RIZAL TECHNOLOGICAL UNIVERSITY
Cities of Mandaluyong and Pasig
SESSION NO. 3 / WEEK NO. 3
MODULE NO.3: The Payment System
1. Transition from commodity money to fiat money
2. Importance of check
3. New technology and payment system
4. E-monet, Bitcoin, and block chain.
5. Cashless society
Overview
Money facilitates transactions in the economy. The mechanism for conducting
such transactions is called a payments system. The payments system has evolved
over time from relying on payments made in gold and silver coins, to payments made
with paper currency and checks written on deposits in banks, to payments made by
electronic funds transfers.
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Cities of Mandaluyong and Pasig
Study Guide
Learning Outcomes
1. Distinguish between commodity and fiat money
2. Explain the importance of checks
3. Enumerate and explain the desirable outcomes of a payments system
4. Explain how a bank client can use automated teller machines (ATMs)
5. Explain how e-money, bitcoin and blockchain are used in the payments
system
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RIZAL TECHNOLOGICAL UNIVERSITY
Cities of Mandaluyong and Pasig
Topic Presentation
The Transition from Commodity Money to Fiat Money
Commodity money refers to a good used as money that has value independent of its
use as money. Fiat money refers to money, such as paper currency that has no value
apart from its use as money. People accept paper currency in exchange for goods and
services partly because the government has designed it to be legal tender, which
means the government accepts paper currency in payment of taxes and requires that
individuals and firms accept it in payment of debts. Money is also useful because of its
ability to serve as a standard of deferred payment. Money can facilitate exchange at a
given point in time by providing a medium of exchange and unit of account.
Historians disagree about precisely when people began using metallic coins. Evidence
suggests that people in China were using metallic coins in the year 100 B.c, and people
in Greece were using them in 700 5.c For centuries, buyers and sellers used coins
minted from precious metals, such as gold, silver, and copper, as money. Gold and
silver coins suffer from some drawbacks, however. An economy's reliance on gold and
silver coins alone makes for a cumbersome payments system. People had difficulty
transporting large number of gold coins to settle transactions and also ran the risk of
being robbed. To get around this problem, beginning around the year AD. 1500 in
Europe, governments and private firms - early banks – began to store gold coins in
safe places and issue paper certificates. Anyone receiving a paper certificate could
claim the equivalent amount of gold. As long as people had confidence that the gold
was available if they demanded it, the paper certificates would circulate as a medium
of exchange. In effect, paper currency had been invented.
In modern economies, the central bank (Bangko Sentral ng Pilipinas), issues paper
currency. The modern BSP payments system is a fiat money system because the BSP
does not exchange paper currency for gold or any other commodity money. The BSP
issues paper currency and holds deposits from banks and the national government.
Banks can use these deposits to settle transactions with one another. Today, the BSP
has a legal monopoly on the right to issue currency. Although in the nineteenth century
private banks issued their own currency, they can no longer do so.
In fact, it is not the government's designation of currency as legal tender that explains
why paper currency circulates as a medium of exchange. Rather, paper currency
circulates because of the confidence of consumers and firms that if they accept paper
currency, they will be able to pass it along to someone else when they need to buy
goods and services. Basically, it is a case of self-fulfilling expectations: You value
something as money only if you believe that others will accept it from you as payment.
Our society's willingness to use pieces of paper issued by the BSP as money makes
them an acceptable medium of exchange.
The Importance of Checks
Paper money has drawbacks. Another major innovation in the payments system came
in the early twentieth century, with the increasing use of checks. Checks are promises
to pay on demand money deposited with a bank or other financial institution. They can
be written for any amount, and using them is a convenient way to settle transactions.
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Settling transactions with checks does, however, require more steps than settling
transactions with currency. Processing the enormous flow of checks worldwide costs
the economy several billion dollars each year. There are also information costs to using
checks the time and effort required for the seller to verif whether the check writer (the
buyer) has sufficient amount of money in her checking account to cover the amount of
the check. Accepting checks requires more trust on the part of the seller than does
accepting peso bills.
New Technology and the Payments System
The Bangko Sentral ng Pilipinas supervises the payments system but doesn't directly
control it because many payments are processed by banks and other private firms,
The BSP has listed what it believes to be the five most desirable outcomes for a
payments system:
1. Security. Episodes in which criminals have hacked into retail credit card systems
and other parts of the payments system have raised concerns about security. Better
security increases consumers' and businesses confidence that funds will not be stolen
electronically.
2. Efficiency. Resources devoted to processing paper checks or other aspects of
processing payments are diverted from producing other goods and services.
Increasing the efficiency of the payments system allows it to function using fewer
workers and computers, or other capital, which benefits the economy.
3. Speed. Fast settlement of payments facilitates transactions by both households and
businesses. 4. Smooth international transactions. The increasing amount of business
that takes place across borders can be facilitated if payments can be made quickly and
conveniently.
5. Effective collaboration among participants in the system. The payments system
needs to efficiently involve governments, financial firms such as banks, and other
businesses around the world. Such involvement ensures smooth transfers of funds in
transactions.
