Facebook's proposed digital currency and global payments systems raise serious concerns. The new world of frictionless international currency flows sets the stage for severe and chronic capital-market volatility

Facebook's proposed digital currency and global payments systems raise serious concerns. The new world of frictionless international currency flows sets the stage for severe and chronic capital-market volatility

Facebook’s unveiling of a new digital currency, Libra, has produced a tidal wave of skepticalcritical, and outright hostile responses. That is understandable, given Facebook’s reputation for carelessness about user data and personal privacy. Nonetheless, public angst won’t stop the company that once promised to “move fast and break things” from forging ahead – and possibly breaking entire national economies in the process.

We don’t yet have a full account of how Libra will work. For all its revolutionary hype, it could turn out to be just another variation on existing payment schemes. Apple Pay, PayPal, WeChat, and other services already each offer a basic payment method, including various convenience-enhancing features to lure customers and businesses. But, in substance, these services are merely an additional link in the chain of existing payment channels, ultimately connecting to the conventional banking system.

If Libra simply competes with these existing players, there could still be rich pickings for Facebook, not just transfer and foreign-exchange transaction fees, but also in terms of data collection. Amassing the payment and transaction details of the social network’s huge user base would be a glittering prize in itself.

But, of course, Libra is being sold as much more than this. As one Facebook executive puts it, “We want sending money to be as easy as sending a text message.” Given that Libra will take the form of private money linked to a basket of stable major currencies, how would this work in practice?

If the people of Argentina could switch from pesos to a basket of stable currencies with a single touch of their smartphones, wouldn’t they then pour into that safe asset at the first hint of trouble in the domestic economy? A standard “efficient market” analysis does not help us answer that question, because in perfect markets, such flows would be self-correcting. According to this view, if the Argentine public abandoned its peso holdings, the peso would depreciate, and arbitrageurs would step in to support the now-undervalued currency. The peso would return to its initial value, and all would be well. Far from posing a threat to financial stability, frictionless international flows would create the “efficient market” par excellence.

Unfortunately, the real world doesn’t work that way. During a spasm of domestic panic, international capital flows in a system without the equivalent of deposit insurance are more likely to follow the logic of a bank run. When depositors fear the possibility of a bank failure, the sensible ones withdraw their money. If the bank fails, they avoid a loss; if it survives, they can simply redeposit their money at little cost. But when enough depositors do the sensible thing and withdraw their funds, the bank will fail.

The same type of self-fulfilling prophecy can also occur in a national economy. If a peso depreciation seems imminent, all rational holders of pesos will dump them for a readily available stable currency, thereby causing the rapid depreciation they feared.

In today’s world, such massive shifts between currencies are rare, because there is substantial friction in international currency transactions. Even with major currencies, the spread between buying and selling rates for a foreign currency is typically around 10% (for retail customers). Moreover, there are also substantial transfer fees, such as those charged by Western Union for foreign workers’ remittances. And though large financial-sector players can and do carry out destabilizing transactions, such as in the 2013 “taper tantrum,” the currency flows in these cases are still constrained by regulatory requirements.

We don’t really know what would happen if the general public suddenly had access to a low-cost, unregulated method of exchanging a volatile local currency for a basket of safe currencies. But the risks are obvious. Countries with a long record of devaluations, like Argentina, as well as any middle-size country with a floating exchange rate, would be highly vulnerable to capital flight.

Proponents of the efficient-markets theory have long pushed for more frictionless transactions, in order to maximize the scope and benefits of the price mechanism. But so far, we have been saved from the disastrous consequences of frictionless international currency flows by the inefficiencies of the prevailing system. Exorbitant transaction fees and anti-money-laundering (“know-your-customer”) regulations have thrown enough sand in the gears to make international currency runs a rare occurrence.

But if Facebook introduces seamless international transactions for the general public, runs will become commonplace. Inevitably, governments will have to step in to introduce a new form of friction to the system. One partial solution is a small universal financial transaction tax of the type proposed 50 years ago by the Nobel laureate economist James Tobin. Though a “Tobin tax” wouldn’t address all the issues concerning privacy and financial stability, it could discourage short-term speculative flows without undercutting incentives for more beneficial transactions such as foreign direct investment.

