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Hot Finance

While the electronic economy hums along in the fiber-optic trenches-helping businesses to run better and faster with technologies including electronic funds transfer, imaging, electronic data interchange, and sophisticated point-of-sale systems-a phenomenon has been putting butterflies in the bellies of even the toughest CEOs and CFOs. That phenomenon is “hot money.” Hot money refers to the …

While the electronic economy hums along in the fiber-optic trenches-helping businesses to run better and faster with technologies including electronic funds transfer, imaging, electronic data interchange, and sophisticated point-of-sale systems-a phenomenon has been putting butterflies in the bellies of even the toughest CEOs and CFOs. That phenomenon is “hot money.” Hot money refers to the trillions of dollars that race from one investment instrument to another, seeking superior returns and churning already volatile markets. But it also defines the transactions and maneuvers of the underground economy: money laundering by international drug cartels, for example, or capitalist profits in developing nations seeking asylum in overseas banks.

Herein lies the predicament: The same digital technology that greases the electronic pipeline threatens to make safeguards against shady transactions ineffectual and to create for crooks a near impregnable payment infrastructure. The danger comes from a wrinkle in the world of ones and zeros developed by a Netherlands-based start-up company, Digicash.

Despite predictions a generation ago auguring the emergence of a paperless society, global business remains a mixture of hard copy and electronics. The Federal Reserve daily charters a fleet of more than 200 planes to move the nation’s 2 billion checks, and postal workers spend much of their time pushing around the tons of paper associated with financial transactions. One upshot is that hot money leaves a paper trail. Though almost all canceled checks do nothing more than verify that an electronic transfer has taken place, they enable the government to “follow the money,” as Deep Throat once said, deterring money launderers and inside traders.

All that may change, thanks to Digicash, founded by entrepreneur David Chaum to transfer cash on the Internet in complete privacy. Bearded, ponytailed, and Santa Claus-plump, Chaum holds a Ph.D. in computer science from the University of California at Berkeley and is well-versed in encryption technology. “Most encryption systems are lock and key varieties, with the lock residing in one location and the key in another,” Chaum says. “That’s the old paradigm. I divide up the lock and divide up the key.” Those divided locks and keys are made of complex, patentable mathematical formulas called algorithms, which Digicash stores in computers in various locations. Separating the locks and keys makes it virtually impossible to find out who is transferring money to whom. The technology hit the market in a preliminary way last year.

In 1992, Chaum wrote an article for Scientific American on privacy and electronic money. That article, as well as his encryption technology, caught not only the attention of hackers and privacy advocates, but also that of the White House, which has begun a review of the nation’s telecommunications policy.

Many worry that if companies such as Digicash sell methods for encrypting money and sending it along the Internet, hot money, laundered money, and secret investing will move even further beyond law enforcement’s control. They envision scenarios where stocks are bought and sold in rapid succession by untraceable, even terrorist, investors in an effort to destroy markets. They worry that drug dealers could safely transfer their ill-gotten gains anywhere without detection. However, not everyone is concerned. “There is a flaw in this thinking,” says Martin Mayer, a business and financial writing guru who is now a fellow at the Brookings Institution. “To transfer money to someone, that someone has to know it is coming. That means paper, the phone, or conventional messages along the Internet, all of which can be traced.”

Sometimes, of course, they can’t be traced. And Mayer’s assessment fails to take into account the fact that emerging technology also may help electronic highwaymen to stay one step ahead of the law through ever-more sophisticated satellite-based cellular phones and digital private telecommunications networks.

Under the best of circumstances, authorities will outfox the foxes, enforcing laws and regulations in a way that does not endanger the privacy required by free nations and free markets. The bottom line is that the conflict between cops and robbers has entered the realm of cyberspace.

As always, cutting-edge technology cuts more than one way. Stay tuned.


Joel Kurtzman, former editor of the Harvard Business Review, is an international business consultant and author. He is the director of the International Trade Program at The Manhattan Institute.

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