El Salvador’s Bitcoin Folly

In a moment of ego-fuelled insanity, El Salvadoran President Nayib Bukele declared a policy that is certain to deliver polar opposite outcomes.

On one hand, a select group of non-Salvadorians are destined to enjoy immense wealth.

While on the other, Bukele’s fellow countrymen and women are to be condemned to a future of even greater poverty.

How is this possible?

Due to the oldest con in the political playbook.

Tell the little guy how much better off he’ll be when the law is passed.

It’s the classic magic trick…look over here, while the real deception (by the insiders) is being created elsewhere.

From the July 2021 issue of The Gowdie Letter

With expat Salvadorians remitting up to US$6 billion back home to family and friends (to spend in the economy), no longer would the poor and downtrodden be ripped off by intermediaries charging usury rates.

Bitcoin is going to cut out the middleman. Chalk up a win for the people against the fiat establishment.

Yep. No more transaction fees on remittances. More money in the hands of the end user.

This one-dimensional view is a distraction to the real game…which we’ll get to shortly.

But first, which is the lesser of these two evils?

Paying a few percent in transaction fees OR having US dollars converted into a highly manipulated Ponzi scheme that could collapse at any time?

It reminds me of the agricultural, film, and forestry tax minimisation schemes promoted in the early 2000s.

Instead of paying the taxman his percentage and keeping the rest, people lost the lot. As it turned out, the taxman wasn’t the bad guy after all. The scheme promoters were far worse.

There is nothing new in this world. Same old con, same storyline, just a different product.

If you think the claim of ‘highly manipulated’ is an exaggeration, please take the time to read this excellent 52-page research paper from the US Journal of Finance titled ‘Is Bitcoin Really Untethered?’.

Tether is a fraud. And it’s a fraud that plays a central role in a sting the El Salvadorian people can ill afford.

To quote from the July 2021 issue of The Gowdie Letter

El Salvador’s economic dashboard

If you’re going to take your nation where none have ever gone before, my guess is, you should do it from a position of economic strength.

Even then, most prudent people would consider it a “crazy brave” call.

To do so from a position of economic weakness…well, that qualifies as “crazy stupid”.

Into which category does El Salvador fit into?

GDP is around US$26 billion…the recent contraction is due to COVID-19 restrictions.


El Salvador GDP

Source: Trading Economics

[Click to open in a new window]

What about El Salvador’s budget?

Like almost all Governments, El Salvador spends more than it what it collects in tax revenues.


El Salvador Government Budget

Source: Trading Economics

[Click to open in a new window]

The latest budget deficit (like that of the US, Australia, et al) blew out due to government support for the COVID-affected economy.

In US dollar terms, the latest budget deficit is US$2.4 billion (GDP of US$26 billion times 9.2%).

How is this shortfall funded?

Certainly not by printing US dollars and having the central bank buy bonds. That’s a luxury only sovereign nations with their own currency can afford (or not afford).

El Salvador needs to raise funds from the market.

A third-world country — run by despots, dictators, and the delusional — can find the bond market an expensive place to rattle the tin.

Depending upon the duration of the bond, the interest rates on past El Salvador debt issues range from 5.87–9.5%.


El Salvador USD

Source: CBonds

[Click to open in a new window]

When your public sector debt load is 90% of GDP — US$23.4 billion — interest costs of this magnitude consume more than US$1-plus billion of the government’s budget.


El Salvador Government Debt to GDP

Source: Trading Economics

[Click to open in a new window]

How do you solve this problem? Borrow more money. But where from?

You go ask your friendly IMF banker to arrange a loan facility with very favourable terms…oh, something like no to minimal interest for three years would be good.

As reported by Reuters on 4 March 2021:

“El Salvador is talking to the International Monetary Fund (IMF) about securing some $1.3 billion in financing and sees a ‘golden opportunity’ to revitalize its economy after the ruling party’s big win in legislative elections, a top government official said.”

Politicians just can’t help themselves. Every time they open their mouth it’s either to tell a blatant lie or half-truth.

We’re told the additional debt is a “golden opportunity” to revitalise its economy.

When, in reality, El Salvador is looking to borrow more money to help pay the interest on the debt it already has.

This is the story so far…El Salvador is an indebted third-world country in need of access to cheap funding to avoid default on its existing bond issues.

Hardly a picture of economic strength.

El Salvador’s Balance of Trade data shows it imports more (goods and services) than it exports.


El Salvador Balance of Trade

Source: Trading Economics

[Click to open in a new window]

This is where the “dollarisation” of El Salvador’s economy — being able to make payment in the world’s reserve currency — has been of benefit.

Imagine how volatile the payment process would have been with a weak currency like the colón?

So, how does El Salvador fund its balance of trade deficit?

From its (almost US$3 billion) foreign reserves.

You can see how the larger trade deficits of recent months have reduced the country’s reserves.


El Salvador Foreign Exchange Reserves

Source: Trading Economics

[Click to open in a new window]

OK, so what’s all this got to do with bitcoin being introduced as legal tender?

Well, this is now where it gets interesting, and we start joining a few dots.

