Facebook proposal to launch a cryptocurrency has been greeted with skepticism, criticism and alarm. The U.S. social media company has a reputation for single-minded pursuit of its own commercial advantage and form when it comes to ignoring privacy issues.
Recall its original motto: move fast and break things. As critics have rushed to point out, putting Facebook's dominating ambition and erratic track record in policing its users together with the crucial infrastructure of global financial payments is a big risk. Red flags have been raised over everything from privacy and regulation to the vulnerability of such a big new financial network to industrialized hacking.
But one more danger needs to be highlighted -- the problem the proposed Libra cryptocurrency would present to developing countries, especially mid-sized open economies in Asia with easily-traded currencies.
For Facebook, and its partner companies, the logic is compelling. Smartphones are ubiquitous, even in poor countries. Bank accounts are not. Typically less than half the population of emerging countries have a bank account. Using cash to pay bills or send money to relatives is hard enough: buying goods online or making international remittances is an expensive challenge. If payments are made between two smartphones, life is made easier and new commercial opportunities open up.
Of course, Facebook is not the first to see the potential. Kenya's M-Pesa pioneered the idea more than a decade ago, using the Vodafone mobile infrastructure.
Many others joined in. PayPal found a special niche, serving e-Bay's payments needs. Cutting-edge innovators like Apple jumped at the opportunity, with Apple Pay. China, with the congenial environment of a huge population with few bank accounts but many smartphones, was a fertile breeding ground for WeChat and Alipay.
But if Facebook's Libra currency entered the market it would have huge competitive advantages. Network externalities -- having lots of connected customers -- are the key to success. Facebook's enormous community gives it unmatched network connectivity. It would not only collect transaction fees, but also scoop up the supplementary prize: the users' data.
But Libra promises more than this. First, it promises to make cross-border transactions "as easy as sending a message". If this means that such transactions are literally as cheap as sending a message, this would indeed be a big advance over other international transfers, which typically flow through the banking system, with its outrageous foreign exchange transaction margins.
Libra's second unique characteristic is that it will be backed by a basket of major foreign currencies. Its value will not fluctuate erratically like Bitcoin, which has no backing. Against any one currency, Libra must fluctuate to some degree as underlying currencies change in relative value, but as a store of value Libra could offer stability over time. This backing also provides assured liquidity.
If Libra's frictionless transactions hold out benefits for consumers, Libra might seem to promise nirvana for financial markets. Easy transactions between all players ought to lead to equilibrating arbitrage and full price discovery. In textbook jargon, financial markets should become 'perfect'.
So, what could possibly go wrong? Quite a lot, actually. As well as the general issues already raised by other commentators, Libra might lead to major financial instability for emerging economies, especially in the Asian region which is mostly more open to global financial flows than Africa or Latin America.
Suppose, say, that the Indonesia public can switch from rupiah to a basket of stable currencies with a simple touch of their smartphones. Whenever there is a shiver of nervousness about the exchange rate, the public can move, collectively and cheaply, into a stable currency holding.
In the perfect markets of textbooks, such flows would be self-correcting. As the public abandons its rupiah holdings, the rupiah depreciates, creating the opportunity for arbitrageurs to support the now-undervalued currency. The rupiah returns to around its initial value and all is well.
Unhappily, the real world is very different. The reality of international capital flows is more like a bank run in a system without deposit insurance. Indonesian residents hold rupiah cash and bank deposits because these are needed for everyday transactions. But if a depreciation seems imminent, shifting out of rupiah into stable foreign currency would be smart. What is rational for an individual Indonesian, if mimicked by many others, would be a disaster for the country.
At present, this sort of widespread shift between currencies does not often occur on a massive scale, because there is substantial friction in international currency transactions. The spread between buying and selling rates for foreign currency for the general public is substantial. On top of this there are heavy transfer fees.
Fortuitously, so far we have been saved from the disastrous consequences of frictionless international currency flows by the prevailing inefficiencies and overcharging of the financial companies, augmented by the red-tape regulations covering money-laundering and "know-your-customer."
If Facebook offers frictionless international transactions to everyone, with the opportunity to put funds into a stable Libra, then the capital-flow reversals and 'sudden stops' which are currently a serious but manageable macro-economic problem could easily become a full-blown crisis.
Exchange rates in emerging economies are not firmly anchored by farsighted analysis, well-founded expectations and stabilizing speculators. Instead, they are driven by waves of fluctuating sentiment. The disastrous 1997 Asian crisis is still remembered, with these memories refreshed by the 2013 taper tantrum. Middle-sized countries with floating exchange rates, such as Indonesia, Thailand and South Korea, are potentially particularly susceptible.
Libra poses multiple global challenges: to financial stability, the safety of the payments system, competition, data, and privacy. For emerging economies, a sensible response might be to "throw some sand in the wheels of international capital flows," as economist James Tobin suggested almost half a century ago. One thing seems sure: in its venture into finance, Facebook cannot be given the sort unregulated free-for-all it has enjoyed so far. And in designing the right regulations, Jakarta as well as New York, London and Tokyo, should have a say.
Stephen Grenville is a non-resident visiting fellow at the Lowy Institute in Sydney, and former deputy-governor at the Reserve Bank of Australia.