I often hear the idea that the U.S. dollar is the means by which the U.S. implements sanctions. And since the U.S. dollar pervades all corners of the globe, the U.S. government's sanctions are uniquely powerful. For instance, Reuters reports that Russian resource giant Rosneft is shifting all its contracts over to euros in order to "shield its transactions from U.S. sanctions."

Another version of this idea was recently floated by David Marcus, the head of the Libra payments project:

"The future in five years, if we don’t have a good answer, is basically China re-wiring” a large part of the world “with a digital renminbi running on their controlled blockchain,” Marcus said. He warned about the prospect of “having a whole part of the world completely blocked from U.S. sanctions and protected from U.S. sanctions and having a new digital reserve currency” with no alternative."

The shared assumption of both the Rosneft and David Marcus quotes is that the U.S dollar is the primary pathway for projecting U.S. sanctions. By going out of their way to adopt a different currency, euros or renminbi, a nation or corporation can sidestep the sanctions threat.

But that's not quite right. Sure, the U.S. dollar is the world's reserve currency. However, the U.S.'s ability to apply strong and effective sanctions has very little to do with the U.S. dollar itself.

To see why, we need to visit how sanctions work. If the U.S. doesn't like a particular company, say Rosneft, and wants to cripple it, it starts with primary sanctions. The government tells U.S. companies to stop dealing with Rosneft on threat of fine.

But the real story begins with secondary sanctions. Here, the U.S. government tells Americans that on top of breaking ties with Rosneft, they must stop doing business with all other foreign entities (European, Canadian, Japanese, etc) that does business with Rosneft.

A foreign company now has a choice. If it is a European refiner, it will have to choose between continuing to buy crude oil from Rosneft or no longer accessing U.S. markets. This means being shut off from U.S. energy exports, doing without Texan oil & gas technology, forgoing U.S. repairs and refinery parts, being exempt from Silicon Valley tech expertise, being excluded from purchasing American assets, and having its existing U.S. subsidiaries threatened. There are also financial repercussions. It will lose access to New York's capital markets and the dollar payments system.

Given a choice between Rosneft or America, which will our refiner choose?

As I wrote a while back at Bullionstar, their are additional costs to being blacklisted by the U.S. government. Blacklisted executives would have to face the possibility of "no longer being able to send their kids to Ivy league schools, travel to Las Vegas for holiday, or seek medical care at Johns Hopkins or the Mayo Clinic." They wouldn't be able to visit the U.S. for business purposes, or explore U.S. job opportunities. I doubt that Russia has enough good job opportunities, universities, vacation spots, and high end hospitals to compensate.

This impressive list of penalties is why the U.S. government's secondary sanctions are so powerful. Almost every foreign company will prefer to give up Rosneft and keep doing business with America.

Now, Rosneft might nudge and wink at its European customers and say "hey, let's just deal in euros. That way we can get around the sanctions. We'll keep doing business together and you won't lose access to the U.S."

But using euros doesn't change the economic calculus facing our refiner. Even if it does business with Rosneft in euros rather than dollars, it is still doing business with Rosneft. And the moment that the U.S. justice department catches a whiff of this (say one of its bankers rats it out), the European company will be blacklisted. And that means losing the entire list of goodies that is associated with access to America. The risk is simply too high.

Fancy payment options like bitcoin or gold don't solve this either. Say that Total, a big European refiner, buys Rosneft oil with bitcoin. Total execs hopes that a bitcoin payment might prevent its bankers from tattling on it to U.S. authorities. But it's very difficult to camouflage the opposite side of that trade--massive movements of crude oil back to Europe. There are just too many bodies involved in that sort of operation. A large law-abiding organization like Total can't take the risk of being discovered. And so, bitcoin or not, it will disconnect Rosneft.

To summarize, what makes American secondary sanctions so effective isn't U.S. dollar hegemony. It is the impressive amount of technology, wealth, goods, services, and experience generated by American companies and individuals. When firms are threatened with losing access to this treasure trove, they will make whatever sacrifices are necessary to keep it.

