More on Bitcoin and the conditions for a takeover of fiat money

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.


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10 Responses to More on Bitcoin and the conditions for a takeover of fiat money

  1. I personally think that Bitcoin is not a currency at all. It is what we misunderstand currency to be. But that doesn’t make it useless to theorize about it the way you do — quite the contrary.

    I’m planning to write a longer reply later, but right now I wanted to point to a 2007 paper by Buiter: “Is Numerairology the Future of Monetary Economics? Unbundling numeraire and medium of exchange through a virtual currency and a shadow exchange rate” Are you familiar with it? This post reminded me of it.

  2. Would you say that Bitcoin is both a medium of exchange (MOE) and a unit of account (UOA)?

    When it comes to Chilean peso and UDF, I’d say peso is both a MOE and a UOA. UDF is only a UOA (abstract). To be precise, “MOE peso” is denominated in “UOA peso”. The latter is abstract. Most of the people don’t distinguish between these two, and instead they say that the same peso acts both as a MOE and UOA. Right? I have found it useful to separate these two concepts. An example: A 10-dollar FR note (MOE) might under some circumstances only buy goods worth 8 dollars (say, a “Gesell tax” was introduced), in which case the price of the goods, 8 dollars, would clearly refer to an abstract dollar (assuming all cash was to be “taxed”).

    So, is Bitcoin a UOA? I’d say it potentially is. That would require that prices of goods (incl. services), or debts, are expressed in Bitcoin. But as long as the Bitcoin price of a good offered for sale changes as the dollar price of Bitcoin changes, I’d say it is a pseudo-UOA at best.

    It seems to me that Bitcoin is a virtual thing with no intrinsic value, the price of which is expressed in USD, EUR, JPY or some other abstract, authentic UOA. In this it is not that different from currency. Where it differs from currency is that currency derives its value from there existing a debt (an obligation to give up goods) of corresponding nominal value. Currency, or any other credit balance, serves as a right to take goods from others without incurring a debt. That right is always matched with an obligation somewhere else in the system, so that there’s a balance (credit = debit). Not so for Bitcoin (or any “commodity money”). These are two fundamentally different things.

    I’m thinking out loud. How does this sound?

    • Tony Yates says:

      Bitcoin could be a UOA but isn’t currently. It’s just a MOE, and not much of one at that. As you say, the UDF is a UOA, entirely abstract, has no material counterpart. The Pesos is a MOA and UOA currently, there.

    • Tony Yates says:

      Well, Bitcoin is a bearer bond just like paper money. You can’t demand anything in return for it unless someone wants to swap it for something else. Likewise, paper money or central bank reserves are not liabilities in the conventional sense, even if for the purposes of sustaining sound money and public finance policy they are treated as such. That is, the authorities are not liable to do anything except exchange a unit of fiat currency for more of the same.

      • What makes Bitcoin a bearer bond? (Other than equating it with paper money which is said to be a bearer bond, but which you say doesn’t represent anyone’s liability in the conventional sense.)

        When additional paper money is printed and enters circulation, there is always a debit to some account (the paper money itself is a “portable credit balance”; part of ‘Currency in circulation’). That debit either increases a debt (say, public debt) in the CB books, or decreases a credit balance (say, bank reserves). Against all the credit balances in CB books there exists a corresponding debit balance, which is a record of someone’s debt (public debt, MBS, etc). If paper money is issued in form of Treasury notes (that is, not in CB books) and given to someone who sells goods to the government, the issuing of it is again matched with an increase in public debt (at first instance through budget / increased expenditures).

        Bitcoin, on the other hand, is not part of this kind of record-keeping system. It might mimic paper money, but that’s only one side of the coin. Bitcoin is a credit without a counterpart in a debit somewhere else in the system. That makes it fundamentally different from paper money. That makes it a pyramid scheme. Paper money might resemble a pyramid scheme when it is misused, but the underlying system is not a pyramid scheme; there is a balance (credit = debit).

        So yes, paper money is not a liability in a conventional sense. It is a right (to take goods without incurring a debt), and that right is a part of a system where the total of rights is equal to total of liabilities (to give up goods without earning a right to take goods). There is no link between rights and liabilities (credit and debit balances) other than at aggregate level.

        This is becoming a lecture now (an accountant lecturing an economics professor). I’m offering glimpses of what I think might be a kind of synthesis: I agree with monetarists that money itself is not a debt/liability, yet I am a “credit theorist”.

      • Tony Yates says:

        These q’s are fine. Although at some point my RSI is going to cut my answers short. A way to see why fiat money is not a conventional government liability is to note that it is possible to have positive steady state inflation, and money supply increasing at the same rate, with a balanced government budget [so debt is not changing, and seigniorage revenue is returned as transfers]. One sense in which it is a liability is that one is typically allowed to discharge tax liabilities with paper money. But I don’t take that as conclusive proof either, as this is IMO a behavioural response by the authorities to the prevailing equilibrium that money is valued, so that the paper money can be spent again by the government.

      • Tony, read more closely. I don’t say fiat money is a government liability. I say it isn’t. Depending on how it came to being, it can be indirectly link to public debt or private debt, or both. But fiat money, as a “portable credit balance”, is never in itself someone’s debt. For instance, in case of the Fed, there is both public debt (Treasuries) and private debt (MBS) among the debit balances that match the credit balances (of which currency is a part of).

        You seem to be arguing against MMT and other credit theories of money, but mine is a different one. I’m working on a longer post on taxation and there, too, my description differs from both yours and typical credit theorists’ description.

      • Tony Yates says:

        OK, on that we might agree then. You seem to be recreating the idea of ‘money as memory’ or ‘record-keeping’ which is perfectly standard. I don’t understand MMT, mainly because I have not seen a simple algebraic exposition of it, which is really needed to contrast it properly with a standard alternative.

      • Well, one could say I’m recreating it. I refer to

      • Well, one could say I’m recreating it. I refer to Kocherlakota here and to Ostroy here.

        As I said, I’m not an economist, so I’m partly guessing here. But I feel that the real “money as memory” story doesn’t fit in algebraic form. It cannot be explained in terms of the standard theory. (This might have something to do with the fact that the monetary system is based on cooperation/institutions that don’t exist in the standard theory of atomistic individuals.) The system is created by individuals coming together and deciding to cooperate, trust each other. In a trade the seller doesn’t receive anything, but he trusts that he will receive something later (there’s a link to “gift economies” here).

        When “fiat money” is a record of the seller having not received anything in return for his goods, and when he cannot walk to anyone and demand something “for his money”, then there must be trust in reciprocity.

        This reciprocity works best when it is not only recorded that the seller gave up goods without receiving anything in return (credit entry/receipt of money) but that the buyer received goods without giving anything in return (debit entry/delivery of money). Then no one, as a holder of money (credit balance), feels entitled to receive goods from others (without incurring a debt) without there being someone else, somewhere in the economy, who feels liable to give up goods (because he received goods earlier and has a debt; a debit balance). These two people don’t need to trade with each other, but on aggregate level there is a balance. The amount of rights, or entitlements, matches the amount of liabilities.

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