El Salv-a-Door

“The irony is that, if the story about Tether’s self-licking-lollipop turns out to be true, then #BTC is doing exactly what it was designed to cure: it props itself up by printing its own money.” – Nassim Taleb

A quick and doomy piece on El Salvador’s decision to make Bitcoin official legal tender, along with a simple prediction. But first, some background.

El Salvador has a gross domestic product (GDP) of $26B, which works out to roughly $3,800 per person (vs. more than $63,000 in the US). From 1993 to 2000, El Salvador pegged its local currency, the colón, to the US dollar at an exchange rate of 8.75:1. In 2001, the country formally switched to the US dollar as their official currency. At the time of this writing, El Salvador has roughly $3 billion in foreign exchange reserves.

Recently, President Nayib Bukele passed a law making Bitcoin legal tender in the country. The law does not appear to be well thought out, as we’ll see, but the most important part of the law states that businesses are required to accept Bitcoin for payment of goods and services. The law will also allow for instantaneous exchange between Bitcoin and US dollars, although the details of how this will work still need to be developed. Finally, the state will work to setup the necessary infrastructure to make this happen, and has (amazingly) set aside $150 million of hard currency, or 5% of its total foreign exchange reserves, in a trust account to buffer its citizenry from volatility in Bitcoin. Mind you, the 90-day realized volatility of Bitcoin is almost six times that of the S&P 500, as shown in the chart below, so I don’t expect that $150 million to last very long. But if I’m right, that will be the least of Bukele’s concerns.

Although El Salvador has dollarized its economy, it does not have access to the Fed’s dollar printer and thus its foreign exchange reserves are especially critical for minding its balance of trade. Dollarizing your economy doesn’t work well if you run current account deficits and don’t have any dollars. In my opinion, if Bukele does not reverse course soon, he won’t have any dollars and El Salvador’s economy will effectively collapse (if you think I’m being a bit hyperbolic, please remember this Substack is called Doomberg; hyperbole has a home here).

Here’s my simple, high-level analysis of the situation:

1. Tether is essentially a US dollar counterfeiting operation. There’s a staggering $63 billion of Tether floating around, most of which is not backed by anything, let alone hard US dollars.

2. The exit ramps from the crypto universe are limited. Getting hard US dollars out of the crypto universe is tough, especially at scale.

3. By adopting Bitcoin as legal tender in El Salvador, Bukele is creating an off ramp from the crypto universe for up to $3B of hard US dollars.

4. There are enough whales in the crypto universe that know the score with Tether and are looking for an exit. They will happily take Bukele up on his foolish offer.

And now, my prediction: this exit door will not remain open for long… this law will get reversed within months.

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