[EMAIL PROTECTED] wrote:
>
> VC writes: "I don't understand why it's a bad thing to allow a 100% backed
> currency to be used as the basis for a fractional reserve banking system."
>
> It's pretty simple, it causes inflation. Right now DigiGold's literature
> says that is maintains a 25% reserve. If fractional reserve services such
> as DigiGold were to take off so that, say, half of e-gold's reserve was
> being used as the backing for 25% fractional reserve currencies, then the
> actual amount of "gold" in circulation would be 2.5 times e-gold's total
> reserve. ( e-gold's reserve + (1/2 of e-gold's reserve * 3)). More than
> doubling the "money supply" would cause the value of the gold to fall in
> half. In reality that is an oversimplification, since the borrower of the
> DigiGold will then redeposit his borrowed funds ("ether-gold") back into
> DigiGold, which allows the same money to be quadrupled again, and again, and
> again. So, in reality, DigiGold with its 25% reserve, may actually create
> 10 times the quantity of "ether-gold" as the real gold in its reserve.
>
> Gold's value to the world as money is that it is relatively fixed in
> quanitity, and only grows at the rate of 1-2% per year.
>
> In order to really adversely affect the price of gold, fractional reserve
> currencies would have to be a lot bigger than they are now. But GATA
> thinks the reason gold is so cheap right now is because of central banks
> selling derivatives on gold, which is essentially the same type of
> fractional reserve practice. When the same piece of gold is counted twice,
> once in the account of the lender, once in the account of the borrower, then
> you will have "gold inflation" which results in a low price for gold.
>
> In real life, what I expect will happen is that the currencies that are used
> for fractional reserve banking with gold will devalue against the 100%
> backed companies. (Since e-gold is 100% backed, it may cause DigiGold to
> start sinking in value compared to e-gold. It would take three grams of
> DigiGold to buy one gram of e-gold, for example.)
>
> The solution to this dilemna is to only lend gold that has been borrowed on
> a fixed-time contract. In other words, CD's don't cause this problem
> because the depositor does not have a "demand account" from which he can
> withdraw his gold at any time. This way the gold doesn't get counted twice
> and inflation does not result.
>
> Ultimately, fractional reserve banking is fraud, especially with gold,
> because if you add up all the deposits, they are far more than the actual
> gold in the vaults. Banks and companies that practice it are selling "gold"
> that is reality "nothing". They use units of weight like grams, but they
> are not selling the customer a real gram of gold, they are selling
> ether-gold.
>
> HK
>
This is complete misunderstanding of the process of monetary creation
used by banks and other creators of money (i.e. currency boards which
back their currency with a Secondary Earning Reserve as well as a
Primary Liquidity Reserve) in the gold economy.
Creators of money issue currency such as account balances, paper notes
or digital bearer certificates based on market demand for such
currencies. In the case we are considering, the currency is issued or
money created in exchange for gold bullion and is redeemable in like
form (either directly or via a chain of redemption).
In order to have market demand for such currency, it must *exceed* the
value of the physical monetary base, so that individuals or firms find
it profitable to tender the physical monetary base and bail it into such
institutions in exchange for their (more valuable) currencies.
Monetary institutions must offer better money (i.e. lower transaction
cost) money for the market to demand it and use it for their exchanges
and/or stores of value.
When currencies fall in value below the physical monetary base, currency
holders redeem their currency for the physical monetary base and the
monetary creation process is reversed.
The price of the physical monetary base is equal to its marginal
non-monetary revenue product, i.e. the marginal usefulness of the
commodity in the industrial production process. Monetary demand for the
physical monetary base, to hold in repositories and/or in coins actually
distorts the market and crowds out non-monetary uses. The storage and
security of the physical monetary base is a monetary transaction cost
and bids resources from productive use, thus the use of debt backed
currencies is the market transaction cost minimising response.
Debt backed currency simply means that the debts of individuals and/or
companies, which are financial assets to their creditors, are being used
as a store of value available for liquidation as may be needed to redeem
the currency. This store of value is complimented by a Primary Liquidity
Reserve to ensure the liquidity and stability of the currency in the
face of large redemption orders or a surge of redemption orders. Issuers
also maintain Owners' Equity to ensure that any losses on
lending/investment activities do not make the issuer unable to meet all
currency liabilities. Furthermore, most currency boards and monetary
institutions designed primarily for use as transactional media rather
than interest paying investment services maintain an Investment Policy
limiting investment activities to reletively short runnning debt
securities of reletively high credit rated debtors, to ensure that
liquidity is maintained and risk is managed prudently. These monetary
institutions, thus provide investment capital to industry and borrowers,
which has a productive return, rather than storing all value as
unproductive physical inventories which in fact misallocate the economic
use of the physical monetary base towards its monetary use and away from
its non-monetary use.
Digigold provides three economic advantages over e-gold. It provides a
lower cost transactional media as there is no storage fee or transaction
fees, it provides various value added features (greater privacy, email
between users), and it provides financial capital to markets in which it
invests its Secondary Earning Reserve. The market can determine if
digigold's advantages offset its operational costs and it if is
providing the best use of the technology (sub-optimal use of available
technology resources will likely lead to a contestor getting the
market).
Fractional reserve banking and currency institutions do reduce the value
of the physical monetary base by reducing the monetary demand for it
(the currencies/balances they issue are economic substitutes). This is
the same as any technology or business practice which economises on
inputs. Holding physical metal in vaults is a transaction cost and
should be minimised. Financial assets can be created which have value
pegged to the physical monetary base by the issuer and these serve as a
transactional media, means of exchange, money, whose unit of account is
identical to the physical monetary base. Its not counting things twice
its creating money, means of exchange, to serve as a store of value and
means of payment just like the physical monetary base, but at a lower
social and user cost.
The value of digigold is pegged to e-gold, because it is issued for and
redeemed in e-gold on demand. The supply of digigold is elastic, nearly
perfectly so, the supply curve is horozontal. If digigold was worth only
a third of the value of e-gold, currency holders would redeem their
digigold for e-gold at face value and get it and make a 200% profit.
Money is created by the market and has as many forms as the market finds
a use for. The ability to spend or redeem is the defining feature of
true money, and so term deposits which cannot be withdrawn before their
term is up are not money. The service of providing for deposits to be
redeemed on demand is called liquidity. Banks and financial institutions
and currency institutions provide this service because it has a market
value. The means of production of this service is to maintain a
portfolio of debt and other investments which does not have (as much)
liquidity along with *reserves* which are the liquid assets, used to
redeem deposits. The financial institution has to choose its prudential
policies so that it can maintain the liquidity service for its
customers. This basically means it has to manage the split between
reserves and lending and maintain adequate owners' equity so that the
ability of the bank to provide liquidity is maintained. Financial
Institutions make money from the margin between the interest rate it
charges on lending and the rate it pays on deposits. The margin for the
bank has to be big enough to cover for the fact that the quantity of
lending is less than the quantity of deposits (but more than reserves
normally). E.g. suppose a bank has 100 million AUG deposits and has 80
million AUG in lending and has 25 million AUG in reserves, charges 10%
on its lending, writes off 2 million AUG in bad debts, pays 4% on its
deposits, makes a profit of 2 million AUG on Owners' Equity of 5 million
AUG.
David Hillary
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