El Salvador and Bitcoin – a silly decision

  • El Salvador has voted to make Bitcoin legal tender.
  • It is difficult to see any rationale for this.
  • In fact, it is a ridiculous move, highlighting President Bukele’s ignorance of economics

In early June, the Congress of El Salvador, acting on a proposal from President Nayib Bukele, passed a law making Bitcoin legal tender. This is the first time a country has taken this step. President Bukele claims that it would help expatriate Salvadoreans to send money back to the country.

Bearing in mind that there are already numerous ways of sending money cheaply across borders, bypassing a banking system that charges huge fees for doing so, it is difficult to see this as the main rationale for the move. In fact, it is difficult to see any rationale at all for it at all – but it is easy to spot the problems.

However, let us clear up something first, namely the issue of ‘legal tender’, which is a phrase frequently spouted but rarely understood. ‘Legal tender’ is the currency which, if you are owed a debt expressed in that currency, you are legally obligated to accept as settlement for the debt. So, for instance, all US dollar bills bear the legend, ‘This note is legal tender for all debts public and private’. This means that if you are in the United States and are owed a debt expressed in dollars, and the debtor is giving you dollar bills to settle the debt, you must accept them. By contrast, you could reject, say, euros, gold or – dare I say it? – Bitcoin. But note the point about ‘a debt expressed in that currency’. Unless the El Salvador government changes the definition of legal tender, all it means is that someone owed a debt expressed in Bitcoin, is forced to accept Bitcoin as settlement for that debt. Someone owed a debt expressed in dollars, cannot be forced to take Bitcoin. 

For all that this seems straightforward, the concept of legal tender is not very well understood, not even by people in finance. It is, in fact, perfectly possible to have a country with no or very limited legal tender, as is the case in Scotland. As for El Salvador, since there was nothing – as far as I know – to stop Salvadoreans from using Bitcoin previously, the impression is that the government of El Salvador doesn’t have a clue what ‘making Bitcoin legal tender’ actually means.

At the moment, El Salvador uses the US dollar as its currency. It seems clear that this will continue to be the case. Hence, El Salvador will have two currencies circulating in tandem, but whose exchange rate can change by several hundred percent. After all, on 16th June 2020, one Bitcoin was worth $9,441. By 16th April 2021, this had risen by 570% to $63,346; and by 9th June 2021 that had in turn fallen to $33,500, a drop of 52%. Leaving aside the difficulty of planning any form of economic activity with such swings, how would a Salvadorean expatriate working in the United States, scraping together money to send back home, feel? If the value of the remittance had quintupled, no doubt wonderful. If it had halved, probably less good. But how to be certain which way if would go?

Moreover, by adopting Bitcoin, El Salvador would adopt a currency over which it has no control. True, this is already the case, since the country uses the US dollar. But the stock of dollars is at least expanding. By contrast, there is a theoretical limit to how many Bitcoins can be created.[1] At the moment, this is not really an issue. The total stock of Bitcoin is worth something like $650 billion, while El Salvador’s GDP is only worth somewhere short of $30 billion. But, assume for a moment that the value of Bitcoin were to drop back from its current $35,000–$40,000 range to $3,000. After all, that’s where it was a few years ago. At that stage, the stock of Bitcoin would be around twice El Salvador’s GDP. Even in the highly unlikely case of El Salvador laying its hands on half the Bitcoin in the world, it would then only be able to see its economy grow, either if Bitcoin constantly appreciated against the dollar; or, if the Bitcoin/dollar exchange rate remained stable, at the price of deflation. The former would add to the instability and confusion of the situation. The latter, sustained deflation, is even worse.  We know this, because that is one of the main causes of the late 19thCentury Long Depression (tellingly, originally called the Great Depression). Much of the world was on the gold standard, but the stock of gold was not growing fast enough to keep up with economic output and the result was years of painful deflation from which the world was eventually saved by the discovery of gold in South Africa. 

There are other reasons to query the decision. For instance, since it would be possible to pay taxes in Bitcoin, the El Salvador government would take on a substantial exchange rate risk. Again, great if the currency’s value doubles between revenue and expenditure. Not so great if it halves over the same period.

In addition, it must be asked if it really makes sense for a small country to take all the risks involved in owning and managing an asset with no value, extremely poor security, extremely poor ESG credentials (Bitcoin mining apparently uses more energy than the entire energy consumption of Argentina) and a hacker’s and blackmailer’s dream.  Does the El Salvadorean government really want to build up a credit balance in an ‘asset’ that places it firmly in the hands of underworld?  Does it really want to run its government accounts and transactions in a currency it cannot borrow?

So what really lay behind El Salvador’s – or, rather, President Bukele’s – decision? Difficult to say. But it is tempting to believe that it was the attraction of being seen as modern, at the cutting-edge of technology, doing something no one had done before. Not to mention diverting attention from the President’s ever more authoritarian tendencies. A healthy dose of complete ignorance of economics probably also helped. But maybe the move was not entirely useless after all – that is, if the problems El Salvador’s action reveals, ensure that others considering the same move, step back from this brink. Although a far more likely development is of course that nothing will happen – in other words, Salvadoreans will continue to use the dollar and ignore Bitcoin, perhaps after trying it once.

Gabriel Stein

[1] The limit is theoretical, since there have already been ‘forks’ in the Bitcoin chain, leading to possibility of more Bitcoin being created than was originally the target.