CURRENCY EXCHANGE | CURRENCY CONVERTER |
EXCHANGING MONEY
THE CENTRAL BANK OF
THE REPUBLIC OF TURKEY
Yuksel Gormez – Christopher Houghton Budd
Abstract
This paper discusses electronic money, its relation to free banking and some
implications for central banking. It begins by introducing its conceptual
framework for modern central banking, in terms of which it then rehearses the
free banking argument. It then reviews the development of e-money in terms of
both electronic payment methods and electronic issue, with special attention
paid
to the latter. The discussion includes both mainstream developments, such as
Mondex, and ‘alternative’ schemes such as LETS. From here the paper proceeds
by way of a consideration of the synergy between electronic issue of money and
free banking precepts, to a consideration of some implications for the future of
central banking generally. It offers an ‘contestable’ model of central banking,
which endeavours to show the effects that e-money may be expected to have (and,
indeed, may already be having) as regards monetary policy, financial supervision
and seignorage. It concludes that even in its current stage of development, the
emergence of e-money not only reflects and supports key free banking concepts,
but may be nudging modern central banking towards free banking practice.
Keywords: electronic money, free banking, central banking
4.3 The Functions of Money
One of the implications of the improvements in the electronic communications
and computing technology is that they alter the traditional complementarity
between the functions of money. In monetary systems based on paper currency
and slow and expensive access to information, the three functions of money (unit
of account, means of payment, and store of value) were almost always connected:
the same instruments – money – served as means of payment, were nominated in
the unit of account (actually, defined the unit of account), and were also an
important form of wealth. Exceptions to this occurred only in exceptional
circumstances (under hyperinflation, rationing of goods, financial crisis and so
on)
when the integrity of money is no longer obvious. The reason for the almost
universal connection of the three functions is in the associated savings in
transaction costs under the traditional payment technology.
Electronisation of payments and transaction situations in general has the power
to
change this. This is the result of improved communications and information.
When up-to-the minute price information (such as exchange rates and asset
prices) are available in any transaction, and when wealth can instantly be
transferred from one asset to another, the reasons why the functions of money
should be connected become weaker and weaker. Transactions may be paid for
with assets which are not denominated in the same units in which the prices are
quoted; and the amount of welath actually kept in the form of the means of
payment may be minimal.
The three functions of money in a “unified” system can be thought of as
exhibited
in figure C:
9 In terms of good financial management, the same effect could be expected on
the part of governments, and
indeed NGOs, were these entities to be conceived and operated in the manner of
commercial organisations.
18
If represented thus, the idea arises that the three functions of money may be
the
monetary version of our earlier depiction of the three main functions of a
central
monetary agency (see Figure A). If that were the case, it would be reasonable to
expect that, just as central banking seems to be undergoing a transformation
from
a unitary to a devolved or articulated form, so money may also be subject to the
same process. In other words, we may need to pass from the idea of money as
consisting of three functions somehow linked and held together as if from a
central point, to the notion of money as the combination or combined effect of
three distinct processes (Figure D).
This development, if it occurs, makes it increasingly difficult for central
banks to
rely on their legal tender powers as suppliers of the mandatory means of payment
to entail a unified unit of account in their respective economies, or a large
demand
for central bank money (reserves or currency). This is not necessarily a new
idea.
Issing (1999) mentions the prospect for separating the functions of money, as do
Browne and Cronin (1995). E-money just extends this possibility and changes the
dynamics of money as a result.
