Tuesday, November 18, 2008

The Scale of Economies part III

The most common objections people have to private currency are fungibility, liquidity, and stability. By showing how private currencies can address these three fears, we are able to put to rest the reasoned objections to the idea, leaving us with only the blind irrational fear of the uneducated, and the malevolent self interest of those invested in the continuance of the state system, to overcome.

Fungibility is the property of good or commodity whose individual units are capable of mutual substitution. What this means is that any one unit of a commodity is equal in value, and can be traded for, any other single unit of that commodity. For instance, one united states penny has the same legal tender value of any other united states penny, or one barrel of oil has the same current value of any other barrel of oil. On the other hand, precious stones, such as diamonds, are not generally fungible, because one diamond is not the same as another diamond.

Fungibility has nothing to do with the trade value of the commodity against other goods and services. That is liquidity. An asset is liquid if it can be easily traded for other dissimilar assets without varying to any great degree the value of the assets being exchanged. For instance, a five dollar Federal Reserve Note has high liquidity because it can be traded for a great number of varying assets, such as McDonald's happy meals, without changing the value of either the five dollar note, or the happy meal.

Assets can be fungible, or liquid, or both. A mass produced plastic fly swatter may be fungible, but good luck trading it for anything of value. At the same time, while livestock can be easily traded, no two animals would be considered fungible.

Stability in this case refers to the property of a commodity to maintain a relatively predictable inherent value over time. With money, this is achieved by backing the currency with real asset and making that currency redeemable on demand of the bearer for is value in that currency. Currently, no major world economy practices this, which is why we have global economic upheaval, fluctuating exchange rates, and market inflation.

Generally, buyers of currency want their money to be fungible, liquid, and stable. That means that units of the same value are interchangeable, that the currency can be easily traded for real assets, and that the value of their currency will be relatively predictable going forward, allowing for real asset management. No widely held currency on this earth currently meets all three criteria. Most are fungible, many are liquid, and none are stable. So in discussing the possible pitfalls of private currency, we must first recognize the problems that exist with the “monopoly” money we use today.

By buyer of currency, I mean the individual. Any time you accept currency in exchange for goods or services you are in effect purchasing that currency. So, when you sell your used car, you are buying currency at the price of a car. When you collect interest on your savings account, you are buying currency from the bank at the price of allowing them to hold and invest your money for a short period of time. When you collect your paycheck, you are buying currency from your employer at the price of your time and labor. You are not a passive receiver of money. You are in fact, the purchaser of real asset, and as such, have a right to demand that that asset have and hold real value.

The reason its important to understand about your role in purchasing currency is because the makers of it, in this case central banks, understand their role in selling it to you. In fact, they make money doing it. Not only does the central bank make money by selling the money to the government, but when you purchase that currency yourself they stand to profit. For instance, if you collect the U.S. State quarters, then every time you buy one, but fail to spend it, the mint makes a profit. They count on this. Its called seigniorage. The government estimates they've made more than $5 billion dollars just on the state quarters that have been removed from circulation by collectors. Isn't that nice. Its like a secret little tax no one knows about that they use to increase revenue. A lot like a secret little tax no one knows about that they use to increase revenue.

So how could private currency address fungibility, liquidity, and stability? Well, fungibility is relatively easy. By printing consistently identical currency, and backing that currency with a commodity of real and sustainable value, such as precious metals or fossil fuels, each unit of currency will have the same relative value and can be easily interchanged. Stability is similarly addressed by the same measures.

When a currency is backed by, or even made of, a real commodity of consistent value then that currencies value will also be consistent. This is why historically currencies were either made of, or backed by, precious metals which hold a constant value by weight and purity. Unfortunately for the state, this made it hard to uncontrollably increase the money supply in order to fund the many wars they wished to participate in, and so they divorced the currency from its commodity backing and left it to “float.” The reason governments can get away with this is because of the money illusion.

The money illusion refers to the tendency of most people to think of their money in nominal terms instead of real terms. For instance, many people would say that there is no nominal value difference between a five dollar bill now, a five dollar bill ten years ago, and a five dollar bill eighty years ago. However, the reality is that in the last eighty years, the five dollar note has lost so much value, that what was five dollars then would cost you nearly sixty dollars now. Here's a quick little calculator to show you how worthless your money has become. By disguising the devaluation of the currency through inflation and seigniorage, and relying on the money illusion, the state is able to hide its theft from the people.

So private currencies could easily address fungibility and stability by backing their value with commodities. For that matter, so could fiat currencies, but then they wouldn't really be fiat currencies any more, and the state couldn't print them in any quantity they desired to fund their violence. So liquidity is the real concern.

How could private currency issuers insure their buyers that the currency would be accepted as means of exchange?


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