Re: Backing

["Perry E. Metzger" <pmetzger@lehman.com>]

Peter Baumbach says:
> "Perry E. Metzger" says:
> > >  Isn't a finite source of backing a problem since it rewards those who
> > > hoard it?  
> > 
> > No. It punishes those who hoard it -- they don't get interest on their
> > money.
> 
> Where does this interest come from.  If you have a 100% backed currency
> with a finite supply, those who hoard it can't lose.

Traditionally, banknotes have NOT been 100% backed. Even if you chose
to have your digital cash itself fully backed, presumably few people
would place their money in checkable accounts (that is, counts upon
which drafts may be drawn) that were not at the very least invested
SOMEHOW. 100% reserve accounts might be available, with negative
interest to pay expenses, but I doubt many would use them for much
other than things like escrow accounts. Certainly whenever a bank
loaned you money or invested money it would do so with fractional
reserve instruments, as banks traditionally have.

> If there is a 
> total of 20,000 tons of gold in the world, and you own 1 ton, then don't
> you own 1/20,000 of the worlds wealth.  As long as the total wealth of
> the world increases, doesn't your wealth increase along with it?

If you own 1 ton, you just own one ton of gold. The medium of exchange
isn't a special commodity.  There isn't one dollar bill out there
somewhere for every dollar of value in property in the U.S. -- not
even one dollar bill for every hundred dollars in value! (I might be
slightly wrong on this exact figure, but the order of magnitude is
right.) Imagine I owned 1/20,000 of the dollar bills in the country
and kept them under my mattress. Would I own 1/20,000 of the wealth of
the U.S.? Would my "investment" grow in value as the U.S. economy
grew? Of course not, and of course not, but thats precisely what you
were implying.

> > >  If neither Alice or Bob have a backed currency, does that mean they
> > > cannot trade?
> > 
> > Depends if they consider what the other has to be of value. Its all up
> > to them.
> 
> If Alice needs her street cleaned and Bob can do it, and if Bob needs
> some food prepared and Alice can prepare it, a currency is unneeded
> for their trade.

Thats correct. On the other hand, most people don't want to trade
directly for services, because that would generate great
inefficiencies. Lets say you were a programmer -- not everyone you
would want to trade with would want or need your skills. How would you
buy bread, say? A medium of exchange is a wonderful way to securitize
barter -- thats basically what it is, you know.

> > >  Has anyone invented a workable "barter currency"?
> > 
> > I don't see what the point would be. Why not just deal in a medium of
> > exchange? 
> 
> Continuing with Alice and Bob, let's add Carl.  If Carl needs his freezer
> repaired and Bob can repair it, and Bob wants some vegetables and Carl
> can supply them, a currency is still unneeded.  Suppose, however, Alice
> wants the vegetables, but has nothing to offer Carl, a "barter currency"

Why not just have people use a normal currency? Seems like you have
some bizarre idea that the poor won't be able to afford the real
currency, which is silly.

> If Alice kicks over a stone and finds a nugget of gold, why should she
> be any richer.  She hasn't done anything for anyone, except maybe
> devalue the gold that everyone else already owns.

Untrue. She's done work. Replace "gold" with "diamond", which she
sells to a jeweler.

You have this strange view that the medium of exchange is somehow
different from any other commodity. It isn't. Get that idea out of
your head.

> Gold makes a good currency because it be can't be created by those who
> have done nothing of value for anyone else. (A government ;-)  Gold makes
> a poor currency when it prevents the economy I describe above from existing
> since none of the participants have any.

It doesn't prevent anything at all. If gold is expensive in terms of
human labor, than all the players involved will use small amounts of
gold for their transactions. IF gold is cheap, they will use large
amounts. In neither case, however, will they notice any difference in
outcome at all. In other words, you are thinking as though the medium
of exchange in and of itself mattered, which it doesn't. 

Replace "gold" with "dollars" in your exposition and see how silly it
now sounds.

> > > Can I.O.U.'s be created such that they work like money?
> > 
> > Sure. Thats what banknotes are.
> 
> Your method requires another participant to the transaction.  Everyone
> must trust that the bank doesn't print more banknotes than it can honor.

Actually, that part is very easy -- the excess clearings rule means
that the bank would go belly up within days or (in the modern world of
electronic banking) hours if it did that -- all the other banks it was
clearing with would notice massive outflow of the backing commodity
from the bank's accounts. Its very hard to cheat in this sort of
system. Thanks to computers, its easier than ever for people to check
on what banknotes (or their electronic equivalent) are good.

> Also, what is the banknote an I.O.U. for? Gold?

Or whatever. It really doesn't matter what the backing commodity is.

> An I.O.U. for particular services or goods are hard to use as a currency
> since you may wish to trade with someone who does not know the person
> whos name is on the I.O.U..  Carl might give Bob an I.O.U. for fixing
> his freezer: "I Carl owe the holder of this I.O.U. two bushels of carrots."
> It would be hard to give this in payment to someone who does not know
> the quality of the carrots or the trustworthyness of Carl.

I think you've just discovered why it is that people use a medium of
exchange and not some strange barter system. Fungibility is an issue,
and the use of a standard medium of exchange means that you can
securitize barter.

> I have just been learning about call and put options on stocks.  If I sell
> a call option, I am agreeing to sell a certain amount of stock at a certain
> price at any time in the future until the option expires.  These options
> behave something like the "barter currency" that I wish to have invented.

Not at all. Puts and calls are bets -- they have behaviors very much
unlike trading in the underlying stocks. Of course, you can build
"synthetics", which behave like the underlying stock, but the options
themselves are rarely used that way because the market is efficient
and thus you can't make money that way.

> People trade these options instead of trading in the stocks.

More accurately, they use options as a means of increasing leverage.

I suggest learning more about how banking and economics works before
discussing this further -- there are some basic assumptions we are
both making that are very different.

Perry