The idea that we should have an artificial global currency detached from the currency of any single nation, or currency zone, has not figured on the international financial agenda for many years. In particular it did not surface in the response to the 2008 international financial crisis.
There are good reasons for this... and bad. The good reason is that the world is awash with liquidity in the aftermath of quantitative easing by the leading Central Banks of the world. We therefore do not seem to need any fresh source of liquidity that a globally managed currency could potentially provide.
The bad reason is the lack of support in the US, the Eurozone and China because of their own self-interest in relation to their own currencies. They do not have in mind broader global considerations.
The question is now re-emerging in the context of moves towards private, digital currencies for domestic and international use. Facebook’s proposal for the Libra, based on a basket of values, is particularly important. The US Fed, the US treasury and Trump himself have urged caution. This blog suggests we should be open-minded to this development.
A Brief History
For most of the period since the Second World War we have become used to the US dollar functioning as the world’s global currency. A report from the European Central Bank in June 2019 noted that at the end of 2018, 62% of the world’s reserves were in US dollars, 63% of international debt and over 40 % of global payments. The Euro is the second most important international currency but its share of reserves and international debt is only between 20-25%. The Euro does however get close to the dollar in its share of global payments.
When post Second World War international monetary arrangements were discussed and negotiated by Harry Dexter White at the US Treasury with John Maynard Keynes heading the British side, the idea of a global currency was a major subject of their discussions. However, they could not agree on the form an international currency should take.
The main cause of failure was not about the technicalities. Haunting the American position across all the talks about post war international arrangements was the fear of a repeat of America’s failure to join the League of Nations after World War I.
With this background, the key issue on the US side was the fear that a credible global currency would effectively involve an open-ended financial commitment and underpinning from the US itself. Any such implicit US guarantee to underpin any global currency was seen as a risk to the willingness of the US Congress to ratify the post war financial architecture.
C20 and the SDR
The issue was revisited after the collapse of the Bretton Woods system of fixed exchange rates at the C20 international monetary reform talks in the early 1970s. There was no agreement on the need for an international currency, or how it would be composed, or what it would consist of, and no agreement on how it would be managed. There was a fear that it would produce an upward bias in the creation of liquidity in the global system and encourage inflationary tendencies in the world.
The talks resulted in the creation of Special Drawing Rights (SDRs) based on a basket of currencies. But the SDR was designed and remains of use only to governments settling their accounts within the IMF. There was no agreement on its wider use.
Since then the likelihood of international agreement on a global currency has receded further. The US authorities have an interest in maintaining the dominant role of the dollar. The European Commission issued a Communication at end 2018 on strengthening the international role of the Euro. The Chinese authorities would like to strictly control the growth of an international role for the Renminbi.
In the light of these interests, there has been no appetite among key governments for an artificial global currency. What however, is now putting the question back on the agenda are the possibilities around private digital currencies with an international appeal based on distributed ledger technology (DLT) and what is known as ‘proof of stake’.
‘Proof of stake’ involves validation and authentication of the entry data, and ledgers along a chain of transactions as compared with ‘proof of work’ DLT, used in crypto currencies such as Bitcoin that involves ‘mining’. In the case of the Libra the chain will have a single data structure rather than involve a collection of blocks. The validators will be ‘permissioned’ so as to ensure confidence.
Do we need a dollar alternative?
Many economists would argue that the global economy will get on just fine without an artificial international currency. The conventional view suggests that the role of the US dollar will gradually decline, following the example of the pound sterling, and that, as this happens, the global economy will work well with several currencies in use for international purposes. Thus, the future is that of a multicurrency system built around alternative national currencies.
The three roles for currencies
Economists traditionally distinguish between three classic roles for a currency: as a unit of account, as a vehicle for transactions or means of payment, and as a store of value.
These distinctions remain valid in thinking about the possible role for an artificial global currency.
First, there has been a move away from currencies in order to store value. Capital markets have become internationally accessible at low cost, and provide security linked to real underlying assets in the global economy. People with assets to invest, store and maintain have moved into international equity markets and also into commodities in the form of property and art.
Investment instruments and vehicles to protect against currency and market swings in particular markets are also available at low cost. Crypto currencies based on ‘proof of work’ DLT also provide their own relatively small asset class. So far, they have been too volatile to offer a safe store of value. They also involve costs of ‘mining’ and adverse perceptions around the trustworthiness of promoters and users.
This means that the private sector does not have any great need for a global currency as a store of value. However official holders of reserves such as central banks will have a continuing interest.
Secondly, the transaction uses for an international currency seem to be diminishing in importance. In domestic economies we are moving to cashless payments systems, based on credit cards and cell phone apps. Some central banks are thinking about issuing their own digital forms of money to replace cash (CBDC).
However, for the moment, International transactions rest on rather inefficient automated transfer systems between banks.
This is where private issuers of means of payment such as Facebook with its Libra proposal, may offer greater efficiency and convenience in both domestic and international markets, particularly for retail and small business users.
Units of account
Thirdly, there remains a case for a more stable unit of account than can be provided by any one single currency. The Libra will reflect a basket of currencies and will be backed by monetary and other assets and thus will offer a high degree of security.
The generalized contingency
The case for establishing an international currency does not rest simply on the need to improve the efficiency of international transactions for retail and small business users or on an immediate need for more security. It is also about contingency planning. It is about a possible crisis that:
In yesterday’s world the introduction of an artificial global currency would probably have involved an official international issuer and manager such as the IMF or BIS. However, conflicts of interest between major shareholders stand as an obstacle.
In the absence of an initiative from the public sector, the gap is likely to be filled by an issuer in the private sector. This is where Facebook’s initiative for the creation of the Libra as a means of payment becomes so relevant. It responds to current needs. It provides a form of contingency vehicle against some future international crisis.
However, there are three important questions. The first is around anonymity and privacy. The second is around whether the development could be destabilising for a multi-currency system in a future crisis. The third is how far the Libra system might develop bank-like and credit creation features.
Anonymity and privacy
The Libra Association White Paper published in June 2019 stated that the data chain will be ‘pseudonymous and allows users to hold one or more addresses that are not linked to their real-world identity’.
However, any reputable private sector source of private money will be operating in a highly regulated environment. In particular, the permissioned validators will likely have to abide by international ‘know your client’ regulations.
This means that users will not have anonymity. Their real-world identity will have to be known to the permissioned validator of the account and their identity and possible uses of the account will potentially thus be known to the authorities.
Privacy will also be questionable. The issue is around the use of personal data by third parties. Combined with other data sources, identities may be traceable. Users may feel that efficiency and convenience gains outweigh any concerns they may have. Facebook's own reputation in this area is low.
If there were to be a loss of confidence in an important currency, such as the dollar or euro, a flight to a private digital currency, such as Libra that offers the protection of a basket of assets, could itself be further destabilising.
There will therefore need to be some form of official oversight. How this will be orchestrated is unclear. A small club of central banks might provide trust.
One of the features of banking is that short term deposits and savings are transformed into longer term loans and credit is created against bank capital and liquidity. A private currency would have credit-like features where ‘proof of stake’ involved approved limits, as in credit card transactions. Users might have an interest in building up their limits. The issuer and the validators and authenticators would thus come close to performing a banking role. Again, oversight would be implied.
There is a case for the emergence of an artificial currency for global use that offers the private sector improved efficiency in transactions and better protection against a generalised financial crisis than reliance on any single currency. In former times we would have welcomed the IMF as an issuer. In today’s world we should be open minded about the potential for the Libra and other similar proposals we can expect.