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.
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.