Libra and monetary sovereignty – Why Facebook should consider breaking up the basket
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A quick note:
I wrote the below as a an outgrowth of a class at the Harvard Kennedy School in December 2019. I argue that Libra could mitigate the public backlash by offering national currencies rather than a new currency backed by a baskets. Libra recently, in March 2020, announced that it is actually taking that step (see here). I had sent the paper to people at Facebook with the support of a professor but did not get a response.
If you’re interested in my thoughts, below is the paper.
Libra and monetary sovereignty
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Why Facebook should consider breaking up the basket
“If the whole process triggered by the availability of new electronic retail means of payment is finally brought to its logical conclusion (…) central banks and governments will be confronted with a very specific problem of pivotal significance: (…) If the means of payment embodying the unit of account, that is notes and coins, is – over time – eliminated as a transaction medium by virtue of the competition of the emerging digital equivalents issued by the private sector, would the familiar existing units of account such as the euro, the US dollar and the pound sterling, continue to mean anything? And, if not, what should be the official response? (…) you may rest assured that [these issues] are crucial to our concerns for the future, albeit probably the somewhat distant future.”
Otmar Issing, former ECB board member, 1999[i]
With the announcement of the Libra foundation –a consortium around Facebook– to launch its own currency, the hypothetical scenario described by Issing moves a step closer to becoming reality. Libra, a digital currency backed by a basket of public currencies, would be immediately available to Facebook’s 2.4 billion users. The announcement was met by strong public reactions pointing out concerns regarding privacy, data security, regulatory compliance on know-your-customer and anti-money-laundering rules, as well as the core subject of this analysis: monetary sovereignty. [ii]
Bruno Le Maire, French Minister of the Economy, declared that Libra would not be authorized on French soil as “our monetary sovereignty is at stake.”[iii] The German and French Finance ministries in a joint statement declared “that no private entity can claim monetary power, which is inherent to the sovereignty of Nations.”[iv] The House of Representatives Committee on Financial Services called for a Moratorium on Libra pointing out the rival currency could lead “to an entirely new global financial system that is based out of Switzerland and intended to rival U.S. monetary policy and the dollar.”[v]
I argue that for Facebook to mitigate these monetary sovereignty concerns, a viable step would be breaking the basket-backing of Libra and instead offer ‘single-currency’ Libras: a USD-Libra, a EURO-Libra, etc. This small technical change as I will argue makes a large difference in terms of monetary sovereignty. Libra would restrict itself to be an efficient money transmitter for existing currencies rather than launching its own form of money.
I present two arguments in support of this case: First, by deciding to make Libra its own currency, Facebook threatens the crucial prerogative of monetary authorities to define the unit of account in their jurisdictions. Second, with its design, Libra threatens to capture the interface between citizen and currency that is at the very foundation of trust in monetary authorities. In a last section, I address Facebook’s interests. I argue that a ‘single-currency’ Libra maintains the promise of easy money transfers and enhancing financial inclusion whilst the impact on costs is ambiguous.
Caveats to the following analysis
Before diving into the analysis, a number of caveats are worth noting:
First, the general backlash had multiple sources, some of which come from broader fears of Facebook becoming too powerful, others of which are very detailed regulatory concerns. My proposal does not address all those concerns but only the particular issue of monetary sovereignty.
Second, it is hard to causally trace back public reactions to their exact root. Public officials noted general concerns about monetary sovereignty rather than explaining exactly why sovereignty is at stake. Indeed, the reactions may even represent a diffuse fear stemming from heuristics or intuitions, rooted in good underlying reasons. As a former high-ranking central banker in a personal conversation put it: “They keep talking about KYC/AML and these technical things. It is really about sovereignty. It is so obvious!” However, if the evidence does not fully convince, my arguments below can be understood more defensively in that states have good reasons to be worried about Libra.
Third, there are good privacy and financial stability arguments (which I personally agree with) that digital currencies representing official currencies should be publicly rather than privately provided. Making this argument is beyond the scope of this paper and I will limit my claim to what Facebook could do if they wanted to mitigate public monetary sovereignty concerns.