Here’s how the recently passed Bitcoin [BTC] law works…

On 22 June 2021, the WSJ revealed the key platform of Nayib Bukele’s grand crypto plan (emphasis added):

“With his [President Bukele’s] blessing, El Salvador’s Congress wasted little time passing the Bitcoin Law. On June 8, with little debate, deputies approved the law by a wide margin in the middle of the night. El Salvador is the first country to pass such a law.

The law’s most glaring flaw is Article 7. It mandates that ‘every economic agent must accept bitcoin as payment when offered by whoever acquires a good or service.’ This article renders the Bitcoin Law a ‘forced tender,’ not a ‘legal tender,’ law.

What does this mean?

Forced tender means exactly that.

Under the law, firms will be forced to accept bitcoin when offered as payment for goods and services.

If a consumer/customer/patron/client wants to pay for goods and/or services in bitcoin, the business is forced to accept it.

But what if the price of bitcoin plunges overnight and the $100 of bitcoin the business accepted yesterday is only worth $50 today?

No worries.

El Presidente has that covered.

Congress legislated into existence a “smoothing” fund.

As reported by Reuters (emphasis added):

“The use of bitcoin will be optional for individuals and would not bring risks to users, Bukele said, with the government guaranteeing convertibility to dollars at the time of transaction through a US$150 million trust created at the country’s development bank BANDESAL.”

OK. So there’s US$150 million held in trust to guarantee against any price volatility.

Three ‘Deep Value’ Stocks to Watch as the Market Recovers. Discover More.

For a country up to its eyeballs in debt, where did the US$150 million come from?

You know that US$3 billion in foreign reserves (set aside to square up the balance of trade ledger)? That’s where it’s from.

The reserves are there to pay for a purpose…to finance what the country needs but doesn’t have.

Can you see how this could get real tricky, real quick if the price of bitcoin gets a tad volatile?

Let’s say 20% of GDP — US$5.2 billion — is transacted in bitcoin. This equates to US$100 million per week in transactions.

A few volatile weeks could make a serious dent in the trust’s funds.

Then what?

Top it up with another withdrawal from the foreign reserves?

Using the country’s reserves to backstop this experiment is a high-stakes game.

And this is where we get to, what I (and others) think is the real end game.

The master manipulators of cryptos are called ‘whales’.

As reported by Bloomberg in November 2020…

A few large holders commonly referred to as whales continue to own most Bitcoin. About 2% of the anonymous ownership accounts that can be tracked on the cryptocurrency’s blockchain control 95% of the digital asset, according to researcher Flipside Crypto.

When you own a truckload of what is ultimately going to be rendered worthless, you need to find a patsy (with sufficient liquid assets) to buy it.

Trying to ‘fence’ it in the market to get real cash, is tough.

Dump too much of it and you might spook the ‘rats and mice’ faithful.

Ah…but if you can convince a nation (one preferably led by an egotistical, millennial dictator) to virtually hand you the keys to its US$3 billion vault, then you have pulled off the swindle of the century.

Now, you have to give credit where credit is due. These crypto con artists are good…very, very good.

What’s been sold as a ‘a win for the little guy against those big, nasty rip-off merchants in the financial sector’, is the BS the faithful swallowed ‘hook, line, and sinker’.

To quote from the July 2021 issue…

Here’s my guess on what happens

When its foreign reserves are being drained to support the “smoothing” reserve, El Salvador will repeal the Bitcoin Law.

With insufficient funds to pay for the shortfall in goods and services its economy imports, our laser-eyed El Presidente goes cap in hand to those foreign powers he told to butt out of his country for a loan…one with generous repayment terms.

Budget restraint will be exercised. The economy will contract.

The poor and downtrodden (the ones this grand scam — sorry, scheme — was supposed to help) will be even poorer and more downtrodden.

When El Salvador’s dalliance with bitcoin is revealed as a giant con, this fanciful idea of bitcoin being an alternative currency or method of payment might finally be exposed for the fraud that it is.

The ending of this story has been well written in the history books. The little guy gets screwed, and the smarties make a squillion.

El Salvador’s bitcoin folly will have in its own dedicated chapter in the yet-to-be-written ‘Crypto…The Con of the Century’.

Regards,

Vern Gowdie Signature

Vern Gowdie,
Editor, The Rum Rebellion

PS: The Rum Rebellion is a fantastic place to start your investment journey. We talk about the big trends driving the Australian Economy. Learn all about it here.


Vern has been involved in financial planning since 1986.

In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognised in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

In 2005, Vern commenced his writing career with the ‘Big Picture’ column for regional newspapers and was a commentator on financial matters for Prime Radio talkback.

In 2008, he sold his financial planning firm due to concerns about an impending economic downturn and the impact this would have on the investment industry.

In 2013, he joined Fat Tail Investment Research as editor of Gowdie Family Wealth. In 2015, his book The End of Australia sold over 20,000 copies and launched his second premium newsletter, The Gowdie Letter.

Vern has since published two other books, A Parents Gift of Knowledge, all about the passing of investing intelligence from father to daughter, and How Much Bull can Investors Bear, an expose on the investment industry’s smoke and mirrors.

His contrarian views often place him at odds with the financial planning profession today, but Vern’s sole motivation is to help investors like you to protect their own and their family’s wealth.

Vern is Founder and Chairman of The Gowdie Advisory and The Gowdie Letter advisory service.


The Rum Rebellion