Policymakers around the world have been discussing a Tobin tax for decades. Now that Libra is looming on the horizon, it is time to put words into action – before Facebook does. 


Stephen Grenville, a former deputy governor of the Reserve Bank of Australia, is a non-resident fellow at the Lowy Institute in Sydney.  Copyright: Project Syndicate, 2019, published here with permission.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

We welcome your comments below. If you are not already registered, please register to comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.

11 Comments

Comment Filter

Highlight new comments in the last hr(s).

Everyone is eyeing the huge profits made by Visa and Mastercard
https://www.marketwatch.com/story/visa-and-mastercard-earnings-more-than...

This is why Libra is so different. Rapid devaluation of a currency when a country gets in the slightest trouble will become commonplace and will spread globally very quickly. This is why I think it would become one of the dominant global currencies very quickly, particularly with payment companies on-board. Really it's what should have happened 20 years ago - the world should have adopted a global currency and put currency speculators out of business to enable frictionless payments. It's just sad it is at this end of the globalisation movement. Would have been much better at the start.

What people aren't thinking about is the reaction this will have with the people that control it. Suddenly they will see themselves as their own viable and strong currency and quickly implement their own monetary policy, including Libra supply side restrictions. Why? Because it will make them very powerful and earn them a lot of money as the currency appreciates.

The tech companies will have a choice: Become the defacto currency for valuing things in multiple (particularly developing) economies, giving them control which translates to future profits. Or simply act as neutral actors creating a frictionless "between other currency" payment system. They will claim the latter, but on implementation will quickly become the former. Shareholders will demand it. The only thing which will stop them is new international agreements to essentially outlaw them (BAU monetary policy and geo political issues with actors who profit from it will become very vocal and lobby everyone and anyone), or military/domestic police action under the guise of "national security".

A global currency could be great, a global fiat currency would be terrible. No one should have that much power. Look at what the US does and how they operate due to the fact that they are currently the worlds reserve currency - now imagine if there was no competition.

You think Govts and central banks are just going to roll over and let Zuckerburg and co take away one of their levers of power?
It will be interesting to see what happens when any of these non Central bank controlled currencies start to look like they might be adopted by the public in a significant way.. the war will be on.

Nope. Hence what I said in the last sentence.

The question is, will domestic authorities be able to react fast enough to stop it? Because the tech co's will say "you are just blocking a payment technology". If they are able to win that argument, then the speed at which it changes into an international currency will be frightening.

Think about this though. If the tech companies only wanted a better payment system, they wouldn't need to create a new currency. But they do and are suggesting an entirely new currency. So I think they have thought about this and are actually saying "we want to play world politics, because we think we can out perform local and international monetary agencies, putting us at the centre of world commerce".

The Zuckbuck (Libra) is all part of the grand plan for one currency, one govt by the oligarchs and global elite. The days of the US $ being the worlds reserve currency are numbered. Many governments including China, Russia, Iran etc see it as a manipulative tool of the US.
Rather than being ‘pegged to a basket of currencies’ (FB would be the only entity that earns interest), any alternative replacement pegged to gold would be a good contender - as good as gold, as they say. Fiat currencies are based on one thing only - trust.
Interesting that Russia and China have been quietly building up significant gold reserves over the last 10 years. He has the gold makes the rules.

Don't forget the fiasco that is Euro, a common currency for the Euro Zone and the miseries it wrought on many of the participant nations. A global currency would never happen. The technology underpinning crypto currencies like the proposed Libra will not be trusted. Already the world is reeling with meta data, control of internet by a few, hacking overload and other unintended consequences of the digital age we are living in. And many large sections of the world population is not yet digitally connected. Criminals and fraudsters would have a field day with Libra and such, without any control by various governments. Between Corporates and Elected governments the choice is clearer.

“But when enough depositors do the sensible thing and withdraw their funds, the bank will fail.” it wasn’t always this way and it doesn’t have to be you know...

" Libra panics " .. . have we run out of tampons or something . .

... ye gods , peak sanitary napkins .... YUCK !

The Banks and money changers will be worried (expect much hand wringing end of world PR) and so they should be... but this is just another currency... the difference is that this transcends borders. A global currency for a globalist world.