Sunday, June 26

El Salvador’s adoption of bitcoin as legal tender is pure madness | Jeffrey frankel


mel Salvador this month became the first country to adopt a cryptocurrency, in this case, bitcoin, as legal tender. I say the first, because others could follow. But they should think twice, because the idea is highly dubious and is likely to be economically dangerous for developing countries in particular.

I’ll admit that I don’t understand the need for cryptocurrencies at all. Like Many economists, I don’t see what problem they solve. They are not well designed to fulfill any of the classic functions of money (a unit of account, store of value or means of payment) because their prices are extraordinarily volatile. This volatility is not surprising, because cryptocurrencies are not backed by reserves or the reputation of a well-established institution, such as a government or even a private bank or other trustworthy corporation.

In fact, bitcoin and its fellow cryptocurrencies were born out of an anarcho-libertarian distrust of central banks. It is true that many central banks, especially developing countries, they have a history of debasing their coins. But adopting bitcoin as legal tender makes little sense for El Salvador.

In 2001, El Salvador adopted the US dollar as legal tender to guarantee monetary stability that the country’s national currency, the colón, had historically failed to achieve. The reform worked: the country’s annual rate of inflation, which had substantially exceeded 10% between 1977 and 1995, has declined markedly since the adoption of the dollar. It has been below 2% since 2012 and close to zero since 2015, a rarity in Latin America.

Giving up the monetary independence afforded by issuing one’s own currency carries costs, in particular the loss of the ability to adjust monetary policy in response to local economic conditions. El Salvador already accepted it when it adopted the dollar. The costs would be even higher if a currency as unstable as bitcoin were the only national currency. But President Nayib Bukele, instead, decided to designate bitcoin and the dollar as legal tender. The logic behind that decision is surreal.

Bitcoin has it has not been Well received in El Salvador. National residents I do not want be obliged to accept it. International markets are also lukewarm. Moody’s degraded El Salvador’s debt in July and S&P I could follow suit. The differential between the interest rate the government must pay on its debt and the US Treasury rate. greatly increased since the plan to bitcoinize was first announced in June.

There is a function that cryptocurrencies seem to fulfill: facilitate illegal transactions. It goes without saying that this is not a use to be encouraged. Worse still in terms of general welfare, the “mining” of cryptocurrencies like bitcoin, which relies on blockchain technology to verify transactions, requires a staggeringly large amount. amounts of energy and therefore damages the environment.

Also, even if one accepts a role for one or two cryptocurrencies, the number that has been created is disconcertingly large: from anywhere 6,000 for 11,000 (or as many as 70,000 digital tokens). The whole notion of the utility of money is that people choose to use the same currency as others, thus minimizing transaction costs. They cannot assess or track the creditworthiness of dozens of issuers. Money is a kind of natural monopoly, which is why governments long ago assumed responsibility for its supply.

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In the mid-19th century in the United States, for example, private banks and other institutions issued an estimated 8,000 competing private currencies. As the governor of the US Federal Reserve, Lael Brainard have you noticed, that period “is now known for inefficiency, fraud and instability in the payment system.” This is essentially why central banks were created.

The logic that works against a large number of currencies domestically also applies internationally. This is one of the reasons why the dollar it remains by far the principal global badge. The world does not have room for 11 international currencies, much less 11,000.

If chronic US fiscal and current account deficits had resulted in a strong long-term downtrend in the dollar value, one could imagine people turning away from the dollar and looking for alternatives. But this has not happened, and particularly not during the period in which cryptocurrencies have risen. And inflation in the United States was remarkably low during this time (although lately it has risen in line with the economic recovery).

Some, including Bukele, claim that cryptocurrencies will bolster financial inclusion by giving the unbanked access to financial services and reducing transaction costs for small cross-border payments, such as remittances from migrants. The latter are particularly important for El Salvador, having averaged around 20% of GDP annually for the past two decades.

But bitcoin is unlikely to be the solution. Other half of reducing such transaction costs seems more promising. And holding or trading such an unstable asset is a particularly bad idea for low-income people, who can’t afford to sustain price swings of up to 30%. in one day. Bitcoin has quadrupled in the price For the last year, that is part of the attraction. But what goes up also goes down.

Another downside is that even digital tech experts run the risk of forget passwords and lose your bitcoin. And at least half of the population of El Salvador first of all, they don’t have internet access.

Many aspects of cryptocurrencies are puzzling, including the success of a prank like Dogecoin. But the adoption of bitcoin in El Salvador as legal tender is perhaps the strangest and potentially most disturbing example of all.

Jeffrey Frankel is a professor at Harvard University’s John F Kennedy School of Government. He served as a member of President Bill Clinton’s Council of Economic Advisers.

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