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deconstructing money, part 2

In Part 1 of this post I suggested that there is not an obligatory connection between strategies for maintaining price stability and the exchange value of the money used as a settlement medium. I insisted on using the term settlement balance, which sounds like (and is) bank jargon, as an alternative to other terms used to refer to a money balance.  My reason for using bank terminology is that I want to use the treasury operations of banks as a model of how businesses and individuals manage their balance sheet.

A bank may be defined as an institution allowed to borrow from the public (accept/create/raise deposits) without prospectus in order to fund its own asset portfolio. The bank generates the bulk of its revenue through treasury operations, seeking a net rate of return from its investment portfolio (loans, securities) that is higher than its cost of borrowing (the interest it pays to attract deposits). The bank maximizes revenue by being as fully invested as possible, maintaining only enough money (vault cash, deposits at its correspondent bank or the central bank) to support the anticipated liquidity demands of withdrawals or (especially) participation in payment systems. The money, the non-interest bearing fraction of assets held against immediate demands for liquidity, is what I am referring to as a settlement balance (see BIS usage of the term in the context of large-value payment systems).

This term settlement balance refers to the fact that all day long the bank sustains inbound and outbound flows as its depositors order payments to people who bank at other institutions but also receive payments.  The inbound and outbound payment system related flows cancel each other out to a large extent so that at the end of the daily payment cycle the bank might make or receive a single net payment that serves to settle (extinguish, with finality) any residual payment related liabilities.

It is in the interest of banks to economize on reserves - to hold the least possible amount of money as settlement balances - in order to be as fully invested as possible. [I'll return to this thought below when I describe the benefit of settlement efficiencies.]

Non-financial businesses and regular people/households do this exact same thing.

With non-financial companies the term settlement balance is not commonly used to refer to their uninvested money. Instead, the rather sloppy term "cash" is used, as in "sitting on a mountain of cash". Cash is one of those unfortunate words with multiple semantic usages. Sometimes the word is used to emphasize the anonymity of bearer media such as Federal Reserve Notes. For this discussion though I am pointing out that cash is often used as a label not only for uninvested money, but also for financial instruments of very short maturity such as the overnight sweep accounts that are the mainstay of so-called cash management. A vanishingly small proportion of any major company's assets are held in the form of money-as-distinguished-from-investment and the rest is in fact invested in a way that takes into account the possibility of drift in the value of the unit of account. The actual money part, the settlement balances, as with banks, are held only to meet immediate, essentially same-day, requirements such as stocking cash register drawers and making sure there is cover for outbound payments through the banking system.

Operating in a multi-currency environment complicates things, but only a little... provided we are talking about adding e-gold as an additional alternative payment option. If there are inbound and outbound e-gold payments (with payment amounts specified in the units the company normally uses for its bookkeeping) the average settlement balance held in the e-gold account is continually and automatically being marked to market as it is drawn down and replenished.

Not to belabor it but people and households (in advanced economies) economize on reserves too.

The major factor that enables a diminishing role for money is efficiencies in payment systems. The Clearing House Interbank Payments System (CHIPS) processes over 350,000 (large value) payments a day with a gross value of $2 trillion, 96% of it settled intra-day, achieving a 500/1 ratio of payment throughput / money used to prime the process.

To briefly recap, in advanced economies, thanks to sophisticated payments infrastructure, the role of money is diminishing. Banks, non-financial companies and households can hold a higher proportion of their wealth in investments that, in normal market conditions, can offset changes in the purchasing power and relative exchange value of whatever medium of payment they happen to use.

The majority of people in the world though - people who live in developing countries (or lower economic strata in advanced countries) - remain excluded from these efficiencies. They are mired in the cash economy. Remote payments under the constraints that exist in less developed economies require the use of expensive and inflexible intermediaries.

The emergence of e-gold, which enables direct end user access to a highly efficient settlement platform without the costs and delays introduced by an obligatory financial intermediary, will change all that. Just as cell phones enabled people worldwide to skip a generation - bypassing the queue for a landline - e-gold enables payment efficiencies that eliminate the need for banks to build a branch (or even an ATM) in every village.

To tell this story requires further elaboration of the role of settlement. The same efficiencies that e-gold affords to poor villagers, enabling secure and low cost access to world markets, will enable banks or other financial intermediaries to extend innovations in domestic payment systems to a global multi-currency environment.

