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Author Topic: The Real Differences Between Fractional Reserve in Fiat, Gold, and Bitcoin.  (Read 2845 times)
theonewhowaskazu
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October 21, 2013, 05:30:22 AM
 #1

Traditional Fractional Reserve: Gold
The traditional form of Fractional Reserve is that of Gold. Depositors, due to practicality, must usually deposit their Gold into a bank so as to allow convenient transactions. There are some maintenance costs associated with storing gold, so the bank must either engage in Fractional Reserve practices, or charge the Depositors, either in the form of transaction fees (this possibility is greatly increased due to the internet) or through periodic holding fees. If Fractional Reserve occurs, it is difficult for the customer to verify how much gold is actually in reserve, thus making the process even more dubious. However, the bank is ultimately responsible for its own lending practices to avoid a bank run, so it can be argued that in a free-market scenario most trusted banks would be responsible with user's deposits. Also, the system is somewhat stable, since without the existence of Fractional Reserve banking, there is still a finite amount of base currency which can be used to sustain market activity, although depending on the gravity of the credit collapse, there is a possibility of severe deflation. Finally, no bank has an infinite line of credit since a bank must still loan out Gold, and cannot loan out more Gold than it has. It can lend the same gold multiple times to create a similar effect, but this cannot be done by the bank "whenever."

Modern Fractional Reserve: Fiat
Currently, fractional reserve banking is done in Fiat, which might also be called "no-reserve banking." In this system, all currency is created through a fractional reserve process which begins when government bonds are exchanged for the first fiat notes. It is difficult for the customer to verify how many fiat notes any bank has in reserve. The bank is not responsible for its own lending practices to avoid a bank run, since more fiat will be lent to it by a Central Bank. This Central Bank effectively does have an  infinite line of credit since it is the issuer of the monetary base consisting of fiat notes. As such this scenario is by definition, not a free market. Finally, the system is not stable because without any debt (public or private) no currency can exist in the system. This means that, even in a 'fiscally responsible' scenario assuming no expenditures on the part of governments, constant inflation must be maintained to pay back the interest associated with this debt. The deflationary problem under this system can be avoided.

Bitcoin Fractional Reserve
Bitcoin fractional reserve is like gold in that the bank's are responsible for their own lending practices and that a monetary base exists outside of the fractional reserve system. However under Bitcoin, it is potentially possible for a bank to provably show it has a reserve, and to quantify that reserve. Also, there is less need to engage in depositing Bitcoins at all, since transactions can easily occur outside of any banking system. The problem of deflation in the case of a fractional reserve collapse still exists, however.

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mirelo
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October 21, 2013, 08:57:55 PM
Last edit: October 21, 2013, 09:26:38 PM by mirelo
 #2

Traditional Fractional Reserve: Gold
The traditional form of Fractional Reserve is that of Gold. Depositors, due to practicality, must usually deposit their Gold into a bank so as to allow convenient transactions. There are some maintenance costs associated with storing gold, so the bank must either engage in Fractional Reserve practices, or charge the Depositors, either in the form of transaction fees (this possibility is greatly increased due to the internet) or through periodic holding fees. If Fractional Reserve occurs, it is difficult for the customer to verify how much gold is actually in reserve, thus making the process even more dubious. However, the bank is ultimately responsible for its own lending practices to avoid a bank run, so it can be argued that in a free-market scenario most trusted banks would be responsible with user's deposits. Also, the system is somewhat stable, since without the existence of Fractional Reserve banking, there is still a finite amount of base currency which can be used to sustain market activity, although depending on the gravity of the credit collapse, there is a possibility of severe deflation. Finally, no bank has an infinite line of credit since a bank must still loan out Gold, and cannot loan out more Gold than it has. It can lend the same gold multiple times to create a similar effect, but this cannot be done by the bank "whenever."

