This is a followup post to my article two days ago giving my immediate impressions on the impacts of the President of El Salvador announcing that he intended to make Bitcoin legal tender in his country.
I've been looking into the details of how President Bukele Ortez came to become involved in Bitcoin, his political position and the strategic reasons that drove him to make this decision.
I will then do an in-depth analysis of the potential impacts.
1. A Short Political History of President Bukele Ortez.
Source:
https://twitter.com/JackRosenNYC/status/1092907281967206400/photo/1
- JackRosenNYC
The first thing to understand is that Bukele Ortez was a third party / independent candidate for President who rejected both major parties which had dominated El Salvadoran politics for generations. He founded the "New Ideas" party in 2017 after breaking with one of the major parties.
He won the 2019 Presidential Election by a huge margin, outpolling, with 53% in the first round, both major parties combined (32% and 14% each).
In the 2021 Legislative Assembly elections his party won another massive election victory with 66% of the vote, completely smashing the two traditional major parties once again. His party holds 56 out of 84 seats in the Legislative Assembly (next biggest party has 9 seats) and 14 of El Salvador's 20 representatives in the Central American Parliament.
Suffice to say that these sort of results are extremely rare in parliamentary democracies and represent a political earthquake and rejection of the establishment of epic proportions.
Normally these sorts of election results are only possible with long standing dictators who have suppressed all opposition. For a new political party with a new leader going up against establishment interests they are nothing short of extraordinary.
He is exceptionally popular in El Salvador with opinion polls rating him 96% support (those saying he is doing a "good" or "very good" job).
2. The President and Bitcoin
President Bukele Ortez's announcement was part of Strike CEO, Jack Mallard's presentation at the Miami Bitcoin 2021 conference and it is really worth watching the whole 21 min video because it gives important background and context, as well as being extremely moving.
El Salvador is a country that has no native currency and adopted the US Dollar in 2001 after their devastating civil war.
- 22% of the country's GDP comes from remittances from Salvadorians working overseas.
- 70% of Salvadorians are unbanked.
There are a number of crypto companies and projects involved in El Salvador from the not-for-profit Bitcoin Beach to companies like Blockstream and Strike. Strike uses the Bitcoin Lightning Network to provide fast, free global payments - perfect for remittances.
According to Strike's CEO, he spent a few months in El Salvador investigating the business opportunity and desperate need of the people of El Salvador. At some point he was contacted by President Bukele Ortez's people and they connected on a range of levels. Mallard showed the President how Bitcoin could solve many of his country's problems and provide his people financial inclusion and hope.
3. Strategic Reasons for adopting BTC as legal tender
3.1 Providing Monetary Stability
The massive monetary expansion (money printer goes Brrrr!) by the US Federal Reserve over the last 18 months is unprecedented in all of US history. Since Jan 2020 the total amount of US dollars in the economy has risen from $15.4 Trillion to $20.1 Trillion - an increase of over 30%.
This is on top of a very rapid increase in US Dollar supply over the last 25 years.
To put this in context, in January 2001, when El Salvador adopted the US Dollar as its legal tender, there were 4.975 Trillion US Dollars in existence (M2). Since then the number of USD in existence has more than quadrupled. This means that the US Dollar's purchasing power is less than one quarter of what it was 20 years ago.
Source: https://fred.stlouisfed.org/series/M2SL
While this is bad for US residents, its impact is cushioned because some of this extra new money is given out to them in the form of handouts and some which gets to productive businesses which assists growth. Of course most of it ends up in the hands of government cronies and the ultra-rich and drives massive asset price inflation.
But however bad this monetary expansion is for US residents, it is much much worse for the citizens of countries, like El Salvador, who are either using the US Dollar as legal tender or whose currencies are pegged to the US Dollar.
They are not getting any handouts and are exposed to the full inflationary effect of all the extra dollars in circulation. Their purchasing power is slashed!
There are only a certain amount of US Dollars circulating in the El Salvadorian economy and its government can't print more. When the purchasing power of those dollars is slashed by 30% in 18 months it represents a 30% economic contraction of the El Salvadorian economy caused by an external factor over which the El Salvadorian government has no control.
This is the Number One reason El Salvador is adopting BTC as legal tender - to provide monetary stability - sound money is essential for economic success. They can no longer afford to have their economy devastated by the irresponsible monetary policies of Uncle Sam.
