El Salvador is in the cryptocurrency news. I can understand why using renewable geothermal energy from a volcano to mine Bitcoin and then sell it to support the El Salvadoran economy in the absence of new IMF support makes sense. But I do not see why it follows that El Salvadorans should be forced to accept Bitcoin in payment for goods and services.
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The economist Hyman Minsky famously observed that creating money is easy but getting it accepted is difficult. Indeed, and innovators throughout history have faced this same problem and dealt with it in different ways.
In 1260, the Chinese Emporer Kublai Khan determined that it was a burden on commerce and drag on taxation to have all sorts of currencies in use, ranging from copper coins to iron bars, to pearls to salt to gold and silver, so he decided to implement a new currency. The Khan decided to replace metal, commodities, precious jewels and specie with a paper currency. A paper currency! Imagine how crazy that must have sounded! Replacing actual stuff with apparently worthless paper! It’ll never work!
Crazy or not, it worked and just as Marco Polo and other medieval travellers returned along the Silk Road breathless with astonishing tales of paper money, so modern commentators (e.g., me) came tumbling off of flights from Shanghai with equally astonishing tales of a land of mobile payments, where paper money is vanishing and consumers pay for everything with smartphones. So what was the Khan’s marketing plan for his new paper currency and how did he persuade merchants to accept it? Well, it was quite simple. If you didn’t accept the emperors paper money in full and final settlement, then he would kill you.
Now, that seem a little harsh by modern standards but as a legal tender law, it had admirable clarity. You may have disagreed with his policies here and there, but you knew where you stood with the Khan.
A similar problem with acceptance arose after the French Revolution when a lack of trust in the state quickly led to a shortage of credit in the marketplace and, therefore, to an immediate demand for a circulating medium of exchange. France did not have a central bank along the lines of the Bank of England, so the revolutionary government took over church lands and, on the basis of this security, issued interest-bearing bonds with the redemption being a portion of the land itself. The interest and redemption were soon abandoned and the notes, the assignats, simply became state-issued currency. In 1793, the National Convention decreed that “any Frenchman convicted of having refused to accept assignats as payment or to have presented or received them at a loss of any kind, shall be condemned, for the first offense, to a fine of three thousand livres and six months’ imprisonment; in case of repeat offenders, the fine shall be doubled and the person condemned to twenty years in irons”. To be honest, even two decades of hard labour wasn’t enough to persuade the populace to accept the new currency at par. By October 1795, 100 Franc assignats could be traded for only 15 sous in coin and the Paris riots of the time opened the door for Napoleon.
Legal What?
Given the history of forcing people to accept new forms of money, I was a little surprised to hear from the Bitcoin 2021 conference in Miami that El Salvador planned to introduce legislation to make Bitcoin legal tender alongside the U.S. Dollar since, as I wrote earlier in the year, I couldn’t see why any country would bother doing this, partly because “legal tender” is such a misunderstood term, partly because whatever else Bitcoin is, it isn’t money. But largely because legal tender is an outdated and essentially meaningless concept, which is why I am baffled by the continued discussion of it.
It doesn’t mean what a lot of people think it means. Here’s a quick legal tender recap, using the United States as the case study. Section 31 U.S.C. 5103 “Legal tender” states that “United States coins and currency [including Federal reserve notes and circulating notes of Federal reserve banks and national banks] are legal tender for all debts, public charges, taxes, and dues”. Here is chapter and verse from The Man commenting on what that means: “This statute means that all United States money as identified above is a valid and legal offer of payment for debts when tendered to a creditor. There is, however, no Federal statute mandating that a private business, a person, or an organization must accept currency or coins as payment for goods or services. Private businesses are free to develop their own policies on whether to accept cash unless there is a state law which says otherwise”.
TL:DR; Legal tender doesn’t mean you have to accept cash. It means that if you incur a debt, you cannot refuse cash in payment, which is different. Businesses in the US are perfectly free to say that they will only accept Bitcoin if they want to (apart from areas such as San Francisco where local legislators have passed the “party like its 1699” laws imposing a stealth tax on retailers by forcing them to accept cash). I don’t know what the current legal tender laws in El Salvador are but I assume that merchants can accept Bitcoin in payment if they want to.
