We already have bond-backed currency

Daniel makes a modest proposal to have a private currency that is backed by an index fund.

I love the idea, but I claim that such a currency already exists, thanks to the ubiquity of credit card/debit card processing. Many brokerages offer debit cards that access your cash holdings. Your cash holdings also earn interest as part of a sweep/money market fund. So in essence, your "cash" is really a very low risk bond fund (or whatever it is that sweep accounts get invested in).

Now, there is plenty to improve about this. Since sweep accounts are simply interest-bearing, they are still vulnerable to dollar decline.  Money market funds earn pretty low rates of interest, and it would be better to put the cash into a bond or equity fund.  The brokerage could make a single purchase / redemption a day in order to account for the net flow of money kept in this form by all customers, so transaction costs would be low. Tax consequences would matter, and complicated strategies might be needed to reduce them. It might be worthwhile having physical cash representing shares in this fund, although calculations would be required whenever you spent it.

But I think it's pretty exciting that, thanks to the fact that POS sales are everywhere, tied into a global network for credit/debit transactions, a version of his proposal is already true, and so perhaps more are not far behind.

An important factor in evaluating the realism of this proposal is: why are sweep account returns so low?  At Etrade, a balance of less than $25K only eearns 0.25% or so, while a $25K - $50K balance earns 2.7%.  I don't see why the balance size should matter, since all the cash of all customers should be invested together.  One nice feature is that you can opt to use a sweep account based on municipal bonds in your state, which are thus tax-exempt.

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the way I understand it

...the interest rate you can get on cash is roughly the rate of a loan with a maturity close to the expected time you will let your cash sit without using it. Since this is unknown, banks act as insurers to provide this rate. People who really intend to save with low risk will commit to long term loans . In a free economy my humble guess is that the rate for cash balances would be almost 0 (our current "expected time" scheme would fail because the lack of a central bank would lead to adverse selection among lenders). Just my 2c, IANAME

 

Competition, DIY credit/equity-backing

I agree that something kind of similar occurs with credit cards and other systems.

I'm still unsure whether all private currency that competes on the basis of value (as opposed to security or other features, as precious metal currencies do) ultimately boils down to providing essentially the same result as my proposal or your rebuttal would, through varying mechanisms.

One very significant feature that credit cards do not provide is anonymity, although Wikipedia currently says:

Various companies now sell VISA, Mastercard or Maestro debit cards, which can be recharged via electronic money systems. This system has the advantage of greater privacy if a card provider is located offshore, and greater security since the client can never be debited more than the value on the prepaid card. Such debit cards are also useful for people who do not have a bank account. Generally cards can be recharged with either e-gold, e-Bullion, WebMoney, or via a wire transfer.

For practical cash management, how about the following:

Hold your short-term cash amount in whatever form of bond or credit you want, in a brokerage account that one can access through a bank interface (I have one, so I know they exist). Pay for goods and services with a credit card, then repay the credit card co. directly from your brokerage/bank account, selling down your credit as you do so or refilling from your income.

Or if you're holding your wealth in equity and have some margined equity, pay the credit card bill directly from margin.

As I wrote before, I don't know much economics, so I hope I've said things correctly and not skipped over parts, and it's entirely possible that I screwed up any of the things I wrote.

I can see various problem

I can see various problem with keeping your cash balance this way

- Holding risky products may be a good idea for long term savings but not for a short term cash balance... what you may be earning on this balance is nothing compared to the risk you're taking. You don't want to walk to the grocery store and find you can't buy that steak after all.

- You have to pay transaction costs, brokerage fees, bid ask spreads each time you make a payment. By not holding cash you forgo its valuable liquidity...

Banking provides to depositors a very liquid bond product with a annual rate that depends on the expected life of the cash balance. There can be issues with this model as well : if the lifespan of cash balances start falling they can become correlated and induce a bank run.

I can see various solutions

So buy insurance, as Sam Bhagwat suggested (http://distributedrepublic.net/archives/2007/09/29/modest-proposal#comments). This could probably all be done for you, if such a currency were provided by a market currency-maker rather than a homebrew solution.

On an open market with competing, interoperable currencies, I'm sure there would be a huge profit incentive to devise a secure, profitable currency.

Sam Bhagwat suggests

Sam Bhagwat suggests insurance against a market meltdown in the form of puts, this is not what I am talking about. I am talking about daily volatility.

The current expected volatility for the next month of the SNP is roughly 1.13% a day, compared to what... say a 0.03% mean.

A currency is not profitable, per se... you have to give up something to get something. You can give up time, certainty, liquidity but you have to give up *something*.

 

 

Why would you have to pay

Why would you have to pay transaction costs, brokerage feeds, or bid ask spreads? The bank can keep all the accounts of all its depositors in a single investment. It keeps enough cash on hand for short-term needs. Each day, the bank does a single transaction, either a purchase or a sale, based on the total net cash flow from all accounts. The transaction costs are averaged across everyone. Or perhaps, allocated to those with higher flow rates who cause more transactions to be necessary.

To pay anyone who takes cash

To pay anyone who takes cash only ?

I was toying in my mind with

I was toying in my mind with a currency backed by a fund which was a mix of Equity Index Funds, Equity Bond Funds, and REIT Index Funds.

There would be a constant state of deflation, which would effectively work as a progressive tax and discourage the use of reckless lending. A kind of lending which took into account the fact the money would grow in value as oppose to decrease in value would probably emerge.

Another positive side effect is that poor investments would be more apparent because you would have an easy comparison to a strong investment strategy.