The white paper released last month by Facebook and its associates describes the Libra, a new cryptocurrency they are planning to launch some time next year. Judging from the white paper, they hope to have designed a mechanism that, by overcoming the problems facing all previous forms of cryptocurrency, can become a generally accepted medium of exchange on the Internet worldwide.
The intent is to create a privately issued currency that will be backed by a basket of hard currencies issued by major central banks. It is supposed to be similar to a currency issued by a currency board, meaning backed by reserve currencies and assets denominated in those currencies and therefore similarly stable in value. Libra’s architects hope to lower transaction costs for operations in this new currency, thus allowing the free flow of resources worldwide, at less expense. Much more could be said about the details of Libra, but one can already get a sense of the major headwinds its architects will encounter in trying to implement their plan.
What the plan really does is make one wonder how much thought they gave to: 1) the nature of money, and 2) how their creation fits within existing constraints. Not enough—or so it seems at first glance.
According to the proposal, Libra is intended to be “a new decentralized blockchain, a low-volatility cryptocurrency, and a smart contract platform that together aim to create a new opportunity for responsible financial services innovation.” As a way to indicate my skepticism about the capacity of Facebook and company to achieve these goals, let me contrast them with what I would call “the Treasury view,” that is, considering not the fiscal policy effects on aggregate demand, but the responses to Libra that are likely from the civil servants and politicians in charge of exercising the monetary prerogatives of the U.S. government.
(A disclaimer at this point: I am not associated professionally with the U.S. Treasury, or the Fed, or any other branch of the U.S. government, or any government for that matter, nor do I collaborate with any of their officers. My simulation of “the Treasury view” is entirely my own.)
The “Treasury view” entails recognizing that, in order for the state to protect the life and property of its citizens, it must be able to use force—either externally, through the armed forces, or domestically, through the police. Monetary prerogatives, in this sense, are just one more weapon in the armory of the Republic. They give the state the capacity to procure stocks of goods beyond the limits of its taxing base at any given time, either by borrowing or, in extremis, by inflating the currency. Notwithstanding the fact that the monetary prerogatives (issuing money and regulating finances) have been applied to uses other than war-finance, the fact is that the original reason for the national state to monopolize them was war-finance. The original reason to hold those prerogatives still remains.
Before addressing Libra’s relation to these existing arrangements, let us talk about one of the derivative applications of the government’s monetary prerogatives that has become standard nowadays in most countries: the management of capital flows.
First, let us assume the validity of the “impossible trinity” as proposed by the Mundell-Fleming Trilemma, which is that a country cannot simultaneously have a fixed exchange rate, monetary discretion, and free international flows of capital.
Next, let us agree with Facebook and its partners that “global, open, instant, and low-cost movement of money will create immense economic opportunity and more commerce across the world.” If we agree with them on that, it makes sense to praise them for stating that “The goal of the Libra Blockchain is to serve as a solid foundation for financial services, including a new global currency, which could meet the daily financial needs of billions of people.”
However, something needs to give. It is not realistic to assume that you will be able to create a “global currency” that will allow “open, instant, and low-cost movement of money” around the world when this would infringe with impunity on the monetary prerogatives of those countries who wish to control their own money supply and at the same time keep their foreign exchange rate fixed. I do not see, for instance, India or China going along with that—and if that is the case, it means 36 percent of the world’s population will be out.
Another relevant activity performed by a central bank, as mainly responsible for the exercise of the sovereign’s monetary prerogatives, is its provision of liquidity (as lender of last resort) to financial institutions issuing claims denominated in the currency the central bank issues. The fact that no single Libra will be minted without the backing of a corresponding reserve in hard currency (as happens with a currency board) does not eliminate the problem that claims denominated in Libras may be issued. A currency board, conceptually, may solve the problem of guaranteeing the monetary base, but it is no solution for problems of liquidity if there is fractional reserve banking.
Are Facebook and its partners prepared to forbid the nodes in their network, such as the managers of digital wallets, from opening credit in Libras to their customers? I doubt they would want to forbid this. Alternatively, would Facebook and its partners accept being regulated as financial institutions by the U.S. government in order to benefit from its umbrella? If so, from where will come the cost reductions they are hoping to realize in comparison with regulated banks?
The main impediment, though, remains the question of the state’s monetary prerogatives as a key instrument for the financing of armed conflict. Anything that would reduce the capacity of the U.S. government to float its debt is a security risk for the country. It is as simple as that.
I do not think that reducing the floating of U.S. dollars, and lessening the dollar’s role as the reserve currency of the world—which the creation of a leveraged system like the Libra would do—would be acceptable to those holding “the Treasury view.” I do not think, either, that a system that would give discretion to Facebook and company to accept, say, Chinese currency as part of their reserves (and therefore to reduce the role of the U.S. dollar) in exchange for a license by the Chinese government to enjoy commercial opportunities in China would be acceptable to those who take “the Treasury view.”
To be sure, the problems discussed here do not seem insurmountable. And perhaps there is room, between the cracks, to make a lot of money with this project. However, more attention must be paid to the essential nature of monetary arrangements if the Libra architects want to succeed in becoming a significant part of these arrangements.