May the Best Cryptocurrency Win: Part 2
As former Fed governor Henry Wallach once said, “Experience is the name we give to our past mistakes, reform that which we give to future ones.”
Let’s consider three of Libra’s “reforms.” A Tisket, a Tasket, a Green and Yellow Basket
Libra’s designers chose to back their token with a basket of currencies rather than with the reigning dollar. This likely was done with an eye toward catholicity. That said, the use of a basket is extremely problematic for a unit of account.
A Libra will wobble against the dollar. Indeed, it will wobble against every other currency in the world.
The Libra-denominated price of everything will vary daily, even hourly. When we pull up to the pump the price of gasoline might be three Libras per gallon. It might be 3.01 Libras per gallon by the time we top off the tank.
This is hardly catastrophic. Yet this is almost certain to prove chronically annoying. It is not optimal for commerce.
Consumers do not like uncertainty in pricing, even ones of a modest order. John Wanamaker made a tidy fortune by inventing the concept of the retail price tag in 1861. This practice has since become de rigueur. Departing from it is a great leap backward.
The use of a currency basket, rather than the dollar, surely was well-intended. It presents as a gesture of respect to a new world order chosen in preference to America-centric.
That said, Eichengreen and Frankel called the basket of currencies’ precursors, the IMF’s SDR, the “Esperanto” of currencies which “lacks a natural constituency.”
A basket of currencies may, in theory, be superior to the dollar. Yet as Yogi Berra taught us, “In theory, there is no difference between theory and practice but in practice there is.”
Libra violates Berra’s law. One can never violate this law with impunity.
Our offering, Frax, tracks the dollar. This provides the Frax immutable stability in the world’s most powerful economy, America, which with less than 5% of the world’s population generates over 20% of the world’s income. America is the world’s dominant economic power. It is unwise to ignore this fact.
Also, not immaterially, the dollar is the world’s legal reserve asset against which other nation’s currencies are held. The dollar is, in fact, the world’s money. It is comparable to how English is the world’s commercial lingua franca. Don’t fight the ticker.
Peter S. Goodman observed in the New York Times last February:
“The dollar has in recent years amassed greater stature as the favored repository for global savings, the paramount refuge in times of crisis and the key form of exchange for commodities like oil… In a clear indication that the American currency has been gaining power, dollar-denominated lending to borrowers outside the United States, excluding banks, soared between late 2007 and early 2018, according to the Bank for International Settlements. It increased to more than 14 % of global economic output from less than 10%.”
And as neatly summed up recently by David Beckworth at Mercatus.org in The Challenges of Dollar Dominance:
“The dollar is now a truly hegemonic currency and, as a result, creates challenges not only for other countries but also for the United States. The dollar’s dominance is evidenced by the 50-80% of international trade being invoiced in dollars, the $28 trillion of relatively liquid, dollar-denominated debt held outside the United States, and the 70% of the world economy’s currencies anchored in varying degrees to the dollar.”
Economically speaking it was a tyro error for Facebook to go with a basket of currencies.
By contrast, Frax will provide a stablecoin that tracks to the dollar. This avoids the ongoing distortion of this token as a unit of account.
This virtue applies domestically to American retail and business consumers. It applies internationally thanks to the dollar’s status as the world’s international reserve currency making the dollar the world’s base money.
Frax, unlike Libra, is to be a stable stablecoin.
Full Reserve vs. Fractional Reserve
Frax will also enjoy the suppleness (and profitability) of the fractional reserve.
Libra’s reliance on 100% backing by the basket of fiduciary (or as they put it, fiat) currencies is another design flaw. The idea that there is something unsound about fractional reserve is a discredited fallacy perpetrated by the late economist Murray Rothbard. Just to, in passing, dispose of the misconceptions harbored by any remaining Rothbard diehards… Adam Smith, the canonical authority on free markets, observed in Wealth of Nations:
“When, therefore, by the substitution of paper, the gold and silver necessary for circulation is reduced to, perhaps, a fifth part of the former quantity, if the value of only the greater part of the other four-fifths be added to the funds which are destined for the maintenance of industry, it must make a very considerable addition to the quantity of that industry, and, consequently, to the value of the annual produce of land and labor.”
Libra’s insistence on100% reserve backing rather reminds us of a trope used in the Beverly Hillbillies. Jed and Granny would pop into the bank to see and count their money.
