Facebook’s unveiling of a new digital currency, Libra, has produced a tidal wave of skeptical, critical, 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.