CCS 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.
>
> For an economist inflation is usually defined as "an increase in
> the money supply". This tacitly assumes there is only one type of
> money which in the case under discussion is false. There are many
> types of money: gold, e-gold, GoldMoney, DigiGold, SRGold and
> more. More precisely and to the present point then: inflation of
> a particular money is an increase in the supply of that money.
>
> Inflation of a particlar money will lead to a systematic change in
> the prices of goods *in terms of that money*. This is not by itself
> a bad thing; it is irrelevant. A money serves just as well as a
> medium of exchange regardless of the general price levels of goods
> traded for it.
>
> The damage that is done is not done by inflation itself but by the
> *process* of inflation. This is because that process does not take
> place instantaneously for all people or simultaneously in all
> places. Consequently, people whose knowledge of what is going on
> lags will make bad economic decisions which may cause themselves
> real economic losses and consequently damage general economic
> performance.
>
Economists define inflation as an increase in the price level, not an
increase in the money supply. The CPI is the economist's proxy for
inflation. Y*P=M*V where Y is real output, P is the price level, M is
the money supply and V is the velocity of money, defined as Y*P/M.
Inflation is an increase in P not V.
The expansion of one gold pegged money occurs as its purchasing power
*increases* above the others, inducing electronic or physical gold to be
bailed in. The supply of these currencies is elastic at the market price
of gold, although not perfectly so. Thus expansion and contraction of
the money supply of particular currencies occurs with little change in
the relative values of the currencies.
> In the case under discussion of multiple currencies things are a
> bit more complicated because one can no longer tacitly assume that
> the use of (and hence demand for) any given currency is universal.
> When there is an option as to which currency to use the demand for
> a currency will be determined by market forces which will respond
> to the apparent the stability and risk of that currency. For a
> systematic discussion I recomment Hayek's book: The Denationalization
> of Money.
>
In a genuinely free market for money, the measure of value will move
a-political commodities such as gold, but the issuance of currency moves
to those legal and economic structures which provide for transaction
cost minimisation. This will include a currency base layer (e-gold,
GoldMoney etc.) of 100% backed currencies whose main function is to
provide mechanism for storage and redemption of commodity value as well
as transactional capacity. These monetary institutions can create a free
and competitive market for the redemption of currency in its physical
base, and the issue of currency for the physical monetary base. The next
layer in a free market will be currencies which are backed by Primary
Liquidity Reserves of monetary base currencies and Secondary Earning
Reserves of interest bearing debts. These currencies offer lower/no fees
and additional value added services. The final layer of the monetary
structure of a free market economy is banks and financial institutions
which borrow and lend as major parts of their businesses. The main
function of these banks and financial institutions is to provide credit
to individuals and small businesses and interest bearing deposits for
depositors. However banks also provide transactional services and other
financial services such as insurance, superannuation, brokerage etc.
Money at all levels is denominated in units of account based on the
physical monetary base, and is issued and redeemed near face value. The
money supply is many times the physical monetary base (the inventories
of the physical commodity), and this is the most efficient, transaction
cost minising market structure. Inventories and their costs are 100%
transaction costs.
> > 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.
>
> Actually, niether e-gold nor DigiGold are gold. The amount of gold
> in circulation would not change at all (no gold is moved in or out
> of e-gold's depositories). The amount of e-gold in circulation would
> drop by 50% since its use as a currency reserve takes it out of
> circulation. The amount of "grams of DigiGold" in circulation would
> be 4 times that of the reserve. But its actual exchange value would
> be set by the market demand for it and could be much less when
> compared to gold or to e-gold.
The amount of physical gold in 'circulation' (storage) changes by the
difference between its rate of production and its rate of consumption.
>
> > More than doubling the "money supply" would cause the value of the
> > gold to fall in half.
>
> Since DigiGold is not gold this is not simplistically true. To the
> extent that there was a demand for DigiGold it would satisfy some of
> the demand for money. This would decrease the demand for gold to use
> as money that would exist if the DigiGold were not available. On the
> otherhand, to create the DigiGold requires that some e-gold (and so
> ultimately some gold) be removed from circulation which uses up some
> of the supply. Exactly how this would change the value of gold would
> be determined by how the market balanced out these various supply and
> demand changes. If the market perceives DigiGold to have been created
> in a responsible manner and to be a more useful money than gold then
> the value of gold could decrease. If the market perceives DigiGold
> to have been created irresponsibly it could be dumped as unsafe and
> fall in price so much that the value of gold increases.
>
> > 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.
