v1.0.4 / 01 jun 07 / greg goebel / public domain
* Money is so taken for granted that there is little awareness of its significance as a technology. In fact, money is about as old as the wheel, has continuously refined for millennia, and in modern times it has become a very sophisticated technology. This document provides a short history of money.
* The ancestor of the monetary system is of course the barter system. A farmer could exchange his produce for the fish obtained by a fisherman or the cloth produced by a weaver. Even today the barter system tends to come back into style in places suffering from tremendous social disorder, or as an informal sideline activity in more harmonious lands.
However, dickering over the relative value of different things tends to be time-consuming and troublesome, and so societies tended to converge towards a common medium of exchange. Pacific islanders used cowrie shells; Aztecs used cacao beans, the main ingredient of chocolate, though it seems a bit unlikely that this was the origin of the modern term of "bean-counter" for an accountant; livestock was common among herding cultures; slaves were sometimes used, too, but they were much harder to control than cattle and so not as popular; and many cultures used salt, including the Romans for a time, leading to the modern term "salary". Incidentally, after World War II cigarettes were used as a medium of exchange in many countries then in very poor condition, and it is said that in Italy "penny candy" was commonly used as "small change" even into the 1970s.
The medium that gradually gained widespread acceptance was precious metals such as gold and silver. Ancient Egypt was one of the first lands to establish transactions using precious metals, though their forms were variable -- rings, bars, wafers, and so on.
Coins are said to have been invented by the Lydians, a people of Asia Minor, sometime after 640 BC, using stamped ingots of "electrum", a naturally occurring amalgam of silver and gold. The scheme was refined by King Croesus, ruler of Lydia from 560 to 546 BC, who introduced coins of true gold. He became identified with wealth in the antique expression "rich as Croesus".
Introduction of coinage was a great boost to commerce, simplifying transactions and allowing them to be conducted more rationally over long distances. The Greeks picked up the idea of coins from the Lydians; since the Greeks had a colonial and trading empire that ringed the Mediterranean, they spread their coinage, such as the "stater" and various multiples of the "drachma", along all the shores of the sea. When Alexander the Great engaged in a campaign of conquest in the 4th century BC that took him to the borders of India, he kept his troops loyal by paying them in coin, and also helped spread the idea further.
The Roman Empire was built on silver and gold coins, as well as legions. The primary coins were the "aureus" and later the "solidus", which were mostly gold alloyed with some silver. As the empire expanded, the expenditures of the state led to the debasement of the coins, beginning with an act of the Emperor Nero in 64 AD. By the end of his reign, the silver content of Roman coins had shrunk by 10%. Other emperors followed his example, and over 200 years from the start of the process, the content shrank to 5%. The buying power of the currency fell accordingly.
The Byzantine Empire came up with a successor to the solidus known as the "nomisa" or "bezant", but it eventually was degraded into near worthlessness. By the end of the 7th century a new coin named the "dinar" appeared and gradually became the predominant coin of the Middle East. By the time of the Rennaissance, European states were producing new coins of their own, including the "ducat", "florin", "nobel", "grosh", "zloty", "guinea", and the Spanish "escudos" -- better known as the "dobloon". Others would follow.
Coins are still with us, though they are now little more than tokens made of non-precious metals. The US gave up minting silver dollars in 1935, and in 1965 eliminated silver in American coins completely, using copper plated with cupro-nickel. Few countries still use silver or gold coins as anything other than collector's items. The American science-fiction writer Larry Niven once proposed that coins be made out of radioactive waste. He reasoned that this would solve the nuclear waste disposal problem, ensure that money circulated rapidly, and lend a new meaning to the expression "money burning a hole in your pocket."
* Niven was of course joking. When the first paper money was introduced in China a millennium ago, many must have thought it was just as great a joke. Who would rest their fortunes in mere pieces of paper? Kublai Khan, the Mongol emperor who ruled China in the 13th century, emphasized that it wasn't a joke when he decreed that those who refused to accept paper money would be executed. He also confiscated all gold and silver, even that carried in by foreign visitors. This was the purpose of Chinese paper money: to ensure total state control over precious metals. It was effectively a totalitarian measure.
