The news that the president of El Salvador plans to adopt BTC as an alternative to the U.S. dollar for transactions in his country has caused quite a stir. Bitcoin has captured its first country. Reactions have varied from “wow, this is BIG for bitcoin” to “this is not going to end well.”
As ever, the truth is probably somewhere in the middle. It’s not a major coup for bitcoin, but it could work quite well for El Salvador. And, importantly, it might establish a real-world use case for bitcoin that doesn’t involve crashing the entire global monetary system. I don’t think bitcoin will replace the dollar as the premier global settlement and reserve currency, but that doesn’t mean it couldn’t be good for some countries.
Frances Coppola, a CoinDesk columnist, is a freelance writer and speaker on banking, finance and economics. Her book, “The Case for People’s Quantitative Easing,” explains how modern money creation and quantitative easing work, and advocates “helicopter money” to help economies out of recession.
El Salvador (population 6.5 million) is a “dollarized” economy. It doesn’t have a currency of its own. Instead, it uses the U.S. dollar as its domestic currency. El Salvador’s relationship with the U.S. is not like that of a U.S. state, or even a territory such as Puerto Rico. It is an independent sovereign country that chooses to use the dollar instead of issuing its own currency. El Salvador is not subject to U.S. law and the U.S. government has no jurisdiction there.
Because it doesn’t produce its own currency, El Salvador’s government can’t print money. And it doesn’t benefit from the Federal Reserve’s money creation. The Fed is not in any way responsible for ensuring that El Salvador has enough dollars for domestic use. So, El Salvador must either borrow or earn the dollars it needs.
It can earn dollars by exporting more than it imports and by receiving dollar remittances from its citizens working overseas. If those two sources don’t provide enough dollars to meet domestic needs, both the private sector and the government can borrow dollars on international markets.
Currently, El Salvador exports less than it imports, but remittances are large enough to ensure that its “current account” – the net value of all its transactions with the rest of the world – remains slightly positive. On balance, therefore, El Salvador is receiving net dollar inflows. But the government is borrowing heavily: In the last couple of years, government debt has risen to over 90% of gross domestic product, and borrowing costs are rising. It’s unclear how much more the government will be able to borrow.
Furthermore, dollar flows are volatile. It’s only a few years since a commodities price crash caused dollar inflows for countries such as Nigeria and Angola to reverse abruptly, forcing them to sell down their dollar reserves to maintain their currency pegs to USD. A dollarized economy such as El Salvador doesn’t need reserves to maintain a currency peg, but it does need dollar reserves to maintain liquidity for domestic banks, businesses and households. Running short of dollars can force it to close its banks and sharply curtail government spending.
In its 2019 Article IV report, the International Monetary Fund said that El Salvador’s dollar reserves are too low for its economy. El Salvador needs more dollar income, and that means developing export industries and encouraging overseas workers to send more dollars home. Earning some income from its existing reserves would also help. Today’s near-zero interest rates on safe dollar investments aren’t good for countries like El Salvador.
Considering all of that, adopting BTC as a second currency doesn’t look like a bad idea. There are several potential benefits.
First, using bitcoin to send remittances could be easier, cheaper and faster for overseas workers than using money transmission services or bank wire…