As for Libra, in an effort to sell his new payments system to American regulators, David Marcus conjured up a world "completely blocked from U.S. sanctions" thanks to a new digital renminbi. But even if firms have the ability to make transactions in digital renminbi, this doesn't change the fact that America's home-grown economic bounty is massive, and foreigners value that bounty above any other, U.S. dollar or not. There are other reasons for regulators to welcome Libra. But bolstering U.S. sanctions isn't one of them.

Last week, we finally got some information about what Libra's currency basket would look like.

A Libra currency basket will reportedly include...
-no Chinese yuan
-50% dollar
-18% euro
-14% yen
-11% pound
-7% Singapore dollarhttps://t.co/YNbRY9Q02x

Libra could have automated the decision by adopting an established unit of account, say the IMF's SDR...

— John Paul Koning (@jp_koning) September 20, 2019

If you haven't heard, Libra is a proposed global blockchain-based payments network. It is being spearheaded by Facebook along with a coalition of other companies including Uber, MasterCard, PayPal, and Visa.

The hook is that rather than going the conventional route and expressing monetary values using existing units-of-account like the dollar, yen, pound, or euro, the Libra network will rely on its own bespoke Libra unit-of-account as its "base language." Libra originally revealed in its whitepaper that the Libra unit would be defined as a basket, or cocktail, of other currencies. Now we know what that mix will likely look like.

Interestingly, the Libra isn't the world's first private unit-of-account. Back in the 1960s and 1970s, several financial institutions came up with their own bespoke units. I learnt about this strange and fascinating episode courtesy of a very readable paper by two economists, Joseph Aschheim and Y.S. Park.

Libra isn't the world's first private currency basket. This paper https://t.co/hfTtHsofgC discusses four earlier attempts...
-Eurco (1973) Rothschild & Sons
-B-Unit ('74) Barclays
-Arcru ('74) Hambros Bank
-International Financial Unit ('75) Credit Lyonnais
Good luck, Libra! pic.twitter.com/di01mzqbab

— John Paul Koning (@jp_koning) September 23, 2019

As I gathered from the paper, the first private artificial currency unit was Luxembourg-based Kredietbank's European Accounting Unit (EUA). Originally devised in 1961 as 0.88867 grams of fine gold, the EUA was soon used to denominate a bond issue by SACOR, a Portuguese oil company. Over the next two decades, Aschheim & Park claim that around sixty or so bond issues would rely on Kredietbank's EUA as their accounting unit.

Between 1968 and 1971, the U.S. Treasury ceased to redeem dollars with gold. When the Smithsonian Agreement—a band-aid attempt to re-cement all currencies to the U.S. dollar—collapsed in 1973, the post WWII system of fixed currencies came to its final end. To help people cope with the sudden babble of floating currencies, several new private units-of-account joined Kreietbank's EUA.

N.M. Rothschild & Sons kicked things off in 1973 with its European Composite Unit, or Eurco. The Eurco was made up of nine currencies issued by members of the European Community, including Deutsche marks, French francs, and Danish kronor. According to Aschheim & Park, Rothshild developed the Eurco "to elicit investors' confidence" in long-term bonds, but as of 1976 only three bond issues had been denominated in Eurcos.

In 1974 Hambros Bank introduced the Arab Currency-Related Unit, or Arcru. The Arcru was comprised of twelve Arab currencies and designed to appeal to Arab investors flush with oil profits. The next year Credit Lyonnais created a bouquet of the ten currencies, both European and non-European, and dubbed it the International Financial Unit, or IFU. This was a far more broad-based unit than the Arcru or Eurco, the relative weights of the IFU's component currencies being based on each country's share of international trade.

Barclays Bank also got into the game in 1974 with the Barclays Unit, or the B-Unit. The B-Unit was made up of five currencies: the U.S. dollar, the British pound, the German mark, the French franc, and the Swiss franc. Aschheim & Park note that whereas the Arcru, IFU, and Eurco were primarily intended for denominating bonds, the B-Unit was designed to be used for making international payments.


Which makes the B-Unit a direct predecessor of the Libra unit.

Look around you today, however, and not one of these private units-of-account listed below exists. Anyone want to pay me in B-Units? I didn't think so. I think this says something quite fundamental about the market's demand for artificial currency units. Businesses and consumers don't really like to use them.

Table from Aschheim & Park

If private artificial currency units have been failures, what about government-provided ones?

