Expert Commentary

Libra The Inflationists Weapon against Deflation

The new Facebook digital currency has launched with a fanfare. There's a reason why established businesses are endorsing it.

Crypto currencies such as Bitcoin that have a limited supply are inherently deflationary. Bitcoin fanatics will tell you that the supply is limited by technology. Period. Old, grizzled market sceptics like me know that seemingly immovable rules can and do change, and that authorities will do whatever they want (see below for an example from 1933). However, on the face of it, Bitcoin supply is limited. So if we imagine a brave new world where Bitcoin is the currency of choice, the limited availability of currency means that prices of goods and services will probably fall due to the quantity of money effect.

Now consider Facebook's Libra. This currency will be backed by existing fiat currencies such as dollars, euros and yen. Supply of Libra will, therefore, be unlimited. In reality, all that Facebook is doing is creating a tool to serve as a method for global payments -- a global currency, if you like. Sounds great, but it will be interesting to see if it is adopted, especially when people realize that their holdings of Libra attract zero interest (Facebook snaffles the interest on the fiat currencies you pay to them in order to hold Libra; a point that, funnily enough, wasn't dwelt on at the big launch).

The point being that Libra is, effectively, just another fiat currency prone to lose value by being inflated away. Global authorities look at a currency like Bitcoin with alarm because it is inherently deflationary. Governments and central banks have made an enemy of price deflation because targeting inflation enables them to print more money and grow control via bigger government. This is why Libra will probably be endorsed by governments and central banks -- it could be the global digital currency of choice that, crucially, won't affect their ability to inflate.

The chart below shows an index of the purchasing power of the U.S. consumer dollar. This shows the effect of domestic price inflation or deflation on your money. The Federal Reserve was created in 1913 and, since then, the U.S. dollar has lost 96% of its purchasing power. Why? Price inflation of goods and services has eaten it away. Note, though, that it hasn't been a one-way street. Purchasing power actually rose between 1920 and 1922 as the U.S. authorities allowed a cleansing recession to sweep through the economy. Some historians note that, by allowing this to occur, it paved the way for the Roaring-20s positive social mood to take hold. Purchasing power also rose from 1925 to 1933. This is important to note because it means that a rise in dollar purchasing power can be associated with a strong economy (1925 to 1929) and not only with a general deflation of money and credit or depression, as occurred between 1930 and 1933.

It was in 1933 that Franklin Roosevelt suspended the gold standard and confiscated (some would say robbed) Americans' gold holdings. That's an example of just how passionately inflationist authorities want to retain control of the monetary system. Libra should be viewed in the same vein.

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