MUMBAI: The new global digital currency of Facebook, Libra, which the company plans to launch in 2020, could transform the world.
But no one – including the founders of this ambitious economic engineering project – can fully predict the possible consequences of the currency. Monetary policy makers should be particularly concerned, as it may be much more difficult to control unemployment and inflation in the world of scales.
CAN BE DOMINANT GLOBAL CURRENCY
In the first quarter of 2019, Facebook had 2.38 billion active users per month. If even a part of them begin using the Weigh to perform financial transactions, purchase and sell products and transfer money, the new currency would quickly gain broad acceptance.
Already the Libra Association, a non-profit Geneva-based non-profit group that will manage digital currency, counts businesses such as Uber, eBay, Lyft, Mastercard and PayPal among its founders. The scales, therefore, could become the dominant global currency – but the one run by the corporation, not the central bank.
Although Libra is based on the same blockchain technology as other crypto currencies, it is expected to be much more efficient. Facebook promises that the Libra system will be able to process 1,000 transactions per second, be user-friendly and have transaction costs almost zero.
Concern is full
It is not surprising that the announcement of Libra prompted a rush of meetings with central banks, the International Settlements Bank and other multilateral organizations.
Some commentators have welcomed the proposed new private money while others want the governments to stop the Vague before it starts.
Critics of the initiative have several issues, including the computer power required to manage the currency, the privacy of user data, and the possibility that new money will boost unlawful activities and markets. But much more attention needs to be devoted to the analysis that the scale can dramatically change global monetary policy.
Most of the institutional structures and systems in the world economy – barter, banking, paper money, financial markets and so on – have emerged through slow, evolutionary processes. Intentional attempts to establish completely new systems have usually provoked unexpected challenges.
The creation of the euro was one such planned act of economic engineering that had unforeseen consequences. In my book "The Economist in the Real World", I discuss how the yields on bonds went out across the eurozone after the Lehman Brothers 2008 collapse, causing the European debt crisis that is still the world economy today.
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Finally, the crisis stemmed from shortcomings in the design of the eurozone (monetary union without proper common fiscal policy – a problem that has not yet been resolved).
At this stage, one can only speculate about the problems that Libra can cause. For example, if Libra becomes popular, people will replace their national currencies – dollars, euros, yuan and rupees – for new digital money to buy and sell many of the products that will be in it.
Many users can then decide to keep Libra instead of exchanging it for their own currency.
Facebook or Libra Association will therefore continue to keep its national money and make money on it by investing Libra's money. They will also be tempted to issue an extra balance to earn seigniorage in the same way that central banks are working on the national currencies they issue.
The reduced ability of inflation control – and policy makers – must have a prominent place on the list of potential risks. Usually, when inflation appears, central banks take steps to control it.
They increase the policy rates and increase the proportion of mandatory reserves to help with the removal of part of the money in circulation.
But the effectiveness of such policies could be considerably reduced if it is one of the largest private money-making authorities. The Vaga itself can create some inflationary pressures because it is an effective liquidity supplement.
More recently, high inflation is visible only in developing economies. There is a tendency to assume that developed economies are immune, but it is naughty to recall that the two most frustrating cases of inflation in history were in relatively rich countries: Hungary in 1946 and Germany in 1923.
In Germany, which cost one brand at the beginning of inflation growth, it cost 100 sextillion marks (one with 23 zero after that) barely a year later.
YOU ARE NOT A RIGHT PLAY
Despite these risks, a call for the momentary suspension of the Scales may not be a real move.
To begin with, it is unclear what the existing law could use to stop the proposed currency. At one level, the scale does not differ much from legally valid coupons that people get their dollars when entering the amusement park and then used to pay for food and driving.
And in a globalized world, a country that rejects the Scales, it can be gradually isolated from others who accept it.
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Policy makers must urgently consider what kind of world the private digital money could create. Then we may need new laws and global contracts to alleviate the potential negative consequences and limit the power of organizations managing these new currencies.
Kaushik Basu, former chief economist of the World Bank and former Indian government's chief economic advisor, Cornell University's economics economist and non-resident senior associate at the Brookings Institution.