5 Electronic Money and Free Banking
The direct or indirect relationship between e-money and free banking has been
addressed quite often recently. For example, Browne and Cronin (1996) pointed
out that laissez-faire banking could emerge endogenously over time in response
to
Figure C : Unified Money
UNIT OF ACCOUNT
MEDIUM OF EXCHANGE STORE OF VALUE
Figure D : Articulated Money
UNIT OF ACCOUNT
MEDIUM OF EXCHANGE STORE OF VALUE
19
technological improvements in information and financial products. As a result,
regulation of the banking industry after e-money could prove unjustified because
of the system’s likely inherent stability and efficiency. White (1995) argues
that
the technology gives an opportunity to issue private bank notes as smart card
balances, which are transferable without bank involvement. He adds that digital
payment technology has begun to foreshadow a world in which central bank
currency is obsolete - replaced, perhaps, by privately issued currency in the
form
of balances written to smart cards or downloaded to personal computers and
transferred by means of electronic wallets or over the internet. He also
investigates the potential of e-money to make small denomination currencies
interest-bearing for the first time in the history, and concludes that, when
combined with anonymity e-money would facilitate the public’s turning away
from government-based notes and coins. Selgin (1996) questioned the general
belief that financial innovation makes monetary controls more complicated. He
proposed that the more financial innovation succeeded the less reliance the
public
would place on central banks as direct sources of exchange media. Therefore, he
argued, the public could afford to deny the central bank its discretionary
powers.
The effects of electronisation are not limited to the retail use of currency but
extend also to the role of the central bank as the supplier of reserves to
banks.
According to Friedman (1999), three factors bring into question the future of
the
central bank’s role as a monopolist over the supply of bank reserves: the
erosion
of the demand for bank money, the proliferation of non-bank credit, and the
development of private bank clearing mechanisms. The conclusion, he warned,
would be that central banks’ ability to conduct monetary policy might
deteriorate
as they could not affect the price level of goods and services in the
non-financial
economy unless they had direct control on interest rate setting.
Goodhart (2000) did not agree with Friedman, arguing that only incompetence (in
monetary policy) rather than the IT revolution or e-money may bring about the
demise of central banks and give a comparative advantage to free banking. He did
not see the possible anonymity with disposable e-purses as important. Goodhart
argued that e-money cannot replace central bank base money because only the
latter can, in his view, enjoy full anonymity, full security and legal tender
status.
However, even if currency demand decreases to zero, the central bank is expected
to be able set the interest rates though direct quotation to the financial
markets.
Obviously, central banks can provide full coverage for the money that they
support as long as they have the power to make unlimited losses with the full
support of the nation. But, the risk of currency substitution may force central
banks to leave rates to be determined by market forces. As long as the support
behind the central bank is both safe and sound, the market price may be affected
by central bank interventions, but once the market questions the cover of money,
the risk of financial crises may follow, as it happened in Turkey in 1994. In
practice, it may be that central bank intervention is rendered unnecessary by
the
realisation of the efficiencies to be brought by IT in general and e-money in
particular.
Freedman (2000) reached a similar conclusion while making a case for the
continuation of central banking. He named two instruments necessary to its
20
survival: the potential to refuse the settlement on payment systems other than
its
own, and -when necessary- making or taking deposits on financial markets to
force the market rates under its control. But, again, the issue was not that
free
banking would require such things, but that they offered a way for central banks
to continue their role in monetary policy management. Woodford (2000) defended
a similar line of argument. Obviously, the power to impose tax gives the power
to
defend the central bank as well, but our concern is whether central banking is
the
most efficient way to maintain the integrity of money and or whether e-money can
increase alternatives to the right to choose with regards money.
All these discussions support the relevance of e-money to free banking. In free
banking terms, the basic requirement for an e-money proposal would be the
promise of convertibility with any other currency demanded by the holder.
Provided the regulatory environment were set to allow private competing
currencies, this requirement would now be met more easily than, say, 50 years
ago. While it may not be appropriate to expect a revolutionary transformation of
current financial systems, further deregulation of domestic and international
financial institutions may lead of itself to an evolutionary transformation
towards
free banking.
