Libra Has a Flawed Crisis Model, Says Ex-IMF Economist

A former senior policy advisor to the International Monetary Fund (IMF) said Libra’s ill-defined relationship with the Federal Reserve has pushed it to adopt emergency protocols similar to the ones the U.S. ditched more than 100 years ago.

American economist Barry Eichengreen, who was an IMF policy advisor in the late 1990s, said in a blog post Saturday with fellow academic Ganesh Viswanath-Natraj, that emergency protections found in the revised Libra whitepaper were similar to the clearinghouse certificates the U.S. used to prevent bank-runs prior to the establishment of the Federal Reserve in 1913.

It isn’t obvious whether the Fed would step in to help Libra in an emergency to act as a lender of last resort, write Eichengreen and Viswanath-Natraj. The whitepaper instead proposes that the network operators could issue “redemption stays” to prevent funds being taken out of the Libra Reserve – the reserve of real assets that underpin Libra’s value – or charge additional penalties to those still wanting early redemption.

“Financial historians will recognise these devices for what they are. They resemble the clearinghouse certificates issued by bank groups in the US in the 19th century in response to bank runs and financial crises,” say Eichengreen and Viswanath-Natraj.

Beginning in the 1850s, the U.S. relied on a network of privately-owned clearinghouses to prevent bank runs through issuing loan certificates. The idea was these would act as a form of quasi-currency that could take over as a means of payment when market confidence in notes issued by a single bank hit rock bottom.

But as Eichengreen and Viswanath-Natraj argue, this private clearinghouse system: “created a situation where not every dollar was as good as every other dollar. [And] It was this unsatisfactory state of affairs that led to the establishment of the Federal Reserve System in 1913.”

It appears Eichengreen and Viswanath-Natraj believe Libra’s emergency protocols could simply be a stopgap until such time as a clearer relationship with the Fed is defined. They cite parts of the whitepaper that say an unspecified “third-party administrator” could be brought in to provide emergency liquidity in a crisis.

But that all depends on whether the Fed chooses to support Libra and both Eichengreen and Viswanath-Natraj argue that “the authors of the White Paper have doubts about whether the Fed will be a compliant lender of last resort to the market in LibraUSD.”

Libra’s revised whitepaper, released earlier this month, dropped the original plan to launch one digital asset that would be pegged to a basket of thirty fiat currencies in favor of issuing a handful of stablecoins each pegged 1:1 with a different fiat currency.

The climb down was a major concession to the politicians and central bankers who said Libra could, in effect, become a rival to the currencies issued by governments.

But both Eichengreen and Viswanath-Natraj argue there are still unanswered questions to how Libra could effect monetary sovereignty. “If residents of another country shift into LibraUSD, that country’s central bank will lose the ability to earn seigniorage. It will lose control of monetary conditions. It will lose the ability to backstop local financial markets,” the blog post reads.

Neither Libra nor Eichengreen responded to requests for comment by press time.