27 January 2020

Bruegel: Libra as a currency board: are the risks too great?

The Libra Association claims it will be analogous to a currency board regime, but they have overlooked the problems of monetary management that come with it, warn Julia Anderson and Francesco Papadia.

Facebook’s Libra project to create a digital currency has had a difficult start, with criticism from authorities, and the departure of some founding members. Libra’s critics have mostly focused on risks associated with money laundering, financial stability and data privacy. But the project also raises questions about monetary management.

Libra’s promotors present it as a payment system innovation. It is, however, also a new monetary system, because it implies the creation of a new currency—at least in the project’s initial form—and because the Libra Association itself has characterised its approach as “similar to the way in which currency boards (eg of Hong Kong) have operated”.

Currency boards are a type of monetary system in which the issuer balances its liabilities with assets in the form of foreign currency. 

Libra is thus analogous to a currency-board regime. And yet, Libra’s proponents have so far overlooked the problems of monetary management that a currency board raises.

In currency boards – and Libra – the issuing entity holds different items on the two sides of its balance sheet and must ensure consistency between them (eg Libra coins on one side, a basket of high-quality assets on the other). But shocks will inevitably hit both the asset and liability sides of the Libra issuer’s balance sheet, potentially disrupting this consistency.

Regulation might overcome some of the challenges, for example, if there were an obligation to create an equity buffer. However, regulating a global currency such as Libra will require deep cross-border coordination and a genuine acceptance of regulation. Creating a new monetary system, such as Libra, seems a disproportionate and potentially ineffective approach to achieving a safe, stable, cheap, simple and instantaneous global payment system.

Full article on Bruegel

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