If we now turn our attention to the relation between e-money and free banking,
it
seems to us that e-money has very significant, even synergetic, effects. Not
only
does e-money foster a clearer understanding of the nature and workings of money,
and thus of its ‘proper’ management with its influence on banking and finance
that has been analysed in the earlier section, but its electronic issue may
provide a
technical means to bring free banking into play. Provided the electronic issue
of
money does not become subject to excessive regulation or outlawing10, it may
enrich currency choice through a process of substitution that has been supported
by the e-money based financial service provision. Chief influences of
electronisation which suggest such a scenario are the following:
1. Because bits and bytes are more easily re-defined than banknotes and coins,
it
may be easier to revise or change currency representation, leading, in the case
of
countries, to easier entry and exit to monetary unions, and facilitating
intercurrency
switching by end-users and, therefore, private money issue. This view
may be supported by the long planned currency conversion in the Euro area with
conventional banknotes and coins. In a future with e-money, any serious
financial
problem that threatens the Euro may allow individual members to express their
reaction with the possibility of designing a new monetary framework. On the
contrary, e-money also ease to join in a short time as well for those potential
members who has been attracted by well-managed Euro. This mechanism, at the
end, puts purely economic pressure to the ECB to respect the integrity of Euro
so
as to exclude any kind of political pressure. As a non-national (denationalised)
currency, it allows non-Euro economies to think of leaving the defence of the
integrity of money to ECB as well.
2. Thanks to the opportunities for transparency afforded by Internet
applications,
money can be backed as easily by commodities as by indices, or both. It does not
10 We recognise that the proviso is substantial, but we are confining our
remarks to the economically feasible,
rather than the politically probable.
21
mean to turn back to commodity backed currencies but the monetary institutions
may not take the risk of inflating their currencies because of these
opportunities
that has been available with the advent of e-money technologies. Integrity of
money may be defended with the cover of money, which is explained in the
following sections but if the society prefers to see a commodity backing,
e-money
can only help to realise this demand.
3. The increasing use of distribution channels such as the Internet, digital TV
and
mobile phones, may enable ‘good money’ to reach end-users more easily.
Conversely, end-users that have need of a reliable medium of exchange may find
it easier to reach better alternatives. For the same reasons, mismanaged money,
what Rudi Dornbusch calls ‘funny money’11, may become limited. E-money in
these mechanisms extends the reach of currency substitution to micro
transactions
other than medium or large transactions. In a sense, currency substitution
includes
not only store of value but medium of exchange function of money as well. This
puts extra pressure to the sustainable inflationary currencies around the world.
4. Ease of access to e-money may speed up the formation of a critical mass, the
moment when people generally become willing to accept the new proposed unit of
account because they become convinced that it now enjoys widespread
recognition and appropriate worldwide liquidity and systemic support. This
potential of e-money allows institutions to challenge mismanaged currencies with
stronger proposals. The face of alternative proposals may be limited only to
imagination. Instead of a non-governmental institution like ECB, a gold mine
company in Australia, for example, may get into the money business to offer an
alternative to inflationary currencies with the help fast speed enrichment of
distribution channels to ease access to the offer. This option may be open to
any
company who can create and sustain a customer base for their offer.
To complete the picture, these many attributes of electronic banking clearly
reflect
key features of Hayek’s (1990) conception of denationalised money – such as
basketisation, autonomous agreement regarding the unit of account, and
indexation.
The defence of central banking per se does not explain currency unions, the
dollarisation trends spreading in Latin America, or the currency substitutions
in
developing countries unstable monies. To discuss the relation between e-money
and free banking are not, therefore, to address directly the threats to central
banking, but to consider the opportunities it presents to create a better
monetary
regime. This is a crucial point. There may well be continued use of
interventionist
settlement of interest rates through forced clearing procedures and depository
instruments, but it is worth mentioning that foreign exchange interventions have
failed many times since 1980 and in different parts of the world.
Insofar as free banking considers that sound money not only delivers price
stability but also financial stability, it may now be only a matter of time
before
free banking challenges central banking in practical fact with the advent of e-
11 “When funny money is no joke”, Financial Times, 3.1.2000. Monetary reformists
also use this term, but
they mean time dollars and the like. See, for example, D Boyle, Funny Money, in
search of alternative currencies.
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