Author: Yangxiao Chen, Zhang Ming
Source: Chief Economist Forum
Editor's Note: The original title was "Yang Xiaochen, Zhang Ming: Will Libra Affect the Chinese Digital Currency? 》
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Since its inception, Libra has stated that it is committed to advancing inclusive finance. This reason seems to resonate easily in today's world. In addition, a basket of sovereign currencies is linked, there is no monetary policy, compliance with the regulatory requirements of various countries, and a decentralized form of management. But can Libra be as inclusive and harmless as it claims to be?
I. Discussions in the early stages of development——Questions on the inclusiveness of Libra
The Libra white paper describes three types of problems in today's financial system: complicated fees, excessive loan interest, and low availability of bank accounts. Libra is also committed to solving these problems. But after a little analysis, it is not difficult to find that there are many logical doubts.
First, how can the Libra service reach customers without a bank account? For users with low availability of bank accounts, although Libra accounts can be quickly opened through the network, Libra coins in the accounts need to be obtained through exchange or other people's transfers. In the absence of a bank account, there is a high probability that the domestic currency and Libra can be exchanged with each other only through cash transactions. Libra's operation adopts the dual model of "Libra Association-Dealer". How can the dealer build such a powerful network to meet the demand for cash transactions? Will it then lead to unofficial Libra regional agents, or even a black market in essence?
Second, the white paper uses several cases to illustrate the high interest rates of traditional financial loans. Does it mean that Libra will introduce low-cost micro-micro loan services in the future? As we all know, as a payment system and as a lending institution, there are significant differences between the two in terms of licenses, management models, and impact on the financial system. If the current plan includes a loan function, the depth and breadth of its evaluation should be greatly enhanced.
Third, whether Libra's comprehensive use cost is lower than that of banks remains to be discussed. The blockchain system does not involve high transfer and wire transfer costs, but other costs still exist. For example, Libra reserves are made up of a basket of currencies, which means that "purchase / redemption" in any currency requires buying or selling a reserve currency basket, which results in exchange costs, including handling fees and exchange rate fluctuations loss. Although the exchange work is most likely to be done by the dealer, the costs incurred will not disappear, it will only be hidden in the exchange rate between Libra and various currencies. This fee may become more apparent to users whose national currency is not a Libra reserve currency. In addition, Libra does not generate interest, so users holding Libra will have to bear the opportunity cost of generating interest, and the lost interest income also needs to be included in the comprehensive use cost of Libra.
Discussion after a certain scale-Libra's potential impact on the existing economic system
If Libra can really become the mainstream digital currency in many countries, the current order of the world economy will most likely be broken. The first is that Libra will introduce a non-nationalized monetary bureau system for small economies; the second is that for large economies, it is more likely to appear as inflation pressures brought by Libra's currency multiplier; and the third is similar to ETFs The design of the fund will generate a large number of intermediate asset forms, which will cause Libra's liquidity management to bring new uncertainty to the global market. Fourth, if Libra develops credit business, it will further complicate the problem.
1.Denationalized monetary bureau system
There are many cases of monetary bureau systems around the world, but Libra, a cross-border monetary bureau system arrangement, is the first to come out. For sovereign states, the simultaneous use of two currencies in their territories will create problems. Libra's absence of an independent monetary policy does not mean that there is no monetary policy: the interest rate and exchange rate level of the anchor currency will largely affect Libra itself. Although Libra has declared that it will not pay dividends to currency holders, there is no need to worry about interest rates. However, its exchange ratio with other currencies will always be dynamically changing, that is, the issue of Libra's "exchange rate" cannot be avoided for the time being. From a practical point of view, the currency bureau system is only suitable for certain types of small open economies, and will Libra introduce it indiscriminately into countries with beneficial consequences?
For small economies, the problem may be more serious. In order to maintain currency stability, Libra currently chooses five relatively strong currencies for its reserve basket (50% USD, 18% EUR, 14% Japanese Yen, 11% British Pound, and 7% Singapore Dollar). According to the exchange rate formation mechanism, the exchange rate between Libra and a country's sovereign currency will depend on the currency policy, balance of payments, and medium and long-term economic development of Libra's anchor currency country and that country. Therefore, the sovereign currency of a country may form a relatively stable exchange ratio with Libra, or it may form a divergence. Under the condition of a single currency, even if the currency of a certain country is weak, foreign currency and domestic economy still have a certain degree of isolation mechanism. However, if Libra is introduced, the strong currency will be directly introduced into the domestic circulation market. This practice can cause three problems:
First, the domestic pricing system uses double standards, which can easily lead to price confusion in the commodity market. Unlike the Special Drawing Rights (SDR) of the IMF, Libra directly faces producers and consumers. Therefore, most raw materials, semi-finished products and finished products can be settled simultaneously using Libra and local currency. If these two currencies cannot maintain a relatively stable exchange rate, it will cause chaos in the commodity market, cause prices to fail, and further transmit to the upstream of the production chain, which will have a more serious impact on the country's circulation and manufacturing links.
