R. A. Hettinga on 22 Sep 2000 17:56:25 -0000

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<nettime> [IBUC Friends] Dr. Richard W. Rahn before the Subcommittee on Domestic and International Monetary Policy

     [also To: Digital Bearer Settlement List <dbs@philodox.com>, 
      dcsb@ai.mit.edu, cryptography@c2.net, cypherpunks@cyberpass.net, 
      e$@vmeng.com, Digital Commerce Society of DC <dcsdc@shmoo.com>]

I met Richard Rahn, a veritable icon of the supply-side revolution, at a
great conference on non-state governance sponsored by e-gold in Nevis this

I did Paul Harrison's and my talk on Fama and Black's "New Monetary
Economics" idea and how to create synthetic non-state numeraires using
bearer wearhouse receipts, etc., as proxies for the Consumer Price Index.

>From the comments below, it looks like the old reality distortion field
still works, right down to the use of "financial cryptography", and
"digital bearer financial instruments" in congressional testimony. (Yeah, I
know, don't testify, it only encourages them, and all that, but a little
vanity goes a long way...)

Thanks, Richard (who's also on the IBUC Friends list) for taking the fight
right to the belly of the beast. :-).


--- begin forwarded text

Date: Fri, 22 Sep 2000 00:03:37 -0500
To: (Recipient list suppressed)
From: Jan <Igniting@ticnet.com>
Subject: ip: Dr. Richard W. Rahn before the Subcommittee on Domestic
  and International Monetary Policy

Dr. Richard W. Rahn

On The Future of Electronic Payments before the Subcommittee on Domestic
and International Monetary Policy
Committee on Banking and Financial Services

United States House of Representatives
Roadblocks and Emerging Practices
September 19, 2000

Mr. Chairman and Members of the Committee, thank you for giving me this
opportunity to testify today on the monetary 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.

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 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 ö
"smart card" ö 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. Gold coins are bearer instruments.

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? 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 worldās 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, hence
reducing the central bankās 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, no new money is created. With any price rule digital money
system (i.e. commodity backed systems), inflation by definition is not a
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 worldās
central banks make 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. 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 banksā 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 banksā 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 totally 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 hence 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." 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
hence 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 countriesā 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 bigger 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 elseās 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 in 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 both privacy and
economic opportunity, will see these recommendations as desirable and


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 governmentās 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.
Remove the capital gains tax from trading in commodities, in order to allow
the full development of commodity backed digital currencies (like gold).
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.

Remove all restrictions on anonymous digital money and payments systems.
Restrictions are almost impossible to enforce, and privacy is a basic human

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.

| Index of Testimony | Cato Institute Library | Cato Institute Home |

--- end forwarded text

R. A. Hettinga <mailto: rah@ibuc.com>
The Internet Bearer Underwriting Corporation <http://www.ibuc.com/>
44 Farquhar Street, Boston, MA 02131 USA
"... however it may deserve respect for its usefulness and antiquity,
[predicting the end of the world] has not been found agreeable to
experience." -- Edward Gibbon, 'Decline and Fall of the Roman Empire'

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