As Bitcoin plummets, why are more countries joining the "big gamble"?

El Salvador's big bet on Bitcoin reflects the dissatisfaction and resistance of a country that has long been at a disadvantage in the existing financial system to the traditional international financial order and rules. It also suggests a grim fact - in the context of global low growth and high inflation, crises and risks have caused the chronic diseases of many countries to burst out, the waiting areas of emergency rooms are overcrowded, but there are not enough relief prescriptions and resources.

▲On November 20, 2021, in Santa Maria Mizata, El Salvador, a Bitcoin symbol appeared on the big screen at the closing ceremony of the Cryptocurrency Investors Conference. Photo/Visual China

This article was first published in Southern People Weekly

Text/ Chen Yang, reporter of Southern People Weekly

“Bitcoin Nation”

Since September 2021, Lu Bingquan, who is in Hangzhou, has noticed a change in the circle: many people have changed their WeChat addresses to "El Salvador". These people may not really be there, but do so to express a sense of community belonging.

Lu Bingquan calls himself a "practitioner", but it is not easy to add the appropriate industry prefix. In his opinion, both blockchain and Web3 (the abbreviation of the new generation of the Internet) have been or are experiencing "demonization". The industry is large and complex, and Lu Bingquan, who "has a complex of crypto natives", does not want to be simply classified.

El Salvador, which has stirred up the community atmosphere, is a small coastal country in northern Central America. The land area is less than two times the size of Tianjin, and the economy is mainly agricultural with a weak industrial foundation. When it comes to El Salvador, the most well-known labels are "volcanoes", "civil war" and "gangs". However, with the official implementation of the Bitcoin Act in El Salvador in September 2021, the country has gained a new label-the first country in the world to use Bitcoin as legal tender.

According to the bill, Bitcoin will be listed alongside the U.S. dollar as the legal currency in El Salvador and can be used for commodity pricing, payment and taxation. The bill also stipulates that unless it does not have the technology required for the transaction, each economic entity is obliged to accept Bitcoin as a payment method for goods or services.

Compared to some people in the industry, Lu Bingquan is "not particularly excited" about this. "The definition of Bitcoin in the Bitcoin white paper is a 'peer-to-peer electronic cash system'. Bitcoin itself is not given any meaning. Salvador is simply using Bitcoin to achieve his own goals and narrative."

After the end of the civil war in 1992, El Salvador launched a round of financial reforms, including pegging the Salvadoran krona to the US dollar at a fixed exchange rate in 1993. Eight years later, in the wave of dollarization of Latin American currencies, El Salvador followed in the footsteps of Ecuador and Panama and became the third Latin American country to use the US dollar as its national currency. In the eyes of the government at the time, "dollarization" would help El Salvador better integrate into the global market, reduce interest rates and foreign exchange risks, activate the economy, and attract overseas investment. Critics believe that the introduction of this policy was not fully prepared and studied, which not only caught businesses and consumers off guard, but also did not help solve the country's structural economic problems.

Although El Salvador has maintained a low inflation rate over the past 20 years, the cost of adopting the US dollar is also obvious. In addition to the need to bear the spillover effects of fluctuations in US fiscal and monetary policies, El Salvador is unable to stimulate investment and consumption through monetary policy when dealing with its own economic and financial crises. It can only rely on tax cuts and increased government spending, resulting in a higher fiscal deficit. At the same time, high crime rates and rampant gang violence offset the attractiveness of low interest rates and foreign exchange risks to external investors, and El Salvador remains one of the Central American countries with the least foreign direct investment.

Some economists have discussed the possibility of introducing a new Salvadoran currency, but the problem is that if trust in the reliability and stability of the government and monetary system cannot be established, economic entities will still choose the US dollar, and currency substitution will be difficult to complete. This dilemma was finally torn open by the current President of El Salvador, Nayib Bukele.

In February 2019, the new generation political leader Bukele was elected president with 53% of the votes, 20 percentage points higher than the main opposition candidate, breaking the situation of left and right wings taking turns in power in El Salvador's political arena. Bukele was born in a merchant family. Born in the 1980s, he has a prominent personality and is good at using social media. His image as a "rigid system reformer" has won him the support of a large number of young voters. During the campaign, Bukele refused to participate in the candidate TV debate and instead live-broadcasted on social media to explain his governing philosophy. After being elected, he often issued decrees on Twitter, and even the appointment and removal of important government positions.

▲Salvadoran President Nayib Bukeleto/People's Vision

However, as his term of office unfolded, this "political rising star" began to frequently encounter criticism from mainstream Western public opinion and was labeled "strongman politics", "populism" and "dictatorship". On February 9, 2020, the federal armed forces once entered the Congress Hall to put pressure on the members who were holding a special session. At that time, Congress was considering a $190 million loan proposed by Bukele to equip the army and police and combat violent criminal gangs. Some media interpreted it as "a reappearance of the high-pressure rule of the dictatorial military government in the 1980s and 1990s." However, this did not affect Bukele's presidential approval rating. He won a landslide victory in the mid-term elections a year later and gained control of the legislature.

