Is Virtual Currency A Real Problem?

By Daniel Indiviglio

All that time spent playing video games may finally be paying off. Literally. According to a fascinating New York Times article today, virtual currency -- credits to buy stuff in video games -- is being taken very seriously. China worries that make-believe video game money could affect its ability to control its money supply. As a result, it's slapping limits on virtual currency. I'm not kidding.

From the NY Times:

Some people have even traded virtual currencies in China, and exchanged them for clothes, cosmetics and other goods.


Last year, nearly $2 billion in virtual currency was traded in China, according to the China Internet Network Information Center. Some experts say they believe there is a much larger underground economy in the virtual world.



And it gets wackier:

Some smaller gaming companies have even set up what are called virtual sweatshops, cramped quarters where young people play online games to earn credits that the companies then sell at a profit to overseas customers in Taiwan, South Korea and even the United States.



So what's the threat? The Times asks a telecommunications professor from Indiana University.

"This action shows that at least one government is concerned about the way virtual worlds challenge its control of society," Professor Castronova said in an e-mail message Tuesday. "As virtual currencies take over more and more purchasing power, control over the effective money supply shifts from the central bank to the game developers."



Interesting theory, but I'd rather someone whose background is a little closer to economics weigh in. Because currency isn't my specialty, I consulted an economist far more qualified to talk on this than me: Randall S. Kroszner. He is a professor of economics at the University of Chicago's Booth School of Business. He's also a former Fed governor, so he knows a thing or two about central banks and money supply.

He couldn't speak to the specifics regarding China as he is not familiar with the details. But I asked him whether virtual currency could really be a threat to money supply, in general. He said:

It could have an impact on currency demand and the so-called velocity of money.


It can complicate the task of a central bank in trying to anticipate what currency demand will be, but much like with other innovations (ex: credit cards, etc.) that hasn't led to an undermining in the ability to control the money supply, but it does make the task a more challenging one for the central banks.



So virtual currency could make managing money supply more difficult, but so do other things like credit cards, which we probably think are okay.

I also think virtual currency seems like any other good -- just more efficient as a means for exchange. For example, there's nothing stopping people from trading ounces of gold for products. An exchange rate exists between gold and real currency. Wouldn't a similar kind of exchange rate hold for virtual currency and real currency? Kroszner agrees:

In principle, it's exactly the same thing as an exchange rate between a particular commodity, wheat, gold, television sets, and the local currency.



In theory, virtual currency could affect money supply. But that it would affect money supply in a very significant way seems like a stretch. As a result, China might intend to limit virtual currency for reasons more important to it than money supply concerns. Such reasons might include censorship aspirations or a dislike of black markets.

Whatever China's rationale, I'll be interested to see if similar controls turn up in other countries. I suspect it's just a matter of time before Uncle Sam decides to slap some virtual taxes on virtual transactions here in the U.S. Maybe we can close the deficit with virtual money!

This article available online at:

http://www.theatlantic.com/business/archive/2009/07/is-virtual-currency-a-real-problem/20485/