How El Salvador's bitcoin adoption could empty it of its US dollar reserves

A man takes part in a protest against the use of bitcoin as legal tender, in San Salvador, El Salvador, on 7 September. Photo: Jose Cabezas/Reuters
A man takes part in a protest against the use of bitcoin as legal tender, in San Salvador, El Salvador, on 7 September. Photo: Jose Cabezas/Reuters

El Salvador’s bitcoin gamble could start a chain reaction that drains the nation of its dollar reserves, an economic expert has forecast.

After the country’s Bitcoin Law came into effect on Tuesday 7 September, economic forecasters expect the majority of Salvadorans to immediately change the bitcoin they receive into US dollars. Tuesday’s crypto-market crash will only reinforce this attitude.

To facilitate mass conversion of bitcoin to dollars, the Central Reserve Bank of El Salvador has been stocked with $150m (£108.25m), an inadequate amount that will need to be continually topped up.

Speaking to Yahoo! Finance, economist Daniel Munevar said that a worrying dynamic will commence, “where El Salvador will experience a constant outflow of US dollars and constant inflow of bitcoin”.

A hardwired process where El Salvador systematically accumulates bitcoin will pay off spectacularly if the price of the cryptocurrency keeps rising. However, if it falls it could be devastating and leave the nation with few options to salvage its economy.

This has led Munevar, a global debt specialist, to claim that Salvadoran president Nayib Bukele is “playing YOLO on the state-level”. He highlighted president Bukele’s Twitter reaction of “buying the dip” when bitcoin fell approximately 20% as an example of this speculator attitude.

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Munevar, who was an assistant to former Greek finance minister Yanis Varoufakis, cited this as revealing the Salvadoran leader’s “disregard for public resources”. Steve Hanke, the former economic adviser to Ronald Reagan echoed this sentiment in a tweet that read: “It’s easy to speculate with taxpayers’ money.”

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Read more: Bitcoin becomes legal tender in El Salvador amid suspicion and protest

Bitcoin is expected to continue its sharp fluctuations over the coming months. Jake Wujastyk, chief market analyst at TrendSpider, told Yahoo Finance UK that major news catalysts like El Salvador’s crypto-gamble, “will lead to extreme volatility in bitcoin in the short term”. This is going to diminish enthusiasm for holding and transacting bitcoin within El Salvador.

Munevar suggested that the Salvadoran government “assume they can handle the short term volatility of bitcoin and profit from a predicted long-term appreciation of the cryptocurrency against the dollar”.

However, in contrast to this, he added that many Salvadorans are in a “level of poverty that can’t absorb that kind of volatility”, leading to a common disposition to cash out their bitcoin immediately for US dollars.

The subsequent dollar outflow could lead El Salvador to attempt to borrow more from the International Monetary Fund (IMF) to meet domestic demands, pay off international debts and for importing goods.

Watch: What is bitcoin?

El Salvador is in debt distress and the IMF has already set indicative fiscal restructuring targets for the nation to be granted a loan request of $389m.

Munevar said the IMF would be very unlikely to supply further aid unless president Bukele’s administration undertook a fundamental fiscal restructure. The former adviser to the Colombian Ministry of Finance went on to describe how the “IMF is a very conservative organisation and if the guarantees are not there to repay a loan, then the IMF will not lend the money”.

The IMF would hold two aspects of president Bukele’s Bitcoin Law as problematic. The law facilitates international bitcoin holders who want to cash out their BTC for US dollars without paying capital gains tax in their own jurisdictions.

Also, according to Munevar, the new law will allow transactions between bitcoin wallets for large purchases that “skirt anti-money laundering regulations”.

“If the Salvadoran government has a fiscal regime that facilitates money laundering then global finance will not want to deal with them. The IMF cannot be seen to be irresponsibly exposing the public resources of a global institution to the economic gamble that is unfolding in El Salvador,” he said.

Critics are calling El Salvador's bitcoin adoption an economic gamble. Photo: Getty
Critics are calling El Salvador's bitcoin adoption an economic gamble. Photo: Getty

This leaves president Bukele’s administration with limited options for replenishing the outflow of dollars from state reserves. In the short term, he may even have to rely upon the bitcoin inflow from money laundering purposes, critics say.

Read more: How changes at crypto exchanges Binance and FTX could impact the price of bitcoin

El Salvador may eventually have to default on their international and financial agreements. However, this outcome could be completely reversed if the gamble pays off and the value of bitcoin keeps appreciating against an increasingly inflationary dollar.

Bitcoin, because of its limited supply of 21 million coins, has been deemed the antidote to inflationary fiat currencies. After multiple Federal Reserve stimulus packages bitcoin is becoming increasingly attractive as a hedge against inflation.

The limited supply of the cryptocurrency encouraged Edward Snowden to tweet on the day that El Salvador’s new law came into effect that Bitcoin’s design “massively incentivises early adoption and latecomers may regret hesitating”.

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