Something I did not stress about the likelihood of a crypto-currency takeover in my Alphaville post that I should have done, and which cropped up in a Twitter exchange with Joe Weisenthal, relates to the fact that in theory, and even in history, the unit of account and medium of exchange can differ/have differed.
So, here, the question I started with was the low likelihood that Bitcoin or similar might take over soon, given the small value of currency in circulation relative to the value of paper US dollars. [100bn compared to 1.4trn].
In this 2000 paper by Woodford he explains how the central bank could retain control of monetary policy, even if people stop using central bank money as a medium of exchange or store of value, simply by central bank money remaining the unit of account.
Analogy: if central banks were given the power to define the metre in a textile based economy, then even without being the monopoly supplier of money they could pump up the business cycle by lengthening the metre. Textile suppliers would have temporarily fixed prices per metre of cloth. [Which amount to amounts of goods they would accept directly, or indirectly, in exchange for a metre of cloth].
The lengthening of the metre would pump up demand for cloth [which was now cheaper in terms of goods per old metre! Still with this?] in the same way that an increase in the money supply reduces the real price of fix-price goods in a conventional model economy. We don’t yet broaden out central bank empires to defining the metre, but we could contemplate it one day: we’d have to include the kilo, litre, and presumably also allow central banks to define the time unit so that the otherwise weightless/dimensionless service economy could be controlled.
In Chile, policy actively sought to disentangle the unit of account from the medium of exchange, with the creation of the Unidad de Fomento.
This was to try to avoid the costs of endemic inflation in terms of the Chilean Peso. Exchange rates between UDFs [which had no material form – you could not buy UDFs] and Pesos were published daily in the newspapers, which were simply ways of presenting changes in the CPI. [See Shiller(2002) and also this nice blog post by JP Konig].
A similar indexed unit of account concept, the ‘Unidad Reajustable’ exists in Uraguay. And there are other examples too.
In the case of crypto-currencies, we are contemplating a switch that from the perspective of the authorities is involuntary, not voluntary like in Chile. But the Chilean experiment shows that the unit of account/medium of exchange separation possible in theory is also possible in practice. If central authorities can will this separation, perhaps markets can coordinate on it too.
That was a long-winded and somewhat contorted way of explaining that it’s at least possible that the take-up of Bitcoin and similar as a medium of exchange mis-states the probability that it becomes a unit of account.
Control of monetary policy may escape central banks even if Bitcoin never takes over as a medium of exchange; similarly, if central banks can retain rights to define the unit of account, it might be relaxed – a small seigniorage loss aside – about losing the role of monopoly issuer of the currency.