Payment Risk

Posted 25 Jun 2008

When a transaction occurs usually a good or service is exchanged for payment.  One risk associated with payment is credit risk.  All fiat currencies are 'bills of credit.'  Commodity currencies have no credit risk because they are solid assets.  The value of a commodity currency is not based on an extension of credit. 

However, the exchange-rate risk is largely determined by supply and demand factors.  When an institution or individual accepts fiat currency, that institution or individual is accepting a promise of value.  Thus, payment risk is assumed until the fiat currency is exchanged for a tangible good or service; at this point the risk is passed on to the individual or institution receiving the fiat currency.

By contrast tangible assets can never become worthless.  Many financial assets, such as currencies like the Zimbabwe $, Continental dollar, stocks such as Enron and bonds such as WorldCom can and often do become worthless ending up in the financial asset graveyard. 

As someone exchanged value for the financial asset when it loses value or becomes worthless that person is 'left holding the bag.'  Thus tangible assets are not subject to payment or credit risk but are subject to exchange-rate risk.  Financial assets have counter-party, performance, payment and exchange-rate risk.  Why take any exposure to unnecessary risk?

"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value.

If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves."  - Alan Greenspan

"Counterfeiting the nation's money is a serious offense. The founders were especially adamant about avoiding the chaos, inflation, and destruction associated with the Continental dollar. That's why the Constitution is clear that only gold and silver should be legal tender in the United States.

In 1792 the Coinage Act authorized the death penalty for any private citizen who counterfeited the currency. Too bad they weren't explicit that counterfeiting by government officials is just as detrimental to the economy and the value of the dollar." - Ron Paul