• Will Libra Be the Next Argentine Peso?

    Will Libra Be the Next Argentine Peso?

    Like the dollars, euros or pounds in your pocket, Libra will be a currency, not an asset. As such, it will not bear interest. But Libra will differ from those currencies in four important respects:

    1. It will be a crypto, not paper, currency;
    2. It will not be fiat currency: its value will be 100%-backed by the Libra Association’s reserve assets;
    3. The Libra Association, Libra’s monetary policy-maker, will have its degrees of freedom limited to that of a currency board; and
    4. Neither the Libra Association nor any other body will act as a lender of last resort for Libra.

    Libra’s currency board nature will initially be a source of strength (Libra’s character as a store of value will be a great improvement over Bitcoin and the hundreds of other fiat cryptocurrencies already in circulation) but, in the long run, will expose Libra to the risk of sudden and sharp devaluation and eventual demise.

    Indeed, the history of currency boards is not a successful one. The most recent example is Argentina’s 2001 political and economic meltdown following the collapse of its decade-old monetary experiment.

    The Argentine peso collapsed for the same reason all monetary boards ultimately fail: it lost competitiveness. The same thing can, and is indeed likely, to happen to Libra.

    In fact, the Libra enterprise is designed to finance itself with the oldest trick in the monetary book: seignorage. As long as interest rates in the basket of assets backing Libra remain close to 0% the public will be willing to hold Libra, but as soon as the world monetary situation normalizes to something close to the historical nominal GDP norm the music will stop – and suddenly. Indeed, just like Argentina in 2001, Libra will, at that point, have lost competitiveness.

    Arbitrageurs will rush to sell Libra for the underlying basket, macro and other asset managers will outright short it, and massive destruction of Libra will be set in motion (by design, Libra has to be destroyed every time it is redeemed). As a final step, the wider public holding Libra will realize that is uneconomic to hold non-interest-bearing Libra when the same currency can be replicated at, say, a 4% yield.

    The ensuing reduction in the volume of outstanding Libra will lead to a collapse of the Libra Association’s seignorage profits and the resulting inability to continue financing the (very costly) security and payments infrastructure underpinning the enterprise. At that point, the Libra Association will need to resort to the one degree of freedom the currency board straitjacket affords it: alter the reserve basket’s composition. Naturally, since the Libra Association’s goal will be to restore Libra’s competitiveness, this composition will consist of shifting the weights in the reserve basket from stronger to weaker currencies; i.e., a devaluation (or rather, since Libra will be a commodity not a fiat currency, a debasement).

    This debasement will likely be the beginning of the end of the Libra enterprise: with losses affecting hundreds of millions of holders who would have rudely awakened to the Libra Association’s awesome power to alter the reserve basket more or less at will, the market will lose faith in the supposedly 100%-backed cryptocurrency and will continue abandoning it even at the devalued/debased level. As Argentina and other examples showed us, currency boards are useful only while they’re trusted, and their utility disappears after that trust is breached for the first time.

    Libra will then likely become one more fiat currency, just like the Argentine peso.

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    Carlos A. Abadi

    Carlos is a 30-year veteran international investment banker who pioneered a number of financial products, such as the trading and swapping of emerging markets sovereign loans in the wake of the 1982 Mexican debt crisis, the trading market for derivatives on emerging markets bonds and loans, the first non-dilutive CET1 transaction compliant with Basel III rules, and the first Chapter 11 filing for a Latin American issuer.

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