The author is an operations analyst for Diebold, Inc., a banking equipment manufacturer.
The financial system of today’s world is the product of centuries of innovation. What began as a barter economy moved through various incarnations in response to the limitations inherent in the evolving systems. Changes will undoubtedly continue to occur in response to social and technological progress. Contemporary discussion of likely changes has focused increasingly on the possibility of a cashless society. The technology for such a society exists. However, the benefits of cashlessness are not yet perceived to outweigh the supposed disadvantages.
This article will discuss the progress toward cashlessness and its relevance to free banking. Free banking historically involved the issuance of bank notes that were redeemable for a “base” money such as gold or silver. Modern proponents of free banking such as Lawrence White have continued to think of it in these terms. White’s colleague at the University of Georgia, George Selgin, has, on the other hand, envisioned a regime under which the existing (U.S. dollar) monetary base would be frozen, and banks could then issue notes that would be exchangeable for base dollars. Both writers apparently envision a society that will continue to use currency and coin as pervasive media of exchange.
A cashless society would mean, of course, the absence of currency and coin. Therefore, a cashless society could mean a barter society in which commodities were traded for commodities. However, barter would represent a major step backward. The cashless society envisioned and discussed herewith refers instead to the widespread application of computer technology in the financial system. Increasingly, funds are being transferred via an “Electronic Funds Transfer System” (EFTS).
The EFTS
As it became apparent that electronic banking was here to stay, Congress in 1974 established the National Commission on Electronic Fund Transfers. The commission studied the infant EFTS, and published its recommendations in 1977. The commission concluded that an EFTS developed in an “orderly” manner would be beneficial to consumers of financial services and suggested that such a system operate outside the public sector. The commission went on to state that “a national EFTS could be supported by as few as 225,000 on-line terminals installed in general merchandise stores.”
As the commission completed its research, the Federal Reserve established “Fed Wire.” Fed Wire is a nationwide electronic communications network that links the 12 Federal Reserve District Banks, all member commercial banks, and the U.S. Treasury. It represents a considerable investment on the part of the Federal Reserve, and has been interpreted by the member banks as Federal Reserve endorsement of a nationwide EFTS.
Transition to an EFTS involves overcoming structural barriers such as high start-up costs as well as the establishment of cooperation and communication among competing banks and retailers. In a sense, by the creation of Fed Wire, the Federal Reserve has provided not only an endorsement of EFTS, but a subsidy as well. Large institutions have capitalized on the Fed’s investment, and smaller organizations must now subscribe to the changes in order to remain competitive.
An EFTS is made up of many components, the most widely known and accepted being Automated Teller Machines (ATMs). Additional integral elements are Automated Clearing Houses (ACHs) and Point of Sale terminals (POSs). As we shall see, the ACHs and POSs, not ATMs, are probably the keys to further progress toward a cashless society.
Federal Reserve economist Michael Keeley has argued that “trends in cash usage and holdings suggest that cold, hard cash is becoming an even more popular means of payment.” He goes on to say that, “Since most ATMs use $20 bills, it is interesting to note that the growth in volume of $20 bills has been greater than that of other denominations since 1977 about the same time that the number of ATMs installed started to grow nationwide.”
Federal Reserve reports on currency have shown a significant increase in the number of bills in circulation, and an increase in the average denomination being used; for example, the number of $20 bills has increased faster than the number of $10 bills. The number of checks being written and the average size of each check have also increased, but at much slower rates.
ATMs
Keeley uses such facts to support his view that a cashless society is “far from reality.” However, a provocative argument can be made that the transition to a cashless society involves an increase in cash usage prior to its disappearance for all but low-dollar and “discrete” transactions. Before the spread of ATMs, a greater percentage of retail transactions involved payment by check. Because of processing delays, checks present opportunities for buyers to make purchases prior to the receipt of the requisite funds in their accounts—i.e., there is a so-called “float.” However, checks also involve a certain amount of time and inconvenience for the parties to a transaction. Before the spread of ATMs the most common method of obtaining cash was from tellers at bank branches. With the limited banking hours of the day and the associated long lines, it was far more common for consumers to endure the inconveniences associated with check writing than to visit a bank branch to obtain cash. ATMs made cash easier to obtain, however, and it increasingly became the preferred method of payment.
