15 May 2021
The decision of the Diem Association, formerly Libra Association, to retreat from Switzerland seems to further affirm a scaling back of its original objective of offering global digital coins. However, it should not lead to the conclusion that private digital payment mediums do not have a role. The limitation of national currencies is that they are national in scope. Private currencies are meant to denationalise currencies and they can.
The Diem Association embarked on an ambitious project to offer a new currency, then the libra, to serve as international payment medium. Its original white paper of June 2019 reshaped the debate about digital currencies and led central banks to look in earnest into adopting central bank digital currencies (CBDC). It stated that “parts of the financial system look like telecommunication networks pre-internet” and that “blockchain and cryptocurrencies have a number of unique properties [like] open access, which allows anybody with an internet connection to participate.” Both still hold.
Libra was meant to become “a simple global currency and financial infrastructure that empowers billions of people.” National currencies serve their national territories and act mostly as unit of account for all prices in the national economy. A car can be produced in a given country and driven everywhere where a road infrastructure is in place. Most goods and increasing services can be employed internationally. Currencies can normally be used only nationally. The idea to have a currency that can be used everywhere is therefore appealing.
The call for international currencies is not new of course. During the nineteenth century, union coins (Vereinsmünzen) served as payment mediums throughout the German Customs Union (Zollverein) and Austria and circulated as legal tender in parallel to state-issued coins to facilitate economic and financial integration. The euro is the best example of the case for a common currency. The IMF’s SDR has remained an ambitious project of serving as international reserve asset. The case for international currencies is strong.
Libra shocked many who thought a currency needs to be issued by a state actor. While historically bank notes were issued by private banks, the dominant currency issuance model is undeniably that of a national central bank. At the same time, most monies are private, being liabilities of the banking system. Other critical services are also private including healthcare, education, life insurance. While some central banks have an enviable record of delivering currency stability, most have not. A private currency may not meet all the attributes of a national currency, e.g., to serve as legal tender or underpin a lender of last resort. But the idea of a private currency to function as payment medium should not be controversial.
For libra to act as international payment medium, it would have to be accepted internationally. This could take the form of local merchants and banks accepting libra and prices being denominated in libra. In dollarized economies, certain prices are often denominated in dollars, so there are precedents for prices to be advertised in different currencies. The use of a foreign currency in a national economy may also cause monetary problems but those would be similar to the constraints of dollarization.
The adoption of libra would have been based on trust. The stability of a currency relative to a given benchmark is normally seen as a prerequisite for currency adoption. Many central banks have therefore pegged their currencies to a foreign currency, typically the dollar, for decades to build trust and many still do accumulating large amounts of international reserves to ensure convertibility of their currencies. The dollar itself was fixed to gold for the same reason through the early 1970s. Building trust will remain the main challenge for private currencies. But the challenge is no different than for any central bank. Daily exchange rate fluctuations are testament to that.
Libra was meant to be fully backed by international reserves. A basket of bank deposits and short-term government securities denominated in national currencies would have been held against every libra in circulation. This approach, akin to a currency board, was meant to signal that libra would have maintained a stable value relative to the chosen basket of assets. It would also have implied that libra would not have caused an expansion of money but merely a substitution of currencies.
The case for a libra remains strong. It was meant to deliver “a lower-cost, more accessible and more connected global financial system.” This is still needed. Libra would have had to prove it is worth holding like every currency has to do every day. With libra retreating, other similar currency projects will surely emerge. Central banks remain in a strong position to defend their currencies against newcomers. But in an increasingly globalised economy, the call for global currencies will remain. Central banks could offer that. But there is no reason the private sector could not.