Like his predecessor who announced the legal circulation of the U.S. dollar 20 years ago, the introduction of the Bitcoin Act led by Bukele also seemed "hasty and improvisational". On June 5, 2021, Bukele appeared in the form of a video at the Bitcoin Conference held in Miami, USA, and announced his Bitcoin plan. Three days later, the bill was passed by Congress and took effect 90 days later.

At the end of June 2021, in an interview with a video program, Bukele talked about the reasons for the introduction of the Bitcoin Act. He mentioned the damage that the "massive printing of US dollars" has done to the Salvadoran economy. "That money is not printed for you. We did not get more US dollars, but we have to bear the high inflation that comes with it."

Just three months before the passage of the Bitcoin Act, US President Biden signed the $1.9 trillion economic stimulus bill passed by both houses of Congress. From March 2020 to March 2021, the total amount of US fiscal stimulus funds reached $5 trillion. Since 2022, the world is accelerating into a new inflation cycle, coupled with the multiple impacts of the Russia-Ukraine conflict and geopolitical economic divisions. According to the Bank for International Settlements, the inflation rate of 60% of developed economies has exceeded 5%, and the inflation rate of more than half of emerging market economies is above 7%, the highest since the 1980s.

It is widely believed that since he cannot print money, Bukele needs other sources of income to make up for the fiscal deficit to avoid a default on the $800 million sovereign bonds due in January 2023, which will affect the outcome of his re-election bid in 2024.

"There are two kinds of decisions, one is to pay for the legacy of history, and the other is based on forward-looking thinking. See where the world is going and get there first so that your citizens can benefit from it," Bukele said in the video program wearing his signature white baseball cap. "We have fallen behind in the existing financial system, why not accept a new system? Why leave the future of monetary policy to others? They will neither consult with you nor care about the impact of (those decisions) on your citizens."

▲San Salvador, people use Bitcoin for payment. Photo/Visual China

Big gamble?

"If 1% of the world's Bitcoin was invested in El Salvador, it would drive GDP growth by 25%." On June 6, 2021, on the eve of the congressional vote on the "Bitcoin Act," Bukele wrote in English on Twitter.

He then listed several reasons why cryptocurrency investors and businesses should move to El Salvador, including good weather, world-class surfing beaches, beachfront properties for sale, and permanent residency after investment. Bukele emphasized that because Bitcoin transactions are no longer an investment asset, they will not be subject to capital gains tax.

However, even for this small country with a population of only 6.5 million, it is not easy to complete the transformation into a "Bitcoin country". Although his approval rating has been as high as over 75% during his tenure, Bukele still encountered considerable resistance in promoting Bitcoin. On the eve of the official implementation of the "Bitcoin Act" in September 2021, a poll covering 1,281 people at the University of Central America in El Salvador showed that 70% of the respondents wanted to repeal the bill, and nearly half believed that the implementation of the bill would lead to economic deterioration.

El Salvador mainly conducts transactions in cash, and 70% of its residents do not have bank accounts, but its Internet penetration rate has reached 55% (Note: China's Internet penetration rate was 64% in 2020). In order to promote Bitcoin at the public level, when the bill came into effect, the government promised that every citizen who downloaded the cryptocurrency application "Chivo Wallet" (Note: Chivo means "cool" in Salvadoran) would receive $30 worth of Bitcoin. Although in January 2022, Bukele tweeted that the application already had 4 million users, recent surveys have shown that the actual penetration rate of Bitcoin transactions at the merchant and consumer levels is still very low.

In March 2022, a survey covering 337 small and medium-sized enterprises released by the El Salvador Chamber of Commerce showed that 86% of the surveyed companies had never used Bitcoin for sales, and only 3.6% of the respondents believed that Bitcoin could help increase sales. In April, a field survey covering 1,800 people released by the National Bureau of Economic Research showed that only 10% of users would continue to use the app after consuming the registration benefits. Those respondents who refused to download it were mainly due to their distrust of the application system and Bitcoin itself.

Unlike traditional assets, Bitcoin lacks a value anchor, and its price depends on people's willingness to buy. The high volatility and unpredictability of Bitcoin prices make it more like a long-term option and difficult to be a good means of storing value. Once the currency value falls, economic entities holding Bitcoin balances may face large fluctuations in wealth and bear the risk of losing money for hard work. This is even more difficult for a large number of low- and middle-income groups to accept.

