Will Libra impinge on monetary policy?

Here’s Tyler Cowen, discussing the proposed new Facebook cryptocurrency called “Libra”:

4. We are told “The association does not set monetary policy.  It mints and burns coins only in response to demand from authorized resellers.”  Maybe, of course there are hundreds of years of debate on that one, google “real bills doctrine,” noting that here we have a semi-dominant private issuer rather than a perfectly competitive banking system.  The association policy on interest rate spreads, floats, and credit, of course, can end up being a monetary policy de facto.  I don’t want to prejudge this one against Libra, since to me the validity of the real bills doctrine is a genuinely open question, but it is worth noting that most economists would not agree with the doctrine in most settings.

I’m no expert on cryptocurrencies, but here’s my best guess on this issue, FWIW.  It will be helpful to begin with a discussion of how the “real bills doctrine” applies to three situations:

1. Is the creation of private bank money inflationary under a gold standard?

2. Is the creation of government fiat money backed by valuable assets inflationary?

3. Is the creation of private currency substitutes inflationary under a fiat money regime?

In each case, you need to consider the impact on the supply and demand for the medium of account (gold in the old days, currency today.)

In my view, the creation of private bank money was slightly inflationary under the old gold standard.  This is because the creation of private bank money slightly reduced the global demand for gold.  But only slightly.  (It did not directly impact gold supply.) Thus you might view the old real bills doctrine as being false, but approximately true.

In my view, the creation of government fiat money is inflationary, even if backed by valuable assets.  There are other opinions, for instance check out the views of Mike Sproul.  My view is that the creation of fiat money tends to boost the supply of money more rapidly than the demand for money, because currency is not a close substitute for other financial assets.  This is obviously less true if you are talking about the creation of interest bearing reserves. For simplicity, it’s easier to evaluate this issue in terms of the pre-2008 monetary regime, where the monetary base was 98% currency.  In that case, I don’t believe the real bills doctrine is even approximately true.

In my view, the creation of private bank money substitutes is not inflationary under a fiat money regime.  While it’s true that these substitutes would slightly reduce the demand for government fiat money (currency), the effect would be small.  And even if the effect were large, I’d expect the central bank to offset it with a reduction in the monetary base.  To the extent that it impacted monetary policy, the issuance of private currency substitutes would merely reduce seignorage.

This last case seems the most applicable to Libra.  I’d expect this system to slightly reduce seignorage, but not too much.  Seignorage does not come from the creation of interest bearing reserves, it comes from the creation of currency.  Most US currency is held for the purpose of hiding wealth.  I expect the demand for $100 bills to remain high, even after Libra.

I suspect that if Libra turns out to be highly successful then it will be a much bigger threat to banks and credit card companies than to the Fed.  But I have no idea whether it will be successful.


Tags:

 
 
 

17 Responses to “Will Libra impinge on monetary policy?”

  1. Gravatar of Benjamin Cole Benjamin Cole
    18. June 2019 at 14:53

    I will posit that the more important question about cryptocurrencies is not whether they will increase or decrease inflation, it is whether they will increase real output.

    It seems to me if central banks are suffocating real true too-tight monetary policies, which is not uncommon, the widespread use of cryptocurrencies could provide liquidity or grease to real economic output.

    Some have posited in the Old West the prevalence of counterfeit currency actually was an economic boon.

    Sadly, Scott Sumner maybe right: central banks, seeing the additional economic activity stimulated by cryptocurrencies, will simply tighten more— we see already, in the present case, that central banks are willing to tighten even if inflation is seen only with a microscope.

  2. Gravatar of Matthew McOsker Matthew McOsker
    19. June 2019 at 00:25

    FT Article
    What exactly is Facebook’s Libra Reserve?

    https://www.google.com/amp/s/amp.ft.com/content/7884a51a-c3bf-3740-9739-9e933e2e8471

  3. Gravatar of Patrick R Sullivan Patrick R Sullivan
    19. June 2019 at 06:51

    I think it highly unlikely that cryptocurrencies will ever be a large enough percentage of the monetary system to have an effect on inflation. Unless you want to think of something like the New Zimdollar as a cryptocurrency;

    https://www.forbes.com/sites/stevehanke/2019/01/16/zimbabwes-monetary-death-spiral/#4a4e666435e7

    ———-quote———–
    Press reports often indicate that Zimbabwe does not have its own money, and that this is the source of Zimbabwe’s problems. This account is incorrect. Zimbabwe has its own money and this is, in fact, the source of Zimbabwe’s problems. This is revealed by the fact that the New Zim dollars are issued at par to the U.S. dollar, but trade at a massive discount to the dollar.

