Facebook last week announced plans for Libra, a new global cryptocurrency. The name seems to be a marriage of the words “livre”, the French currency throughout the Middle Ages based on a pound of silver, and “liber,” which is Latin for “free.” Facebook claims that Libra will give the freedom to easily transmit funds across borders to the 1.7 billion adults in the world without access to traditional banks.
Money is defined by three attributes. It is a unit of account (prices of most things you buy are quoted in dollars), a medium of exchange (you can deliver payment for those items by transferring your dollars to the seller), and a store of value (you can hold your wealth in the form of cash dollars until you want to spend it).
Why do the pieces of paper we call dollars have value? When paper currencies are introduced, the sovereign often gives them initial value by promising to redeem a one-pound note for a pound of silver. But eventually the pieces of paper come to be regarded as having intrinsic value even in the absence of such promises. This value stems from the fact that having a common unit of account, medium of exchange, and store of value greatly facilitates transactions. We can do everything much more efficiently– and therefore, we can all be richer– if we live in a world where we can pay for oranges using dollars instead of delivering to the seller the physical item that the orange-grower happens to want. A social agreement to use paper dollars as money allows us to enjoy that benefit, so it’s in everybody’s interest to keep it going.
As a result of money’s value as a facilitater of transactions, governments obtain an extra source of revenue just by printing seemingly worthless pieces of paper, essentially appropriating for the government some of the social value that the existence of money helps generate. Governments use this power to get things of real value, such as pay the soldiers or acquire interest-earning assets. This revenue source is known as “seigniorage.” Seigniorage in the form of interest earned on investments by the Federal Reserve and turned over to the Treasury contributed $62 billion in revenue for the U.S. government in 2018.
No surprise that private companies would like a piece of that action, if they could get it. Facebook earned $7 billion in profit last year, more than the entire GDP of some small poor countries like Malawi and Sierra Leone. So why not act like a sovereign government and issue its own currency? Moreover, Facebook isn’t doing this alone, but has partnered with dozens of other companies, including Mastercard, Visa, Ebay, Paypal, Spotify, Uber, and Lyft. Unlike Paypal, which is a functioning medium of exchange, Libra is also proposed as a unit of account: prices would be quoted and transacted directly in Libra. And unlike cryptocurrencies like Bitcoin, whose value fluctuates wildly, the idea is that the value of the Libra would be fixed based on a basket of stable currencies like the dollar, euro, and yen, supported by an endowment of reserves (interest-earning assets in those currencies) that are added to or subtracted from with each transfer into or out of a Libra account:
For new coins to be minted, there must be a commensurate payment of fiat by resellers into the reserve. Through interaction with authorized resellers, the association automatically mints new coins when demand increases and destroys them when the demand contracts. Because the reserve will not be actively managed, any appreciation or depreciation in the value of the Libra will come solely as a result of FX market movements.
This sounds essentially like a 100%-reserve currency board. When you convert your dollars into Libra, the association invests your dollars in low-risk assets of the currency basket. If the value of the euro subsequently depreciates against the dollar, your Libra will be worth fewer dollars than you put in. But it’s still worth the same amount in terms of Libra. Though who’s to stop some other institution from offering a Libra-denominated account, just as banks in Europe can offer a dollar-denominated account, and operate (as private banks do) with a fractional-reserve balance sheet? That would introduce a new dimension in the rapidly mutating world of shadow banking. And it’s unclear who would or could regulate it.
There are additional risks to your potential Libra account, including security or logistical problems with the blockchain technology, development of superior payments technologies, or government regulation. And it’s not clear how much your holdings would be worth if, for example, Facebook were to declare bankruptcy. If the Libra becomes successful, and then for some reason experiences a collapse, it could generate its own financial crisis.
On the other hand, there is no doubt that having a unified and stable system for international transactions would be a big benefit for many people in the world, and thus a not inconsequential source of seigniorage revenue to Facebook and its partners from the interest earned by the invested assets. Certainly having a unified stable currency benefited members of the European monetary union, making it easier to buy and sell across borders. But we saw in 2011 that it can also be a big problem. It would have been very much in the interests of some of the periphery countries of Europe to see a sharp depreciation of the exchange rate at that time. But they couldn’t, because they were tied to the euro. If most Congolese transactions come to be transacted in Libra, it could make it harder for the country to deal with a shock like a collapse in real commodity prices.
If the Libra becomes successful, it could undermine the ability of governments to force negative interest rates– the Libra could start to look like a more attractive money than euros. And it also poses potential competition for governments’ seigniorage revenue, which poorer countries often rely on because the lack of infrastructure makes it hard to raise revenue using other forms of taxation. Though if it does help improve the efficiency of the payment system, perhaps the wealth created would generate other new targets for tax revenue.
It is an interesting experiment. I don’t know how it will turn out.