“Money is about to enter a new era of competition”
Print Title: “The Transformation of Money”
MIT Technology Review, April 12, 2022
Humans and Technology
by Eswar Prasad
“Digital technology is poised to change our relationship with money and, for some countries, the ability to manage their economies.”
Money is one of humankind’s most remarkable innovations. It makes it possible to trade products and services across great geographic distances, between people who may not know each other and have no particular reason to trust each other. It can even be used to transfer wealth and resources over time. Without money, trade and commerce—all human economic activity, really—would be severely constrained in terms of time and space.
The privilege of issuing money is synonymous with economic power. So it should come as little surprise that history is replete with examples of currency competition, both within countries and between them. In China, home of the world’s first paper money, currencies issued by private merchants and provincial governments competed for many centuries. Indeed, banknotes issued by governmental and private banks coexisted in China as late as the first half of the 20th century.
What finally, decisively ended this competition was the emergence of central banks, which were given the exclusive privilege of issuing legal currency and tasked with maintaining its stability. This shift happened quite early in Sweden; the world’s oldest central bank, the Riksbank, was established there in the 17th century. In China, competition closed with the founding of the People’s Bank of China in 1948, shortly before the formal creation of the People’s Republic of China. Since the central banks stepped in, competition has been mostly international, with the relative value of currencies depending on the reputation and stability of the central banks issuing them.
We now stand at the threshold of another era of upheaval. Cash is on the way out, and the digital technologies that are replacing it could transform the very nature and capabilities of money. Today, central-bank money serves at once as a unit of account, a medium of exchange, and a store of value. But digital technologies could lead those functions to separate as certain forms of private digital money, including some cryptocurrencies, gain traction. That shift could weaken the dominance of central-bank money and set off another wave of currency competition, one that could have lasting consequences for many countries—particularly those with smaller economies.
In ancient societies, objects such asshells, beads, and stones served as money. The first paper currency appeared in China in the seventh century, in the form of certificates of deposit issued by reputable merchants, who backed the notes’ value with stores of commodities or precious metals. In the 13th century, Kublai Khan introduced the world’s first unbacked paper currency. His kingdom’s bills had value simply because Kublai decreed that everyone in his domain had to accept them for payment on pain of death.
Kublai’s successors were less disciplined than he was in controlling the release of paper currency. Subsequent governments in China and elsewhere gave in to the temptation of printing money recklessly to finance government expenditures. Such wantonness typically leads to surges of inflation or even hyperinflation, which in effect amounts to a precipitous fall in the quantity of goods and services that a given sum of money can buy. This principle is relevant even in modern times. Today, it is trust in a central bank that ensures the widespread acceptance of its notes, but this trust must be maintained through disciplined government policies.
To many, however, cash now seems largely anachronistic. Literally handling physical money has become less and less common as our smartphones allow us to make payments easily. The way in which people in wealthy countries like the United States and Sweden, as well as inhabitants of poorer countries like India and Kenya, pay for even basic purchases has changed in just a few years. This shift may look like a potential driver of inequality: if cash disappears, one imagines, that could disenfranchise the elderly, the poor, and others at a technological disadvantage. In practice, though, cell phones are nearly at saturation in many countries. And digital money, if implemented correctly, could be a big force of financial inclusion for households with little access to formal banking systems.
Cash still has some life in it. During the covid pandemic, even as contactless payments became more prevalent, the demand for cash surged in major economies including the US, presumably because people viewed it as a safe form of savings. Many states in the US have laws in place to make sure that cash is accepted as a form of payment, something that would protect people who cannot or do not want to pay through other means. But consumers, businesses, and governments have generally welcomed the shift to digital forms of payment, especially as new technologies have made them cheaper and more convenient.
The decline of physical cash, once valued as the most definitive form of money, is but a small feature of the rapidly changing financial landscape, though. One of the most dramatic forces of change has been the rise of cryptocurrencies, which have shaken long-held precepts about money and finance.
Bitcoin, the cryptocurrency that started it all, may not have much of a role to play in this monetary future.
About the Author:
Eswar Prasad is the Tolani Senior Professor of Trade Policy at Cornell University.