    It didn’t take long after the government started issuing New Zim dollars for Zimbabwe to experience its second bout of hyperinflation. Remember that hyperinflation occurs when the monthly inflation rate reaches 50% per month and remains above that rate for at least 30 consecutive days. This initial threshold was breached on September 14, 2017, and with that, the 2017 episode of hyperinflation commenced.
    ———-endquote———-

  4. Gravatar of Philo Philo
    19. June 2019 at 09:42

    “Most US currency is held for the purpose of hiding wealth. I expect the demand for $100 bills to remain high, even after Libra.” I take it that holding the Libra fiat money will not also serve the purpose of hiding wealth. Bitcoin etc. do serve that purpose, but I suppose they are too speculative to constitute attractive alternatives to $100 bills.

  5. Gravatar of Nick Nick
    19. June 2019 at 11:14

    as stated in the white paper, libra will be completely funded by short term assets in high quality countries. as such i see extremely small monetary policy impact, this is simply like keeping your money in a money fund that pays zero interest, the slight difference is it has some fx components.

    the operators of libra will take the interest on the basket of assets backing libra, given the very real possibility that those assets will net yield a negative interest rate in the not so distant future maybe libra will die (or be designed to depreciate, which i suspect a libra customer would not be so keen on) before it ever gets going.

  6. Gravatar of Benjamin Cole Benjamin Cole
    19. June 2019 at 16:25

    I think Nick is right.

    Cryptocurrencies will only support real growth if they can escape the eyes of the panopticon, and are essentially currencies widely enough accepted but created out of thin air.

    It is worth pondering if cash and certain cryptocurrencies will become even more popular if negative interest rates become the norm.

    Ken Rogoff has said we must eliminate cash in order to bring about long-term negative interest rates.

    By the way, there is now more than $5,000 in paper cash in circulation for every US resident. In Japan, it is the equivalent of $8000.

    My understanding is that cash is widely used in Japan in the still-thriving mom-and-pop retail sector and in many other types of transactions. We can hope this means that Japanese living standards and incomes are higher than reported.

    Scott Sumner may be somewhat correct in his position that cash is used to hide wealth, but I think cash may also be used, more importantly, to shield transactional income from onerous business and labor taxes.

  7. Gravatar of Greg Jaxon Greg Jaxon
    19. June 2019 at 18:48

    In your three questions about new issues being inflationary, I find the public/private distinction to be the most crucial. A private issuer has no incentive to cause inflation, whereas the government often does. I hope all three cases assume “backing by valuable assets.”

    I do not see the relevance of real bills or their associated central banking “doctrine” to Libra or to fiat legal tender systems, unless by the term you mean the kinds of paper accepted during the 1920s at the NY Fed (i.e. often single-signature bills with no evidence that they would circulate on their own). Perhaps these false bills (in particular the callable margin loan paper) are what sour you on the approximate objective truth of the original gold bills that circulated in merchant supply chains and were highly sought after by issuing banks in need of highly liquid (& discounted) reserves to back their notes.

    If you think Libra’s short term sovereign debt backing constitutes a “real bills doctrine” in action, then (although I think you’re mistaken to apply that terminology) I’d agree that Libra will be inconsequential and non-inflationary.

    Also like some of the other commenters, I count loss of transactional anonymity as a form of seignorage.

  8. Gravatar of Philo Philo
    19. June 2019 at 20:22

    “I think cash may also be used, more importantly, to shield transactional income from onerous business and labor taxes.” (B. Cole.) Yes, hiding transactions is not quite the same as hiding wealth. I wonder which motive is a more important contributor to the public’s desire to hold currency. (Of course, there is also a desire for currency as a facilitator of transactions, even open ones.)