Over the past year or so, Bitcoin has experienced dramatic price fluctuations. In April 2021, the price of Bitcoin first surged to a historical high of $63,000, then fell below $30,000 in July, approached $70,000 again in November, and fell below $20,000 in June 2022.

On September 6, 2021, Bukele announced that the Salvadoran government had purchased the first batch of 400 bitcoins. According to statistics from CoinDesk based on Bukele's tweets, as of July 1, 2022, when the latest purchase took place, El Salvador had purchased a total of 2,301 bitcoins, with a total investment of approximately US$103.9 million, while its actual value has shrunk to US$46.6 million.

In an interview with a local TV station, Alejandro Zelaya, the Minister of Finance of El Salvador, said that because Bitcoin has not been sold, "floating losses" do not mean actual losses. Bukele also responded to the "concerns or anxieties" of the outside world in a tweet in mid-June 2022. "My advice is to stop looking at the charts and enjoy life. Investing in Bitcoin is safe, and after going through the bear market, Bitcoin will rise sharply." He emphasized, "Patience is the key."

But for El Salvador, this "patience" seems extravagant and elusive. According to a report released by CNBC (Consumer News and Business Channel) at the end of June, Bukele's "Bitcoin gamble" has cost about $425 million in public funds. In a country with a per capita GDP of $4,400 and a debt ratio of 84% of GDP, betting public funds on a highly speculative market may be even more deadly.

▲An employee of a store in San Salvador, the capital of El Salvador, displays the "Chivo Wallet" application. Photo/Visual China

Fork in the road

In early 2021, El Salvador started negotiations with the International Monetary Fund (IMF) to obtain a loan of about US$1.3 billion. However, the negotiations were deadlocked due to the IMF's concerns about El Salvador's Bitcoin policy.

Over the past year, the IMF has repeatedly warned the Bukele government that the legalization of cryptocurrencies could pose huge risks to financial and market integrity, stability, and consumer protection. But the Bukele government disagrees. In February 2022, it again rejected the IMF's suggestion to "dissolve the $150 million trust fund created for cryptocurrencies and return the unused portion to the treasury." The three major international rating agencies have successively downgraded El Salvador's credit rating due to the country's narrowing financing options.

Loans provided by the IMF are different from general commercial loans. They often require borrowing countries to implement tight fiscal and monetary policies. The negotiations are complex, the conditions are harsh, and they often come with political clauses. In order to reduce its dependence on IMF loans, the Bukele government had planned to issue a 10-year, $1 billion Bitcoin bond in mid-March 2022. This plan was not implemented as scheduled. Salvadoran Finance Minister Alejandro Zelaya said in an interview in March that the turbulent international situation affected the implementation of the plan.

The visible positive changes are reflected in the tourism industry, which is "one of the main engines of the national economy." In February, the Minister of Tourism of El Salvador said in an interview with local English media that since the implementation of the Bitcoin Act, El Salvador's tourism industry has grown by 30%, of which 60% of tourists are from the United States. But this is not enough to dispel the haze cast by the "Bitcoin Winter" on the country's economic prospects. El Salvador has invested heavily in Bitcoin and its related infrastructure, and has reduced fiscal spending in other areas for this purpose. For Bukele, who presents himself as a "political strongman," this is a gamble that is difficult to turn back.

On July 8, Bukele posted the New York Times report on Twitter and said, "They say we are heading for default. If we pay all the fees on time, will they publish an apology?" At the end of the tweet, Bukele attached a winking and smiling emoji.

The cost of default is painful. Rising global oil prices, inflation, and U.S. interest rate hikes have hit the already weak economic foundations and fragile financial systems of emerging markets. The first "explosion" in 2022 was Sri Lanka, a South Asian country that has declared "national bankruptcy." In late May, Sri Lanka defaulted on its sovereign debt for the first time in 70 years. In the following two months, due to insufficient foreign exchange reserves, Sri Lanka experienced shortages of basic necessities such as fuel, food, and medicine. In June, the domestic consumer price index rose 54.6% from the same period last year, and food prices soared 80%. The worsening economic crisis has further triggered a political crisis. The day after Bukele ridiculed the New York Times, large-scale demonstrations broke out again in Colombo, the capital of Sri Lanka. Demonstrators successively occupied the presidential residence, the presidential office area, and the prime minister's office, and set fire to the prime minister's office. The prime minister and president of Sri Lanka announced their resignations one after another.

Even though El Salvador's exploration of the "Bitcoin Country" has been bumpy and is considered by mainstream rating agencies to have a "negative outlook", this path is still attractive to some marginal countries that lack sovereign currencies or are mired in inflation. In April 2022, the Central African Republic passed a cryptocurrency regulatory bill, making it the second country in the world after El Salvador to use Bitcoin as an official currency.