Neither Necessary Nor Sufficient
Legal tender isn’t even necessary. I remember a story about a schoolboy who was chucked off a Welsh bus for trying to pay with a Scottish banknote. The bus company apologised, saying that “Scottish currency is legal tender” which, of course, it isn’t. Scottish banknotes are not legal tender in England or, for that matter, Wales. In fact Scottish banknotes are not legal tender anywhere, even in Scotland. As it happens, Bank of England banknotes are not legal tender in Scotland either, because Scotland (which has a separate legal system) has no legal tender law although bizarrely (and thanks to Colin Platt for this via Twitter) Royal Mint coins are legal tender in Scotland in thanks to the Coinage Act 1971 (Section 2).
No legal tender banknotes! Oh my goodness, it must be chaos!
Actually, it isn’t. I’ve been to Scotland several times and I’ve often seen Scots buying things in shops using banknotes, cards and mobile phones. So not having legal tender laws does not seem to be much of a barrier to trade. This shows how uninteresting the issue of “legal tender” really is in the modern age and for decades I’ve tended to assume that any article, tweet or LinkedIn comment that talks about making a digital currency legal tender is written by someone who doesn’t really understand either topic.
So why attempt to make Bitcoin legal tender?
El Salvador is a cash economy, where roughly 70% of people do not have bank accounts, and remittances are a fifth of the economy. In the 1990s Salvador operated under a “peg” with the national currency, the colón, trading around nine to the dollar. But in 2001, El Salvador official adopted the U.S. dollar as legal tender. As a result, all wages, and prices, all accounts and transactions, were covered to dollars and over a period of time the domestic currency vanished. The result of handing over monetary policy to the Federal Reserve was, as this IMF paper explores, pretty positive. Removing the risk of devaluation and currency together reduced interest rates by 4-5% giving a net saving of around 0.5% of GDP per annum for the private sector. The net saving for the public sector was about half that and it was offset by the seigniorage foregone: the £10 note in my pocket is an interest-free loan to the Old Lady of Threadneedle Street, but if the UK dollarised then it would be replaced by an interest-free loan to Uncle Sam.
Talking about seigniorage, by the way, it is important to understand that the US Federal Reserve banknotes that are in circulation in El Salvador and elsewhere, stuffed under mattresses in Colombia and fuelling the less-formal sections of the Mexican economy are in essence an interest-free loan to Uncle Sam. If El Salvador decided to bring in a digital dollar then it could reclaim the seigniorage for itself by issuing against an interest-bearing dollar reserve.
Bitcoin Republic
Rather than implement a digital dollar in a form that makes sense as a digital currency, President Nayib Bukele (labelled a “millennial dictator” by some and an “instrument of god” by himself) announced that “I will send to congress a bill that will make bitcoin a legal tender” and like thousands of other people I listened in live on Twitter Spaces while he did just that and it was ratified by the delegates.
But why pass this bill? As noted there was nothing to stop merchants in El Salvador from accepting Bitcoin if they wanted to, and it sounds a tad illiberal (to say the least) to force people to accept something they don’t want to. JP Koning was quick to point out the perverse implications of requiring Salvadoran stores and markets (what the bill refers to as “economic agents”) to set prices in bitcoin and accept bitcoin as payment. No Salvadoran will choose to take advantage of this feature: the Bitcoin folks for fear of missing out on a price rise, and no-coiners out of fear of bitcoin’s volatility. This is why the President announced at $150m fund to be set up to convert the coins received by merchants into dollars “instantly” (although it is not clear to me what this means in this context).
This isn’t about legal tender at all. It is, as the economist George Selgin notes, compulsory tender. Something wholly different and surely at odds with the libertarian outlook of Bitcoin’s founder(s) which is why it is no surprise to me that some El Salvadorans are “concerned it may just be a tool for corrupt officials”. David Gerard wrote about this in Foreign Policy, speculating whether the President preparing to inject bitcoins into the economy, mark them as “dollars” to make up the government’s deficit, and the grab the actual dollars (coming in via remittances) to pay foreign debts in a kind of stealth de-dollarisation. (This why, I assume, the markets left Bitcoin flat after the announcement while the price of El Salvadoran debt went off a cliff.)
Like many others, I will watch the dynamics of El Salvador’s cryptocurrency sector with great interest and as a student of new forms of money I will be fascinated to see and understand the consequences of the bill. Whether it will happen or not — the Salvadoran Finance Minister Alejandro Zelaya sought technical assistance from the World Bank to help it to use bitcoin as a parallel means of exchange alongside the U.S. dollar, but the Bank refused “given environmental and transparency drawbacks” — I have to say, though, that I am unconvinced that making one particular cryptocurrency a form of compulsory tender will deliver financial inclusion that improves the lot of the average El Salvadoran.
(An edited version of this article first appeared on Forbes, 14th June 2021.)
Snippings 