3.2 Slashing Remittance Fees and Costs drives huge GDP boost
When 22% of your GDP comes from remittances from your citizens working overseas, the fees and costs of traditional forms of remittance are a very big deal. With end-to-end fees of 10-20% on remittances and additional costs (such as travel to and from Western Union physical office on both ends) cutting still further into actual amounts available for spending by recipient, up to 50% of the sender's money is being lost in transit.
This scenario from the Bitcoin Beach website is illustrative:
Current Option using Western Union- Son drives to Western Union Office and pays $7 fee. Mom has to pay to take the bus an hour away and retrieve the money. Cost to son $7 plus an hour of his time. Cost to mom $2 in bus fare and 4 hours of her time plus the risk of traveling on bus with money.
New Option using Bitcoin- Son uses the new Strike App (https://strike.zaphq.io/) linked to his US bank account to send $100 in BTC over Lightning network. Cost to son $0 and 3 minutes of his time. Cost to mom $0 and receives payment immediately, directly to her phone.
If the sender can save an hour of time and petrol and parking by sending from his/her phone they can afford to send more money.
If the recipient can save 4 hours, bus fares and risk they can use that time productively (perhaps posting on Hive) and have more money left to spend.
As this change plays out across millions of El Salvadorans, the economic impact is a potential 11% GDP boost for the El Salvadoran economy and significant improvements to the quality of life of millions of remittance recipients.
3.3 Becoming a Crypto Hub and destination for Nomad Capitalists
If you follow Andrew Henderson of Nomad Capitalist you will understand that there is a substantial global market for citizenship, residency and attractive places to live and do business.
Many smaller countries offer citizenship and residency-by-investment programs (C/RBI) and compete for global entrepreneurial investment.
Crypto entrepreneurs are an attractive and wealthy new breed who are increasingly looking for alternatives from over-regulation in legacy brand economies like the US.
With many sitting on large unrealised cryptocurrency gains, they are looking for lower tax and lower cost of living alternatives.
With this announcement President Bukele Ortez has made a strong pitch to Nomad Capitalists and Crypto Entrepreneurs:
- Beautiful beaches and people
- great surfing
- cheap beachside property with no property tax
- no capital gains tax in Bitcoin sales
- BTC as legal tender creates millions of new potential customers for crypto businesses.
The President has promised immediate permanent residence to crypto entrepreneurs who invest 3 BTC in an El Salvadoran business. This is a good deal as most C/RBI programs require minimum investments ranging from $100k to $1.5M.
I'm sure that there will be many taking up his offer and this will be a bring tremendous growth to the El Salvadoran economy.
4. Other Countries likely to follow suit
I've identified above the three strategic factors that drove El Salvador to adopt BTC as legal tender:
- use of the US Dollar as legal tender (or have own currency pegged to USD)
- have remittances as a big percentage of GDP
- have programs designed to attract individual foreign entrepreneurs and investment with established citizenship or residency by investment programs (C/RBI)
I've now examined which countries have all or at least two of the above characteristics (remittances 5% of GDP or above).
Countries with all three BTC friendly characteristics (in order of declining remittances as percentage of GDP):
- Tonga (37.2%, Peg to multiple currencies incl USD, Suspended CBI program)
- El Salvador (20.9%, USD)
- Bermuda (20.7%, USD)
- Marshall Islands (14.2%, USD)
- Montenegro (10.5%, Euro but not in EU)
- Dominica (8.4%, USD Peg)
- St Vincent and Grenadines (5.7%, USD Peg)
- Belize (5.2%, USD Peg)
Countries with 2 out of 3 BTC friendly characteristics:
C/RBI & High Remittances
- Samoa (17.2%)
- Moldova (16%)
- Jamaica (15.6%)
- Georgia (12.9%)
- Armenia (11.2%)
- Jordan (9.9%)
USD & C/RBI
- Panama (USD)
- St Kitts & Nevis (USD Peg)
- Saint Lucia (USD Peg)
- Grenada (USD Peg)
- Antigua & Barbuda
USD & High Remittances
- Micronesia (5.8%)
- Timor Leste (5.0%)
I note that Panama is already talking about following El Salvador's lead. It is well experienced in attracting Nomad Capitalists.
I think Belize, Bermuda and other Caribbean Island nations will be looking very seriously at what El Salvador is doing.
Remember, all these countries are competing to attract entrepreneurial talent and investment so will not want to be left behind now there is a new player in the field offering a unique competitive advantage.