Take the International Monetary Fund's Special Drawing Right (SDR) basket, which has been in existence since 1970, almost fifty years. If there was a demand to make international payments using public artificial units of account, surely commercial banks would eventually have met that demand by implementing SDR-denominated payments systems. Indeed, Aschheim & Park speculate on the possibility in their 1976 paper. It's worth reading this section in full:

"International banks may soon be willing to accept deposits denominated in SDRs because a potential demand for SDR funds already exists, as manifested by recent SDR bond issues by the Swiss Aluminum Company, the Swedish Investment Bank, and Electricite de France. The process, indeed, is already under way. In July 1975 the Bank Keyser Ullmann in Geneva (a subsidiary of Keyser Ullmann of London) announced that it would henceforth accept demand and time deposits denominated in SDRs. These SDR deposits are to be convertible at any time into any currency at the SDR exchange rate applicable on that day. Similarly, in August 1975 the Chase Manhattan Bank in New York instituted a range of banking facilities in SDRs, including loans, deposits, and futures trading. As this process spreads and as more international transactions are denominated in SDRs, banks may begin to allow direct transfers between SDR accounts, internally and then between banks. In consequence, the SDR may be transformed from mere numeraire (international quasi-money) into an outright means of payment (full-fledged international money)."

Again, look around you today. How many banks let you open an SDR-denominated bank account and make SDR payments? None that I'm aware of. Maybe the IMF's SDR was never well designed, or maybe Barclays was too small to drive B-Unit adoption. Or more likely SDRs, B-Units, and the other artificial currency units mentioned in Aschheim & Parks paper are all monetary dead-ends. In pursuing the same path, Libra could be making a big mistake.


What is it about artificial currency baskets that makes them non-starters? My first post about Libra delved into this question. Let me repeat my argument below to spare you the effort of clicking through.

In an alternative reality, let's imagine that Facebook only allows users to join and converse on its platform after having learnt Facebook's artificial language, Facebookish. English, French, Chinese, and all other languages are banned.

In this alternate reality, all Facebook users understand each other because each one is fluent in Facebookish. Comprehension is a great thing. But hardly any of us would be on Facebook to begin with. Who wants to go through the effort of learning a new language? Not me.

In the real world, Facebook has long since decided against the Facebookish approach. Instead, it supports a multitude of local languages—Arabic, Chinese, English, Hindi, and more. Sure, the drawback is that we can't always understand what other Facebook users are saying. But at least users don't have to go through the hurdle of learning new grammar and syntax. And Facebook has thrived as a result of this simple and obvious design choice.

The adoption of a Libra unit of account is the monetary equivalent of forcing users to learn Facebookish. Sure, at least with Libras we'll all be using the same currency units. But this ignores the costs we'd all have to incur as we learn a new monetary patois. From a very young age we all figure out how to "speak money". We speak in our local unit-of-account. As a Canadian, the Canadian dollar has always been the means by which I describe prices to people around me, and remember values, and engage in cost-benefit calculations. Facebook wants to force us all to learn a new monetary language, a Libra-based one. But in doing so it's setting a huge hurdle to adoption.

So I'll just repeat. No matter how skillfully it goes about designing Facebookish (or Libras), artificial languages and artificial units are dead-ends. They're utopian, and definitely not user-friendly. (Ok, I may have described it all better in my original post, so just head on over.)


That being said, over the last few months I've been slowly warming up to Libra. Out of the millions of crypto projects that have come out over the last decade, it comes close to the Fedcoin vision I originally outlined on my blog back in 2014, and twice now for R3.

To begin with, a Libra token would be stable (unlike bitcoin) thanks to credible and strong issuers. Since it would be decentralized, the network would be resilient. And since a Libra is a token, and not an account, it should be relatively open for everyone to use. At the same time, David Marcus, the architect behind Libra, is making the right noises about financial privacy. (Whether his intentions are genuine or not, it's tough to say.)

From the Libra whitepaper

I think (and I could be wrong here) that there is a growing desire on the part of consumers for more financial privacy. Unfortunately, governments hew to a post-9/11 mindset that regards privacy as a pervasive threat. Facebook may be one of the only organizations with the financial heft to articulate consumers' desires for more privacy in a way that regulators can't ignore.

