This article first appeared in Forum, The Edge Malaysia Weekly on July 22, 2019 - July 28, 2019
On June 17, a Facebook white paper proposed a new global digital currency that it plans to launch in the first half of 2020. The Libra will be managed by a “not-for-profit” Swiss-based Facebook-led consortium of “for-profit corporations”, with Uber, eBay, Lyft, Mastercard and PayPal among its founding members.
The initiative has received mixed reactions. While a few have cautiously welcomed it, most commentators want it stopped or tightly regulated, with one calling it a “totally insane idea”.
Even US President Donald Trump declared that he is not a fan of cryptocurrencies that facilitate illegal activity, adding that “if Facebook and other companies want to become a bank, they must seek a new banking charter and become subject to all banking regulations, just like other banks, both national and international”.
Trump’s comments came a day after US Federal Reserve chairman Jerome Powell told lawmakers that Libra could not move forward unless it addressed concerns over privacy, money laundering, consumer protection and financial stability.
Meanwhile, the G20 finance ministers agreed that the regulation of cryptocurrencies requires a global coordinated effort involving national, regional and international authorities that span into different regulatory and geographical borders.
Unlike other cryptocurrencies with no intrinsic value, Libra will be backed by “a basket of bank deposits and short-term government securities”. Hence, when anyone buys Libras, the Facebook-led consortium will acquire matching securities in different currencies, reversing this process when Libras are redeemed.
Although securities’ prices and exchange rates will become more volatile, it is claimed that the Libra will be more stable! The plan is to become more decentralised over time, more resistant to regulation, and hence, an unregulated “shadow” payment system.
Cost-cutting appeal
Facebook claims that Libra will be more efficient than all existing payment platforms, which are both fragmented and costly, with highly regulated financial institutions at their core, facing expensive prudential compliance requirements against money laundering and for consumer and privacy protection.
By avoiding them, Libra could reduce costs, particularly for cross-border transactions. As Facebook asserts, its user-friendly Libra system can process 1,000 transactions per second at almost no transaction costs. Early this year, Facebook had 2.38 billion active users monthly. Libra will allow Facebook users to make financial transactions anywhere, almost instantaneously.
As the Libra becomes more popular, the consortium may offer more services, particularly credit. Thus, Libra can shake up world finance, not just banking systems, by circumventing and disrupting central banks and governments.
Compounding risks
Critics have raised privacy, money laundering, consumer protection and financial stability concerns, pointing to Facebook’s track record of disregarding privacy, exploiting user data and failing to control its platform.
Facebook has already been investigated for massive privacy violations, anti-competitive practices, eroding the free press and fomenting ethnic cleansing while the “new money” may enable more illicit activities.
According to the Bank for International Settlements, cryptocurrencies issued by big tech companies, such as Facebook, could quickly dominate global finance and threaten competition and stability.
Matt Stoller, of the Open Markets Institute, described Libra as “a private global International Monetary Fund run by ‘tech bros’, except it needs reserves so it will need a giant bailout during a crisis”, highlighting four core problems with Libra:
- First, to ensure a reliable payment system while preventing illicit financial activities, for example, money-laundering, terrorist financing, tax avoidance and counterfeiting.
- Second, preventing conflicts of interests such as access to information, business relations or technology.
- Third, a greater global systemic risk if Libra succeeds. Governments will need to prepare for public bailouts of a private “too big to fail” system due to the systemic threat posed, which then requires more liquidity than any single central bank or government can provide.
- Fourth, the governments’ ability to pursue sovereign policymaking will be curbed as Libra and related decision-making will be in private corporate hands, not democratically accountable governments. Mark Zuckerberg once bragged, “In a lot of ways, Facebook is more like a government than a traditional company … We’re really setting policies.”
When Libra becomes popular and the consortium offers other financial services, private for-profit companies would have their own central bank and “fiat currency”, undermining central bank and government control over monetary policy. This will effectively privatise monetary policy, with scant regard for public interest.
Not for profit?
Facebook claims the Swiss-based consortium governing Libra will be a not-for-profit foundation. But as Libra becomes popular, people will exchange their national currencies for Libra. When they hold Libra, the Association will earn from investing users’ money, and may even issue extra Libra to earn seigniorage, as central banks do with national currencies.
They can also profit handsomely from regulatory arbitrage, for example, between regulation and no regulation, or even just less regulation. Even if Libra remains just a payment system, fully backed by fiat currencies in reserve, consortium decisions to buy certain currencies and assets will move bond markets and exchange rates. Partners’ profits from using the financial data of Libra users can grow rapidly if loosely checked and regulated.
First target: Developing countries
Facebook’s explicit target is 1.7 billion people across developing countries without banking services, with a promise to speed up transactions and cut costs. Thus, developing countries with poor capacities and capabilities are especially vulnerable to the Libra threat. The introduction of the Libra will likely accelerate the losses for countries that are already losing trillions of dollars via illicit fund transfers.
Macroeconomic policies in major advanced economies make developing countries’ financial sectors vulnerable to shocks and volatility. Their limited capacity for making independent macroeconomic policies will be further constrained.
As with the dollarisation temptation, those in countries with weak currencies will be tempted to “Libralise”, reducing the use of national currencies for accounting and invoicing and further complicating monetary policy and stability.
Alternatives?
Such an unregulated, privately owned and directed global payment system issuing its own currency that further diminishes policy space for development is alarming, especially for developing countries.
But merely suspending the initiative until full ramifications are understood with appropriate regulatory measures in place will not address the problems of existing systems that encourage such moves, for example, governments and central banks have lagged behind technological developments and have been slow in enabling low-cost real time transactions.
Therefore, policymakers must urgently consider alternatives such as creating publicly owned digital currencies to supplement traditional monetary instruments. They also need new laws and global treaties to check those issuing global digital currencies and mitigate negative fallouts.
Jomo Kwame Sundaram, a former economics professor, was United Nations assistant secretary-general for economic development. He is the recipient of the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought, and a member of the Economic Action Council. Anis Chowdhury, a former professor of economics at the University of Western Sydney, held senior United Nations positions from 2008 to 2015 in New York and Bangkok.
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