http://www.goldeconomy.com/ Douglas Jackson. CEO, Gold & Silver Reserve Melbourne, Florida The Gold Economy, © 2000. Part I: the base money "If it ain't broke, don't fix it." Joe Sixpack, during the pleasant phase of a credit bubble, regarding existing monetary systems. "You can't make a silk purse out of a sow's ear." Thus far lonely voice of the architect of the AUG economy. Existing currencies, along with their transfer and settlement mechanisms, are broken. Electronic payment systems, often referred to as electronic currencies, can aid in mitigating certain egregiously flawed aspects such as the excessive cost and fraud-ridden (and therefore repudiable) nature of payment transactions. There are, however, more fundamental problems, namely systemic risk, deriving from the non-economic bases of national currencies. These problems are profound and structural - built into the core premises of government central banks - and can only be remedied by the invisible hand of the market. Commerce depends on mechanisms for conveying value with the least possible loss through time and across ownership boundaries, that is, from a payer to a payee. Electronic transactions, secured and authenticated by cryptographic means, address the latter aspect and may effect the following improvements over conventional payment mechanisms: Immediate settlement (requires balance checking and realtime crediting of the payer's asset account) Low (or no) direct cost Non-repudiation (no chargebacks or other reversal of payments) Impossible to counterfeit the payment medium, a payment instruction, or a payment notification Effective authentication of payment instructions (impossible to access funds without authorization of their rightful owner) Direct access, with bi-directionality (anyone can pay or be paid) No need for user to prove creditworthiness Programmatic interface (an API enabling users to build their own user interface or automated interaction with their own backend transactional and accounting systems) Reduced latency relates to the time dimension, but is not the fundamental element of the value equation. Electronic money isn't just about circulating bits of information. In the long run, more than anything, it is about the contractual obligations those bits embody. National currencies sometimes serve as adequate stores of value (the time aspect) for sustained periods. Unfortunately they are subject to other, conflicting, priorities. The additional, mutually related, imperatives of national currencies, to: assist the client State to finance its expenditures, attenuate or forestall recession, foster higher levels of employment than would obtain by than economic means, and, prevent periodic collapse of national banking systems are not only non-economic but are inimical to economic calculation because, being political ends, they inevitably entail the occasional suspension or outright abrogation of private contract. Money and, the related concept, currency are economic goods. The market excels at providing economic goods. The private supplier of money and/or currency has a strong incentive to perform obligations because otherwise long term success is impossible. Failure of a private economic actor to perform obligations leads to impaired reputation and ultimate dissolution. This article explores factors that will prevent most new so-called electronic currencies from ever playing a significant role in financial intermediation, let alone becoming contenders in the worldwide competition to predominate as the settlement medium of choice for debt instruments. This matters because the success of any currency has a positive correlation with the extent of its total value in circulation. An extensive circulation requires willingness on the part of both payers and recipients to hold a balance of the currency rather than immediately "cashing it in" for "real" money (i.e., conventional banking system liabilities). A related and larger factor is whether banks themselves elect to accept deposits, hold cash balances, and make loans in the new currency. Five strategies are outlined. The first four are flawed to an extent likely to prevent their emergence as qualitatively significant innovations. The fifth, referred to as the AUG economy, is presented as a viable candidate to become the privately issued currency of choice worldwide. Case 1: purely fiat electrons Some financial cryptographers, starting from the premise that money is nothing but information, imagine that: scarcity, that is a strictly finite quantity of units, assured by auditable safeguards, combined with, non-counterfeitability, and, robust transactional mechanisms suffice to comprise a basis of value for eMoney. The adroitly designed and circulated bits presumably would be sold on the basis of their self-evident suitability as a medium of exchange. A slightly more sophisticated variation on this theme (popular also with patriot movement loons) admits to the relevance of balance sheets, to the extent that the bits would be loaned into circulation, buying debt instruments denominated in the same units. This is admittedly alluring, especially given the similarity of this approach to the until-recent ease of selling comparably valuable shares in dot com IPOs. The weakness of this strategy, however, would be the competitive threat of some other issuer of equally technically elegant bits who stood behind their currency with demonstrable readiness to buy back their units on demand with some designated outside money. Case 2: CutesyBucks Most electronic currencies or