5. Potential Impacts
5.1 Global impact of BTC becoming legal tender
As I noted in my earlier post, once one country adopts BTC as legal tender then it becomes foreign currency for the purposes of tax and accounting codes in all other countries. These changes not only reduce or eliminate tax on sale of BTC but also greatly simplify accounting for BTC.
It is difficult for a country to exclude BTC as a foreign currency as it is against laws of international comity and and insulting to a sovereign power. As I've noted above, other countries have strong strategic incentives to follow, so it will become increasingly difficult to try to exclude BTC as a legitimate foreign currency.
5.2 Central Banks buying BTC as reserve asset
One little mentioned part of President Bukele Ortez's announcement is that the El Salvadorian central bank will be buying BTC and holding it as a reserve asset.
UPDATE: The current bill does not provide for the Central Bank to hold BTC. It will be held in a development bank that will have $150M USD to acquire BTC from small merchants that want immediate conversion of BTC to USD. However the President has indicated that the Central Bank holding BTC is likely in the future.
This is another major first and will open the way for other central banks to do the same, just like MicroStrategy led the way for BTC to become a corporate treasury reserve asset.
In a very conservative culture like central banking no one wants to be the first to do anything new. But once the first central bank does it and their country benefits, then others will follow, few at first and then in a herd mentality.
BTC is a hedge against inflation and US dollar debasement and will enter the mix of central bank assets.
It goes without saying that this means massive buying pressure on BTC, especially once larger nations start becoming involved.
5.3 Supplanting the US Dollar as the global reserve currency
In my view, this has been the ultimate destination of BTC for some time but things are moving along much faster than expected.
It is less than 12 months since MicroStrategy (in Aug 2020) broke the ice of major corporations buying BTC and yet here we are with the El Salvadoran central bank about to do so.
To understand how this step, from a poor country with less than 7 million people, can lead to the demise of the US Dollar as the world's reserve currency, one needs to understand the history of global reserve currencies, the US's recent behaviour in relation to the US Dollar and the geopolitical dynamics.
5.3.1. Global reserve currencies have a limited lifespan
This table shows how various country's currencies have been the global reserve currencies for periods and then lost that status to another country. Source economicreason.com
5.3.2. Global reserve currencies depend on trust of other countries
While military prowess and economic strength are certainly factors in becoming a global reserve currency, it is the trust of all the other countries of the world that is crucial.
That trust is based on two inherent promises:
- that the currency will be kept stable, with gradual, predictable increases in monetary supply to match economic growth - best achieved by adopting the gold standard
- that the reserve currency status will not be abused by using it as a weapon too frequently and against too many other countries.
The United States of America has fundamentally violated the trust which the countries of the world placed in it at Bretton Woods in 1944.
- First it unilaterally dropped the Gold Standard in 1973.
- Then it started printing USD well in excess of real economic growth, culminating in the massive debasement of the US Dollar over the last 20 year and particularly the last 18 months as outlined in section 3.1 above.
- Finally, it has massively over used the USD's reserve status and its pre-eminent role in the global financial system (eg SWIFT, IMF, World Bank etc) as a weapon against not just small rogue states like North Korea and Iran but against major global powers like Russia and China. It has even begun to threaten the EU.
While massive money printing has hurt the smaller countries of the world as outlined above, abuse of global reserve status has pissed off large powers and caused them to seriously look for alternatives.
Russia and China have created alternatives to SWIFT and have dramatically reduced their use of US dollars in their international trade.
Russia has now completely de-dollarised its sovereign wealth fund, cut USD holdings of its central bank massively. Both have bought huge amounts of gold.
The problem for Russia and China is that no one trusts them or their currencies either and they barely trust each other.
Neither the Yuan nor the Ruble is a serious contender for a new global reserve currency. Nor is the Euro, which represents a bunch of has-been countries with no serious military power projection capabilities whatsoever.
So we are in a situation where most countries don't trust the USD any more, but there is no obvious replacement amongst national fiat currencies.
Enter BTC, a currency with a fixed, stable supply, like gold, that requires no trust and is not controlled by anyone.
It meets all the requirements for a global reserve currency and is the only option that all countries can trust when they can't trust each other.
As central banks gradually bring BTC into their reserves and more and more business starts being conducted in BTC and other cryptocurrencies, the inevitability of BTC as the new global reserve currency will become clear to even the biggest Bitcoin skeptics.
El Salvador has the honour of being the country to start this momentous geopolitical process. It will benefit enormously from its decision.
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