Modern Fractional Reserve: Fiat
Currently, fractional reserve banking is done in Fiat, which might also be called "no-reserve banking." In this system, all currency is created through a fractional reserve process which begins when government bonds are exchanged for the first fiat notes. It is difficult for the customer to verify how many fiat notes any bank has in reserve. The bank is not responsible for its own lending practices to avoid a bank run, since more fiat will be lent to it by a Central Bank. This Central Bank effectively does have an  infinite line of credit since it is the issuer of the monetary base consisting of fiat notes. As such this scenario is by definition, not a free market. Finally, the system is not stable because without any debt (public or private) no currency can exist in the system. This means that, even in a 'fiscally responsible' scenario assuming no expenditures on the part of governments, constant inflation must be maintained to pay back the interest associated with this debt. The deflationary problem under this system can be avoided.

Bitcoin Fractional Reserve
Bitcoin fractional reserve is like gold in that the bank's are responsible for their own lending practices and that a monetary base exists outside of the fractional reserve system. However under Bitcoin, it is potentially possible for a bank to provably show it has a reserve, and to quantify that reserve. Also, there is less need to engage in depositing Bitcoins at all, since transactions can easily occur outside of any banking system. The problem of deflation in the case of a fractional reserve collapse still exists, however.

Fractional-reserve banking based on Bitcoin must replace Bitcoin with a Bitcoin proxy, just like fractional-reserve banking based on gold replaced gold with a gold proxy. The only difference is that the money supply available for bank reserves would be fixed and easily verifiable, so the central bank no longer could create money against government debt. However, fractional-reserve banking eventually requires the central bank to have that ability, which would in turn press for the conversion of Bitcoin proxies into independent money based on debt, just like today. So fractional-reserve banking based on Bitcoin is just its own programmed obsolescence.
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October 21, 2013, 09:40:18 PM
 #3

Fractional-reserve banking based on Bitcoin must replace Bitcoin with a Bitcoin proxy, just like fractional-reserve banking based on gold replaced gold with a gold proxy.
There is a huge difference between a Bitcoin 'proxy' and a Gold proxy. Gox-Bitcoin, Bitstamp-Bitcoin, Coinbase-Bitcoin, those are all Bitcoin 'proxies.' Do those eventually obsolete Bitcoin? Obviously not, because merchants can easily accept Bitcoin itself, not the proxy, and thus the proxy is constantly being converted into the base currency.

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The only difference is that the money supply available for bank reserves would be fixed and easily verifiable, so the central bank no longer could create money against government debt. However, fractional-reserve banking eventually requires the central bank to have that ability which would in turn press for the conversion of Bitcoin proxies into independent money based on debt, just like today.
Wait, what? I have no idea what you're talking about. The only reason why a central bank exists in the first place is because of its government-sponsored monopoly. How exactly would a Bitcoin 'central bank' ever begin to exist? If people really wanted, in a free market, a central bank's inflated money more than Bitcoin, that would prove that the central bank is providing a service that is worth more to people than the devaluation of their currency.
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  So fractional-reserve banking based on Bitcoin is just its own programmed obsolescence.

The final question, of course, being "is gold 'obsolete'?"


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October 21, 2013, 11:01:33 PM
 #4

There is a huge difference between a Bitcoin 'proxy' and a Gold proxy. Gox-Bitcoin, Bitstamp-Bitcoin, Coinbase-Bitcoin, those are all Bitcoin 'proxies.' Do those eventually obsolete Bitcoin? Obviously not, because merchants can easily accept Bitcoin itself, not the proxy, and thus the proxy is constantly being converted into the base currency.

Money proxies go through many stages. In the beginnings of gold-based fractional-reserve banking, although goldsmiths gave people receipts for deposited gold, those receipts were not yet money: people started using them as money because they were much more convenient than the gold they represented. Then, goldsmiths started loaning receipts for nonexistent gold. Fast-forward to 1971: Nixon eliminates the last vestige of gold-backing from the dollar. Do not get fooled by the seeming innocence of monetary proxies.

Still, you are not just talking about money proxies, but about those proxies in the context of fractional-reserve banking. In other words, you already start in a relatively advanced stage of monetary proxy development. In that stage, fractionally backed proxies are loaned recursively at interest, so:

1. Their supply must become a multiple of the money supply they represent.

2. Even more money must be created to pay the resulting interest.

Because no more bitcoins can be created, the ratio of bitcoin to its proxy representations must continually decrease, just like that of gold to dollars continually decreased, eventually reaching zero.