  9. Gravatar of ssumner ssumner
    19. June 2019 at 21:04

    Philo, I would not rule out some Libra coins being used to hide wealth, I just don’t expect it to dramatically reduce the demand for $100 bills. But it’s an open question.

  10. Gravatar of Matthew Waters Matthew Waters
    19. June 2019 at 23:36

    Libra could not hide wealth because approval of transfers will be contingent on KYC and tax reporting. The ways around KYC can be done in the current financial system (such as having a stand-in beneficial owner, i.e. rathole).

    As outlined in the paper, libra will act like a an ETF with Government Money Market Fund assets. Reseller exchange the assets for new libra or exchange libra for the assets. ETFs such as VOO also work by large traders exchanging assets for shares.

    First, Libra may require security registration in US. Second, what purpose does it serve? For stable assets in dollar terms, one can get a US bank deposit or Treasury-backed MMMF. The white paper also mentions an asset basket with multiple currencies. Who wants a bank account which varies based on other countries’ currencies?

  11. Gravatar of Mike Sproul Mike Sproul
    20. June 2019 at 16:30

    Hi Scott:

    a) “the creation of private bank money slightly reduced the global demand for gold. But only slightly. (It did not directly impact gold supply.) Thus you might view the old real bills doctrine as being false, but approximately true.”

    Consider two kinds of inflation: (1) Gold inflation, which happens when gold buys fewer goods than before.
    (2) paper inflation, which is when a paper dollar buys less gold than before.

    The real bills doctrine, correctly understood, says that issuing new paper money in exchange for real bills of adequate value would not cause PAPER inflation, since the issuing bank’s assets move in step with its money-issue. The RBD can, however, cause gold inflation. Needless to say, this point confused the thinking of many people on both sides of the RBD debates.

    b) “While it’s true that these substitutes would slightly reduce the demand for government fiat money (currency), the effect would be small. And even if the effect were large, I’d expect the central bank to offset it with a reduction in the monetary base. “

    The central bank could only offset it if it had enough assets to buy back enough currency to accomplish that reduction. Conclusion: The central bank’s assets determine the value of the central bank’s money.

  12. Gravatar of ssumner ssumner
    21. June 2019 at 09:21

    Thanks Matthew.

    Mike, Agree on point a.

    On point b, I’d say that in a country like the US the central bank has more than enough assets to keep the value of money stable, and if they did not then the Treasury would provide the needed assets.

  13. Gravatar of Mike Sproul Mike Sproul
    21. June 2019 at 11:32

    Scott:
    Agree on both points a and b, but doesn’t this turn you into a backing theorist, saying that the government’s assets (=Fed + Treasury) determines the value of the dollar?

  14. Gravatar of ssumner ssumner
    21. June 2019 at 14:29

    Mike, No, the value of money is determined by the supply and demand for money, assuming the Fed doesn’t bump up against any constraints. Because I don’t expect them to bump up against any constraints, it’s simpler to just focus on the supply and demand for money.

    I will concede that there are scenarios (Venezuela?) where backing determines the price level. In other cases (the US in the 1960s and 1970s), the Fed created lots of inflation despite having plenty of backing. They were trying to reduce unemployment.

  15. Gravatar of Lorenzo from Oz Lorenzo from Oz
    21. June 2019 at 16:12

    See, that exchange in the comments between Scott and Mike Sproul is why this blog is like a free high quality seminar on monetary economics …

  16. Gravatar of Philo Philo
    21. June 2019 at 17:12

    You express the view that “the creation of private bank money substitutes is not inflationary under a fiat money regime.” But in your view, in a fiat money regime the central bank has near-complete control over inflation. *No event* is inherently inflationary or deflationary, because of potential monetary offset by the central bank. If we knew the theoretical views and the policy objective of a particular central bank, we might be able to predict that it would react to this or that event in a way that would create inflation or deflation; but there is no general answer as to how *all possible* central banks would react to a particular kind of event—including the creation of private bank money.

  17. Gravatar of ssumner ssumner
    22. June 2019 at 08:06

    Philo, Suppose a central bank is targeting NGDP. Then a negative supply shock is inflationary, but a successful cryptocurrency is not. So there is a substantive issue here.

Leave a Reply