will clearly become increasingly important as it becomes easier for individuals to find alternative payment methods.
Some authors foresee mutual funds becoming the basis for privately issued monies. [6] I am not so certain. Mutual fund-based money would eliminate any reason for runs to develop. [7] But I suspect that many individuals and businesses are risk averse enough when it comes to their "payment account" that they want it at a fixed (or growing, but not fluctuating) value. Developing "trust" will also almost certainly require that privately provided credits be payable in something other than more cyberspace credits. But what? It is difficult to imagine returning to a gold standard, for example.
A contract might develop, however, whereby a "bank" customer could ask to have his or her account paid in some other financial asset--U.S. Treasury securities, Aaa corporate bonds, or even gold futures, for example. To protect the issuer of the cyberspace credits, it might be that the "bank" can choose to make payment with any of a pre-established list of securities. Conversion factors applied to the market values of different types of securities would be established and agreed to up front. [8]
Conclusion
To a very real extent, the world's citizens are already enjoying the advantages of competition among currencies. National monetary authorities are already discovering that to attract and retain financial capital, they must provide a stable economic and financial environment. The extent of effective competition is likely to increase as the physical location of financial service providers becomes less important and the range of choices available expands.
References
Browne, F.X., and Cronin, D. (1995) "Payments Technologies, Financial Innovation and Laissez-Faire Banking." Cato Journal 15 (1): 101-16.
Deane, M., and Pringle, R. (1994) The Central Banks. New York: Viking Penguin.
Dowd, K., ed. (1992) The Experience of Free Banking. London: Routledge.
Hayek, F.A. (1976) Choice in Currency: A Way to Stop Inflation. London: Institute of Economic Affairs.
Hayek, F.A. (1978) Denationalisation of Money--The Argument Refined: An Analysis of the Theory and Practice of Concurrent Currencies, 2nd edition. London: Institute of Economic Affairs.
Rockoff, H. (1986) "Institutional Requirements for Stable Free Banking." Cato Journal 6 (2): 617-34.
Selgin, G.A. (1988) The Theory of Free Banking: Money Supply under Competitive Note Issue. Totowa, NJ: Rowman and Littlefield.
Selgin, G.A., and White, L.H. (1994) "How Would the Invisible Hand Handle Money?" Journal of Economic Literature 32 (December): 1718-49.
Taylor, M. (1995) "The Economics of Exchange Rates," Journal of Economic Literature 33 (March): 13-47.
Vaubel, R. (1986) "Currency Competition versus Governmental Money Monopolies," Cato Journal 5 (Winter): 927-42.
White, L.H. (1984) Free Banking in Britain: Theory, Experience and Debate, 1800-1845. New York: Cambridge University Press.
Woodall, P. (1995) "The World Economy: Who's in the Driving Seat?" The Economist, October 7, Survey.
[1]There are those who predict that eventually there will be no circulating currencies. That may be the government's preferred solution, but I suspect there will continue to be a demand for an anonymous form of payment. Currency provides one method, although not the only method, for achieving that anonymity.
[2]See, for example, White (1984), Rockoff (1986), Selgin (1988), and Dowd (1992).
[3]Indeed, a bank that established its reputation for readily paying gold for notes returned to it might find that its notes began to circulate longer as they became more widely accepted as a reliable store of value.
[4]See, for example, Deane and Pringle (1994).
[5]Investors still exhibit loyalty to their domestic financial markets. See Selgin and White (1994).
[6]See, for example, Browne and Cronin (1995).
[7]Because mutual fund shares are constantly marked to market, there is no advantage to being first in line to receive your funds.
[8]Treasury bond futures contracts are based on an artificial bond with a standardized (and constant) coupon rate and maturity. When Treasury bond futures contracts come due, those owners of futures contracts who do not cash settle can choose from one of several actual bonds to meet the delivery requirements of the contract. Again, conversion factors for different types of bonds are established and agreed to by all market participants up front.
Prepared for the Cato Institute's 14th Annual Monetary Conference, May 23, 1996, Washington, D.C.