L/Cs, e-gold and regulated banking

[Ian Grigg]

(Guys, this has drifted out of crypto into finance, so I
have a feeling that it will disappear of the crypto list.
But the topics that are raised are interesting and important
enough to carry on, I think.)


>> > [Hal:]
>> > Interesting.  In the e-gold case, both parties have the same bank,
>> > e-gold ltd.  The corresponding protocol would be for the buyer to
>> > instruct e-gold to set aside some money which would go to the
>> > seller once the seller supplied a certain receipt.  That receipt
>> > would be an email return receipt showing that the seller had sent
>> > the buyer the content with hash so-and-so, using a cryptographic
>> > email return-receipt protocol.
>> [iang:]
>> This is to mix up banking and payment systems.  Enzo's
>> description shows banks doing banking - lending money
>> on paper that eventually pays a rate of return.  In
>> contrast, in the DGC or digital gold currency world,
>> the issuers of gold like e-gold are payment systems and
>> not banks.  The distinction is that a payment system
>> does not issue credit.
> [enzo:]
> Actually, seeing issuance and acceptance of L/C's only as a money-lending
> activity is not 100% accurate. "Letter of credit" is a misnomer: an L/C
> _may_ be used by the seller to obtain credit, but if the documents are
> "sent for collection" rather than "negotiated", the payment to the seller
> is delayed until the opening bank will have debited the buyer's account
> and remitted the due amount to the negotiating bank. To be precise: when
> the documents are submitted to the negotiating bank by the seller, the
> latter also draws under the terms of the L/C a "bill of exchange" to be
> accepted by the buyer; that instrument, just like any draft, may be either
> sent for collection or negotiated immediately, subject, of course, to
> final settlement. Also, depending on the agreements between the seller and
> his bank, the received L/C may be considered as collateral to get further
> allocation of credit, e.g. to open a "back-to-back L/C" to a seller of raw
> materials.
>
> However, if the documents and the draft are sent for collection, and no
> other extension of credit are obtained by the buyer, the only advantage of
> an L/C for the seller is the certainty of being paid by _his_
> (negotiating) bank, which he trusts not to collude with the buyer to claim
> fictitious discrepancies between the actual documents submitted and what
> the L/C was requesting. (And even in case such discrepancies will turn out
> to be real, the opening bank will not surrender the Bill of Lading, and
> therefore the cargo, to the buyer until the latter will have accepted all
> the discrepancies: so in the worst case the cargo will remain under the
> seller's control, to be shipped back and/or sold to some other buyer.
> If it acted differently, the opening bank would go against the standard
> practice defined in the UCP ICC 500
> (http://internet.ggu.edu/~emilian/PUBL500.htm) and its reputation would be
> badly damaged). So, the L/C mechanism, independently from allocation of
> credit, _does_ provide a way out of the dilemma "which one should come
> first, payment or delivery?"; and this is achieved by leveraging on the
> reputation of parties separately trusted by the endpoints of the
> transaction.

An excellent description;  I was unaware that the system
could be used in a non-credit fashion.  Thanks for correcting
me.

> Generally speaking, it is debatable whether "doing banking" only means
> "accepting deposits and providing credit" or also "handling payments for a
> fee":

There are many definitions of "banking" and unfortunately
they are different enough that one will make mistakes
routinely.  Here are the most useful three that I know of:

1.  borrowing from the public as deposits and lending those
deposits to the public.  This is the favoured definition for
economists, because it concentrates on the specialness that
is banking, which is the foundation for its special regulatory
structure.

2.  Banking is what banks do, and banks do banking.  This is
the favoured definition of banks, and often times, regulators,
because it gives them a free hand to exploit their special
franchise / subsidy.  It was codified in law in many countries
as just this, but I believe it is out of favour to write it
down these days.  However, the Fed and other US regulators have
from time to time resorted to this definition, when convenient.

3.  Banking is what the regulator says is banking.  This is
the favoured definition of regulators, and sometimes of banks.
It means that there is little or no argument or discussion in
protecting the flock.  This is the much more prevalent in
smaller countries, where the notion of "sending in the lawyers"
is simply too expensive.

4.  There is a popular definition that says something like,
if it is to do with money it is banking.  That's not a very
useful one, but it's prevalent enough to need to be aware of
it.

> ... surely banks routinely do both, although they do not usually enjoy a
> _regulatory franchise_ on payments because failures in that field are not
> usually argued to be capable of snowballing into systemic failures.
> (Austrian economists argue that that's also the case with provision of
> credit, but it's a much more controversial issue). In the US, as we know,
> Greenspan's FED decided several years ago against heavy regulation of the
> payments business, and most industrialized countries chose to follow suit.

Right!  (Although, I'd suggest that the "payment systems
regulatory" question is polarised between the Fed and
the German model.  In the German model, payment systems
are part of banking, and are subject to heavy regulation.
I've not heard of the Germans and their followers accepting
the Fed model.  This debate is played out in the EU over
and over again, and there it can be loosely characterised
as the Germans + supporters versus the Brits plus supporters.)

>> So, in the e-gold scenario, there would need to be
>> similar third parties independent of the payment system
>> to provide the credit moving in the reverse direction to
>> the goods.  In the end it would be much like Enzo's
>> example, with a third party with the seller, a third
>> party with the buyer, and one or two third parties who
>> are dealing the physical goods.  There have been some
>> thoughts in the direction of credit creation in the
>> gold community, but nothing of any sustainability has
>> occurred as yet.
>
> That would probably end up attracting unwelcome attention by the
> regulators.

Well, one could speculate on that and many other things.
Perhaps an anecdote would illustrate that better than I
can in more speculation:  in the very early days, e-gold
did go to the Fed and ask them if they considered e-gold
to be ... within interest.  The Fed said, "gold is not
money and therefore it is not of interest."

This would have been back in 97 or so.  Now, that's what
the Fed said then.  Obviously they are using definition #3
above.  And, just as obviously, things can change...

> Besides, wouldn't that require some sort of fractional
> banking, resulting in a money supply multiple of the monetary base by an
> unstable multiplier, and ultimately bringing back the disadvantages of
> fiat currencies?

If the separate party were to hold and create credit
based on contracts of deposit, using e-gold as the
money and as the accounts system, this would be doing
banking according to definition #1 above.  However,
note that it would have both the advantages of both
a hard money - 100% reserved digital gold - and the
advantages of fractional reserve.  The bank could
only lend out what it had attracted in deposits,
which would result in a stable multiplier.

The trick is to separate the payment system from the
bank!  The easiest way to do this is to ban payment
systems from being near or related to credit systems,
which is what we espouse in our unregulated finance
systems governance models.  (This is why e-gold is a
payment system in Nevis, and G&SR is a seller of e-gold
for dollars in Florida.  On paper at least, G&SR can
go bankrupt and e-gold carries on.)

The offerers of credit and loans were all third parties
that more or less had nothing to do with e-gold.  Such
separation, in theory, allows the creation of a stable
credit expansion system which is only limited by the
efficiency of the players.

iang