Chinese paper money did work well enough for a time. Marco Polo was impressed by the system during his visit to the Middle Kingdom. However, if there was a tendency to debase coins, the temptation to simply print more paper money regardless of the consequences was often irresistible, and public confidence in paper money was weak anyway. In 1294, paper money was forcibly introduced in Persia, but led to economic disaster. Even in China, paper money had been more or less abandoned by the 15th century.
In the meantime, the first modern banks had been evolving. Moneylending and similar activities were essentially as old as money itself, and there were banks in Roman times, but they were more or less local affairs. The idea of a formal bureaucratic organization that spanned borders to handle savings, investment, and loans didn't start in earnest until the 13th century. There were difficulties at first, with some early bankers burned at the stake, but by the 14th century Italian entrepreneurs were starting to make a go of the concept, the Medici family becoming the most famous of the lot. They used conventional metal currency, but conducted financial transactions using "bills of exchange", which were documents obtained at a given price that specified a particular payment when presented.
For example, in 1317 the Italian banking firm of Peruzzi and Bardi arranged the transfer of the monies collected from the churches of England to the Pope in Italy. The London office of Peruzzi and Bardi obtained the coinage and sent a bill of exchange to Rome, which was then redeemed to the Pope in coinage by the Rome office of the bank. The money changed hands without having to be carted from England to Italy. Bills of exchange could also be transferred through many hands before they were redeemed. They weren't exactly paper money, being something more like a modern money order, but they were close to paper money, and did much to grease the wheels of commerce.
The Italian bankers also invented modern double-entry bookkeeping and the notion of a check -- a document that authorized the withdrawal of a specified amount of money to the bearer. The idea of a check was fairly obvious, but there was the perpetual threat of forgery, and it didn't become a reality until late in the 14th century, after adequate safeguards had been developed.
* The notion of paper money began to reemerge in Europe at the end of the 17th century. According to tradition, the first European to introduce paper money was a Swedish banker named Johan Palmstruch, whose Stockholm Banco began to issue the stuff in 1661. The offering went well enough at first, but success led to the bank's overextension. Palmstruch, like any good modern banker, called to the government for financial help. Unlike a modern banker, he was taken to trial for mismanagement and sentenced to death, though the sentence was commuted to life imprisonment.
Despite the unhappy ending to Palmstruch's scheme, the idea was one whose time had come, and paper money was adopted by other European countries. One of the rationales behind the establishment of the Bank of England in 1694 was to issue banknotes, and it has been doing it ever since. The Bank of England, incidentally, wasn't a government bureaucracy, being instead founded as a private institution under a government charter; in 1844, it would be given an effectively monopolistic charter to issue bank notes. Other nations established such "central banks" to control the manufacture and distribution of currency.
* Generally, the original idea behind European paper money was to simply provide what amounted to a token that was redeemable in gold or silver. The paper was more convenient in many ways, and as long as it was regarded as equivalent to precious metals, users were confident in it.
There was, as always, a tendency to cheat. In 1716 a Scotsman named John Law persuaded the Duke of Orleans, then the French regent for the young Louis XV, to allow him to start a bank and issue paper currency. Law's bank, which was formalized as the "Banque Royale" in 1718, was another roaring success, but unfortunately a little accounting showed that the bank had issued twice as much paper money as there was gold and silver in France to back it up. The bank and the scheme collapsed, and Law fled the country.
France did not turn back to paper money until the revolutionary government began to issue "assignats" in the 1790s, and this scheme went worse than Law's. Like many shaky governments, they simply printed more banknotes to cover their debts, ultimately driving the currency down into worthlessness. It is said to this day that the French are somewhat more suspicious than other folk of paper money.
The Americans showed an interest in paper money even before independence. The concept was heavily promoted by Benjamin Franklin, whose publication POOR RICHARD'S ALMANAC gave him an influential forum for spreading his ideas. Printing currency was also a natural extension of his printing business, and he printed paper banknotes for the colony of Pennsylvania.
