Unlike the krypto-kool-aid drinkers, FB recognizes there are problems with cryptocurrencies in their current iteration. That’s why they’ve issued their own.  There are major differences between Libra and other cryptocurrencies, and that is why FB has issued new crypto. And by the way, the very fact that FB is introducing Libra means that they are refuting both the premise and value of all other cryptos currently available. Again, the very fact that FB is introducing Libra means that they are refuting both the premise and value of all other cryptos currently available.

In fact, the very first thing FB says in the Libra white paper is that there are inherently two problems that they want to fix. All other cryptos are too volatile, which creates the additional problem of irresponsible financial services. Some of the problems with crypto currencies I’ve mentioned in the past fall under irresponsible financial services.  As we’ll see there are other problems that FB is attempting to address as well.

The introduction points to several major issues that FB sees: geographic distance to a local bank, exorbitant fees to make transactions or borrow money, not having enough money to meet minimums, and not having the proper documentation. Perhaps FB summarizes all that best when blaming accessibility.

FB correctly identifies the issues that cryptocurrencies face, like BitCoin and others, in widespread adoption. Even the recent rally in their prices is possibly attributable to only what we call whales, or the largest dozen or so owners of the entire crypto space. Retail and institutional investors aren’t coming in, regardless of being traded on the futures exchange or any ETFs. FB’s problems with the current crypto space include volatility, scalability, and poor options for both storing value and as a medium of exchange. As I have said in the past, this is why crypto does not hold widespread confidence, which is one of the properties necessary for a currency to work.

Especially key is this from FB, “Some projects have…aimed to disrupt the existing system and bypass regulation as opposed to innovating on compliance and regulatory fronts to improve the effectiveness of anti-money laundering. We believe that collaborating and innovating with the financial sector, including regulators and experts across a variety of industries, is the only way to ensure that a sustainable, secure and trusted framework underpins this new system [emphasis added]. And this approach can deliver a giant leap forward toward a lower-cost, more accessible, more connected global financial system.”

Certainly, FB has lofty goals for Libra and the world. But I am not so sure the means will be so lofty. The first red flag is that they want to claim Libra, like other cryptocurrencies, as decentralized. Yet if FB itself is overseeing their own blockchain and currency, doesn’t that mean that it’s centralized to FB? It’s not centralized to the government, but FB is a centralized entity with an HQ, paid employees, a hierarchy with a CEO and a board of directors, etc. 

Much the same as a government’s own central bank, except that FB wants to rule the financial world with their cryptocurrency. That’s not good news for all the other cryptos (or the rest of us) as the crypto crowd wants the rest of us to believe. And FB actually spells this out in section 2 of their proposal, saying there will be a global HQ in Geneva Switzerland, with a board of directors overseeing the currency. That sounds awfully centralized, much like a central bank or the IMF.

One of the big benefits that FB is building in, however, is that the Libra will be backed by assets, much like the dollar was backed by gold until August 1971. The intent is to stabilize the price of the Libra, as priced in any other currency. In other words, if FB wants to keep the Libra at a 1:1 ratio with the dollar, they’ll be able to by using the assets that back the Libra. 

Theoretically, this would solve the store of value problems. However, if the Libra is backed with other fiat currencies but not real assets, then even if they are able to maintain a ratio of Libra to USD at 1:1, we’ll anyway face the same problems of inflation and devaluation. And of course, if the dollar loses all public confidence and becomes a relic of monetary history, what does that mean for the Libra?

In fact, FB itself already has told us that there will be problems with the Libra because of the way they are addressing the stable value over time issue. They want to use a basket of bank deposits alongside short term government securities to back and stabilize the Libra. If you think that sounds like the prospectus for your money market account, that’s because it is; FB has borrowed this idea from Wall Street.

Now, if you’ve read my prior writings you know that I think the dollar is going to fall precipitously with the next crisis. Not the next recession. That won’t happen, because the next recession will be the greatest financial crisis this country and the world has known in modern history. Bank deposits will become worthless, and therefore anything backed with bank deposits, like the Libra, will become worthless. And because we’ll have a crisis of confidence in the dollar, that also means that government securities, ie government bonds (treasuries), will also become worthless. Transitively speaking, that means your Libra will be worthless.

Another red flag to me is that FB talks about security throughout their white paper. Really FB? With all the reports of FB itself watching people’s accounts and all the security breaches and all the stories about selling our data, are we really expected to believe FB when they say security is their priority? And don’t come and tell me that the blockchain is unbreachable.  It’s been breached several times already to the tune of billions of losses for the owners of the coins. With a track record that would make Richard Nixon blush, I doubt the veracity of their security claims, and I certainly wouldn’t trust FB with my money.

