Interview with Benjamin J. Cohen, author of The Future of Money

Benjamin J. Cohen is an economic consultant for OpenCoin, a Professor of International Political Economy at the University of California, Santa Barbara, and author of, among others, The Future of Money (2004), The Future of the Dollar (2006), and The Future of Global Currency (2010).

The Ripple Blog recently spoke with Professor Cohen about the impact of electronic currency on the global economy.

In The Future of Money you describe eCash and Cybercoin as being e-money 1.0 and centralized currencies like frequent flier miles and the now defunct Flooz and Beenz as 2.0. Would you consider the new math-based currencies (like Bitcoin and Ripple) as e-money version 3.0?

Yes, that is exactly what they are — a new generation of electronic money that represents a quantum leap beyond earlier versions 1.0 and 2.0. In 2000 The Economist predicted that “there will almost certainly be a version 3.0 — not least because technology is making it increasingly easy to come up with new schemes.” Bitcoin was the first of the new generation, and now we have Ripple as well.

You identified a number of key technological hurdles for electronic money to succeed: security, reliability, confidentiality, portability, and most importantly, trust and value. Have the new math-based currencies solved these issues?

As far as I am competent to judge, I think it is clear that the new math-based currencies do indeed offer effective solutions to the key technological challenges: security, reliability, confidentiality, and portability. Trust and value, however, are another matter and cannot be solved by technology alone. Much depends on social psychology, which is inherently difficult to predict or control. We must remember that money is a social institution. A money is anything that people come to believe will be accepted by others to perform the functions of money — a medium of exchange, unit of account, and a store of value. A money’s value and acceptability, ultimately, rest on the reciprocal faith of a critical mass of transactors — an “intersubjective” understanding about the instrument’s future usability and purchasing power, which really cannot emerge without a gradual accumulation of competitive market practice. In the end, earlier versions of electronic money, like Flooz or Beenz, failed because they couldn’t generate that kind of reciprocal network of trust. Because of their technological improvements, Bitcoin and Ripple stand a much better chance, but only time will tell.

Will the value of electronic money always be linked to more conventional currencies?

Again, this is a matter of trust. The more people gain confidence in the inherent value and usability of math-based currencies, the looser the link will become, just as it did for paper currency. Two centuries ago, few were prepared to voluntarily accept paper currency that was not directly convertible into precious metal — gold or silver. Today, who worries about that? In time, the same should happen with electronic money.

How long will it take? (In the past, you have speculated “one or two generations.”)

Like most economists, I’m prepared to predict a trend or specify a date, but not both in the same sentence. I’m prepared to stick with my earlier suggestion of “one or two generations.” Beyond that, my crystal ball is cloudy.

How can electronic currencies overcome the inertia of existing currencies?

Overcoming inertia in monetary matters is difficult. To persuade people to make use of a particular money, they have to be convinced that others will in turn accept it — which is not easy when, in effect, everyone is waiting on everyone else. What electronic currencies need to do is convince people that they are actually easier to use than conventional money — for cross-border transactions, for example. The world economy is becoming more and more globalized. More and more transactions require transferring purchasing power between currencies, which in turn may involve onerous bank transfers or currency conversions. Electronic money cuts through all that and does so in real time. That is the big advantage that could eventually help to overcome inertia.

What impact will electronic currencies have on central banks and monetary policy?

Assuming that the new electronic currencies are successful, they will have an enormous impact on the power of sovereign states to abuse the power they have traditionally enjoyed as the creators of money. For centuries it has been accepted that within its own territorial frontiers, each nation should have just one money — its own, created and managed by the government. In effect, the government was granted monopoly control over the money supply within its borders. And as we know, governments have often abused that monopoly power, running the printing presses to support public spending, causing inflation and sometime even hyperinflation — what economists call the “inflation tax.” Once electronic moneys are up and running, they will provide competition to state moneys, thus limiting the state’s power. If the state creates too much of its own money, causing the money’s purchasing power to be eroded by inflation, transactors will now have the option of switching to a valid alternative. That option will act as a discipline on the inflationary propensities of governments.

Do you predict a proliferation of electronic currencies?

In principle, one could imagine hundreds, perhaps even thousands, of competing electronic currencies — at least initially. But eventually competition could be expected to weed out all but the best. That’s the way markets work. Something new is created, competitors rush in, and eventually some survive and the rest disappear. Think about the car industry. Who now remembers the Stanley Steamer? Who now remembers Betamax? So I would expect the population of electronic money first to increase, then to decrease until some sort of equilibrium is established.

Is deflation a problem for currencies like bitcoins or ripples? This is an economic criticism we see frequently.

It is true that if there were only one money in the world and its supply were rigidly fixed, sooner or later a deflation would set in — too little money, too many goods and services. But ripples are NOT the only money in the world, and it is the aggregate of all moneys that counts (relative to production of goods and services). We already live in a world of multiple moneys, including not only state moneys (the dollar, pound, yen, etc.) but also all kinds of “private” currencies (from very limited community currencies to frequent flyer miles and bitcoins). It is the total supply of all currencies that matters, not just one single digital currency.

Moreover, if there were really to be a shortage of money in the aggregate, there would be nothing to prevent the introduction of yet other new moneys. Once the idea of a virtual currency becomes widely accepted, there is technically no limit to the number of currencies that can be created.

But of course in that kind of world, moneys begin to compete for the favor of transactors and investors, and the currency that is most favored will be the one whose supply is guaranteed never to increase. So the potential deflationary effect actually becomes the currency’s greatest competitive advantage.

In addition to being a decentralized currency, Ripple acts as a decentralized exchange, making cross-currency payments and trades easy. Would you agree that this could have significant impacts on people’s relationships with national currencies?

I agree completely. Under the system that has prevailed over the last two centuries, currencies were identified with the territory of the states that issued them. But once people get used to the convenience of a digital currency that can be used anywhere without the need for going through the foreign exchange market, the link between money and individual territorial states will be weakened. In effect, money will be globalized for a global marketplace.

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