Threats to monetary sovereignty: the danger of Libra as a new unit of account
To understand the potential impact of Libra on monetary sovereignty, it is crucial to understand how its launch can affect public prerogative over money and to assess which specific prerogatives it might affect. Money has three core functions: it is a unit of account, a means of payment and a store of value. The ‘means of payment’ and ‘store of value’ functions have traditionally, though not exclusively, been provided by private enterprise.[vi] The ‘unit of account’ function, in contrast, has characteristics of a public good.[vii] It describes the way in which people assign value to goods and services. Money in this sense is a measuring tape, a common metric or more fundamentally the language that agents use to communicate value.[viii]
Price stability is crucial for all functions of money, yet in terms of public involvement, the ‘unit of account function’ is by far of greatest importance.[ix] In maintaining price stability monetary authorities aim to make sure that everybody speaks the same money language in its jurisdiction, that the “unit of account always means the same thing to different individuals both at one and the same moment and over time.”[x] Having such a (common) understanding is vital for efficient functioning of the economy.
Libra, with its design as a currency basket of national currencies, introduces its own unit of account, a new denomination. The key danger for monetary sovereignty is the potential of Libra becoming the new yardstick in which the value of goods is measured within a state’s jurisdiction. In simple terms: If people start increasingly using Libra for buying things on platforms, e.g. on marketplace, and they quote the prices of goods in Libra, they might start thinking and communicating about value in terms of Libra, independent of where they live. Such a scenario would effectively seize governmental control over the way value is traded and their monetary policy instruments to affect this.
Assume for instance that within the US, the pricing of goods would become dominated in Libra. Public involvement in managing this yardstick would be limited. If prices of goods were to be quoted in Libra, the effect of monetary policy would be limited to whatever percentage their domestic currency represents in the basket. Or turned on its head: the prices in which value is measured within a jurisdiction would be affected by economic conditions and policy responses of other countries whose currencies are represented in the basket.
The question is of course whether and how such a situation might materialize. Paradoxically, there is little knowledge on how money acquires its ‘unit of account’ function. There is an implicit assumption that such coordinated social behaviours simply emerge from the dominant medium of exchange[xi] but as Buiter puts it: “Nobody understands the mysteries of the unit of account or numéraire, but for some reason in most societies today for most of the time, central-bank issued fiat money or base money has been the unit of account for most contracts (…) – empirically and for reasons we don’t understand.”[xii]
Indeed, the combination of that lack of knowledge about how money derives this function and the intuition that it comes from its use is arguably what generates such scepticism against Libra. Its very promise is to solve existing user pains in monetary exchange and providing a convenient medium that is directly available to 2.4 billion users. There are good reasons to be doubtful that Facebook could upheave the current system in such a fundamental way (and indeed, as I argue below it may be a hurdle in customer uptake). However, the potentiality of it attaining dominance coupled with unclarity about how this process unfolds gives enough reasons for policymakers to be weary.
Or formulated more pointedly: Introducing a service to 2.4 billion people that is seen to be a key prerogative of the public and publicly provided is bound to be greeted with a cold response. As the mentioned former high-ranking central banker phrased this point: “They [Facebook] don’t understand how aggressive that is; to come up with ‘their own thing’ on your soil.”
The above directly informs the key difference between today’s Libra and a ‘single-currency’ Libra. A USD-Libra may become the dominant medium of exchange, yet it would leave the ‘unit of account’ function unaffected. It would compete with money transfer operators, not with the publicly provided terms that goods are priced in. In this sense, it would be far less intrusive on a crucial public function.
Losing the interface to the customer – the issue of trust and credibility
The announcement of launching Libra must be understood in its context. It comes at a time where central banks around the world are already racking up their attempts to maintain relevance in the public to fulfil one of their core tasks: managing trust. To maintain price stability, central banks need to keep inflation expectations well-anchored. The very organizational setup of central banks in today’s advanced economies –politically independent entities subjected to the narrow goal of price stability– is designed to maintain public trust; to ensure the credibility of monetary authorities not to debase money in the pursuit of private goals.[xiii] It is the result of a historical trial and error process to find an issuance mechanism that allows for sufficient flexibility to react to economic circumstances and at the same time credibly ensure that this power will not be not misused.