Many colonies enthusiastically printed their own currencies in the mid-18th century. As it turned out, they were too enthusiastic, and in 1764 the British Crown banned further issues of banknotes by the colonies. This was no doubt prudent, but it was also done in a high-handed fashion. Furthermore, the colonists had also been pushed to printing banknotes by Crown policies that worked to keep gold and silver in Britain, starving the colonies for currency so badly that Spanish coins were in widespread use among them. This is why America doesn't use the pound as the national currency; the colonials generally traded in "dollars", the English name for Spanish "reals", with both the English name and the Spanish coin derived from the Central European "thaler".
In any case, the issue of money was one of the thousand little cuts that drove the Americans to revolt against Britain. The colonies declared themselves as independent states and printed money on their own again, as did the Continental Congress. They all proved just as undisciplined as they had been before, and with exactly the same results. A popular phrase of the time, "not worth a Continental", described what the citizens thought of Continental banknotes. Section 10 of the American Constitution established in 1789, providing a central Federal government above the squabbling states, expressly prohibited the states from printing their own money. That right was reserved for the Federal government, though the first national mint wasn't opened until 1794 and currency wasn't issued until 1797.
The issue definitely did not include paper money, though it was progressive in adopting a "decimal" currency scheme, organized in nice neat multiples of ten. The idea had been pioneered by the Russians, though other states retained their more irregular systems. In Britain, for example, four farthings made a pence, 12 pence made a shilling, and 20 shillings made a pound. There was also a "guinea", which was a pound and a shilling. The British would more or less retain this scheme until 1971, when a pound became a hundred pence.
Incidentally, the motto on the first American pennies was "Mind Your Business", though this would make saying "a penny for your thoughts" a bit contradictory. There was a push to put George Washington's profile on the coins, but Washington himself, though instinctively methodical in cultivating his public image, had a very clear and disciplined idea of where to draw the line, and the independent Americans by and large thought the idea smelled of elitism and class distinction. Faces would not appear on any sort of American currency for a century.
American paper money did appear for a short time during the War of 1812 as an emergency measure, but it was abandoned as soon as possible. For decades after that, the only paper currency in the United States was issued by banks themselves. These commercial banknotes remain interesting collector's items, but at the time they were regarded with much suspicion, since they were used by many banks to put over frauds.
Both the North and South finally turned back to paper money during the Civil War. Confederate currency became one of the most notorious examples of a bogus currency in history. The South printed twice as much paper currency as the North, and Confederate money faded into extinction before the Confederacy did, suffering devaluation by a factor of almost a thousand. Of course, the restored Union did not recognize the currency of a rebel government as legitimate, and those Southerners who had piles of it found it little better than wallpaper.
Union "greenbacks" were issued beginning in 1862 by the Federal government due to a lack of coinage to cover expenditures. The banknotes were not redeemable on demand for gold or silver, but the government did agree that they would be redeemable at some unspecified time after the war. They were effectively something like zero-interest bonds. When all coinage began to become scarce in the North due to hoarding, Congress first authorized the use of postage stamps as "small change", but this proved impractical because they had to be kept dry. After issuing a special "postal currency" that didn't have glue on the back, in the fall of 1863 the Union began to print miniature banknotes in denominations that would ultimately range from 3 to 50 cents. They proved popular and would continue to be issued into 1876.
The value of the Federal greenback declined steadily until late 1864, then rebounded since it was obvious that the Union would win the war and presumably make good on its debts. By that time, Union greenbacks were also in fairly common use in the Confederacy, and after the war they would be retained as the popular currency of the reunited America. The US government finally announced in 1879 that greenbacks could be exchanged for gold, but relatively few people did so, since paper money had become well established and secure by that time. The disreputable commercial banknotes were long gone, having been killed off by a 10% tax passed in 1866 that made them uncompetitive.
There still was a hot debate over money policies, which figured prominently in presidential elections in the 1890s. There are some who believe that Frank L. Baum's fantasy novel WIZARD OF OZ, published in 1900, was at least partly intended as a satire or parable on the issue, with its references to yellow brick roads and green glasses. Although this might be stretching things a bit, it should be noted that in the book Dorothy wore silver instead of ruby slippers; the moviemakers felt that Judy Garland would be more photogenic wearing ruby slippers.
