Libra As A Competitor To Inflationary Central Banks

Authored by Pietro Bullian and Fabrizio Ferrari via The Mises Institute,

As an international private currency, Libra will be in competition with publicly issued currencies.

It could have large and fruitful repercussions on the global monetary policy, especially with reference to those countries where central banks are still heavily subject to political influence and tend to pursue inflationary monetary policies.

The introduction of the Libra project to the public has generated a lot of fuss over the consequences this cryptocurrency may have for the stability of the global financial system.

At first, we need to clear the ground from the most common mistaken facts about Libra running over the news. As detailed in this white paper, Libra will be a fully backed digital currency, it will be issued solely upon demand, and its value will be given by a basket of reserves whose composition will be diversified, privileging safe assets and stable international currencies (as thoroughly described in thetechnical part of the white paper dedicated to the functioning of the reserve mechanism).

Thus, despite the rumors, we know as a fact that Libra will not:

  • run its own monetary policy, since it will not be in control of its money supply;

  • create commercial-banks money, since it will not leverage on its costumers’ deposits to create new units of Libra operating under a fractional-reserve scheme like regular commercial banks do;

  • be pegged to any existing currency, since it will not take a specific commitment to fluctuate in a stringent range vis-a-vis any currency or basket of currencies.

Lastly, the fear that a sudden bank-run may cause the collapse of the Libra is either irrational or it confirms early critics have not yet understood the basic functioning of the project. In fact, the fully backed-ness of Libra would make it much safer than commercial-banks deposits we daily accept as means of payment, because Libra would be always redeemable—at least—into legal-tender currency; this redeemability would not be just theoretical (as it occurs with commercial-banks money and fractional-reserve banking) but also practical, because a unit of Libra could be created if, and only if, a unit of monetary base (i.e., legal-tender currency) or a claim on it (i.e., a unit of commercial-banks deposits) were conferred in exchange for that very unit of Libra.

In other words, while commercial-banks money (that is, deposits) can be created out of thin air—simply granting a loan—Libra would be instead created if, and only if, backed by a formerly existing unit of money—either of the central bank or of commercial ones (recall: money of commercial banks are deposits, which entitle the owner to claim a unit of monetary base, i.e., legal-tender currency).

For all these reasons — sticking to what we really know about Libra so far — Libra will have a value which will be stable in time with respect to the main reserve-currencies of the world. The relatively stable value of Libra, together with its worldwide accessibility, is what we believe may have positive and interesting repercussions. Libra may become a safe, accessible, cheaply storable reserve of value for those people living in countries that experience unbearable high levels of inflation to this day.

Moreover, the analogies between Libra and the first steps of the Hayekian proposal of “Denationalization of Money” (1976) are strikingly patent, insofar as Libra:

  •  is a privately issued medium of exchange;

  •  is subject to a 1:1 reserve system, in which money-creation out of thin air is not allowed;

  •  remains fully redeemable in terms of existing legal-tender currencies.

Therefore, Libra — if not impeded by governmental legislative power — would provide consumers with a medium of exchange whose inflation would be the weighted average of the safest legal-tender currencies of the globe, thus naturally displaying a potential standard deviation of its value — that is, deflation or (more likely) inflation — closer to them than to that of more volatile currencies. After a while, highly inflated legal-tender currencies (especially in those countries with relevant governmental interference and political influence over central bank’s activity) would be gradually less demanded in exchange for goods and services and, were governments not to forbid payments denominated in terms of Libra-units (that is, were they to allow Libra to exist as a full-fledged means of payment), then Libra could (analogously to what is postulated by the Grisham’s Law, but —somehow — in reverse) drive governmental money out of the payment-mechanism and prompt agents to hold to Libra for payment-purposes.

Thus, citizens would be induced to hoard governmental money only in order to pay taxes — since government would not, most likely, forego their privilege of imposing which unit of account taxes are to be paid in, that is, which unit of account is decreed to be legal-tender currency — and would be given the opportunity to access a slightly more competitive money-market.

For example, were Libra allowed to circulate alongside the publicly issued currencies in countries such as Turkey or Argentina, which at present experience high level of inflation, citizens of these countries will soon start to be interested in storing their wealth in Libra-coins, which is what has in part already happened with Bitcoin or major international currencies — like the dollar. The advantage Libra could have over Bitcoin is that it promises to deliver far better in price stability, while the advantage it could have over the dollar is that it has the potential to flow freely over the internet, overcoming the capital control barriers and all sort of government limitations.

Surely, critics point out that the currencies of said countries will not be accepted as a collateral for the issuing of Libra, hence these people will not be the early adopters of the currency. Nevertheless, Libra may eventually get to these countries from the international trade, via inflows of capital or (more likely) goods and services purchasing; and, since money transfers in Libra would be far cheaper and easier to handle, Libra could then start to be adopted as an alternative currency by more and more people inside the country. In such a scenario, people will express their preference for Libra instead of their local currency, and that will represent an incentive to the local central banks not to act inflationary so to restore the confidence in their own currency, displaying the fruits competition could bear also in a traditional public dominated market — as that of currencies currently is.