The sustainability of this solution depends on an association of money with that trusted institution, whether explicitly recognized or implicitly, embedded in societal convention. With the fading out of cash in several advanced economies, the question of how and why central banks maintain relevance in interacting with citizens has been the subject of increased attention. Indeed, existing plans to launch central bank digital currencies are a direct result of the potentiality of moving to a cashless society. The early movers in this space have been countries where cash is effectively vanishing.[xiv]
Most of the literature on central bank digital currencies focusses on functional, financial stability arguments around the notion that as cash disappears, citizens should have alternative means to hold direct monetary claims against the government (rather than claims against private institutions or ‘private money’, which all forms of electronic money are today).[xv]
There is, however, an underappreciated argument regarding cash as a physical embodiment of state power, as a direct interface between central banks and citizens that is necessary for maintaining a trusted relationship. As Genais and Landau describe the implications of a cashless society: “money would no longer be a physical manifestation of sovereign authority (…) Citizens would no longer have any visible symbol linking money to the authorities and to the Central Bank. Symbols are important for money (…) Connecting the Central Bank to money might be important for the effectiveness of Central Bank’s communication.”[xvi],[xvii]
How does this argument about cash relate to Libra? It informs the context in which the Libra announcement is interpreted by public authorities. Central banks are already questioning how to maintain relevance as digital forms of money are becoming increasingly attractive. Libra directly jumps beyond this first step: The Libra association not only offers a product that might speed up the process towards a cashless society; It adds a second layer onto the estrangement between central banks and money by recrafting national currencies into a basket and adding its own branding.
Admittedly, Libra’s construction of backing the currency in national currencies tries to leverage the trust of the existing institutions rather than to replace it. However, whether by intention or not, the prospect of it becoming a widely used form of currency effectively captures an interface of central banks to interact with its “customers”, which is at the core of fulfilling their societal role.
Of course, the proposal of introducing ‘single-currency’ Libras does not completely alleviate this problem. ‘Single-currency’ Libras too could accelerate the fade-out of cash. This is however the crucial point: Offering a USD token to 2.4 billion customers would in itself be a move that exerts high pressure on monetary authorities.[xviii] Indeed, part of the core reaction to the announcement included policymakers committing to explore central bank digital currencies[xix] and politicians calling on central banks to speed up the process towards offering more efficient electronic payment means[xx]. As some argue it even forces central banks to either accept the dominance of private tokens or start offering their own digital currencies.[xxi] This type of competitive pressure on the public may be healthy, yet, it may be sensible to limit the upheaval of the status quo to one type of innovation that already puts monetary authorities on the defensive.
What is in it for Facebook?
The benefits moving to a system of ‘single-currency’ Libras should be clear by now. A USD-Libra would be an entirely different product than Libra in its current form as it de facto reduces it to an efficient transmitter money. In simplified terms, it is the same as if Venmo offered a USD-Venmo (which would not change much) and added the option to hold multi-currency accounts (which would add a very commonly offered product to its offering).[xxii]
Indirectly, it might take off pressure from Facebook stemming from fears of it becoming too powerful as a state-like entity, which has yielded criticisms as it is in the processes of building a judicial branch for regulating speech with its oversight board. It would of course not alleviate concerns regarding regulatory compliance and privacy.[xxiii]
Importantly, the key benefits of Libra could be maintained, whilst the impact on costs of managing the system is ambiguous:
The key ambition of Libra as highlighted in its white paper is to enable cheap and efficient payments and to ensure financial access for the traditionally underserved. Buried later in the paper the key enabler of financial inclusion is mentioned: “We believe that decentralized and portable digital identity is a prerequisite to financial inclusion and competition.”[xxiv] Through providing such identification services Libra aims to loosen a key constraint to accessing financial services, especially in emerging economies: the lack of identity documentation or high bars to prove one’s identity.
Whether the motives are truly benign and directed towards realize financial inclusion or whether the project is driven by the desire of owning the digital identity of more than 2 billion people, the choice of basket backing does not affect this feature. That is, ‘single-currency’ Libras would come with the same infrastructure of providing (or requiring) a digital identifier to onboard on the platform.