* By the early 20th century, paper currency was in widespread use all over the world. The failures in paper currency were not really due to the fact that the paper money wasn't adequately backed by gold or silver. Although many nations clung to the gold standard well into the 20th century, all money amounts to is a medium of exchange, allowing the citizens of a country to engage in transactions. The US finally completely abandoned the gold standard in 1971. All nations now use "fiat currencies", money which has no intrinsic value and is not backed by precious metals.
The problem with paper currencies was not that they were often inadequately backed by precious metals. The money circulating in a society, in a sense, mirrors the material wealth of a country. It is relatively easy to print more banknotes, but not so easy to increase the overall material wealth of a nation, and so if twice the number of banknotes is printed given the same amount of wealth, the value of each banknote is more or less cut in half. This happened automatically, as if by magic, every time a weak government tried to cheat. The most famous example was the Weimar Republic that ran post-World War I Germany, where inflation took place by a factor of trillions.
The idea that there is an "inherent" value even to gold and silver is something of an illusion. A money supply based on precious metals is not absolutely more stable than one based on paper. When the Spaniards and Portugese conquered much of what would become Latin America in the 16th century, they seized large quantities of gold and also obtained rich gold and silver mines, with the result that the value of their gold and silver currencies plunged to about a third of their original value.
Some astrogeologists have calculated the value of the metals in a single typical metallic asteroid; if some future generation were able to nudge one into orbit around the Earth and then render it down, the haul would be so huge that it would dramatically devalue every precious metal in circulation. Even without such a monstrous kick in the teeth, the price of gold tends to fluctuate drastically, dropping or rising relative to relatively stable fiat currencies. Money, as the saying goes, "is worth what everyone thinks it's worth", and that rule applies just as much to gold as to paper bills. The real concern is discipline in the printing of money. If too much money is printed, it becomes devaluated. If too little is printed, it stifles commerce. Mainstream economists will admit that it may be harder to cheat with a gold standard, but point to its restrictiveness as a crippling flaw.
There is still a school of thought that believes money should at least have some hard currency backing, but it's well off the mainstream. In 1998, US Federal Reserve chairman Alan Greenspan commented: "I am one of the rare people who still has some nostalgic view about the old gold standard ... but I must tell you I am in a very small minority among my colleagues on that issue." As for advocates of a strict gold standard, mainstream economists regarded them as pushing "the economic equivalent of leeching."
The actual amount of money printed is unsurprisingly a tricky issue, all the trickier in modern times since now maybe about 10% or less of all the money in prosperous countries is in the form of physical coins or banknotes, the rest existing only in the form of ledger entries in electronic accounting books. Not only are banknotes no longer backed by gold; the bulk of money isn't even backed by banknotes.
Control of the money supply does not really mean printing banknotes. Such control is performed by careful tweaking of interest rates to adjust the "price" of money; dictating what proportion of a commercial bank's deposits have to held in government reserve banks; and buying or selling government securities.
Even if most money is in the form of numbers in account statements, those numbers have to balance overall; no private citizen or commercial entity can legally "make up" new dollars by just inserting new values into an account statement. A government central bank can do so, however, using the "new" money to pay off debt; and in principle could also buy up securities to reduce the total amount of money in circulation. Since the primary job of a central bank is to prevent inflation, adjustment of the money supply is done very carefully, with the central bank chairman keeping a very close eye on statistics for inflation and national wealth, and making changes in monetary policy slowly and carefully.
* One of the biggest landmarks in monetary history took place at the beginning of 2002, when twelve European countries conducted one of the largest exercises in public logistics in history: the introduction of the new euro currency, which replaced the national currencies of the group nations. Roughly 14 billion nice crisp new euro banknotes were printed and put into circulation, along with 50 billion shiny new coins, while old national currencies were phased out.
Fans of banknote art found the euro dull. This was largely due to the fact that euro notes were distributed in twelve different countries that in many cases had long histories of intermittent mutual frictions, and so nothing that could cause offense was included on them. They not only didn't include any images of people, they didn't include any images of real scenes. Britain didn't sign up for the euro, mostly because the British didn't want to be subject to monetary policies made in Brussels, but the bland format of the euro notes also meant that the Queen would have to "lose her head". The fact that the Queen's image has only been on British banknotes since 1960 only highlights the emotional nature of this complaint, but then emotions have figured prominently in the history of currency.
