March 14, 2004

Backing - Defined

Over on the DGCChat list, where new currency engineers haunt, squabble, and rebuild the financial system every Sunday, the question of "backing" has arisen.

Economists in the field of money issuance have long known that "backing" is an imprecise term, and they insist on definitions whenever they feel dialogue becomes contaminated by the word.

One plausible response is to avoid use of the word, but, as frequently pointed out, the rest of the world declines the forebearance. For this reason, I use the following definition:

Backing is the sum total of all assets that give rise to value in an issue.

Assets, in the context, include physicals (metals) and balances (cash) held at institutions, as well as intangibles like reputation, and non-physicals like future cash flow.

Reserves, then, are tangible or accountable assets that are held in escrow for the sole purpose of backing an issue. E.g., the gold held by a DGC counts as reserves, and these reserves are perhaps the major component of backing for a DGC.

Additional components of backing include reputation, faith in governance structures, law, and various derivatives such as tax receipts or a book of business. Also included might be network effects such as customers holding an issue and using it for that purpose - their expectations have momentum, and that helps the value, albeit in a fashion that might be thought of as circular.

It is, then, right and proper to say that the US dollar is backed by the-full-faith-and-credit-of-the-United-States-government (said very fast), as well as by an expectation of future receipts (which might be the same thing!).

Posted by iang at March 14, 2004 08:22 AM | TrackBack