[Continued from yesterday's Part 1.]
By: David A. Smith
Yesterday’s post, using as source material two articles, one from the Economist (April 5, 2014), the other from the Wall Street Journal (March 27, 2014; green font), both commenting on a new paper published by the National Bureau of Economic Research, established that the rise of electronic money (credit cards and electronic transfers) corresponded with, and likely contributed significantly to, a drop in interpersonal violent crime (burglary, assault, and larceny).
Not much point if his walleyt has no cash in it
Neither the paper’s authors nor the journalists, themselves all citizens of the highly electronic and connected formal world, flagged any of the downsides of electronic money or the upside of cash – and that’s understandable given their perspective, as the drawbacks of cash become significant only when cash is used in transactions between people who do not know each other and who are unlikely ever to see each other again.
Slums are different, because though they are economically rational, they are not the formal world. In slums, everybody knows everybody, people’s physical mobility is limited (everybody goes home at night to the slum), and there will be a form of alternate power hierarchy (even if criminal and extortive) and a means of conflict resolution and subsequent recourse.
Mafia neighborhoods in Boston like the North End were reputed to be very safe for tourists because the mob didn’t want any street crime to attract police presence to the area.
A few decades back, when I was doing investor asset management for the affordable housing properties our company has syndicated, the elderly living on pensions had to go to the bank to deposit their social security or pension checks; and their way home was fraught with peril the closer they got to their apartments, because the teenage sons of other resources could plot their path and then lie in wait (often in stairwells adjacent to the elevators).
Nobody is going to rob us, going down the mountain
We don’t have any money, going down the mountain
When we start going up the mountain, then you can sweat
For that matter, in the 1800s traders in Tennessee, walking home from New Orleans after having sold goods they floated down the Tennessee and Mississippi Rivers, were always at risk of being waylaid on the Natchez Trace, because they were known to have cash and known to follow a fixed route.
Worn down by thousands upon thousands of walkers
“Cash is critical in stimulating street crime because of its liquidity and anonymity.”
’Street crime’ is a negative externality of the informal economy (what I called the set of Anonymous Activities referenced above).
Not Tekin for a fool: the puzzle has not been solved”
At this point, let’s stipulate to the authors’ conclusion – emergence of electronic money as a principal medium of exchange reduces interpersonal violent crime, especially in formal societies with good governance where its efficacy is high and the external costs of compliance and use are low.
Thus the NBER study is like Newtonian classical mechanics – applicable in the common case familiar to economist, namely the formal world (and a world, it should be noted, where government is benevolent, efficient, and obviously of value to citizens). Within that Newtonian economic universe, the NBER study’s findings are compelling.
The wider world, with informal economies and imperfect governments, is like Einsteinian mechanics that apply more broadly, with Newtonian mechanics a subcase when a certain element – in this case, the net economic benefit of informality – is set to zero.
Make sure you know who’s who
In slums, however, the government is present only as an external force, often one that applies regulations and taxes, both of which are costs imposed on economic activity, and gives the slum dwellers far less in municipal benefits than they receive in those taxes and regulatory impositions.
How does electronic money compare with physical cash from the perspective of market participants?
Upside of electronic money
1. No larceny (breaking and entering homes, say)
2. No robbery (theft via violence)
3. Automatic receipts and proof of payment
4. Intermediary stop-loss protection (credit cards, banks)
5. Globally accessible
6. Instantly transferable
These upside features are incredibly powerful, and have facilitated a revolution in global commerce. At AHI, for instance, we work with clients around the world, from Abu Dhabi to Haiti to Mongolia, and we work with individual consultants who need to be paid in all those places. From my desk, I can wire them money with certainty it will get to them, and they can collect it without risk. That is simply extraordinary and a convenience so great I cannot imagine how we would have done business without it.
While the removal of cash may benefit poorer neighborhoods, which are disproportionately affected by street crime, replacing cash with debit cards and other electronic forms of money might bring in another set of complications.
You pays your money and you takes your choice
Electronic money has its downsides too:
Downside of electronic money
1. Requires reliable access to high-speed broadband
Neither the authors nor the journalists remarked on this presumption, because to them, living deep in the formal world, ubiquitous reliable instantaneous internet connectivity is a given. If you’re poor, not on the Web, lack a laptop (or even a reliable cell phone), or have no credit cards and possibly no bank account, these are significant barriers to entering the system. And each of those physical goods that you need to enter the electronic information network are themselves subject to theft, larceny, and robbery. Cash has none of those entry barriers.
2. Regulatory requirements
3. Inescapability of taxation
4. Post-closing warranty/ liability risk
5. Theft by hacking
Electronic payments are already falling prey to sophisticated types of crime, carried out on an unprecedented scale. Just a few months ago, a data hack at Target Corp. captured headlines after millions of debit and credit cards were compromised.
This last point bears mentioning. Electronic money flowing through a bank, for example, exposes the bank to money laundering charges, and the settlements have run into the billions. It has led to the rise of global accountability among formal banking institutions – which is a good thing – and as a result, the adverse selection of corrupt or criminal activities into anonymous forms of electronic transfer.
Indeed, there are now virtual ways to make transactions without a paper trail.
Fears of the downside of electronic money explain the rise of Bitcoins, a form of high-tech hawala about which I have not posted (though instinctively I profoundly distrust the mechanism, as it relies on both the encryption and the honesty of the encryptors).
A network that uses people and cash
Before there was electronic technology (before the invention of global banks and interbank wires, basically 1950 or later), as an alternative to cash merchants and bankers invented non-cash forms of international credit: bills of exchange in the seafaring nations, hawala in Muslim countries. But cash persisted as the principal medium of exchange, and in the emerging world it still is, because it’s the ideal medium of exchange for a purely informal economy.
And what if Bitcoin equals the value of crime?
When it comes to crime risk, Bitcoin eliminates the interpersonal violent forms but magnifies the non-violent ones (fraud, embezzlement, defalcation) – and it does so at the price of forfeiting any of the formal world’s regulatory and enforcement mechanisms, leading to unfathomable messes like this:
Hackers Hit Mt. Gox Exchange’s CEO, Claim To Publish Evidence Of Fraud
The Bitcoin community has been angrily pressing for details on what the Bitcoin exchange Mt. Gox has described as a massive hacker attack that stole hundreds of millions of dollars’ worth of its users’ bitcoins and left the company bankrupt. Mt. Gox’s staff isn’t talking. So another group of hackers say they’ve broken into the company’s servers to provide answers of their own.
On Sunday, hackers took over the Reddit account and personal blog of Mark Karpeles, Mt. Gox’s CEO, to post an angry screed alleging that the exchange he ran had actually kept at least some of the bitcoins that the company had said were stolen from users. The hackers also posted a 716 megabyte file to Karpeles’ personal website that they said comprised stolen data from Mt. Gox’s servers. A screenshot posted by Mt. Gox’s hackers, seeming to show administrative access to the company’s database of trades.
Update: Users on Reddit are warning that the hackers’ files may contain malware designed to steal bitcoins. Other Reddit users have confirmed that they found their own account history in the data, indicating that it’s not fake. But for security reasons, I don’t recommend anyone download the collection of hacked files.