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.