Cryptocurrencies could constrain a country’s choices

GS-III: Cryptocurrencies could constrain a country’s choices

CONTEXT

Facebook announced launching a cryptocurrency called Libra, designed to appeal to its global user base of over 2 billion.

Libra

It will be backed by a basket of fiat currencies.
It is supported by a consortium of large-scale corporate houses, financial services firms, and venture capitalists.
Millennials have little patience for expensive traditional banking methods for cash transactions. They would likely flock to alternatives like Libra.

Impossible trinity

It is the “trilemma” of monetary policy. It states that it is impossible to have all three of the following conditions fulfilled at the same time:
A fixed foreign exchange rate
Free capital movement
An independent monetary policy
Even before cryptocurrencies, governments looking to control the monetary aspects of their economies have been subject to this trilemma, and have been forced to implement only two of the three conditions.
If you want control over both your exchange rate and monetary policy, you would have to impose controls on free capital movement.
Hence the existence of capital controls such as India’s Foreign Exchange Management Act.
The trilemma is a theory based on the “uncovered interest rate parity condition”.
It is supported by evidence-based studies where governments that have tried to simultaneously pursue all three goals have failed.
Strong capital controls have meant that other means of payment have been in use before, such as the infamous “hawala” system.
The ease of use and the scope of new Big-Tech cryptocurrencies are about to create global currencies of a completely different class.
Economists argue that such currencies will affect the exchange rates and monetary policies of traditional currencies. This is because the introduction of a global digital currency removes the capital control levers that sovereign nations have today.

Conclusion

Thus the advent of Big Tech cryptocurrencies means that countries would have one less lever to pull.

Source: Live Mint

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