Within a few years a certain backlash had set in against the euro, with advocates in some nations suggesting that it was a blunder and that the national currency be revived. A number of German localities came up with a more active response, making up their own currencies for use by citizens and businesses in the area. These local currencies were essentially promotional gimmicks, being convertible into euros and simply intended to boost local commerce. They were never intended to replace the euro and were not generally recognized outside of the localities where they were issued.
* Money is still printed. If the reckless printing of paper is no longer a major problem, another problem that has shadowed paper currency since the beginning is still around, and in fact in some ways is getting worse: counterfeiting.
The Bank of England conducted a strong crusade against forgers early in the 19th century, giving the public information on how to recognize bogus banknotes, and sending counterfeiters to the gallows. The bank was still unable to stamp out the practice, and later in the century a counterfeiter named Leon Warnerke raised it to an art form. Warnerke's origins were mysterious since he was a master at covering his tracks, and it is likely that the name Warnerke was just another one of his many aliases. He came out of Eastern Europe someplace, and became on the surface a photographer and a businessman in London, living a comfortable and seemingly respectable existence. In reality, he was a leader of sorts in a loose group of anarchists and other revolutionaries, a specialist in producing high-class forgeries of Eastern European currencies, particularly roubles. He was never caught up to his death in 1900. There is some suspicion that he even faked his death.
While producing high-quality banknotes is difficult, distributing them is a bigger problem. Governments tend to have better resources for doing this, and in fact governments have traditionally been the most ambitious and effective of forgers. The British produced large quantities of bogus assignats to undermine revolutionary France, and the Union helped the process of devaluation of Confederate paper money along by printing it themselves and sending it South. Oddly, one of the Union counterfeiters of rebel currency, Samuel C. Upham of Philadelphia, actually marked his banknotes as "facsimiles" in fine print along the margins, and marketed them through Yankee newspapers as "mementos". The practice of using counterfeiting as a weapon has continued to this day, being employed effectively against Saddam Hussein in the Gulf War, and even more recently against the Taliban in Afghanistan.
Arguably, the most professional campaign of forgery was conducted by the Germans in World War II. They had control of expert counterfeiters who had been imprisoned in the Sachsenhausen concentration camp, and even manufactured very convincing paper, which can be more difficult to forge than a banknote's appearance -- Warnerke, incidentally, was very good at manufacturing his own paper. The Bank of England managed to obtain some of the bogus German currency, and found the forgeries so good that it was said the only way in which they differed from the real thing was that the real thing wasn't as good.
* Given the long history of counterfeiting, of course officials involved in the introduction of the euro went to great lengths to protect the currency. Detailed images of the new banknotes weren't publicized until almost the last moment, and the police investigations of losses of pre-release euros were unusually energetic.
The euro featured four layers of security. The first were simple measures that were announced to the general public, such as watermarks and security threads. Incidentally, threading currency paper with special security threads is not new, having been done for over a century, though it has been enhanced by improved technology. The second was a set of seven or eight measures that have been announced to about five million professional money handlers. The third was another set of features to help machines spot bogus banknotes. The fourth layer remains secret.
All such security measures are well and good, but unless a counterfeit is very badly done, most people will not have the training or skill to recognize it as one. Counterfeiters are usually careful to push banknotes in small quantities in places where the risk of detection is lowest -- poorly lit bars and pubs, for instance.
Since counterfeiting is an illegal activity, of course statistics on its extent are uncertain. Some estimates place the proportion of bogus currency in Western Europe at about 3%, but the ratio is much higher in less developed countries. The usual target is the $100 bill, and many of the forgeries are very good. There is some suspicion that "rogue" states like Syria and Iran are engaged in their production.
Part of the reason counterfeiting is more of a bother than ever before is because it is now easier for small-time operators to pull off. All they have to do is get a high-resolution scanner and a high-end color printer, and a personal computer system becomes a home mint. The banknotes produced by such "casual counterfeiters" are of course easily recognizable as bogus by anyone with minimal training, but such forgeries are common enough to be a substantial nuisance.