Second, Libra may have a squeeze effect on the local currency. This effect will not only benefit the general public, but will also cause social instability and wealth transfer. The underlying asset of Libra is the reserve currency of a large country, which has obvious stability and liquidity advantages compared to the currency of a small country. When two currencies can be used at the same time, residents will naturally choose a more convenient and stable currency, which is the so-called "good currency to drive out bad currency." The exchange process corresponds to the country ’s domestic currency being sold and buying reserve currencies in the foreign exchange market, which will cause the country ’s currency to have depreciation pressure. The devaluation of the local currency will make its exchange rate with Libra lower, which will further encourage domestic residents to exchange Libra in order to seek asset preservation. So the country will form such an awkward situation: the sooner you exchange your local currency for Libra, you can enjoy a relatively high exchange rate; the later the exchange, the lower the exchange rate. Once this situation is formed, on the one hand, it will cause panic selling of the local currency, and on the other hand, it will actually lead to the redistribution of social wealth, which will be transferred from the late redeemer (the general public) to the early redeemer (the affluent prophet). .
Third, small economies may lose their independence in monetary policy. When two currencies are used simultaneously, their exchange rates need to be kept as stable as possible to ensure the smooth operation of the market. However, behind Libra is the currency of a number of large countries. To be consistent with it, the national monetary policy must be as subordinate as possible to the monetary policy of the large countries. This is undoubtedly equivalent to Libra forcibly introducing the currency bureau system into these small countries. However, due to the obvious differences in the economic cycle, economic structure and external environment between countries, following the policies of large countries may cause incalculable problems to these small countries.
2.Libra's multiplier effect
For large economies, larger economies may avoid the problems of the small countries mentioned above to a considerable extent. But Libra's operating model also brings new challenges. The author believes that the "multiplier effect" of Libra currency may be the most worth discussing. This problem was first raised by MIT's Alex Lipton and others, but it has not been dubbed the "multiplier effect". In the traditional monetary system, the multiplier effect is produced by commercial banks through continuous credit activities. The final money supply in the market will be several times the base currency issued by the central bank. Does Libra's lack of credit activity mean that there is no multiplier effect? For large countries (especially reserve currency countries), Libra will also use the corresponding reserve currency to purchase securities such as high-grade bonds while putting digital currencies on the market. In other words, this part of the reserve currency has not been stored, but has returned to the financial markets of these countries and entered circulation. This is equivalent to doubling the local currency used to buy Libra in the market: half of it is in the form of Libra and the other half is in the form of local currency, which will bring some inflationary pressure to the above countries.
3.Libra's liquidity management
The white paper emphasizes that Libra does not pay interest to users, so there are two real problems for users: the balance may not be enough when needed; and leaving a large amount of Libra in the account is a waste. Therefore, how to turn Libra into an interest-earning asset as soon as possible when it is idle, but quickly realize it when it is needed, is the basic requirement of users for Libra. Cash also has this problem. However, cash can be accessed on demand by banks. Behind it is a highly developed liquidity management system of the banking system. In order to achieve a balance between risk and return, the banking system has strong constraints on liquidity management from the regulatory level. Each bank also has a mature management system to meet the liquidity needs of all parties.
In terms of liquidity management, Libra's situation is more complicated. The entire system involves four asset forms: the combination of national currencies, reserve currencies, financial assets invested by reserve currencies, and Libra currency. The first three are real assets, and mutual conversion needs to have a real connection with global financial markets. When it is large enough, it can have a significant impact on financial markets. Bank liquidity management mainly considers the proportion of different asset types and the matching with the liability end. Although the management is complicated, it is mainly based on the same currency, so matching can be completed by relying on several domestic market transactions. The above three realistic asset forms of Libra determine that they must operate simultaneously in the financial markets of multiple countries and the global foreign exchange market, not only involving the ratio of different types of assets in different countries on the asset side, but also between different currencies on the liability side. Comprehensive control of liquidity shows its complexity.
When the scale is large enough, Libra's liquidity management will affect at least three aspects of the global market:
First, the volatility of the foreign exchange market has increased. The exchange between the national currency and reserve currency combinations of various countries will be frequent, and a force will be formed, which will make the consistency of the trend of each reserve currency stronger. However, countries that are reserve currencies have large differences in their economic development stages and monetary policies, and exchange rate trends may not have been the same. The convergence force brought by Libra will disrupt the pricing logic originally formed in the foreign exchange market and increase market volatility.