The question of whether the infrastructure to process and manage payments would be more expensive is less straightforward:
Efficient payments in a ‘single-currency’ Libra system require an infrastructure for currency exchange (e.g. between USD-Libra and EUR-Libra). This requires some mechanism to apply exchange rates as part of a transfer. The current Libra proposal technologically is simpler to operate. The current blockchain-based processing is a secure protocol for transferring one unit of Libra to another user, independent of Libra’s relative value to other currencies. Calibra, the wallet and currency exchange, serves as the customer end-point. Customers are onboarded and exchange fiat currency for Libra on Calibra. Once Libras are held in the wallet, the transaction on the blockchain is simply a shift in “who owns the Libra”; no further exchange rate needs to be applied as part of the transaction.
The complexity of a ‘single-currency’ Libra system depends on design and there are different options: Adding a protocol for cross-currency exchanges on the blockchain settlement would arguably be more complicated given the necessary integration of ‘third-parties’ offering exchange rates. This would require a solution such as an added smart-contract layer whereby transfers are only executed if people agree on an exchange rate. A simpler solution would just separate the processing of ‘single-currency’ Libras. That is, each ‘single-currency’ Libra would run on its own ledger. Customers would hold multiple ‘single-currency’ Libras in their wallet. Before initiating a transfer to another user, they would have to ensure that they have sufficient amounts of the currency they wish to send (e.g. USD-Libra) and if they do not, exchange one for the other (e.g. EUR-Libra for USD-Libra). Admittedly, even the latter system makes things slightly more complicated. But it should be noted that the basic infrastructure has to be in place anyways: Calibra already will have to provide foreign exchange services, pricing Libra in different domestic currencies and enabling quick transfer from fiat to Libra. This same infrastructure of foreign exchange management can be used to enable exchanges from one ‘single-currency’ Libra into another. In simple terms: on top of offering transfers from USD to Libra, Calibra would offer transferring USD-Libra into EUR-Libra.
At the same time, there are benefits to managing such a system. The current Libra system requires a complex management of pricing a multi-currency unit in single-currency units: Users will buy Libra, a basket of currencies, with one currency only. And when they cash-out, they do not receive a basket of currencies but one currency in return. This requires a complex system of hedging and reserve management that can be explained by example: if a customer buys USD100 worth of Libra, new Libras will be minted and directly backed by “purchasing” a basket of reserves that at current exchange rates, is worth USD100. Ideally, for correct pricing these exchanges of the USD100 into the different reserve currencies happen at the same point in time to minimize exchange risk. In a ‘single-currency’ Libra, the USD100 for the purchase of USD-Libra can directly be used as the reserve. Or if a foreign currency, say Filipino Peso, is used for the purchase of USD-Libra a simple bilateral exchange rate, rather than multiple exchange rates, will be applied.
That is, the advantage of the current Libra-system in its simplicity once fiat has been transformed into Libra comes at the price of maintaining a more complex system of exchange between fiat and Libra. It is unclear how exactly the costs of these systems compare to each other but at the very least it is not obvious that the foreseen system of Libra requires less resources.
Last and perhaps most importantly, a system of ‘single-currency’ Libras may actually make it a more attractive product, precisely for the reasons why central banks are weary of the project: the ‘unit of account’ function of money. John Paul Konig offers an illustrative analogy to this point: Offering Libra is the monetary equivalent of only offering a Facebook account in a new language Facebookish, rather than supporting a multitude of languages.[xxv] The costs for customers to learn and adopt how to communicate value in terms of Libra serves as an adoption hurdle after users have been socialized in national units of account.
This is of course pure speculation on how customers will react to products, and indeed speculating about customer behaviour rather than testing it is bad practice in product development. However, one can have hypotheses and it is noteworthy that attempts in the past to market basket currencies –Barclays B-Unit (1974), Credit Lyonais International Financial Unit (1974) or Rothshild & Sons Eurco (1973)– ultimately proved unsuccessful in customer adoption.[xxvi]
Technological capabilities today are of course different than in the 1970s and the potential for Libra to alleviate existing pains in payments has a better value proposition than currency baskets in the 1970s. And of course, Libra would get a headstart with more than 2 billion customers in place. However, it is noteworthy that in the 1970s, times of substantial currency turmoil, where a strong use case for stable currencies existed, even the customers that should be apt to adopt the parlance of international monetary exchange, international traders, did not adopt those products.