Please bear with me. It is a difficult tale to relate linearly. It will be easier to see the whole picture when the components can all be joined by hyperlinks.

deconstructing money, part 1

In my recent Better Money post I proposed that money that did not lose its exchange value over time... would generally be better than money that did. In response, Sameer Parekh asserted the benefit of stable value and pointed out the important distinction between a money balance and an investment.

In this post I am going to agree with Sameer, to a point, but argue that stability of purchasing power is not of primary importance in evaluating options (i.e., the medium and/or platform) for settlement.

Price stability is good but instability is not necessarily all that bad. Lets compare two cases, goods and services sold outright, vs. debt instruments. Fluctuations in the value of the unit of account used to price goods and services - lets call it the invoicing unit - have always been dealt with by price changes. A Sunday newspaper or a Big Mac costs more USD now than twenty years ago, reflecting the decreased purchasing power of the dollar. Markets are pretty good at providing information to guide pricing, with the traditional exception of the "sticky downward" thing with wages (and house prices?). Excessively large and/or rapid changes in the purchasing power of a particular unit exact a higher economic cost but more gradual or less severe fluctuations can be taken in stride by the market. Part of the process by which economic actors insulate themselves from fluctuations in the value of money is to hold a proportion of their wealth in investments instead of money balances. I will expand on the money vs. investment thread below.

Debts are trickier because of the time element. Poorly predictable fluctuation of the purchasing power and/or relative exchange value of the units used in specifying debt contracts tends to create winners and losers and is economically costly. In an extreme case, where the borrower and the lender remain in the debt contract until maturity,  a(n unexpected) decline in value of the unit of specification favors the borrower since debt service and repayment of principal are done with cheaper money than what was originally calculated/borrowed. In the more general case, whenever an investor/lender holds a debt security for any interval, or some entity carries debt, anticipated fluctuation of the value of the pricing unit is just one of a multitude of factors that must be estimated in order to decide whether to make a portfolio adjustment or change in financing structure respectively.

An elegant solution is to specify debts using either a unit that is adjusted to such fluctuations or a unit designed to represent stable value. An example of the first strategy is Treasury-Inflation Protected Securities, also known as TIPS, where the debt is specified in US dollars, with the principal adjusted every six months using the Consumer Price Index (CPI). The other approach that has been advocated is to price goods, services and debts using a synthetic unit of account (numeraire) representing a different (than the CPI) adroitly weighted bundle of commodities (and/or existing currencies, and/or services).

Here is where e-gold comes in. With e-gold, it is convenient to deconstruct the money abstraction, enabling the use of whatever invoicing unit is convenient while taking advantage of settlement efficiencies obtainable with a medium that happens to be denominated in a different unit of account.

The de facto reality that emerged early on with e-gold was that most Spends were (and continue to be) specified in conventional legacy units such s "Pay account xxx $20 worth of e-gold". For the first time, actual practice supports the idea that advocates of basket units etc. have been describing for decades - price goods, services and debts in their idealized unit but pay/settle with some actual suitable medium.

But isn't it true that the exchange value of the e-gold one receives continually fluctuates relative to all other currencies? Uhh, yeah, all currencies (brands of money) continually fluctuate relative to all other currencies  (except for the minor ones that are hard pegged to specified major reserve currencies). So, (our hypothetical interlocutor continues) wouldn't the e-gold User lose the benefit of the stable invoicing unit thing and find themselves again adrift in the sea of potentially volatile exchange rate exposure?

Yes, but.. this exposure only affects the limited quantity of e-gold the e-gold User happens to be holding, a sum I will refer to as a settlement balance. In the next installment of this post I will delve into the money vs. investment distinction and describe the diminishing role for money. To preview - individuals, like businesses and banks, don't hoard money. They keep enough on hand to meet liquidity demands (anticipated outbound payments mostly) and invest (or spend) the rest.

The buck starts here. (So does e-gold.)

In an earlier post I made reference to the role of liability as it relates to monetary issuance. In this post I want to explain all that. To preview: money that is someone's liability - (potentially) good. Money that is no one's liability - not so good.

It is certainly possible for a monetary system to circulate money that is no one's liability. Under the late 19th century classical gold standard, for instance, some (eensy weensy) proportion of the money stock that actually circulated was gold coins. Simplifying a lot, one could say that these gold coins had 'intrinsic value' because the stuff they were made out of was valuable and the value didn't ultimately depend on the strength of anyone's balance sheet. They could be melted down and their market value as a commodity closely approximated their notional value. The value of gold coins therefore had hardly anything to do with liability, except liability as in a  warranty sense, where the imprimatur of the State (Caesar's image and inscription, if you will) afforded confidence that the gold was genuine.