Second, it affects the pricing logic of financial markets. Although it may not chase up and down, Libra reserve currency will still participate in cross-border capital flows as part of international "hot money". When the reserve currency portfolio is converted into a financial asset portfolio, low-risk assets with a high credit rating will be preferred, resulting in a decline in the yield of these assets. Because high-credit products are often anchors in pricing other products (such as US debt), in effect, the expansion of Libra's scale will drive down the yield of low-risk financial products and credit expansion; and the shrinking scale will lead to a large number of sales Out, making yields upward and credit contraction. This will bring new variables to the monetary policy transmission of reserve currency countries and increase market uncertainty.
Third, financial disintermediation. As a means of payment, Libra essentially directs the value circulating in the banking system to the Libra network. As mentioned above, the multiplier effect of Libra duplicates the value of fiat currencies: half of it is placed on the Libra network, and the other half continues to exist in the traditional financial system in the form of reserve assets. This model disintermediates the currency that should have been involved in the creation of bank credits into Libra, forming "off-balance sheet assets" of the financial system. This move will undoubtedly make Libra enter into a competitive relationship with commercial banks to a certain extent, reduce the role of banks in the financial system, and thus pose a greater challenge to the traditional financial supervision model.
Although in the U.S. House of Representatives hearing, the project leader Marcus tried to deny that Libra was an ETF fund, but its currently announced operating model does have too many similarities with the ETF, in particular, both need to purchase and ultimately purchase assets combination. Similar to ETFs, Libra theoretically has two ways of acquiring: buying new shares or buying transfer shares from the secondary market. The white paper does not currently mention the secondary market transfer method, but from the perspective of efficiency, the purchase / redemption method requires repeated exchange and exchange of assets, resulting in a lot of costs; it is better to establish a secondary market transaction mechanism and fine-tune on the liability side, and It does not involve repeated adjustment of the underlying assets, which is beneficial to the liquidity management of the entire system. However, whether the establishment of a secondary market is conducive to maintaining the stability of Libra's value is also an issue to be discussed.
4. Potential credit creation capabilities
Although Libra currently claims that it is only used for payment, if it expands, we cannot prevent it from providing some service modules with credit creation functions, such as micro-credit loans such as “micro-credit loans” or “huayan”. Its mode of conducting such business can be very flexible, and it can provide loans to users at the dealer level instead of being presented by the Libra Association. We may even wish to make a bold guess that credit business is the only way for Libra's future development, because as mentioned earlier, in its white paper, it clearly identified excessive interest on loans in some regions as a problem to be solved.
If Libra conducts credit creation, it will undoubtedly have a significant impact on the global financial system. In the traditional financial system, credit creation and currency issuance are completed through the two-tier structure of the "central bank-commercial bank". The central bank is responsible for placing the base currency and assumes the role of lender of last resort. Commercial banks directly face end customers and complete a series of specific tasks such as credit creation and deposit absorption. In the Libra system, the relationship between associations and dealers may also evolve into the relationship between central banks and commercial banks. Once credit creation is carried out, first of all means that the Libra system has the willingness and ability to add assets without surrendering the reserve currency, that is, Libra is no longer strictly linked to the reserve currency, and its value basis has undergone a fundamental change: Into a sovereign-like currency. The Libra Association will actually become a super-sovereign central bank.
So, will this super-sovereign central bank succeed? Money is a liability of the central bank. The reason why the central bank is able to issue currency is that its bottom layer has state-owned assets and future taxes as its value support. The reason why the Bretton Woods system finally disintegrated (the US dollar decoupled from gold) is still believed that the amount of gold held by the United States can no longer support its currency issuance. But once Libra broke away from its reserve assets, there was no other value basis at the bottom. Even if it is widely used worldwide, it can be regarded as the basis of value, then Libra will evolve into a typical Ponzi scheme, and it will eventually escape the fate of failure.
Therefore, if Libra wants to solve the problems of low loan availability and high interest rates, the way it creates credit itself may not bring good results. The author believes that there are two other ways to try: First, Libra cooperates with commercial banks to act as a medium for payment tools and information collection, enabling the bank to extend its services to areas with less developed financial services. Second, the dealer pays 100% of the reserve in advance, obtains a certain amount of Libra currency, and then transfers it to users who need loan services with a certain amount of interest or commission. The user will repay the principal to the dealer in the form of Libra or local currency within the prescribed period. In this way, the Libra system does not involve the issue of credit creation. The so-called loan is just that the dealer lends out the stock Libra it owns, avoiding the problem of decoupling Libra from the reserve assets.