However, we need not worry too much about all this because Bitcoin proxies have no inherent reason to be more convenient than bitcoins themselves.
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October 22, 2013, 04:16:30 AM
 #5

There is a huge difference between a Bitcoin 'proxy' and a Gold proxy. Gox-Bitcoin, Bitstamp-Bitcoin, Coinbase-Bitcoin, those are all Bitcoin 'proxies.' Do those eventually obsolete Bitcoin? Obviously not, because merchants can easily accept Bitcoin itself, not the proxy, and thus the proxy is constantly being converted into the base currency.

Money proxies go through many stages. In the beginnings of gold-based fractional-reserve banking, although goldsmiths gave people receipts for deposited gold, those receipts were not yet money: people started using them as money because they were much more convenient than the gold they represented. Then, goldsmiths started loaning receipts for nonexistent gold. Fast-forward to 1971: Nixon eliminates the last vestige of gold-backing from the dollar. Do not get fooled by the seeming innocence of monetary proxies.
Monetary proxies exist because they serve a purpose. What do you suggest, banning them all? So much for the free market  Undecided
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Still, you are not just talking about money proxies, but about those proxies in the context of fractional-reserve banking. In other words, you already start in a relatively advanced stage of monetary proxy development. In that stage, fractionally backed proxies are loaned recursively at interest, so:

1. Their supply must become a multiple of the money supply they represent.
And how can you possibly protect yourself against this? Banning loans altogether?

Say you are an 'innocent' loanbroker. Mr. Money comes in with 10 BTC, and says 'hey, lend this out and pay me 1% interest.' So you accept the money, and lend it out. Is there anything fraudulent about that transaction? Then, another person comes in with 10 BTC, and says 'hey, lend this out and pay me 1% interest.' What exactly are you going to do, make them prove its not the same money? Of course not, you're going to take it, and re-lend it out as well. And if it was the same money? Then you "created" 20 BTC, when Mr. Money goes up to another person and says "hey, I lent this 10 BTC 6 months ago at 1% interest, want to buy it from me for 10 BTC, you'll make that 1% as profit at the end of the year?"

Who exactly is at fault in this scenario? Mr. Money asked you to invest his money. Is that in any way fraudulent? Nope. You did what he told you to do. Is that fraudulent? Nope. Somebody borrowed from you, using the rates you stated. Obviously, thats fine as well. Then he spent the money, and the person who got the money, who had no way of knowing it was borrowed, invested it in turn.  Is that fraudulent? Of course not. Then, Mr. Money sold your debt, while fully representing what it is, and a person bought it, because buying the debt made logical sense.

Nobody did anything wrong. Unless you are for banning debt entirely, fractional reserve can and will happen in one form or another because  people want to borrow, people want to lend, and money lent to you is an asset, an asset that can be bought and sold just like any other asset.

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2. Even more money must be created to pay the resulting interest.
Okay, no. If I give you 10 BTC, you lend it out, and owe me 10.5 BTC, and get a borrower to promise to pay you 11 BTC, and somebody spends  that 10 BTC again, and that 10 BTC is lent to you again, and you owe 10.5 BTC, and you get another borrower to promise to pay you back 11 BTC, that additional 2 BTC that you say must be 'created', will, in a free market, either be (A) earned by the borrowers or (B) destroyed, when a default occurs.

The only reason why in the USD system dollars must constantly be created to pay the resulting interest is because there is effectively no M0, and every dollar carries an interest rate payable to the federal reserve, who in turn passes a fraction of those profits to banks. There is no such constant 'leak' of value of all Bitcoins, because they don't carry an interest rate payable to anyone.
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Because no more bitcoins can be created, the ratio of bitcoin to its proxy representations must continually decrease, just like that of gold to dollars continually decreased, eventually reaching zero.

