Global Trade Center

Today, with payment by credit card, the merchant is guaranteed payment the moment you place the order, and the goods can be shipped immediately. By eliminating the delay the credit card reduces the trading cost of using mail order. It makes mail order more competitive with buying from local merchants. Because local merchants face this competition, their prices are lower and consumers are better off.

The payments system is also of great importance to financial institutions. For many, the provision of payments services is a substantial source of income. A recent estimate suggests that for the 25 largest bank holding companies between 30% and 40% of their operating revenue came from payments-related services. You cannot understand banking without an understanding of this aspect of the business.

Payments mechanisms are a key element in the structure of financial markets. You cannot make sense of overnight lending or the government securities market, for example, without understanding how payments are executed. Furthermore, the increasing globalization of financial markets has transformed the trading of foreign exchange-one part of the payments system-into a growth industry. Worldwide trading volume in foreign exchange reached $1.5 trillion a day in 1999.

We begin our study of the payments system by examining the different types of money in our economy. Next, we look at the different ways of making payments. We then compare the user of different methods of payment in different countries and examine the reasons for the differences. Next, we look at foreign exchange. We conclude by examining the efficiency and stability of the payments system.

THE DIFFERENT TYPES OF MONEY
Payment means the transfer of money. So we begin with money. There are two different types of money-government money and bank money. The branch of government that produces government money is usually the central bank-in the United States, the Federal Reserve. So we will call the two types of money Fed dollars and bank dollars.

FED DOLLARS
The most basic type of money in the U.S. economy is the dollar bill. The dollar bill is a Federal Reserve note, created by one of the 12 Federal Reserve Banks (you can see which one by looking at the seal to the left of the picture of George Washington on the front of the bill). In form, Federal Reserve notes resemble the banknotes that commercial banks once issued. In addition to Federal Reserve notes the Fed also creates money in the form of deposits. The Fed is a bank. It accepts deposits from ordinary banks, from the federal government, and from some other institutions (it does not accept deposits from ordinary firms and households). The Fed’s depositors can make withdrawals and deposits in the form of Federal Reserve notes, and they can transfer ownerships of their deposits by check or electronically. We shall call money that is created by the Fed-Federal Reserve notes and deposits at the Fed-Fed dollars.

Payments

Payment modes

The two activities are technologically similar. This similarity generates economies of scope that draw lenders into the provision of payments services and payments processors into lending. In the preceding chapters we focused mainly on lending; in this chapter, we shall look at payments.

The payments system is of great importance to the economy. Payments are an inseparable part of trade in goods and services. The lower the transactions cost of making payments, the more trade there will be and the greater will be the gains from trade. How well the payments system does its job has enormous effects on the overall efficiency of the economy.

For example, consider the mail order business. Before the days of the credit card, mail order involved considerable delays. Payment was by check, and the check would spend several days in the mail. Generally, the merchant would not ship the goods until the check had cleared. This, too, would take several days. The substantial delay made mail order relatively unattractive in comparison to buying from a local merchant.