Comparison of Libra and the central bank's digital currency
When Libra was controversial, the central bank's proposed digital currency, Digital Currency Electronic Payment (DCEP) by the People's Bank of China, was in full swing, and it would soon enter the actual issuance stage. Although they are both digital currency attempts, the model chosen by Libra and DCEP is completely different from the ultimate goal.
Through logical deduction, the possible consequences of the two are also very different: in terms of management methods, Libra currency will gradually be separated from the traditional financial system, that is, “financial disintermediation”; but DCEP will separate cash transactions that the traditional banking system cannot track individually. Gradually included in the scope of management, we might as well call it "cash back". In terms of its impact on the market, Libra will complicate financial markets, exacerbate market volatility, and reduce the effectiveness of monetary policy. DCEP's enhanced unified management of M0 will largely help central banks achieve their monetary policy goals. In terms of international influence, Libra ’s reserve assets are mostly dominated by the US dollar, so it will strengthen the US dollar ’s global dominance, and may have a certain impact on the sovereign currencies of non-reserve currency countries. It has no significant impact on the foreign exchange market. Without adversely affecting other currencies, it can create favorable conditions for the in-depth implementation of RMB internationalization, and play a positive role in enhancing China's international status and voice.
In summary, although Libra and the central bank's digital currency DCEP are ostensibly trying to expand the currency into the digital realm, making daily payments more convenient, in fact, no matter from the analysis of technology, model, and results, the two are completely separated from each other. Go in opposite directions. Of course, neither is currently officially launched, and we can only conduct theoretical analysis and logical deduction based on existing public materials. Before the product goes online, a lot of technical adjustments are inevitable.
Fourth, cold thinking of digital currency and blockchain
Digital currency and blockchain are like twin brothers. With the promotion of digital currency, the current blockchain technology has received great attention at the core level, and many potential application scenarios have been derived under the repeated fermentation of the market. However, the blockchain technology has been invented for more than ten years. So far, it is not that the market has not paid enough attention or has not invested enough resources, but the practical application of combined industries is still scarce. The author believes that there is a deep reason for this contrast, that is, the boundaries of technology are not as endless as the market advocates.
The essence of blockchain is a bookkeeping method that allows parties who do not trust each other to trust each other through a consensus mechanism. But just like accounting, clear and accurate accounts do not mean that the underlying business can stand the test. From the author's micro observation, the main application scenario of the current blockchain is also to ensure the security of the information after the "on-chain", to achieve the purpose of tampering. This security is indeed important, but it may not be a key issue facing the industry today. Taking financial fraud as an example, the method of fraud several years ago was mainly to modify the accounts or "two books". However, as auditing efforts have become more intensive, it has become increasingly difficult to modify accounts. So in recent years, the method of counterfeiting has been upgraded: the books are kept strictly consistent with various documents, and articles are made directly at the underlying business level. If the business is falsely added, the cash flow, merchandise warehousing, and storage order can be real, but the goods issued can be out of stock, or even empty boxes, which is the so-called "brush order". Such behavior is difficult to reflect on the books. The author takes this as an example, not to specifically point out that this method of counterfeiting cannot be prevented, but it is indeed beyond the field that blockchain technology is good at. When the fairness of the work of "bookkeeping" itself has not become the bottleneck of the development of the real economy, how much is the value of the blockchain technology generated by bookkeeping and how to better serve the real economy? Issues worth rethinking.
The success of the blockchain in the field of digital currencies mainly stems from the fact that currency exchange is mainly reflected in the bookkeeping level, and does not involve lower-level businesses, so it is just covered by the advantages of the blockchain. But from another perspective, the relatively complicated consensus process of the blockchain has also affected the real-time and concurrency of transactions to a certain extent. The author suggests that the capability boundary of the blockchain should be viewed rationally and dialectically. Its advantages in the field of digital currency are not suitable for unlimited extension, so as not to cause invalid investment of social resources. Of course, the blockchain technology itself is also constantly innovating, and the boundaries of capabilities are bound to expand. Digital technology is only a tool after all. I sincerely hope that the only direction after the large-scale promotion of digital currency is to make life better. But in the end, we will wait and see.
Note: This article only represents the author's personal opinion. Xiaochen Yang is a researcher at the Center for Global Economics and International Finance at the Institute of International Finance, University of Science and Technology of China. Zhang Ming is a researcher, PhD supervisor, and director of the China Chief Economist Forum.