Having Facebook as financial privacy advocate is a fragile win, no? It would be too bad if Libra (and whatever level of financial privacy it promises to bring to mainstream consumers) never attains widespread usage because of a basic design flaw, one that obligates us all to adopt the monetary-equivalent of Facebookish


If not an artificial currency basket, what should Facebook do? I think that most consumers who engage in cross-border transactions want to keep swimming in their domestic currencies up until the last minute. Only at the 'buy now' or 'send now' moment—i.e. when a purchase it to be consummated or funds transferred to a friend—do we want to leave the bubble of our home currency. Pre-accumulating some strange alien token, whether those be SDRs, B-Units, or Libra, just isn't on the table.

If it wants to stay customer friendly, Libra needs to design its network to allow for the flow of tokens denominated in state currencies (U.S. dollars, Chinese yuan, British pounds, Indonesian rupee). And then it needs to design a cheap, transparent, and easy way for these tokens to move from person to person. This is what PayPal does. It's also worked for Transferwise. Visa and MasterCard too. None  of these platforms have created their own curious units, PayPalios or TransferWise-units or Visa-oos. They've allowed customers to remain safely ensconced in their domestic currency bubbles until the final 'send now' moment.


Putting aside my criticisms of Libra's decision to use an artificial currency unit, what do I think about its choice of basket?

I am left wondering what sort of process David Marcus and the folks at Facebook have used to generate the basket components. Potential Libra users will want to know ahead of time how they can expect a basket's components to be updated as time passes. After all, if their wealth is to be held on the platform, customers will wonder what is to prevent a sudden rewriting of the basket in a way that favors the network at their expense?

One important rule that everyone will want to know is what economic thresholds are being used to filter out or include various currencies. For instance, if the Korean won starts to become a popular international currency, at what point will Libra decide to include it in the basket? If so, would it boot out another currency to make way for the won, or keep it?

The current Libra components are definitely odd, and give no indication of what process the architects are using to populate the Libra basket. For instance, I'm not aware of any selection process or rule that would lead to the Singaporean dollar comprising 7% of what is supposed to be a "global currency." Don't get me wrong. I like Singapore. It punches above its weight. But Singapore doesn't account for 7% of world trade, or 7% of the world's population, or 7% of global anything.

Or why does the euro account for just 18% of the Libra basket while the U.S. makes up a mammoth-sized 50%? The European Union has twice the population of the U.S. and accounts for a far larger share of exports. And where is the Chinese yuan? Exiled for political reasons?

One wonders if the euro's small share has to do with the effect that Europe's negative interest rates might have on network profits. For each Libra it has issued, the consortium will have to keep a Libra's worth of assets in reserve. Far larger profits can be earned it it reduces the euro portion of the basket and increases the U.S. dollar portion. After all, that would mean more exposure to high-yielding U.S. dollar assets and less to negative-yielding European ones. But that's a terribly ad hoc way to construct a currency basket.

My last thought is this. If Libra has its heart set on choosing an artificial currency unit as the basis for its global currency, it should have probably just go with the IMF's SDR basket rather than brewing its own strange currency concoction.

The IMF's SDR basket (source)

Consider how exchange-traded funds which track an index outsource all of the decisions about index methodology and components to third-parties like Standard & Poors, MSCI, and FTSE. This makes the exchange-traded fund more credible. Using SDRs would pre-commit Libra to avoiding conflicts of interest and thorny politics, the IMF becoming the theater for determining the basket. One could find worse third-parties than the IMF.

Facebook recently announced a new cryptocurrency, Libra. I had earlier speculated about what a Facebook cryptocurrency might look like here for Breakermag.

I think this is great news. MasterCard, Visa, and the various national banking systems (many of which are oligopolies) need more competition. With a big player like Facebook entering the market, prices should fall and service improve, making consumers better off.

The most interesting thing to me about Facebook's move into payments is that rather than indexing Libras to an existing unit of account, the system will be based on an entirely new unit of account. When you owe your friend 5 Libras, or ≋5, that will be different from owing her $5 or ¥5 or £5.  Here is what the white paper has to say:

"As the value of Libra is effectively linked to a basket of fiat currencies, from the point of view of any specific currency, there will be fluctuations in the value of Libra."