However, we need not worry too much about all this because Bitcoin proxies have no inherent reason to be more convenient than bitcoins themselves.
Obviously they are more convenient because, of course, they will earn you interest if you invest your Bitcoins into them. Which means people, for fairly clear reasons, will do so.

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October 22, 2013, 10:32:12 AM
Last edit: October 22, 2013, 10:59:17 AM by mirelo
 #6

Monetary proxies exist because they serve a purpose.

Of course, they serve a purpose, which is not making loans possible, but rather making money circulation easier. Before loaning receipts for deposited gold, people loaned the gold, which nobody could multiply at will: Bitcoin makes this possible again. You need not scam people in order to loan them your money.
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October 22, 2013, 02:51:32 PM
 #7

Monetary proxies exist because they serve a purpose.

Of course, they serve a purpose, which is not making loans possible, but rather making money circulation easier. Before loaning receipts for deposited gold, people loaned the gold, which nobody could multiply at will: Bitcoin makes this possible again. You need not scam people in order to loan them your money.

What are you even talking about. Sure, they make money circulation easier, but so would non-fractional reserve.

There needs not to be a centralized authority in order for a fractional reserve multiplying effect to occur. Person A lends person B 10 BTC, person B gives 10 BTC to person C, person C lends person D 10 BTC, then person A & person C want to buy coffee but don't have the money since they lent it, but the person selling the coffee decides to accept Person B and person D's IOUs instead of actual money because they carry an interest rate, and he knows Person B and Person D to be reliable.

Since the 2 IOUs act as currency, 30 BTC worth of goods were exchanged, and 10 BTC is still owned by a borrower about to be spent, so the money was effectively quadrupled, and there was no central reserve authority.

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October 22, 2013, 04:23:05 PM
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Monetary proxies exist because they serve a purpose.

Of course, they serve a purpose, which is not making loans possible, but rather making money circulation easier. Before loaning receipts for deposited gold, people loaned the gold, which nobody could multiply at will: Bitcoin makes this possible again. You need not scam people in order to loan them your money.

What are you even talking about. Sure, they make money circulation easier, but so would non-fractional reserve.

That is precisely what I said: monetary proxies are not exclusive to fractional-reserve banking - nor is their purpose.

There needs not to be a centralized authority in order for a fractional reserve multiplying effect to occur. Person A lends person B 10 BTC, person B gives 10 BTC to person C, person C lends person D 10 BTC, then person A & person C want to buy coffee but don't have the money since they lent it, but the person selling the coffee decides to accept Person B and person D's IOUs instead of actual money because they carry an interest rate, and he knows Person B and Person D to be reliable.

Since the 2 IOUs act as currency, 30 BTC worth of goods were exchanged, and 10 BTC is still owned by a borrower about to be spent, so the money was effectively quadrupled, and there was no central reserve authority.

Let us play this game: imagine everyone using Bitcoin IOUs thus partially replacing Bitcoin as money while multiplying the supply of "bitcoins" by, say, ten. Then, answer me: since the supply of actual bitcoins is fixed, from where would come the additional bitcoins to pay the outstanding interest on those IOUs? Would we create new IOUs for paying interest on the old ones? Then create even more IOUs, until we eventually start backing IOUs with IOUs and utterly forget about bitcoins?

Of course, this game is meaningless from the start since no coffee seller would prefer to rely on debtors just to gain interest on their debt instead of owning an ever-appreciating money that requires trusting nobody.
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October 22, 2013, 05:22:42 PM
 #9

Monetary proxies exist because they serve a purpose.

Of course, they serve a purpose, which is not making loans possible, but rather making money circulation easier. Before loaning receipts for deposited gold, people loaned the gold, which nobody could multiply at will: Bitcoin makes this possible again. You need not scam people in order to loan them your money.

What are you even talking about. Sure, they make money circulation easier, but so would non-fractional reserve.

That is precisely what I said: monetary proxies are not exclusive to fractional-reserve banking - nor is their purpose.

There needs not to be a centralized authority in order for a fractional reserve multiplying effect to occur. Person A lends person B 10 BTC, person B gives 10 BTC to person C, person C lends person D 10 BTC, then person A & person C want to buy coffee but don't have the money since they lent it, but the person selling the coffee decides to accept Person B and person D's IOUs instead of actual money because they carry an interest rate, and he knows Person B and Person D to be reliable.