This move also attracted strong opposition from international and regional financial organizations such as the IMF, the World Bank and the Bank of Central African States. Some critics also pointed out that the bill was not a simple transformation of monetary policy, but a "populist statement." President Touadéra responded that the conventional economic form is "no longer an option" for Central Africa, and he hopes to build Africa's first tax-free "crypto center" in Central Africa in the future.

A report by the World Bank shows that despite its rich natural resources, the Central African Republic remains one of the poorest and most fragile countries in the world. Long-term political instability, rampant violence and heavy dependence on natural resources have led to low economic diversification and lagging private sector development in the country. According to the "2020 Global Human Development Index (HDI) Ranking" released by the United Nations Development Program, the Central African Republic ranks second from the bottom among the 189 countries published.

Previously, the legal currency of Central Africa was the CFA franc, and the six member states of the union were all former French colonies. The Central African franc adopts a fixed exchange rate system closely linked to the euro, and member states must deposit half of their foreign exchange reserves in the French central bank to obtain guarantees from the French Ministry of Finance. Opponents regard it as a "relic of the French colonial era." The price of a lower inflation rate is fiscal austerity and limited macroeconomic options, which ultimately restrict economic growth. In recent years, the franc zone has been increasingly calling for monetary sovereignty and getting rid of "voluntary slavery."

At the end of 2019, the West African Monetary Union, which also belongs to the franc zone, took the lead in reaching an agreement with France to launch a number of currency reform measures, including renaming the CFA franc to Eco, transferring foreign exchange reserves from France, and no longer having French representatives on the central bank's board. The plan was originally scheduled to be implemented in 2020. However, due to multiple factors such as the impact of the epidemic, economic recovery and geopolitical games, the launch time has been postponed to 2027.

The transition of the ecosystem is long and bumpy, and Central Africa has chosen to take a different path. In an interview, Central African President Touadéra claimed that the historical system seemed to have built an insurmountable wall of bureaucracy, which stuck Central Africa in the existing system, deprived it of development opportunities, and unable to make full use of its rich local resources. On the contrary, smartphones and Bitcoin will become alternatives to traditional banking, currency, and financial bureaucracy, providing a "new path to a bright future."

Like Bukele, Touadéra also described cryptocurrency as the key to achieving inclusive finance in his country. However, according to data released by WorldData in 2020, only about 10% of the population in Central Africa has access to the Internet. According to data from the World Bank in 2022, only 14.3% of residents in the country have access to electricity. In the short term, the vast majority of citizens do not have the necessary digital infrastructure and expertise to practice "inclusiveness" and participate in this "overtaking on the curve" experiment.

But what cannot be avoided is that the "thunder" is getting closer and closer, and the coverage is getting wider and wider. The "International Debt Statistics Report 2022" released by the World Bank shows that the debt vulnerability of low- and middle-income countries has increased sharply, and "half of the world's poorest countries are facing external debt crises or very high external debt risks." Against the backdrop of low global growth and high inflation, crises and risks have caused the chronic diseases of many countries to burst, and the waiting areas of emergency rooms are overcrowded, but there are not enough relief prescriptions and resources.

▲In San Salvador, several vendors have anti-Bitcoin stickers on their carts/Visual China

In May 2022, El Salvador, as the host country of the annual meeting of the Alliance for Financial Inclusion (AFI), welcomed representatives from 32 central banks and 12 financial institutions from 44 countries. Participating countries include Nigeria, Rwanda, Egypt, Nepal, Pakistan, Haiti, Paraguay and other African, Asian and South American countries. Before the summit, regarding the legalization of Bitcoin, the participating countries generally expressed their concerns and worries about anti-money laundering, combating the financing of terrorism, consumer and investor protection, and the introduction of complex products to people with weak financial and digital foundations. They look forward to finding some answers during their trip to El Salvador.

Bukele attended the summit and posted a group photo. "Sowing seeds," the president wrote on Twitter, in the gesture of a "pioneer."

Whether it is a ladder or an abyss, the exploration of "Bitcoin Nation" provides an opportunity to verify a series of controversial topics. What needs to be weighed is the economic cost of this experiment and the potential economic benefits, as well as other costs that may be paid in the process.

As for Lu Bingquan, when conditions permit, he may go to the distant El Salvador to "check in". In his view, this is a win-win situation: for industry insiders, especially some "grassroots", people need to find and verify their beliefs in larger and more concrete things; and for the founders of the "Bitcoin Country", they have created a kind of "spiritual totem" and also enjoyed the gathering and harvest of attention.

No one knows how long this “win-win” situation will last. The only thing that is certain is that Bitcoin is not a panacea and cannot solve a country’s structural problems at the political and economic levels, which will ultimately determine the possibility of development.