So Libra will not just be a new way to pay, but also a new monetary measurement. Given how Facebook describes it in the brief quotation provided, the Libra unit will be similar to other unit of account baskets like the IMF's special drawing right (SDR), the Asian Monetary Unit (AMU), or the European Currency Unit (ECU), the predecessor to the euro. Each of these units is a "cocktail" of other currency units.

Facebook's decision to build its payments network on top of a new unit of account is very ambitious, perhaps overly so. When fintechs or banks introduce new media of exchange or payments systems, they invariably piggy back off of the existing national units of account. For instance, when PayPal debuted in 2001, it didn't set up a new unit called PayPalios. It used the dollar (and for the other nations in which is is active, it used the local unit of account). M-Pesa didn't set up a new unit of account called Pesas. It indexed M-Pesa to the Kenyan shilling.

I couldn't find a good explanation for why Facebook wants to take its own route. But I suspect it might have something to do with the goal of providing a universal monetary unit, one that allows Facebook users around the globe to avoid all the hassles of exchange fluctuations and conversions.

Global monetary harmony an old dream. In the mid 1800s, a bunch of economists, including William Stanley Jevons, tried to get the world to adopt the French 5-franc coin as a universal coinage standard. Jevons pointed out that the world already had international copyright, extradition, maritime codes of signals, postal conventions—so why not international money too? He wrote of the "immense good" that would arise when people could understand all "statements of accounts, prices, and statistics." It would no longer be necessary to employ a skilled class of foreign exchange specialists to take on the "perplexing" task of converting from one money to the other.

But the plan to introduce international money never worked out. (I wrote about this episode for Bullionstar).

Global money like Libra might seem like a great idea. But ultimately, I suspect that the decision to introduce a new unit of account will prevent Libra from ever reaching its full potential. Units of account are a bit like languages. If you are an English speakers, not only do you communicate to everyone around you in English, but you also think in English. Likewise with the dollar or yen or pound or euro. If you live in France, you're used to describing prices and values to friends and family in euros. You also plan and conceptualize in terms of them.

It's hard to get people to voluntarily switch to another language or unit of account once they are locked into it. For instance, in the 1800s L.L. Zamenhof attempted to get the world to adopt Esperanto as a language in order to promote communication across borders. To help facilitate adoption, Zamenhof designed it to be easy to learn. But while around 2 million speak Esperanto, it never succeeded in becoming a real linguistic standard. The core problem is this: Why bother learning a new language, even an easy one, if everyone is using the existing language? 

Facebook's Libra project reminds me of Zamenhof's Esperanto project. Nigerians already talk and compute in naira, Canadians in dollars, Indonesians in rupiahs, and Russians in rubles. Why would any of us want to invest time and effort in learning a second language of prices?

Let me put it more concretely. I do most of my families grocery shopping. Which means I keep track of an evolving array of maybe 30 or 40 food prices in my head. When something is cheap relative to my memory of it, I will buy it—sometimes multiple versions of it. And when it is expensive, I avoid it. But this array is entirely made up of Canadian dollar prices. I don't want to have to re-memorize that full array of prices in Libra terms, or keep two arrays of prices in my head, a dollar one and a Libra one. I'm already fluent in the Canadian dollar ones.

Nor will retailers like Amazon or the local corner store relish the prospect of having to advertise prices in both the local unit of account and Libra, plus whatever unit Google and Netflix choose to impose on us. 

So Facebook is inflicting an inconvenience on its users by forcing us to adopt a new unit of account. To make for a better user experience, it should probably index the Libra payments network to the units of account that we're all used to. 

If not, here is what is likely to happen. We'll all continue to think and communicate in terms of local currency. But at the last-minute we will have to make a foreign exchange calculation in order to determine out how much of our Libra to pay at the check-out counter. To do this calculation, we'll have to use that moment's Libra-to-local currency exchange rate. This is already how bitcoin transactions occur, for instance.

But this means that Libra users will lose one of the greatest services provided by money: money's interval of certainty. This is one of society's best free lunches around. It emerges from a combination of two fact. First, most of us don't live in a Libra world in which we must make some sort of last-minute foreign exchange calculation before paying. Rather, we live in a world in which the instruments we hold in our wallet are indexed to the same unit of account in which shops set prices.

