Years of Poems and Spirits

There have been a few articles on virtual money spilled over to the real world. First it was a piece on NPR about SecondLife. Now I just read one about QQ money on WSJ (c).

I take issue with the WSJ article because it implied that virtual money could pose a threat to total money supply. As one of the interviewed said, “If I were a policy maker, I would certainly be very cautious,” My contention is, the virtual money is there because even cash is not liquid enough sometimes. Infact, if it has anything to do with inflation, because virtual money reduces transaction cost, it actually helps to reduce inflation not to increase it.

First of all, to assert that the wide adoption of virtual money could have any impact on inflation assumes it has deeply penetrated economic life. There has to be such a popular usage that items in the CPI basket are contaminated. Therefore, as long as Chinese consumers are not paying their grocer, housing, education, transportation … in QQ money, I suppose policy makers don’t have to be so cauticous.

Secondly, although cash is supposed to be the most liquid form of money, it is not liquid enough in this context (online gaming). The driver that propels QQ money is precisely because of the lack of digital form of money (e.g. credit card) in China. In other words, virtual money is a substitute of credit card, not cash. The WSJ article said itself: the QQ money is not unlike airline mileage points. If that is the case, what is to be “cauticous” about?

The question then turns to: what determines the exchange rate between the real and virtual money and what does that tell us, if anything at all, about foreign exchange? Conceptually, one may say this exchange rate represents two “economies”: one real, one virtual. Then can we apply existing FOREX model to this situation? If not, where is the problem?