Silence in response to Facebook’s announcement this week is tantamount to endorsing its dangerous new venture. Governments must not allow private, profit-seeking parties to put the entire global financial system at risk. If banks are “too big to fail,” then states definitely are. If governments fail to protect us from Facebook’s latest act of hubris, we will all pay the price for it.
The problem is that she makes (at least) one major factual and one major conceptual error that completely undermines her whole argument.
The factual error:
Libra, we are told, will be pegged to a basket of currencies (fiat money issued by governments), and convertible on demand and at any cost.
Told by whom?
Pistor has not even read the white paper of the product she is denouncing.
According to the white paper:
A basket of bank deposits and short-term government securities will be held in the Libra Reserve for every Libra that is created, building trust in its intrinsic value.
Further we are told:
The actual assets will be a collection of low-volatility assets, including bank deposits and government securities in currencies from stable and reputable central banks.
So the peg is to a basket of financial assets – denominated in fiat currency and priced in fiat currency – but it is not “a basket of currencies”.
Then there is the conceptual error:
Should Libra ever face a run, central banks would be obliged to provide liquidity.
No. Libra is not a fractional reserve currency.
By fully backing each coin with a set of stable and liquid assets (described later) and by working with a competitive group of exchanges and other liquidity providers, users can have confidence that they will be able to sell any Libra coin at or close to the value of the reserve at any time.
If there were a run on Libra – users would simply redeem their Libras (Zucs or Zucbucks) for fiat.
So Pistor is worried about a non-problem. Facebook is not proposing to create a bank – that could experience a run. That might need to be bailed out. That could face moral hazard due to implicit guarantees. Etc. Etc. Etc. They are proposing a payment system with a 100% backed currency.
So what are the potential problems?
(1) Facebook proposes to create a minimum-variance portfolio to provide the intrinsic value. A large systemic shock to the global financial system could severely reduce the value of that portfolio. Okay – that could happen. People might lose money under that scenario. But … under that scenario everybody is losing money.
(2) Facebook might cheat. They might not maintain 100% backing. Libra might become a fractional currency. That is a potential problem. This is where the institutional arrangements surrounding Libra become important.
(3) The peg might be unstable. This is effectively a fixed exchange rate system. Fixed fiat exchange rates always get attacked. The story goes something along these lines – speculators start shorting the currency driving up short-term interest rates in the economy. After some to-ing and fro-ing the government can no longer bear the economic pain of high short-term interest rates and abandons the peg. It isn’t clear to me where the equivalent short-term interest rate is that imposes high economic costs on the system. (If you know – email me there is heaps of money to be made).
On these points see the Q&A between Tyler Cowen and Christian Catalini – especially Q4b and Q7.