Good riddance. A major point I want to make in this post is that lumps of gold were and are pretty pathetic when it comes to service as a transaction medium. On the other hand, liabilities that can be redeemed for lumps of gold are greatly superior.

How so?

Lets focus on what I will call monetization. Monetization is the conversion of assets that are a good store of value, but not adequately money-like... into money. I propose that monetization ideally entails passing the value of an asset portfolio across a balance sheet so that it can be rendered as numerically expressed liabilities.

How can this be good? Transmuting assets into liabilities introduces the taint of possible non-performance, of default, doesn't it? For purposes of the present discussion I'm going to gloss over the topic of default risk, saving it for detailed discussion in later posts, and concentrate instead on the benefits of monetization.

Consider US dollars. All US dollars are someone's liability. They all belong to someone (for whom they constitute assets) but they also assuredly live on the liability side of someone else's balance sheet. All of these dollar-denominated liabilities derive their value from the assets that are on the other side of the respective balance sheet. For now let's concentrate on those US dollars that constitute direct liabilities of the Federal Reserve, the base money of the US dollar. [In a later post I will explain base money, contrasting it to broad money].

The Fed holds a lovely portfolio of assets.  Valuable? You betcha! Money-like? Well...

The bulk of the assets held by the Fed are Treasury securities - currently about $790 billion of notes, bills and bonds, with another 24 billion of repos collateralized by treasury securities. Other major classes of assets held by the Fed include: gold (certificates) - $11 billion (carried on the balance sheet at $42/ oz.. Marked to market the gold would be valued at $176 billion, and ~ $39 billion of "other assets" mostly consisting of foreign currency and securities. [Note that to even describe the value of these various assets it is expedient to use the standardized unit, US dollars, that derives its value from them].

It would be hard to buy a a pizza with a treasury bond.

Treasury bonds, bills and notes come in a range of coupon rates and maturity dates, both of which parameters affect their market value from moment to moment. They also come in large chunks, never smaller than $1000 face value. Lets say you want a large pizza with pepperoni and banana peppers, hand tossed. You also plan on tipping the delivery guy 10% (cheapskate!). Suppose the pizza place elects to price a large, hand-tossed, two-topping pizza at 0.01 of a treasury bond so your total payment will add up to 0.011. This simply wouldn't work. Which bond, the 13% of 2012 or the 5.5% maturing in 2008? And how would the delivery guy make change?

The problem with a diverse asset portfolio such as that held by the Fed is that the assets are not sufficiently fungible or divisible for direct use as money. The passage though, by accounting means, across the balance sheet to the liability side enables the value to be rendered as pure numbers. One person's 12.748 is identical to someone else's 12.748 and with either version of 12.748 one could subtract  4.32 and consistently come up with a remainder of 8.428. Perform this math with credits and debits of account records on a database and you also achieve very efficient transferability.

Just as one Treasury security in the Fed's portfolio may differ from another in terms of market value, gold coins vary as well. Two may be of the same design and nominal weight but one of them may be old, worn and lighter than the less circulated one. One may be a fake - cleverly fashioned lead with gold plating. Some coins may have numismatic value higher than their melt value. Likewise, making change in a protocol where gold coins are the standard of value invariably entails the introduction of distortion and/or liability. "Your purchase totaled 0.743 of the value of the gold coin you gave me. Here are a combination of silver and copper coins that are accepted as constituting a value equal to the remainder of 0.257 of a gold coin". How can this combo of silver and copper coins always happen to be worth 0.257 of the standard gold coin? Uhh, because some financial institution somewhere takes on the liability of assuring that specified combinations of the silver and copper coins can always be traded in for the standard gold coins, even if the melt value of the silver etc. is less than the gold.

A remarkable monetary event of the 20th century was the nationalization of gold that Americans had deposited into the banking system. My point in referring to this is not to criticize that act but to highlight a truth that I will use later as I undertake to contrast e-gold with the gold standard. The reason most gold coins were sitting in bank vaults (and therefore vulnerable to confiscation) was because they were more useful monetarily as reserve assets backing bank deposits (liabilities) than as hand-to-hand money. Quite frankly the gold seized in the 1930's continues to serve very efficiently - the metal stays put in Ft. Knox  (conspiracy theories aside) but the liabilities partially/indirectly backed by it change hands with a velocity that is the very substance of GDP.

As we proceed, I hope to effectively articulate that the very best place for gold to serve a monetary role is in the vaults where it is held in allocated storage backing e-gold.