Money makers have ways of fighting back. As mentioned, the right sort of paper is important for a good forgery, and one part of the security game is to ensure that such paper is very tightly controlled. The world's three most prominent manufacturers of papers for currency are Crane's, in Massachusetts; Portals in Hampshire, England; and Chamalieres, in the Auvergne. Chamalieres is owned by the De la Rue concern, which is the biggest printer of banknotes in the world, with clients in 150 countries. Portals, which was acquired by De La Rue in the 1990s, has been providing paper to the Bank of England since 1742, and claims to have never had any paper stolen, though some nitpickers say it did happen once during the 19th century.
Other traditional schemes for protecting currency are to make the designs intricate, and use inking patterns that are hard to duplicate. US greenbacks, for example, were traditionally printed in two inks, green and black, with the two colors overlaid in very specific ways. Plastic notes, which may include features like transparent panels to make them very hard to copy, are now standard in Australia, New Zealand, and Romania; dozens of other countries have introduced them on a more limited basis. It is still not impossible to forge plastic notes, and some countries the citizenry has not been happy with them.
Still another approach is to come up with new designs frequently. The lifetime of the average banknote pattern used to be about 15 or 20 years, but now it's changed every decade in most countries. The Americans have been unusually stodgy in this regard, with modern dollar patterns dating back to 1929, but even they have been forced to compromise and produce variations on old patterns to deal with counterfeiters, rearranging the layout of the bills and then introducing bills in "rainbow" colors.
* Although counterfeiting is as old as money itself, "money laundering", or the processing of money obtained from illegal sources to conceal its origins, is a relatively modern concept. Investigators like to "follow the money" and that was more difficult in the days when transactions were performed in cash.
Modern efforts to deal with crime and particularly terrorist networks have led to a race between law enforcement and money launderers. So far the launderers seem to be winning. There are a number of countries that have little bank regulation but good privacy and secrecy laws, making banks established in these countries ideal conduits for launderers. International pressure to make such banks more transparent has made only limited progress.
To add to the headache, unsurprisingly gangsters and terrorists have developed tricks to make the lives of financial investigators more difficult. One is the "starburst", in which a bank receives a large deposit of dirty money and then automatically distributes that money in small parcels to many different accounts in different locations, as per the instructions of the depositor. Another is the "boomerang", in which the money is sent on a long, circuitous trip through different accounts around the world, many of which may be "black holes" in countries where investigating finances is difficult, to ultimately end up back in the account where it started.
Terrorist finances can be even trickier to deal with than gangster finances. In the first place, the money may not be visibly "dirty" at all; modern Islamic terrorists have been able to obtain funding from wealthy individuals or charitable organizations. The money will remain "clean" until it is used in a terrorist attack. There has been a general crackdown on Islamic charities and intelligence organizations have been paying much closer attention to them, so it appears that this path for funding has essentially dried up.
Terrorists often tend to rely on cash, since it is difficult to trace, and have a long tradition of obtaining that cash through robbery or other crimes. Josef Stalin reputedly started out as a bank robber for the Communist Party. Small sums of cash may be parceled out to sympathizers, who stash them away in private bank accounts for use by the network on demand; and the reliance of modern Islamic terrorists on low-tech methods means that they don't have to store large piles of cash.
Islamic terrorists also have an ace in the hole in the form of hawala, an ancient Middle Eastern financial practice in which one banker hands out money on a verbal assurance that money has been deposited someplace else, where he may get his hands on it when he needs it. Although dealings in the Middle East are not noted for their extreme honesty, the integrity of hawala is enforced by long tradition, and it is both scrupulous and hard to trace.
* The arrival of the computer age is now helping change the concept of money once again. Modern computer-based commerce is rooted in the "charge card", which evolved roughly in parallel with the computer.
The first modern charge card was issued by Diner's Club in 1950, being created in part by a financier named Frank X. McNamara, who as the story has it was embarrassed when he came up short for a restaurant bill. The original Diner's Club card actually made of pasteboard, with plastic not introduced until 1955. The Diner's Club card was only really honored by a network of restaurants, making it a convenience for the wealthy so they didn't have to carry around large amounts of cash or fumble with checks.
The charge card, as was the case for many items that started out as toys for the rich, was gradually democratized. American Express, established mostly on its traveller's checks, introduced a more general charge card in 1958. Banks saw what was happening and followed, with the Bank of America introducing its "BankAmericard" in the same year. The 1958 introduction of the BankAmericard was accompanied by the first-mass mailing campaign to get charge cards into the hands of consumers.