In section 4, FB gets into the currency itself and the reserves, or backing of the currency. FB says they’ll be using bank deposits and government securities to back their crypto, from well established, trusted central banks, with investment-grade credit rating. The implication is that the institutions would be willing to put money into this because their charter allows and it’s considered safe. And FB is saying that this will help ensure that the value of Libra coins will remain stable with low inflation over time.

In the same breath, however, FB warns that because there will be a basket of government securities and currencies backing the coins, they can’t guarantee a fixed conversion ratio into any currency!

The truth here is that if they are warning about not guaranteeing a stable conversion ratio, and if they are warning that they will accept low inflation, that means that over time your coins will convert into lower and lower amounts of your currency, which of course in the US means dollars, and which of course means that the Libra is not going to be a coin that stores value over time. Even if the ratio remains stable, your purchasing power will be lost to inflation.

On the one hand, this makes it just like any other fiat currency, which is worthless. On the other hand, it’s good that they warn about this because if they want to comply with the financial standards of all countries, then they really have to warn buyers of this caveat emptor.

And herein lies a major flaw of Libra.  In fact, without even realizing it, probably because FB did all this research into crypto without doing any research into what makes a real currency into real money, they printed their flawed understanding in black and white for all to see. Unfortunately, most other people will miss this as well, because they also don’t understand what the difference between real money vs currency is. FB says “the assets behind Libra are the major difference between it and many existing cryptocurrencies that lack such intrinsic value and hence have prices that fluctuate significantly based on expectations.”

Well, I’ve got news for you. The same thing happens on a daily basis with the assets FB wants to use to back Libra. That means that Libra’s purchasing power will also fluctuate, because the whole point of having cash in your pocket, regardless of the form of cash you hold, is to be able to buy stuff, pay your bills, and keep the tax man at bay.

Now the good thing here, though, is remember that I said that the assets that back Libra are set up to function like a money market account. Money market accounts earn interest, and by virtue of the fact that Libra will be backed by government securities, which is bonds, the Libra’s backing assets will earn interest. But if you own Libra, you won’t see any of that interest in your Libra account. Instead, FB will use the interest to eliminate transaction costs and pay a return to investors rather than users. 

While it’s a good thing that the transaction costs of Libra will be eliminated, the problem is that about 33% of the world’s sovereign bonds are still yielding negative returns, and 17% of European junk bonds are giving a negative yield. How in the world will they cover transaction costs using negative-yielding assets, which are guaranteed to lose money!? 

And this problem is about to get worse. Central banks around the world have all recently announced either a pause in rate hikes, entered into QE and rate cuts or they’ve announced, like the Fed, that the door is open to QE and rate cuts. Which means a greater proportion of bonds will be yielding 0% or negative returns. And if any of these governments default, either implicitly through inflation, or explicitly in outright default, the yields will be even less.

In summary, the white paper reads much more like a money market account prospectus, and while FB has a good idea or two to help eliminate the flaws found in other cryptos, the Libra is also a flawed currency like any other crypto or any other fiat like the dollar. Libra is intended to refute all other cryptos, but truth be told, everyone knows about crypto already, and if they wanted to adopt it they would have by now. FB won’t likely change the general consensus and convince people to adopt the Libra. If anything, they’ll steer clear of FB’s poor security history and propensity to spy on its account holders.

This white paper of theirs actually makes the case for the government to intervene, call out all cryptos as tradable security on an exchange (they already trade on the futures exchange anyway), and regulate the living daylights out of them.

In fact, the Treasury Secretary, Steven Mnuchin, a couple of days ago came out with pretty strong language against cryptos, and more strong language today. And rightfully so, one of his biggest claims is that cryptos open the door for all kinds of crime and criminals. But more than that, Mnuchin, Fed chairman Jay Powell, and several politicians from both parties have stated correctly that Libra presents a threat to the entire global currency system. G7 finance ministers all came out very strongly against all cryptos, and our own Congress here in America was not very happy with the congressional proceedings this week regarding the "Zuck-Buck". 

One last, not too serious comment about the Libra. It is set to launch in the first half of 2020. But there are memes already circulating, saying “Your Libra account has been suspended for 30 days because you have purchased something that does not conform to our community standards. At the end of the 30 days, you’ll regain full access to your account.” It’s just a joke intended to poke fun at FB, however Orwellian you may think it is.

That’s it for now, and thanks for reading Volume 90 of The Macro Market Wrap Up With The Mad Genius. Make sure to leave any questions or comments below. Until next time remember that there is always a bull market somewhere in the world, and on the opposite side of every crisis there always lies opportunity.