payment systems that have recently been introduced by commercial companies have adopted existing national currency units for their unit of account. The seeming advantage of this approach is familiarity. The general public has a very crude grasp of the abstraction referred to as money. People commonly acquire their conception of money at a proto-verbal developmental stage and equate the national currency used as money in their environment with the concept of money itself. Use of familiar units, however, requires that the new currency-liabilities presumably redeemable for "real", i.e. banking system, money-be reserved with financial assets denominated in the same national currency and generally consisting of deposits in the banking system. At least four complications result: 1. Financial institutions are highly unlikely to accept deposits or hold balances of the derivative currency that is simply a non-interest bearing liability of some other financial intermediary. Any cash reserve that banks hold will be in the form of higher powered or base money - bank notes, or, deposits at the central bank or an intermediary correspondent bank. Rather than hold some other institution's electronic currency they would be better off creating user interfaces of their own, and internal settlement mechanisms, enabling their own depositors to efficiently transfer value to the accounts of other depositors resulting in, voila! - their own brand of electronic currency. 2. Merchants and other recipients of payment have little incentive to hold onto electronic currency that in most cases is simply thinly disguised deposits, lacking even deposit insurance. 3. There is little prospect that major borrowers will elect to issue debt instruments specifically denominated in the particular electronic currency. 4. The loading function, that is, conversion of value from straightforward banking system liabilities into eCurrency balances is a cost center. What would motivate a person to pay a bid/ask spread to trade USD for eUSD? The issuing institution instead often ends up saddled with the direct costs, fraud and payment repudiation risk of a credit card merchant in their effort to transfer value into their settlement space. Each of these factors poses a severe impediment for any electronic currency denominated in existing national currency units seeking to build a large circulation and dominate the market. On the contrary they will face a proliferation of lookalikes as multiple banks seek to offer more convenient interfaces, a more trendy set of strategic partners, more catchy ads and more giveaways. A new currency needs to be: a new currency. Case 3: 'Peez', a hybrid of case 1 and 2 A hybrid approach is to denominate a medium in existing national units and distribute (sell) it at unit for unit parity, but redeem (buy it back) at a sharply reduced rate such as 50 cents on the dollar. The justification of a 100% or so premium is the claimed utility of the system as a promotional device, a type known as a loyalty scheme. Actuarial estimates of wastage (users with small odd amounts unlikely to ever be aggregated into a sum large enough to bother redeeming) might justify maintenance of a reserve ratio even lower than the redemption percentage. This strategy, loyalty scheme qua currency, is limited in that the medium can never achieve full currency status. User-to-user payment capabilities, for instance, must never be implemented because a secondary exchange market would spontaneously develop. An actual competitive market would quickly discover the appropriate exchange rate relative to other media, which would of course approximate the buyback rate the issuer was capable of sustaining. Case 4: CephaloPoints This approach, favored mostly by academic people smarter than everyone else, involves defining a unit or numeraire as in index derived from a diverse basket of economic goods. The virtue of the indexed unit is purchasing power stability. In the world that uses CephaloPoints, the role for money per se, that is, particular widely accepted non-interest bearing cashlike current claims, is sharply reduced or eliminated. Wealth could remain fully invested at all times and all payments would entail a series of embedded exchanges using CephaloPoints as the unit but not necessarily the medium of settlement. There are several difficulties with this approach, which may account for its greater popularity as a public policy prescription than as a basis for actual entrepreneurial endeavor. 1. The public, given a choice (as opposed to the implementation strategy for the euro) is as disinclined to learn a new pricing unit as Americans, for instance, are resentful of having kilometers shoved down their throats. 2. Defining an index entails intensely political considerations. Inclusion/exclusion, especially of higher order goods such as technical products, implies endorsement of their importance to the economy. The periodic reshuffling of the index components would lead to relative winners and users, analogous to the S&P effect, and engender lobbying of the august experts entrusted with definition and redefinition of the numeraire. 