Charge cards began to take off. Other banks formed an association with Bank of America to get on board the BankAmericard. In 1960, about a quarter of a million BankAmericards were in use; by 1968, the number exceeded one million. Other organizations were getting into the act, with one group forming the "InterBank" association. By 1970, Americans were sold on "plastic", and other nations were following.
There was just one difficulty: the charge card organizations were losing money hand over fist. The wild promotion of charge cards had given a surprising number of people the idea that they were magic bottomless sources of money, and at the time delinquencies on credit purchases were running at over 20%, ten times the modern rate. There was also the problem of charge card crime, which of course shadowed the charge card from the outset: thieves are very quick to exploit new opportunities.
There were more fundamental problems as well. Charge card transactions involved much the same sort of paperwork as traditional checks, which made the transactions expensive to handle. Another issue was the fact that charge cards were "balkanized", with many competing charge card organizations and no one charge card recognized everywhere. Big retailers such as Sears had their own charge cards and wouldn't take anybody else's plastic. Fans of credit cards usually kept a stack of them in their wallets in those days.
* In 1970 Dee Hock became CEO of BankAmericard, and he had visions of how to get the charge card business under control. Computers were more powerful, cheaper, and far more widely available than they had been a decade earlier, and in 1973 under Hock's direction BankAmericard implemented the first electronic system to handle charge card transactions. This cut down fraud and overhead, greatly improving BankAmericard's profitability. BankAmericard became Visa in 1976; InterBank similarly became Mastercard.
In 1979, Hock scored another major coup by persuading giant retailer JC Penny to accept the Visa card, pointing the way towards the "universal" charge card. Other changes towards electronic commerce were taking place during the decade as well. The US government began to implement "electronic funds transfers (EFTs)", eliminating most of the physical exchange of paperwork.
The 1980s led to the rationalization of charge cards, with the traditional "credit card", in which transactions were made on credit to be paid up at a bill date, complemented by the "debit card", in which transactions were made against a balance in a checking account, just as with a traditional check.
The availability of improved software helped make credit cards increasingly profitable, by permitting ever more detailed credit background checks and elaborate arrangements of interest rates -- for example, to offer a credit card with a zero-percent interest rate up front, with the interest then rising steeply if the user defaulted on payments. (In the baroque world of credit-card finance, a user who always pays the bills on time is said to be called a "deadbeat" by the credit-card companies.) Software was also developed to help deal with credit-card theft, by examining the pattern of transaction on a particular card and then temporarily freezing the account after an unusual transaction.
EFTs became common, as did the use of charge cards to perform transactions over the telephone, a transaction that would have been otherwise very clumsy. The rise of electronic transactions provided a basis for Internet commerce as the personal computers spread widely through the 1990s. Security was, and remains, a concern, and so online charge card transaction systems were designed using the "Secure HTTP (https)" protocol to protect charge card numbers from theft.
The rise of the Internet also saw the introduction of purely online financial transaction systems. The most popular at present is the "PayPal" system, which was founded in 1998 and as of 2007 had over 100 million participants. PayPal users maintain an online money account that can accept charge-card transactions, or transfers from other PayPal accounts. All that's needed to perform a PayPal-to-PayPal transaction is an account name. PayPal automatically performs conversions between different currencies. The scheme tends to be secure because a recipient cannot take money from a PayPal account: the account owner must give the money to the recipient.
There are also a number of Internet-based "digital currency" schemes. Some are actually based on the gold standard, with users buying initial shares of a central gold deposit and trading among themselves with those shares. PayPal is not regarded as a digital currency scheme, since it maintains accounts in national currency. Digital currency schemes have not caught on in a big way, though unfortunately they have proven useful to criminal organizations operating on the Internet, who like the relative lack of traceability of transactions.
* Of course, the rise of online charge card and PayPal transfers has led to a subculture of thieves trying to exploit the system. One popular scheme is "phishing", in which a thief mass emails ("spams") users of an online service, claiming their credit card information has been lost and linking them to a phony credit card entry site where their data can be stolen. Much the same sort of trick is employed against PayPal users.