These questions on customer adoption are beyond the scope of this paper and require empirical testing. My contribution in this article was to show how Facebook could mitigate monetary sovereignty concerns if it wanted to. Ultimately the choice presented here boils down to a simple question that Facebook should ask itself: Should we keep pushing a product that puts us under intense public scrutiny? Or should we tweak it, focus on becoming and efficient payment system and dial back on plans that have the potential to upheave the monetary systems?
[i] Issing, Hayek, Currency Competition and European Monetary Union, 29–30.
[ii] For an overview of the reactions, see O’Neal, “Facebook Libra Regulatory Overview.”
[iii] Koning, “Does Libra Threaten Monetary Sovereignty?”
[iv] French Ministry of Economy and Finance, German Ministry of Finance, “Joint Statement on Libra.”
[v] Zmudzinski, “US Congress Requests Moratorium on Facebook’s Libra Stablecoin.”
[vi] Issing, Hayek, Currency Competition and European Monetary Union, 16.
[vii] Issing, Hayek, Currency Competition and European Monetary Union, 16.
[viii] Brunnermeier, James, and Landau, “The Digitalization of Money,” 7; Issing, Hayek, Currency Competition and European Monetary Union, 15–17.
[ix] Issing, Hayek, Currency Competition and European Monetary Union, 16–17.
[x] Issing, 17.
[xi] Landau and Genais, “Digital Currencies – An Exploration into Technology and Money,” 70.
[xii] Buiter, “Global Economics View – Gold: A Six Thousand Year-Old Bubble Revisited,” 8.
[xiii] For the seminal papers introducing the idea of independent central banks as the solution to the time-inconsistency problem if inflating for political gains, see Kydland and Prescott, “Rules Rather than Discretion: The Inconsistency of Optimal Plans”; Barro and Gordon, “A Positive Theory of Monetary Policy in a Natural Rate Model.”
[xiv] Barontini and Holden, “Proceeding with Caution.”
[xv] Barontini and Holden; Landau and Genais, “Digital Currencies – An Exploration into Technology and Money”; Brunnermeier, James, and Landau, “The Digitalization of Money.”
[xvi] Landau and Genais, “Digital Currencies – An Exploration into Technology and Money,” 68.
[xvii] Indeed, the introductory quote by Issing points out that the fading out of “notes and coins” in circulation itself might already be sufficient to render the unit of account function unnecessary.
[xviii] Marsh, “Why Central Bankers Got Serious About Digital Cash.”
[xix] G7 Working Group on Stablecoins, “Investigating the Impact of Global Stablecoins.”
[xx] French Ministry of Economy and Finance, German Ministry of Finance, “Joint Statement on Libra.”
[xxi] Niepelt, “Libra Paves the Way for Central Bank Digital Currency.”
[xxii] Transferwise for instance offers such multi-currency accounts.
[xxiii] Another potential consequence should be noted: If Libra became a widely used medium for payments in the longer-term future, its basket backing might become self-defeating for two reasons: Once financial products and loans are granted in Libra, and credit and derivative markets in Libra develop, it generates a money multiplier. In that case, the original reserve of fiat currencies will be insufficient to secure the amount of Libra denominated assets created (“Facebook’s Libra Must Be Under Central Bank Oversight, PBOC Says.”). At this point, Libra will either have to become a fractional reserve system, reneging on its initial promise of fully backing outstanding claims, or be inherently deflationary. Moreover, the mechanism may be self-defeating in its choice of trust-anchor: Today it may appear unrealistic that Libra itself as the issuing entity will be the key source of trust. However, in say 70 years if payments are predominantly made in Libra with people having grown up under a Libra-system, leveraging the trust from currencies that are not the dominant use of payments seems almost paradoxical (and might even become deflationary).
[xxiv] Libra Association Members, “An Introduction to Libra,” 9.
[xxv] Koning, “Moneyness,” September 23, 2019; Koning, “Moneyness,” June 25, 2019.
[xxvi] For an overview see Koning, “Moneyness,” September 23, 2019; Aschheim, “Artificial Currency Units: The Formation of Functional Currency Areas.”
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