Since the 2 IOUs act as currency, 30 BTC worth of goods were exchanged, and 10 BTC is still owned by a borrower about to be spent, so the money was effectively quadrupled, and there was no central reserve authority.

Let us play this game: imagine everyone using Bitcoin IOUs thus partially replacing Bitcoin as money while multiplying the supply of "bitcoins" by, say, ten. Then, answer me: since the supply of actual bitcoins is fixed, from where would come the additional bitcoins to pay the outstanding interest on those IOUs?
The same way all debt is paid back, by the debtor working harder in the future, or defaulting and losing his property.

I don't understand ow and why you seem to think the process of making an IOU spendable somehow changes it from a payable IOU to a non-payable IOU.
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Would we create new IOUs for paying interest on the old ones? Then create even more IOUs, until we eventually start backing IOUs with IOUs and utterly forget about bitcoins?
the only case in which new IOUs are created to pay interest on the old ones is if both the creditor and the debtor is irresponsible, since nobody would accept such worthless debt as payment and the debt has no way in which it can actually be paid back.
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Of course, this game is meaningless from the start since no coffee seller would prefer to rely on debtors just to gain interest on their debt instead of owning an ever-appreciating money that requires trusting nobody.
So, you think that nobody accepts Inputs.Io? Coinbase? etc...

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October 23, 2013, 11:43:37 AM
Last edit: October 23, 2013, 12:49:57 PM by mirelo
 #10

I don't understand ow and why you seem to think the process of making an IOU spendable somehow changes it from a payable IOU to a non-payable IOU.

What you don't understand is that the moment you make any IOU "spendable" you turn it into money. However, IOUs are not money. They are the owing of money: they are debt, not money. The moment you turn them into actual money you need more money to pay interest on old money (debt principal). Finally, since you turned IOUs into actual money, the new money will be more IOUs, which will require more interest payments, hence more debt-based money, then even more interest payments, etc.
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October 23, 2013, 03:02:41 PM
 #11

I don't understand ow and why you seem to think the process of making an IOU spendable somehow changes it from a payable IOU to a non-payable IOU.

What you don't understand is that the moment you make any IOU "spendable" you turn it into money. However, IOUs are not money. They are the owing of money: they are debt, not money. The moment you turn them into actual money you need more money to pay interest on old money (debt principal). Finally, since you turned IOUs into actual money, the new money will be more IOUs, which will require more interest payments, hence more debt-based money, then even more interest payments, etc.

So, by buying corporate bonds, are you turning debt into money?

Seriously. Assets are always exchangable for other assets. Money owed to you is an asset. It isn't money because it doesn't have a standardized worth. Calling debt money when its spendable is like calling a house money when you sell it.

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October 23, 2013, 03:05:38 PM
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So, by buying corporate bonds, are you turning debt into money?

Not me: the central bank. I cannot create money.
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October 28, 2013, 04:25:20 AM
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Seems like you two are arguing over semantic differences more than anything else.

Quote from: mirelo
However, we need not worry too much about all this because Bitcoin proxies have no inherent reason to be more convenient than bitcoins themselves.

Perhaps not more or less convenient, but potentially more available. If proxies are not available for bitcoin, then the likely result is little lending at all. With or without the proxies, one has to tread a very fine line with bankruptcy risks. However, we know that proxies for bitcoin will exist and they will be plentiful. See: altcoins, the perfect proxy.

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October 28, 2013, 11:48:59 AM
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Bookmarked.
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October 28, 2013, 02:13:51 PM
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Seems like you two are arguing over semantic differences more than anything else.

Quote from: mirelo
However, we need not worry too much about all this because Bitcoin proxies have no inherent reason to be more convenient than bitcoins themselves.

Perhaps not more or less convenient, but potentially more available. If proxies are not available for bitcoin, then the likely result is little lending at all. With or without the proxies, one has to tread a very fine line with bankruptcy risks. However, we know that proxies for bitcoin will exist and they will be plentiful. See: altcoins, the perfect proxy.