Better Money

The trademarked slogan "Better Money" is displayed on the homepage of the e-gold site. As best I recall, I came up with that one myself.  In making this claim my intent was (and is) to stimulate thinking and discourse along the lines of "In what way(s) can one brand of money be better than another?"

Thinking back, the logic for what I'm going to say next derived from an essay I read in '97 or '98 by Antal Fekete. I just now tracked it down again and it is still online. I haven't re-read it again in detail so I don't want to imply I agree with everything it says though on a quick scan it still looks pretty worthwhile.

Fekete described money as "a transmitter of value through space and time…with the least possible loss".  Transmission of value through time correlates to money's role as a store of value. Transmission through space is a reference to money's usefulness as a medium of indirect exchange, that is, a means of effecting payment. It looks to me like he meant or was emphasizing physical space, distance.

I prefer to think of the space part as transaction space, where value is conveyed from a payer to the recipient of payment, a change of ownership or entitlement.

So how can one brand of money be better than another?

Money that does not lose its exchange value over time - relative to goods and services, relative to other brands of money - would generally be better than money that did. I say generally because, as with most propositions, there are exceptions -circumstances where some participants in a money economy stand to gain from a decline in exchange value. There are also circumstances where an increase in exchange value can be disruptive, creating winners and losers. At some point I hope to expand on this. It ties into (among other topics) discussions on balance of payments, an area where e-gold or any globally oriented and designed currency can alter or invalidate existing paradigms in an interesting way.

e-gold's performance as a store of value perfectly mirrors physical gold since it is backed at all times by a 100% reserve. For present discussion purposes, suffice it to say that gold has a long track record of being ascribed exchange value and is unlikely to become worthless pending very significant advances in physics. [There is, by the way, a provision in the e-gold Account User Agreement that could be triggered in a circumstance where gold is no longer scarce in an economically meaningful way.]

How about the other dimension - preservation of value across transaction space?

In the long run, which I define as the post-transitional phase after e-gold has been embraced by mainstream institutions and is fully integrated into banking/payments/financial arrangements, many payment mechanisms will be unaffected. A credit card transaction will be a credit card transaction regardless of whether the payables or receivables are due in GBP, USD or AUG.

There are two payment scenarios though where e-gold can offer unique advantages, something better,  than what is possible with legacy brands or money.

The first case is direct acceptance of e-gold, as it currently exists, for payments over the Internet.There is not a single entity that currently accepts payment online who would not stand to reduce their costs and extend their market reach by adding e-gold as an alternative, additional option. e-gold is the only truly global payment platform. An online retail merchant can accept e-gold from anyone anywhere at extreme low direct cost, with immediate settlement and no risk of payment reversal (chargeback) even if the payer has no plastic, no credit history, even if they are unbanked altogether.

The direct cost issue is significant. Imagine a large retailer selling computers online and accepting plastic. The fee for accepting a credit card payment for a $2,000 computer may be higher than $20. The fee for receiving the same value in e-gold would be e-gold's maximum Spend fee - 5 gold cents, that is, 5 cg of e-gold, equivalent at current exchange rates to less than $1.20.

For the recipient of payments using a credit card intermediary such as PayPal or Neteller, the differential is even wider. The payment processing fees for these services must incorporate the full credit card fee (since that is how a payment is usually "funded") and add a further markup to cover their costs of adjudicating disputes such as when (as is not uncommon) they suck payments back from recipients. For every $1 million of payments processed via PayPal [eBay/PayPal uses the term Total Payment Volume or "TPV"], PayPal extracts over $38,000 in revenue. PayPal's revenue, of course, constitutes the expense of their users. With e-gold, in contrast, for every $1 million worth of velocity, the system deducts Spend fees totaling about $2,000 worth - one nineteenth as much. Both of these pale, though, compared to the vig that Neteller extracts,  $138,000 per every $1 million "receipted", more than 65 times the fees e-gold charges. Youch!

The second case where e-gold can afford benefits unachievable with any other currency relates to its function as a settlement platform. The truly unique and unprecedented characteristic of e-gold is not that it is digital, or tied to gold, or online. It is the fact that end users can directly access the settlement platform... without going through any financial intermediary. To tell this story though requires a clear understanding of the role of liability in monetary arrangements.

e-gold is...

Since this blog is going to be all about e-gold, a natural place to start is with a succinct definition of e-gold. I promise to offer a succinct definition... but I am not going to stop with the succinct version.