Monetary economists call this a wedding of the medium-of-exchange and unit-of-account functions of money. This fusion is really quite convenient. It means that we don't have to make constant foreign exchange conversions every time we pay for something. A bill with a dollar on it is equal to the dollars emblazoned on sticker prices.

Secondly, shops generally choose to keep sticker prices fixed for long periods of time. Even with the growth of Amazon and other online retailers, Alberto Cavallo (who co-founded the Billion Prices Project) finds that the average price in the U.S. has a duration of around 3.65 months between 2014-2017. So for example, an IKEA chair that is priced at $15 will probably have this same price for around 3.65 months. This is down from 6.48 month between 2008-10. But 3.65 months is still a pretty long time.

Prices are getting less sticky thanks to online shopping: https://t.co/AVikQrJjJ6

A price change endured for 7 months back in 2008. It now lasts just 3.7 months. This effect is particularly strong in sectors where Amazon has high market share i.e. electronics & household goods. pic.twitter.com/ncAYkagA0b

— JP Koning (@jp_koning) June 25, 2019

Why do businesses provide sticky pricing? In the early 1990s Alan Blinder asked businesses this very question. He found that the most common reason was the desire to avoid "antagonizing" customers or "causing them difficulties." Blinder's findings were similar to Arthur Okun's earlier explanation for sticky prices whereby business owners maintain an implicit contract, or invisible handshake, with customers. If buyers view a price increase as being unfair, they might take revenge on the retailer by looking for alternatives. (I explore these ideas more here).

Anyways, the combination of these two factors—sticky prices and a wedding of the unit of account and medium of exchange—provides all of us with an interval of certainty (or what I once called money's 'home advantage'). We know exactly how many items we can buy for the next few weeks or months using the banknotes in our wallet or funds in our account. And so we can make very precise spending plans. In an uncertain world, this sort of clarity is quite special.

Given Libra's current design, the interval of certainty disappears. Store keepers will still keep prices sticky in terms of the local unit of account, but Libra users do not benefit from this stickiness because Libras aren't indexed to the same unit as sticker prices are. Anyone who has ≋100 in their account won't know whether they can afford to buy a given item two weeks from now. But if they hold $100, they'll still have that certainty, since dollar prices are still sticky.

If money's interval of certainty is important, it is particularly important to the poor. The rich have plenty of savings that they can rely on to ride out price fluctuations. The fewer resources that a family has, the more it must carefully map out the next few day's of spending.  The combination of sticky prices and a wedding of the unit-of-account and medium-of-exchange affords a vital planning window to those who are just barely getting by.

This clashes with one of Libra's founding principles: to help the world's 1.7 billion unbanked. Here is David Marcus, Libra's project lead:

3/ Because it's time for the internet to have a protocol for money, and it's time to try something new for the 1.7 billion people who are still unbanked 30 years after the invention of the web.

— David Marcus (@davidmarcus) June 18, 2019

Most of the world's unbanked people are poor. But Libra won't be doing the poor much of a favor by choosing to void the interval of certainty that they rely on. If Facebook and David Marcus truly wants to help the unbanked, it seems to me that it would better to index Libras to the various local units of account.

I suppose there is an argument to be made that Libras could provide poor people in nations with bad currencies a haven of sorts. Better Libras than Venezuelan bolivars, right? But the nations with the world's largest unbanked populations—places like India, Nigeria, Mexico, Ethiopia, Bangladesh, and Indonesia—all have single digit inflation, or close to it. Extremely high inflation is really just a problem in a few outliers, like Zimbabwe and Venezuela.

Besides, providing those who endure high inflation with a better unit of account isn't the only way to help them. Offering locally-denominated Libras that offer a compensating high rate of interest would probably be more useful. Not only would these types of Libra offer inflation protection, but they would preserve the interval of certainty.

Thankfully, I suspect that Libra is very much a work-in-progress. The current whitepaper seems to give only a hint of what the project might become. If so, one of the changes I suspect Facebook will have to make if it wants to get traction is to link the Libra network to already-existing units of account. A new unit of account is just too Utopian.