MUMBAI: Facebook's new global digital currency, Libra, which the company plans to launch as early as 2020, can change the world.
But none – including the founders of this ambitious economic engineering project – can fully anticipate the currency's possible consequences. And monetary politicians should be particularly concerned because they may find it much more difficult to control unemployment and inflation in a Libra world.
IT CAN BE A DOMINANT GLOBAL CURRENCY
In In the first quarter of 2019, Facebook had 2.38 billion monthly active users. If even a fraction of them start using Libra to carry out financial transactions, buy and sell products and transfer money, the new currency will quickly gain wide acceptance.
Already the Libra Association, a Geneva-based non-for-profit group that will operate the digital currency, counts companies such as Uber, eBay, Lyft, Mastercard and PayPal among its founders. Libra can therefore become a dominant global currency – but one is run by a company, not a central bank.
Although Libra is based on the same blockchain technology as other crypto curves, it is expected to be much more effective. Facebook promises that the Libra system will be able to process 1000 transactions per second, be user-friendly and have a virtually zero transaction cost.
GROUP IS BREWING
Not surprisingly, the Libraen announcement has led to a flame of central bank meetings, of the Bank of International Settlements, and of other multilateral organizations.
Some commentators have welcomed the proposed new private money, while others want governments to stop Libra before it comes off the ground.
Critics of the initiative have several concerns, including the computing power needed to manage the currency, the privacy of users' data, and the possibility that the new money will nurture illegal activities and markets. But much more attention must be devoted to analyzing how Libra can dramatically change global monetary policy.
Most institutional structures and systems in the world economy – barter, bank, paper money, financial markets and so on – emerged through slow evolutionary processes. Conscious attempts to establish brand new systems have usually given rise to unexpected challenges.
The creation of the euro was such a planned economic economic act that had unforeseen consequences. In my book A Real World Economist, I discuss how bond yields diverged across the euro area following the collapse of Lehman Brothers in 2008, causing the European sovereign debt crisis to continue to break the world economy today.
READ: "Banking is still a highly exploited industry" 10 years after the collapse by Lehman Brothers
The crisis was ultimately the deficiencies of the euro area's design (a monetary union without sufficient common fiscal policy – a problem not yet addressed).
At this stage, one can only wonder if the problems Libra can cause. For example, if Libra becomes popular, people will exchange their national currencies – dollars, euros, yuan, and rupees – for the new digital coin to buy and sell the many products that will be priced in it.
Many users can then choose to keep Libra instead of switching it back to their own currencies.
Facebook or Libra Association will therefore continue to keep their national money and make money from it by investing Libra users money. They will also be tempted to issue extra weapons to achieve seigniorage in the same way that central banks deal with the national currencies they issue.
Inflation – and decision-makers reduced ability to control it – must look prominent in the list of possible risks. Usually when the central bank takes steps to control it.
They raise the key rate and increase the reserve ratio to help look up some of the money in circulation.
But the effectiveness of such policies can be significantly reduced if one of the largest money-making authorities is a private organization. And Libra itself can create some inflationary pressure because it is an effective addition to liquidity.
In recent times, high inflation has only been seen in developing economies. There is a tendency to assume that advanced economies are immune, but it is innovative to remember that the two most devastating cases of inflation in history were in relatively rich countries: Hungary in 1946 and Germany in 1923.
In Germany, it costs A mark at the beginning of the inflation fluctuation costs 100 sek-characters (one with 23 zeros thereafter) barely a year later.
LESS IT NOT A RIGHT MOVE
Despite these risks, an immediate stop against Libra is perhaps not the right move.
First, it is unclear what existing law can be used to stop the proposed currency. At one level, Libra is not very different from the statutory coupons that people buy with their dollars when they enter an amusement park, and then use to pay for food and tours.
And in a globalized world, a country that rejects Libra can find itself gradually isolated by others who take on.
LES: The beginning of the end of crypto course values and the start of one alternative, a comment
Politicians must as soon as possible assess what kind of digital digital money can create. We can then need new laws and global agreements to curb potentially negative fallout and curb the power of organizations running these new currencies.
Kaushik Basu, former chief economist of the World Bank and former chief financial advisor to the Government of India, is a professor of economics at Cornell University and Nonresident Senior Fellow at the Brookings Institution.