Crypto-currencies and the vestigial states they plunder

That headline was a bit strong.

But a thought.  In a previous post on Alphaville I wrote about how the currency area that a private sector cryptocurrency created would be undesirable.  That was because it would likely straddle national borders, and therefore there would not exist institutions to funnel fiscal resources around it to perform the functions that we hope for in an optimal currency area, and have been tragically absent in currencies like the Eurozone.

Rather obviously, the vestigial states carved up by this hypothetical crypto currency would face new problems and constraints.

In a conventional currency area, where the state has a monopoly on supplying the currency, to some extent the central bank can stand behind its government, which may need to borrow large sums to tackle fiscal or financial crises.  I say 'to some extent' because the costs of high inflation, and the inefficiency of money-financing when inflation is expected, limit the ability of the money printers to stand behind fiscal policy.  [One reason why I think those who dismiss concerns that the UK could ever have faced a run on its own sovereign bonds as unfounded are wrong].

If part of the economy now functions using a cryptocurrency, this financer of last resort function does not work so well for the affected region.  [I say 'region', though the cryptocurrency takeover need not be of any contiguous geographical area].  Resources to be funnelled to that part of the economy have to be in Cryptos, which means either issuing bonds directly to the quasi 'foreign' Crypto economy, or milking the vestigial fiat currency holders, and then going to the market to buy Cryptos.

If the former, then the central bank does not stand behind those fiscal actions.  And if the latter, this highlights how the vestigial state constitutes a shrinking of the inflation-tax-base for the 'standing behind'.

The central bank could try forcing those in the Crypto part of its economy to accept its own currency in any emergency operations - like paying local government civil servants, or suppliers - but it would face subjecting the economy to the same trauma as Tsipras contemplated would happen if Greece had exited the Euro and began issuing new Drachmas.

In view of this, we might expect the authorities not to be particularly relaxed about a significant invasion of private sector crypto-currrencies.  That is, unless they happen to be presiding in states which cannot discipline themselves to use the financer-of-last- resort function sparingly enough, and have the wisdom to forego it.