A proper exegesis of e-gold requires some elaboration. [I like that word exegesis. It will be a struggle not to overuse it. I'd love to hear Eddie Izzard ad lib with "exegesis". I'm also fond of "explication".] e-gold entails subtleties, with ramifications that I regard as profound and important. For example, I think the concept of "base money" is interesting and would be a useful construct for anyone with an interest in how financial systems work. In discussing e-gold, the idea of base money is a building block that will facilitate precise discussion of multiple topics ranging from efficiencies that mainstream banks will eventually realize via an embrace of e-gold to the holy grail of a monetary system that is automatically self-regulating vis-a-vis quantitative money supply.

If a person already has a good grasp of monetary principles - the nuts and bolts of central banks, banking in general - it is relatively simple to describe how e-gold is similar to and in what respects it differs from contemporary and historic models. Most people, however, have a pretty vague sense of what US dollars are or how the Fed works. Stick with the e-gold blog and I believe you will also gain a better grasp of dollars, dalasi, rubles and the various other legacy brands of money.

I anticipate a number of entries will be devoted to fleshing out monetary jargon, the terms of art that have specific meaning and connotation in a monetary theory context. Often it will be possible to hyperlink to existing definitions [for instance the reference to "indirect exchange" below], but at times the terminology will need to be developed or extended in an e-gold specific context [e.g., "primary dealer"].

To proceed (with haiku-like brevity):

e-gold is a service that mobilizes the value of gold for payments via the Internet.

Preview of a more fully elaborated definition:

e-gold is a medium of indirect exchange, constituting a liability of e-gold Ltd., denominated in weight units and backed 100% by the net gold content of physical bullion held in appropriate custodial arrangements. e-gold is also a book entry settlement platform directly accessed by end users, and therefore usable as a payment mechanism. e-gold is designed to serve as the base money of and settlement platform for an alternative global currency that can be variously referred to as e-gold or AUG.

Coming soon:

Someone recently told me that it confuses people when I refer to a quantity of e-gold as a liability. Along this line, I've encountered gold bugs fond of reciting that gold is an asset that is no one's liability... and going on to draw the non sequiturial inference that money based on gold isn't anyone's liability either?! Clarity on the liability topic matters and we should talk about it.

Q&A with e-gold Founder

One of these days, hopefully soon, I'm planning to do a talk radio interview. In preparation I recently met with a radio journalist to familiarize her with e-gold. We decided to record our discussion...

Welcome to the e-gold blog

Hi, I'm Douglas Jackson and this is the first entry of the e-gold blog. Welcome! My goal in this first note is not to introduce myself - I'll surely get to that by and by - but rather to scope out my/our blogatorial intentions.

I will write from a personal perspective but will mostly talk about e-gold. Given that e-gold.com has been online since November 1996, that means I have a lot of catching up to do. The story that I will relate will therefore not be told chronologically. What I have in mind instead is to explain e-gold, its doctrine and logic, my vision of how the emergence of e-gold can advance the material welfare of mankind. Sometimes, for instance when describing the rationale that informed various decisions or policies, this will entail recreating a historic context. At other times, for example when I compare e-gold to legacy monetary institutions such as government central banks or the various historic flavors of gold standards, this will require some teaching. It probably also goes without saying but I will make no pretense of objectivity. I believe e-gold can serve as a fulcrum for a better future. I can do no other than to speak as advocate - apologist and polemicist - for e-gold.

We [Reid, Barry and I] debated whether to start a personal (Douglas Jackson) vs. an outright corporate (e-gold Ltd.) blog. The fact that the URL you entered to reach this page contains "e-gold" indicates which arguments prevailed. My sense and expectation though is that the personal vs. corporate thing will not greatly influence the voice with which I post. I am the Chairman of e-gold Ltd. and it is appropriate to call me the "Founder" of e-gold. I could offer a disclaimer protesting that I am offering opinions that are mine alone and do not reflect the official position of e-gold but I can't think of an edifying instance wherein the two viewpoints diverge. Nonetheless, I don't want to hog the mike either since the health and future of e-gold depend on the expertise and best efforts of many people.

A final (for now) comment... Anyone remotely familiar with e-gold knows that it is currently, August 2007, under legal (and reputation) attack by the United States Secret Service.  I intend though to stick to the affirmative message of e-gold in this blog - to undertake to do a better job telling the e-gold story and to become more visible as the human being primarily responsible for e-gold. The legal wrangle will be the subject matter for a separate legal blog.