Debit cards can be used like checks: Cash registers in supermarkets and retail stores
are linked to bank computers, so when you use a debit card to buy groceries or other
products, your bank instantly credits the store's account with the amount and deducts
it from your account. Such a system eliminates the problem of trust between the buyer
and seller that is associated with checks because the bank computer authorizes the
transaction. In recent years, many consumers have begun using apps on their smart-
phones or smart-watches that are linked to credit or debit cards. For example, Apple
Pay and Android Pay allow, consumers to buy goods at any store with a compatible
register at the checkout counter by waving their phone or watch. Apple Pay and
Android Pay are examples of proximity mobile payments. While the total volume of
transactions using such payments is relatively small, it has been increasing rapidly.
Automated Clearing House (ACH) transactions include direct deposits of payroll
checks into the checking accounts of workers and electronic payments on car loans
and mortgages, where the payments are sent electronically from the borrower's
account and deposited in the lender's account. ACH transactions reduce the
transactions costs associated with processing checks, reduce the likelihood of missed
payments, and reduce the costs lenders incur in notifying borrowers of missed
payments.
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Forty years ago, Automated Teller Machines (ATMs) did not exist. To deposit or
withdraw money from your checking account, you needed to fill out a deposit or
withdrawal slip and wait in line a bank teller's window. Adding to the inconvenience
was the fact that many banks were open only between the hours of 10 AM. and 4 pM.
(which were called bankers' hours). Today, ATMs allow you to carry out the same
transactions at your bank whenever it is most convenient for you. Moreover, ATMs are
connected to networks (such as BANCNET, Megalink, so you can withdraw cash from
the ATMs of banks other than your own.
E-Money, Bitcoin, and Blockchain
The boundaries of electronic funds transfers have expanded to include e-money or
electronic money, which is digital cash people use to buy goods and services. One of
the best-known forms of e-money is the PayPal service. An individual or a firm can set
up a PayPal account by linking to a checking account or credit card. As long as sellers
are willing to accept funds transferred from a buyer's PayPal (or other e-money)
account e-money functions as if it were conventional, government-issued money. The
central bank does not control e-money, though, so it is essentially a private payments
system.
Recently, journalists, economists, and policymakers have been debating the merits of
bitcoin, a new form of e-money. Unlike PayPal, bitcoin is not owned by a firm is instead
the product of a decentralized system of linked computers. Bitcoins are produced by
people performing the complicated calculations necessary to ensure that online
purchases made with bitcoins are legitimate—that is, that someone doesn't try to
spend the same bitcoin multiple times. People who successfully complete these
calculations are awarded a fixed number of bitcoins typically 25. This process of bitcoin
"mining" will continue until a maximum of 21 million bitcoins has been produced—a
total expected to be reached in 2030.
Because people can buy and sell bitcoins in exchange for dollars and other currencies
on web sites, some people refer to it as a "cryptocurrency." You can buy bitcoins and
store them in a "digital wallet" on a smartphone. You can then buy something in a store
that accepts bitcoins by scanning a bar code with your phone. A number of web sites,
such as BitPay, which is based in Atlanta, allow merchants to process purchases made
with bitcoins in a way similar to how they process credit card payments.
Despite these possible benefits to using bitcoin, it has not yet been widely adopted.
The introduction of Apple Pay and Android Pay provided consumers with a way to use
their smartphones linked to a credit card to make payments, which undercut one of
bitcoins advantages. Some firms also question whether the software underlying bitcoin
is capable of dealing with a large number of transactions. The most popular online
bitcoin exchange, Japan-based Mt. Gox, closed in 2015, further reducing confidence
in the crytocurrency.
Despite the problems with bitcoin, the underlying technology behind it, known as
blockchain, has attracted interest from both firms and governments as they attempt to
increase the speed, efficiency, and security of the payments system. Blockchain is
technically a distributed ledger, or an online network that registers ownership of funds,
securities, or any other good, including movies and songs. Blockchain allows
individuals and businesses around the world to settle transactions instantly and
securely on encrypted sites. The ability to direct transactions through blockchain could
eliminate banks and other intermediaries, potentially greatly reducing costs. The
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RIZAL TECHNOLOGICAL UNIVERSITY
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greatest stumbling block to businesses adopting blockchain is the complexity if the
technology and its resulting high cost. If the cost declines over time, blockchain may
become a key part of the payments system.
CASHLESS SOCIETY
Blockchain and other new payment technologies are exciting and lead some
commentators to predict a "cashless society." A Federal Reserve study found that
noncash payments continue to increase as a fraction of all payments, and electronic
payments now make up more than two-thirds of all noncash payments. Not
surprisingly, the number of checks written has been dropping by more than 2 billion
per year. In reality, though, an entirely cashless (or checkless) society may be difficult
to attain in the near future for two key reasons.
(1) As we noted with respect to blockchain, the infrastructure for an e payments system
is expensive to build.
(2) Many households and firms worry about protecting their privacy in an electronic
system that is subject to computer hackers, although supporters of blockchain believe
its encryption technology can overcome this problem. While the flow of paper in the
payments system is likely to continue to shrink, it is unlikely to disappear.
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Guided Exercises / Learning Activities
REVIEW QUESTIONS
Questions
1. What are the sources in inefficiency of a barter system?
2. What is Fiat Money?
3. Explain the expression "Legal Tender".
4. Explain briefly the importance of using checks in paying for goods or services
purchased.
5. Describe: e-money bitcoin blockchain
6. Describe a cashless society. Is it easily attainable?
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Assessment
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Assignment
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References
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