Altcoins are not Bitcoin proxies: they are competing (or complimentary) currencies.

There is no other social, public reason for the existence of monetary proxies other than convenience. Of course, there is an individual, private reason for their existence, which is to take wealth from other people without their noticing it.
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October 28, 2013, 02:15:09 PM
 #16

So, by buying corporate bonds, are you turning debt into money?

Not me: the central bank. I cannot create money.

Why, exactly, not? People here seem to be acting like spendable debt is money 'created.' If you make a specific debt spendable, how are you not creating debt any less or more than the central bank?

Seems like you two are arguing over semantic differences more than anything else.

Quote from: mirelo
However, we need not worry too much about all this because Bitcoin proxies have no inherent reason to be more convenient than bitcoins themselves.

Perhaps not more or less convenient, but potentially more available. If proxies are not available for bitcoin, then the likely result is little lending at all. With or without the proxies, one has to tread a very fine line with bankruptcy risks. However, we know that proxies for bitcoin will exist and they will be plentiful. See: altcoins, the perfect proxy.

How are altcoins the perfect proxy? They float against BTC and therefore aren't a good proxy at all. If anything, the 'perfect' proxy would be coloured coins.

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October 28, 2013, 02:25:15 PM
 #17

Why, exactly, not? People here seem to be acting like spendable debt is money 'created.' If you make a specific debt spendable, how are you not creating debt any less or more than the central bank?

When I exchange my credit for your money, I am just transferring that credit to you while you transfer your money to me. I am not monetizing credit. When the central bank becomes the creditor of the government, it does that by creating money that did not exist before that moment. For that money not to steal its value from already existing money (which it eventually will), the same value must come from the liability just created. This is what monetizing credit looks like.
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October 28, 2013, 02:29:41 PM
 #18

Why, exactly, not? People here seem to be acting like spendable debt is money 'created.' If you make a specific debt spendable, how are you not creating debt any less or more than the central bank?

When I exchange my credit for your money, I am just transferring that credit to you while you transfer your money to me. I am not monetizing credit. When the central bank becomes the creditor of the government, it does that by creating money that did not exist before that moment. For that money not to steal its value from already existing money (which it eventually will), the same value must come from the liability just created.

Ok, ok. I concede that a central bank is the only person who has the power to create M0.

But what about fractional reserve banking? You agree that they're "creating money", right? But they're not creating any M0, correct? So what are they doing? They're taking normal debt, and making it spendable. Thats the extent of them creating money, they exchange money for an IOU, and say "go spend this IOU as if it were money", while keeping your actual money. So now 2 people have the money.

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October 28, 2013, 02:34:55 PM
 #19

How are altcoins the perfect proxy? They float against BTC and therefore aren't a good proxy at all. If anything, the 'perfect' proxy would be coloured coins.

Because they completely invalidate the notion that bitcoin is some special butterfly with reserved status like gold. I guess a more accurate way to say it is that the cryptocurrency market aggregate as a whole is a proxy for money. If bitcoin's price is rising it is unappealing to borrow, so some will borrow in LTC or whatever else, reducing the necessity for FRB. It is far more agreeable to borrow real LTC than proxy-BTC, don't you think? Homerism aside, of course.

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October 28, 2013, 02:41:42 PM
 #20

How are altcoins the perfect proxy? They float against BTC and therefore aren't a good proxy at all. If anything, the 'perfect' proxy would be coloured coins.

Because they completely invalidate the notion that bitcoin is some special butterfly with reserved status like gold. I guess a more accurate way to say it is that the cryptocurrency market aggregate as a whole is a proxy for money. If bitcoin's price is rising it is unappealing to borrow, so some will borrow in LTC or whatever else, reducing the necessity for FRB. It is far more agreeable to borrow real LTC than proxy-BTC, don't you think? Homerism aside, of course.

Just what the heck. I don't even know what you're talking about. You seem to be under the impression that the easier something to get, the more likely it'll be used as money, when its really the opposite way around.

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