As Leslie Dale Feldman writes in Rustics and Politics: The Political Theory of the Beverly Hillbillies:
“[Granny] gets a paper bag for the money and goes to see Mr. Drysdale. Jed says, “Just give her the money and we’ll go” and they think that Mr. Drysdale doesn’t have the money, or, if he does have it, it will fit in the paper bag. Granny says, “I don’t want no check. I want my money — cash.” Mr. Drysdale says, “I’ve got all of your money” and Jed asks, “Where is it?” to which Mr. Drysdale replies, “It’s invested — in stocks, bonds.” At this point Jed, who does not know what “invested” means, says, “Mr. Drysdale, you always told me I have $45 million in cash” and Mr. Drysdale says, “Well, you have — but not cash cash — like I said, it’s invested.” Jed says, “Maybe you better start getting’ it together — it would ease my mind considerably to see it” to which Mr. Drysdale says, “You don’t understand.”
Granny and Jed transfer Granny’s money, in a check, to Mr. Cushing’s bank — but then ask him to see the money. “Dogged if he didn’t go through it quicker than Mr. Drysdale,” says Granny when he can’t produce it and she puts the money back in the Commerce Bank with Mr. Drysdale. In “Lafe Lingers On,” Lafe Crick, from back home, gets a job as a night watchman at the Commerce Bank so he can “watch” Jed’s money. When he gets to the bank he looks around Miss Jane’s office for the money — but he doesn’t see it and Mr. Drysdale explains, “Mr. Clampett’s fortune isn’t actually here.” Like the Clampetts, Lafe thinks the money is actually in the bank
The Clampetts, with their fortune, do not understand the concept of “interest” or the fact that you cannot take $11 million out of the bank in a paper bag, or the fact that the bank cannot give you $11 million — it would be like asking for the money in the form of barter — in goats, pigs, and chickens — which is something they might also do…
John Locke describes the move from barter to money in The Second Treatise of Government….”
No hillbilly elegy here. Libra’s designers appear intent on moving us backward. Intent or not, it is unthinkable that the world will retreat to pre-Lockean economics, even with the help of the blockchain.
It is unnecessary – and retrograde – to maintain a 100% reserve. As monetary commentator Nathan Lewis (recently called by Steve Forbes “the world’s foremost monetary expert”) observed at Forbes.com upon an analogous matter:
“The amount of metal piled in a vault has little relationship to the value (or quantity) of paper banknotes. In 1779 the Bank of England held 953,066 ounces of gold in reserve. In 1783 it had fallen to 339,261 ounces. A year later, in 1784, it had grown to 1,683,724 ounces. The gyrations had no effect on the value of the British pound, pegged to gold at 3.89375 pounds per ounce.
Nor did banks ever have a 100% reserve of gold. In 1888 U.S. banks had a bullion-to-banknote ratio of 34.86%. By 1895 it had fallen to 12.33%. In 1906 it had grown again to 42.42%. It did not matter to the value of the dollar, which was pegged to gold at $20.67 per ounce.
A gold standard does not place some artificial limit on the supply of money, nor is the supply of money constrained to the output of gold mines. Between 1775 and 1900 the US’ base money supply increased by 163 times – in line with an expanding economy and a population that went from 3.9 million in 1790 to 76 million in 1900. Over this 125-year period, the amount of gold in the world increased by about 3.4 times due to mining.”
We can only look upon Libra and cry, with Mr. Drysdale, “You don’t understand.” We believe reliance on this model has crippled Libra right out of the gate.
Libra or Frax: Who’s the Better Candidate?
We submit that Libra’s designers have made three fatal design errors. The Frax team, by contrast, has seized upon several powerful design advantages which should give it pole position in the race to become the Synthetic Hegemonic Currency.
To reiterate, Bank of England Governor Mark Carney observed at Jackson Hole that:
“While the likelihood of a multipolar IMFS might seem distant at present, technological developments provide the potential for such a world to emerge. Such a platform would be based on the virtual rather than the physical.”
Meaning, presumably, stablecoins.
The world is manifestly moving from a Cold War bi-polar geopolitics to a Post-Cold-War American unipolarity to an emerging multipolar geopolitical order. This may well have implications, sooner or later, for the dollar’s hegemony. What might come next?
“As a consequence, it is an open question whether such a new Synthetic Hegemonic Currency (SHC) would be best provided by the public sector, perhaps through a network of central bank digital currencies.” [Emphasis added.]
Both Libra and Frax contend for the status of the genesis block of the coming Synthetic Hegemonic Currency. With that in mind let’s compare the two:
- A wobbly unit of account.
- Fully reserved.
- A stable unit of account.
- Fractional reserved.
Choose one. May the best cryptocurrency win.
Editor, Gilder’s Daily Prophecy