Last week’s FBI’s raid on the private silver-backed currency project, the American Liberty Dollar (ALD), has generated a great deal of discussion on blogs and message boards. In the discussion there has been some confusion about what the project was about.

Confusion is understandable because the ALD set-up is not completely simple or transparent. On the one hand, the ALD marketed one-troy-ounce silver rounds (for legal reasons not called “coins”) and notes redeemable for the one-ounce rounds. On the other hand, it marked the rounds and notes “$20”, meaning “20 US dollars”. How can a round be both “one troy ounce” and “US$20”, when the market price for similar one-ounce silver rounds from other sources is not currently US$20? (The private Northwest Territorial Mint, for example, is currently selling one-ounce silver rounds at $15.28 in bulk, buying at $14.43. These prices include a premium over uncoined silver.) More generally, how can a one-ounce silver round have a fixed price in US$ when the US$ market price of silver varies from day to day? Some commentators think there must be something fishy here. “Silver” on the Mises.org blog supposes the Liberty Dollar project was “designed to trade silver medallions to the ignorant and unwary at premiums that were many multiples of the market norm.”

But there is another explanation for the fixed US$ price on ALD rounds and notes. I take the ALD literature at its word that the Liberty Dollar project was intended to provide an alternative currency to compete with the Federal Reserve note. Its “monetary architect” Bernard von NotHaus decided to denominate the ALD in US$ to make it, like 19th century private banknotes, compatible with the dominant existing unit of account. Dollar denomination was to make it easy for people to use ALD rounds and notes as currency. If ALD medallions or notes had been denominated only in “ounces” then the many potential recipients who think in US dollars, and who have no idea about the current spot price of silver, wouldn’t have known what dollar value to assign to them. The US$ denomination of ALD avoided unit-of-account incompatibility with the dominant US$-denominated payment system.

Denomination in US dollars, however, conflicted with the ALD claim that its paper notes and electronic claims were “100% backed” by silver. A $20 ALD note, backed by a one-ounce silver round in an Idaho vault, is “100% backed” only if we accept that the round is worth $20. Marked to market, the silver round to which it is a claim is in fact currently worth only around $15. On a marked-to-market basis, then a $20 ALD note is not 100% but instead fractionally backed. In the same sense, even ALD one-ounce silver rounds, marked $20, are partially tokens rather than completely full-bodied.

I have no objection to fractional-reserve banknotes. As I have noted elsewhere, fractional backing is necessary for a circulating bearer note to be feasible. A note with 100% reserves (on a marked-to-market basis) could not circulate easily and anonymously because the issuer would have has no way recover storage costs. The ALD notes could waive explicit storage fees because the issuer sold the notes at above the market value of the reserves, using part of the profit to pre-pay the warehouse fees.

The fact that it was denominated in dollars (to provide unit-of-account compatibility) had an ironic implication, as I noted in an article in 2000: it meant that the ALD offered no great advantage in prospective purchasing-power stability over standard US$ (Federal Reserve) notes. Insofar as they passed at their marked $US value, the purchasing power of ALDs varied exactly with that of Federal Reserve notes. The slight advantage of the ALD $20 note is that it does have the one-ounce silver redemption option setting a lower limit to how far its purchasing power could fall—unlike a Federal Reserve note, which has no lower bound.

When I made the above no-great-advantage argument in 2000, I considered it unlikely that the silver-redemption limit would become relevant, given that the futures market price of silver at that time made "silver at US$10 an ounce" unlikely. But as it turned out, silver rose above $10, and the redemption option did come into play. Originally it was the $10 ALD note that was redeemable for the one ounce round. (The spot price of silver was then around $5.) This US$10 “basis” became infeasible (because of the need for a mark-up to pre-pay the warehousing fees) as the market price of silver rounds approached US$10. The ALD switched to a US$20 “basis” when the spot price of silver crossed $7.50, and holders of the one-ounce-redeemable note enjoyed a one-time nominal gain.