Most users have become wise to such emails, which can be easily recognized from their contrived sense of urgency and the fact that they rarely include the user's specific name; service providers are also careful to say they won't ever request data in such a fashion. However, given a large enough spam distribution, with the emails produced by a third-party computer that has been "hacked" and taken over so they can't be traced back to the thief, there will be a large enough number of naive users who will fall for the trick.
* Other forms of electronic money include phone cards / gift cards, magstripe cards, and smart cards. All are more or less variations on the old notion of a "chit card" or "ration ticket", used to "purchase" a fixed sum of a resource until the sum is depleted.
Phone cards and gift cards are identical except for what they buy, both providing access to a one-shot charge card account maintained by the phone service provider or retailer. Terrorists have found phone cards useful, since a card can be bought over the counter and used anonymously by anyone, making its use difficult to trace. Incidentally, credit cards have been used as a form of terrorist funding. It must give a suicide attacker a certain grim sense of amusement to run up large bills on a credit card when he knows he'll be dead before they come due.
Magstripe cards and smart cards record and track the sum themselves, with magstripe cards storing the data on a magnetic strip and smart cards storing it in a digital chip with nonvolatile memory. Early smart cards used a plug-in type connector, but now they increasingly use a "contactless" or "near field" short-range radio communications interface. The interface features an antenna embedded in the card that not only allows the card to communicate with a card reader, but also powers the card from the electromagnetic energy emitted by the reader, eliminating the need for the card to be fitted with a battery.
* All these technologies are basically special purpose, associated with specific company or service or government program, no "universal" system comparable to Visa having emerged just yet. However, it appears that such a universal system is now emerging in the form of the "wallet phone".
The roots of the wallet phone go back to a few years to the increasingly widespread use of contactless smart cards for storing mass transit ticket information in Japan and Hong Kong. As the popularity of the smart cards increased, shops around train stations gradually acquired readers to allow the cards to be used to purchase small items. Now wallet phones -- cellphones incorporating the same near-field interface, along with their normal cellphone electronics -- are being sold in Japan and Hong Kong.
The wallet phone is handier than the smart card, since the phone user can interrogate the status of ticket data stored inside, buy tickets, perform transfers with a bank account, and track transactions. Advocates of the scheme feel the wallet phone has enormous potential; a wallet phone could be held up to a "smart poster" advertising, say, a concert, that will send the phone to a website for more information and to purchase tickets.
Tickets are only a start. Handling cash and coins is troublesome; it is in particular a nuisance for retailers, and automating the process with wallet phones would be very profitable for them -- all the more so because many transactions could be performed without involving a sales clerk, reducing labor overhead. Near-field readers are increasingly common, and cellphones are all but universal; making the hookup between the two should be relatively straightforward, though creating effective standards for cash and ticket transactions is a challenge.
Interestingly, such cashless transaction systems are of great interest to businesses in undeveloped countries, where there is a great deal of theft and counterfeiting. Cellphone operators in undeveloped countries are already offering services to allow workers in the cities or overseas to transfer funds cheaply back to their families in their home villages, with the operators disbursing prepaid cards where banks aren't available. Wallet phones will make such schemes even more convenient.
Security is a concern. Although the near-field interface is very short range and so the transactions are hard to intercept, at the moment cellphones are vulnerable to viruses and another forms of "malware". Once cellphones become electronic wallets, malware writers will have a very strong incentive to rip them off.
International consortiums are now working on global standardization of wallet phones. They are likely to be common in a few years, though it is unclear how long it will take for them to predominate: cash and coins have been around for a long time, and people are not likely to give them up until the advantages of a new system are obvious. However, once retailers start offering a discount for the use of purely electronic transactions, the incentive to abandon cash and coins is going to become increasingly hard to resist.
* Sources include:
* Revision history:
v1.0.0 / 01 apr 05 / gvg
v1.0.1 / 01 feb 06 / gvg / Added wallet phones, other small items.
v1.0.2 / 01 apr 06 / gvg / Minor corrections.
v1.0.3 / 01 apr 07 / gvg / Minor updates.
v1.0.4 / 01 jun 07 / gvg / Minor updates.
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