>
> Inasmuch as the "redeposit" of DigiGold does not change the amount of
> e-gold in reserve or the liabilities of the DigiGold system it will
> not allow emmission of more DigiGold if DigiGold keeps to its
> reserve governance commitment. Strictly speaking all DigiGold (like
> all e-gold) is always on deposit; it cannot be literally redeposited
> since it never is anything else but a deposit. All you can do is
> transfer the owner of the deposit (or redeem it).
The investment of digigold may not be in digigold denominated assets, it
could invest in e-gold denominated financial assets or in other gold
markets where banks borrow and lend gold. Digigold invests in gold
denominated assets. Borrowers of gold, in whatever form, may exchange it
for USD and invest in US government or corporate bonds as a speculative
position (aka the gold carry trade). Thus investment in gold-denominated
assets may not increase the demand for digigold, especially if digigold
is a reasonably small part of the gold currency economy.
>
> > 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.
>
> True. That is unchanged by any fractional reserve banking.
>
> > 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.
>
> GATA's ideas are interesting but unlikely in the long run. Again: gold
> and derivatives on gold are not the same things. That is why they have
> different prices. The same piece of gold is not counted twice. What
> may be done is for people to not demand a sufficiently high price
> differential between gold and derivatives of gold. If so the market
> will sort it out in the end and those who made the poor decisions will
> lose a lot of value (which loss, of course, may be dumped on the
> taxpayers).
Gold and gold-substitutes (financial gold) should have the same value,
but ultimately the monetary demand for gold has little long run effect
on its price, which depends on non-monetary demand and marginal costs of
production.
>
> > 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.)
>
> This is quite possible. But not necessaarily so if the fractional
> reserve banking is done prudently AND the fractional reserve currencies
> have genuine advantages (such as no storage charges) over 100% money.
> Whether this is possible or not I do not know. But the market will
> decide.
>
This is not possible as digigold is issued for and redeemed in e-gold on
demand. The extent of price different is limited by this elastic supply
policy. Please remeber that the primary liquidity reserve is not the
only reserve in these currencies, these is also a secondary earning
reserve. In the case of digigold the sum of the primary liquidity
reserve and the secondary earning reserve is more than the currency
issued, i.e. there is positive owners' equity. Thus digigold *can* meet
its currency liabilities with its assets. The threats digigold's ability
to meet its currency liabilities on demand are:
1. Digigold may not maintain an adequare primary liquidity reserve, and
a surge or redemptions or a large redemption could deplete the primary
liquidity reserve and some currency holder may face a DELAY in effecting
their currency redemption.
2. Digigold may not maintain an adequate value of assets against its
currency liabilities, thus some currency holders could face a LOSS OF
VALUE when digigold goes bankrupt and creditors (currency holders) get
less than 1000mg in the gram.
3. Digigold could lose money on its investments with the same results as
2.
Digigold has three policies corresponding to threats 1., 2. and 3. They
are:
1. maintain a target primary liquidity reserve of 25% of currency
liabilities. Investments in the secondary earning reserve are sold and
the proceeds deposited in the primary liquidity reserve if the primary
liquidity reserve ratio falls below this value to restore it above this
value.
2. maintain a target owner's equity of 8% of the secondary earning
reserve. This means issuing shares to raise capital (or raising capital
by some alternative means) as digigold grows and not paying out any
dividends while the owners' equity is below the target amount.
3. maintain a prudent investment policy for the secondary earning
reserve (i.e. invest in high quality debt securities of short duration,
this provides for liquidity should the value be required quickly to
replenish the primary liquidity reserve during a run of redemptions.)
Also there is a limit on the proportion of lending to any individual
debtor or related group of debtors.
These policies, and accounting, auditing and structuring to assure
currency holders of their implimentation, provide a basis for faith in
the ability of digigold to maintain the value of its currency.
> > 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.
>
> If a CD is in bearer form it can serve as money. If it is not then
> a promisory note with the CD as collateral can serve as money. You
> can't get away from it.
This is a poor money because its value is too sensitive to market
conditions and is not divisable. But it can still act as money.
>
> > 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.
>
> You are adding up different things as if they were the same
> thing. The error is yours.
>
franctional reserve banking is not fraud, depositors know, or should
know, that most of their funds are lent out and that is how they can
earn interest.
David Hillary
> > 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.
>
> They are not selling "gold" and they are not selling "nothing". They
> are selling contractual obligations. The "problem" lies in your own
> misunderstanding. If they do not misrepresent the terms of the
> contract and they fulfill those terms then it is not fraud.
>
> CCS
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