POSs
The use of POSs may displace the use of cash obtained from ATMs just as the use of ATM cash has displaced checks. POS use reduces many of the liabilities of cash. For example, crimes such as mugging and purse-snatching would decrease in the absence of cash, and the opportunity costs of cash would be eliminated insofar as a consumer’s funds would always be in interest-bearing accounts.
The shift away from cash and toward POSs may be obscured for a time by the use of currency to engage in tax evasion or illegal activities such as drug dealing. Progress toward cashlessness may also be obscured by the use of U.S. dollar bills in the former Soviet Union and elsewhere. But as such areas stabilize and adopt more sophisticated technology, their payments practices will probably start to resemble those in the United States.
Transition Problems
The transition to a fully electronic transfer of funds system will not be impeded by households; through the use of debit cards they are already in the process of becoming comfortable with the advantages of EFTS. Rather, some of the parties engaging in high dollar transactions will provide resistance until the issue of float costs and benefits is resolved. Insofar as there are delays in processing checks, there is a float cost to the businesses getting paid. This cost is equivalent to a working capital expense for receivables. There is a corresponding benefit to payees who can continue earning interest until their checking accounts are finally debited. Elimination of this float would result in a significant redistribution of income among businesses, and this may explain some of the present resistance to EFTS conversion. The amount of interest earned via check float is now estimated to be between 40 and 50 billion dollars annually. Understandably, the recipients of this interest will resist its disappearance.
Canada has addressed the float issue by way of a banking industry and central bank accord that provides for same-day accounting of checks presented for payment. The float has been significantly reduced by the implementation of a retroactive interbank settlement process. This innovation has removed the float associated with the check clearing process, but not that which occurs when a payee holds a check for a period of time before processing it.
In order for the U.S. to overcome the barriers to an EFTS created by the float, it appears that voluntary conversion on the part of businesses, rather than regulation, is the answer. The U.S. Treasury has already reduced check use and shifted many government payments to electronic transfer. Among these are Social Security, federal payroll, and even large federal contract payments. It can be expected that the spread of electronic transfer practices will continue in the private sector as well, with the loss of float costs and benefits being considered in the terms on which parties are willing to do business with another.
Free Banking
The progress toward an EFTS could further complicate the Federal Reserve’s attempts to manage the U.S. money supply. As economists are well aware, the public’s demand for cash influences the quantity of money in circulation. Perhaps more serious is the internationalization of money flows and the proliferation of new types of accounts. With electronic systems shifting funds from one type of account to another, and from one country to another, it has become difficult or perhaps impossible to say what “the” money supply is.
Part of the appeal of free banking is that it makes such issues moot. Financial institutions and customers could pursue their interests independently with their actions being coordinated by the invisible hand of the market. A cashless society would pose no special problems in this context. The 12 Federal Reserve District Banks could be privatized in the form of Automated Clearing Houses; the district bank stock to which member banks subscribe upon joining the Federal Reserve System could be converted into transferable shares in the ACHs. The newly privatized ACHs would presumably play a major role in interbank lending and reserve settlements.
In the case of either a gold-based or paper-dollar-based free banking system, base money could be kept at the ACHs, but it need not be. As long as all claims and settlements were continuously recorded, base money would only have to be available at ACHs or member banks to meet occasional customer requests.
In conclusion, the movement toward a cashless society is proceeding incrementally. Cash may continue to be useful for some time, especially for discrete transactions, but even these may become increasingly automated. Given the rapid growth in technology (e.g., pocket-sized cellular telephones), it is not difficult to imagine devices whereby even the most informal purchases could be automatically debited from the buyer’s bank account.
EFTS is likely to have a profound and visible impact on everyday decision-making. Some of the more obvious benefits are reductions in financial transaction time and cost, and a reduced need for cash which would, in turn, decrease the amount of interest forgone. The opposition to a cashless society is likely to become increasingly silent as it is defeated by subtle economic pressures exerted by the federal government and financial industry giants; they continue to realize the benefits of the transition to an EFT system. As this transition continues, the issue of float is likely to fade as well.
While we may not see a completely cashless society in the immediate future, the foundation has been laid, and the available evidence indicates that we are indeed moving in that direction. The fate of the Federal Reserve depends, of course, on political considerations, but the progress toward EFTS could ultimately prove to be a key factor leading to its replacement by free banking.