bob looney teaches economics at the Naval Postgraduate School in California.
Published November 2, 2021.
OK, you managed to get elected president of El Salvador, the young democracy born out of a horrendous civil war, and sustained your popularity for some time after the 2019 election by containing street crime and playing the social media game very well. But the bloom is off the rose for President Nayib Bukele, due to the steep pandemic-driven recession, a lukewarm response to the Covid-19 threat to public health and growing anger over widespread government corruption.
What to do? Bukele’s answer may surprise: begin to flex a little authoritarian muscle, and distract the masses with some razzle-dazzle PR magic by declaring bitcoin to be legal tender in El Salvador alongside the U.S. dollar!
Yes, you read that right. And while you may not be especially interested in the fate of this small (pop. 6.9 million), middle-income (per capita about $8,000 in terms of purchasing power) Central American nation, probably best known in the United States as a source of high-end coffee beans and the MS-19 gang, the Bitcoin initiative does add a wacky feature worth a closer look.
Setting the Stage
El Salvador’s never-robust economy went over a cliff as Covid-19 swept through the land, among other problems paring remittances from the country’s diaspora community that as recently as 2019 supplied one-fifth of the country’s purchasing power. In 2020, GDP contracted by 9.5 percent while reported unemployment increased to 9.4 percent. And thus far, some 3,600 Salvadorans have died from the pandemic.
Now, these figures aren’t so awful compared to, say, Brazil’s or even the United States’. And in any case, the tools available for tackling El Salvador’s problems by this leader or any other are pretty limited. But few citizens (of democracies, anyway) are inclined to grade their governments on a curve. And Bukele, ever a showman, understood an appeal for patience was not going to fly. Instead he offered a threat veiled as a joke, labeling himself the “world’s coolest dictator” in his Twitter bio — and in September unveiled an entertaining distraction by proclaiming the legendary private cryptocurrency bitcoin as El Salvador’s legal tender along with U.S. dollars.;
Bitcoin, Up Close and Personal
Although bitcoin has been around since 2009, no country other than El Salvador has adopted it as currency. It’s not hard to understand why. All one needs to do is consider the functions that money serves and ask whether Bitcoin can do anything traditional currencies can’t do just as well — or much, much better.
First and foremost, a worthy currency must be widely accepted as a medium of exchange that is stable in value at least in the short term. Bitcoin has gotten just a bit of traction in the world of commerce: for example, the Oakland Athletics baseball team recently sold a full-season suite for one bitcoin. But this was an exception that proved the rule, an offer that was open only for a week precisely because nobody knew what one bitcoin would be worth in dollars even hours later.
This same problem of uncertainty exists in El Salvador. Bitcoin values may change 10 or 15 percent before they can be converted into dollars (or into tangible assets like dinner). For businesses, this creates unacceptable financial uncertainty. “We’re still not sure what benefits the government expected,” said Leonor Selva of El Salvador’s National Association of Private Enterprises.
The Strike app relies on internet access in a country that the World Bank reports had only 135 secure internet servers per million people in 2020.
For starters, Bukele claimed the adoption and use of bitcoin would reduce the costs of funneling all those three-and-four-figure remittances that the 1.4 million El Salvadorans living in the United States send home to their families. Many now pay disproportionate fees to Western Union and other international small transactions specialists. However, other newer technologies appear far more promising in this regard than bitcoin.
The government also sees El Salvador becoming a center for bitcoin “mining” — creating new bitcoins for international circulation by solving humungous computer algorithms. But this takes a ton of electricity, and it is far from clear it would be a profitable business. In any case, the business could thrive or die on its own, whether or not bitcoin was the currency of the land.
Bukele’s government developed its bitcoin fantasy with help from Jack Mallers, the CEO of Strike, a digital wallet app that enables small bitcoin payments. The government offered $30 worth of bitcoin to encourage Salvadoreans to download the Strike app, which reportedly enables instant conversion of bitcoins into dollars. But the app relies on internet access in a country that the World Bank reports had only 135 secure internet servers per million people in 2020. And although the app’s transactions are backed by a $150 million fund, that’s a far cry from the assurances provided by the full faith and credit of the United States behind the dollar.
Not surprisingly, international financial organizations are raising collective eyebrows at Bukele’s bitcoin dalliance. The IMF diplomatically noted that the decision “raises a number of macroeconomic, financial and legal issues,” warning that “crypto assets can pose significant risks, and effective regulatory measures are very important when dealing with them.” The World Bank, for its part, rejected a Salvadoran request for technical assistance in introducing bitcoin, expressing concerns that the near-anonymity of bitcoin transactions would facilitate illegal activity in a country already plagued by organized crime.
These disapproving words should carry some weight since El Salvador is seeking a $1.3 billion loan from the IMF to break its economic fall. And even that sum may not be enough. Fitch, the credit rating agency, estimated in April that the country would need $2.4 billion in external financing to limp through 2021 without a foreign exchange crisis and that its debt-to-GDP ratio would reach 92 percent by the end of the year — an increase of almost 22 percentage points from 2019.
Actually, the bitcoin adventure has a touch of déjà vu about it. Way back in 2001, another Salvadoran government made the case for shifting from its own national currency, the colón, to the U.S. dollar. The switch to dollarization, it was argued, would increase confidence in the economy and attract investment, domestic and foreign. Yet IMF data show average investment increased from 17.5 percent of GDP for 1990-2001 to just 17.8 percent for 2002-2020. When at first you don’t succeed ….
The explanation for El Salvador’s low investment rates is almost certainly tied to investor concerns with the country’s eroding economic freedom and governance quality than its choice of official tender. On the Heritage House Index of Economic Freedom, the country fell from “mostly free” following a period of reforms in 1999 to “moderately free” in 2011 to the verge of “mostly unfree” by 2021. El Salvador’s ranking on the World Bank Governance Indicators fell from the 43rd percentile in 2014 to the 29th in 2020 for Control of Corruption, the 37th to the 17th for Rule of Law and the 54th to the 38th for Government Effectiveness for the same years.
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It’s hard to escape the conclusion that the president’s bitcoin escapade is all sizzle and no steak. For now, though, Bukele can still fashion himself a modernizer, while bitcoin distracts from the floundering economy and ongoing Covid-19 woes. Meanwhile, El Salvador awaits practical solutions to its very real problems.