3. Payment, that is, transfer of value from one owner to another, in the absence of a specified medium would entail obligatory, possibly barter-like intermediate exchanges. An analogy (an N-by-N market, as opposed to one with a common medium of settlement) would be an airline attempting to offer direct flights between every pair of the 15 cities they serve, requiring 210 routes, some likely to be pretty sparsely utilized, instead of the 28 routes needed if one city serves as the hub. The person with a CP 352.00 balance of FideliTrade Plain Vanilla Fund that needs to pay CP 64.00 worth of value to the orthodontist, who prefers Mozilla High Yield, requires a counterparty or counterparties willing and capable of accepting the payer's instruments and coughing up the requisite 64 CP worth of the payee's preferred varietal. Each intermediate exchange entails additional bid/ask spread and non-zero latency. [This author is putting his money where his mouth is vis-a-vis a continuing role for money per se as the most marketable good and hence great utility as a medium of exchange and settlement.] 4. Stable purchasing power is not nearly as beneficial to the user of a new currency as would be movement of exchange rates favoring holders of the new stuff relative to who-cares-else The AUG strategy adopts a particular non-financial good as a basis of value, using standard physical units as the unit of account. The AUG economy is already emerging as a monetary and financial system: organized in layers built on e-goldR as a non-financial base money, and, using AUG as unit of account. Case 5: AUG (AGG, PTG, PDG) Non-financial, in this context, means 'containing no element of debt'. It should not be construed as meaning 'free of exchange rate risk'. AUG should be thought of like a foreign currency. A bank offering deposit accounts denominated in AUG would reserve them with an e-gold or DigiGold account, analogous to a bank offering EUR accounts and pyramiding them on the bank's own EUR account at a correspondent bank. AUG is used as to designate grams of gold. A payment for dinner in the amount of 3.125 grams, for example, would be expressed as AUG 3.125 (one decimal place beyond gold cents). It should be noted that although the unit of account is standard weight units, users of the e-gold system do not need to think in terms of weight. The e-gold system enables payment instructions such as "Pay account X $23.05 worth of gold". This approach is based on the following postulate: Implementation of a non-financial base money that can circulate efficiently in accordance with the defining characteristics of electronic currency listed above is the foundation for achieving the institutional/systemic ideal that has heretofore always eluded monetary architects - an elastic money supply that autoregulates via unambiguous, minimal latency, negative feedback mechanisms. The money supply is elastic because financial intermediaries are free to add layers of fiduciary currencies, denominated in AUG and backed by a primary reserve of e-gold and/or DigiGold plus an earning portfolio of AUG-denominated debt instruments. The system autoregulates more effectively because everyone has direct recourse to the non-financial base money. Never before has it been possible for a person to insulate their self totally from financial risk and yet enjoy the conveniences of a remote payments system. The gold standard did not offer such effective recourse because the most basic layer that provided an adequately fungible, divisible and portable medium was fiduciary - comprised of bank notes and deposits. In addition to recourse, the existence of e-gold provides an implacable benchmark for exchange markets that would cause any whiff of impairment that might lead to inconvertibility to feed back immediately to facilities of issue. The second article in this series will describe DigiGold, designed to be the basic financial currency of the AUG economy. DigiGold is constituted on a fiduciary contract that is sufficiently stringent as to function as a very tight feedback loop influencing short term interest rates. The core institutions of the AUG economy are profit seeking commercial companies. Their advantage over electronic payment systems denominated in existing national currency units is highlighted by the loading function. Instead of acting as a cost center, distribution of AUG currencies is a profit center. Whereas, as noted above, no one is likely to pay a bid/ask spread to exchange their bank account money for like-denominated eMoney, there is an explosively emerging, competitive market for exchange of national currencies into e?gold. G&SR/OmniPay, the US company that originally developed e-gold, now specializes in exchange. It charges a 4% bid/ask spread, accepts only bank wires, and imposes a USD 1,000 transaction minimum and is experiencing growth in its exchange business with a doubling time of four months. In the first three quarters of 2000, G&SR/OmniPay has processed over USD 50 million worth of exchanges from national currency into e-metal and vice versa. Some independent market makers, willing to accept risky (fraud-ridden and therefore repudiable) payment methods, such as checks, PayPal, and credit cards are commanding spreads as high as 15%. An additional factor that is unique to a currency 100% backed by a physical commodity in unencumbered segregated storage is a positive feedback loop affecting relative demand. There is an absolute correlation between growth of e-gold in circulation and offtake/retention of physical metal. It is likely that growth in circulation beyond a certain flexure range will cause flight into AUG to move exchange markets (the "gold price") providing positive reinforcement favoring holders of AUG. Stable purchasing power may be a tidy notion for systems at equilibrium but massive redistribution of wealth favoring holders of a new currency is a better selling point for igniting a demand driven migration.