El Salvador is Poised to Sacrifice its People on the Altar of Crypto
Gesellians are watching recent developments in El Salvador with a combination of curiosity and horror. Most countries in the world want to achieve greater conrol over their monetary systems so they can adjust their money supplies to suit the needs of their economies. But El Salvador is doing the opposite. They are adopting a highly volatile instrument, the supply of which they have no control over whatsoever, as legal tender. It is hard to imagine how the country's experiment with Bitcoin could possibly end well for the people of El Salvador.
In just the past year, the price of Bitcoin has been as low as $9,000 and as high as $63,000. It currently sits at half of what it was worth just two months ago. So, requiring people to accept Bitcoin as a form of payment is essentially like forcing them to bet on a roulette wheel every time they receive payment for goods and services. But the volatility of Bitcoin isn’t even the scariest part.
As Silvio Gesell explained over a century ago, using hoardable money as legal tender causes poverty, wealth inequality and periodic episodes of economic stagnation and collapse.
To be clear, the concept of cryptocurrencies in general is not in any way opposed to Gesellian principles. In fact, future currencies based on Gesell's ideas will in all likelihood be digital. However, the crypto movement thus far has the entire concept of money exactly backwards.
As Gesell explained, money has two primary functions. It is both a medium of exchange and a store of value. (Some would argue that money has other functions as well, but these two are the most important.) The problem is that these two functions are mutually contradictory. Any form of currency that is designed to function as a store of value will systematically fail to perform its function as a medium of exchange.
The reason for this inherent contradiction is hoardability. The vast majority of real goods and services in the economy are not hoardable. They lose value with the passage of time. They rot, they break, they rust, they get stolen, they become obsolete. Thus their holders have a strong incentive to sell them as soon as possible. And, generally speaking, the longer they wait, the more they lose. This is the fundamental dynamic that drives the whole economy. The depreciating nature of real goods and services creates pressure to transact. And, since the same pressure applies to everyone, negotiations take place on a level playing field.
Money, however, is largely immune from this pressure. It can be hoarded without penalty. Holders of money can postpone their purchases without suffering economic loss. If a producer of milk and a holder of money meet to negotiate a transaction but fail to reach an agreement, the milk producer loses value with every day that he keeps his milk. But the holder of money suffers no loss as a result of failing to transact. He can come back a day, a week, a month later, and his money will still have the same purchasing power. But what will happen to the value of milk after a day, a week, a month?
Therefore, what would have been a level playing field in a negotiation involving real goods and services becomes unlevel as a result of the interposition of money. The hoardability of money injects an element of unfairness into virtually all transactions which are intermediated by money.
Because of the unequal incentives which apply to goods & services in comparison with money, there is a tendency for money to stop circulating when crisis or uncertainty create expectations of falling prices.
If prices fall, producers of goods and services still have to sell, because the longer they wait, the more they lose. Therefore they have to sell their products, even if they do so at a loss. But the same is not true of holders of money. If holders of money expect prices to fall, they will simply postpone their purchases. After all, why buy something today if it can be bought cheaper tomorrow?
And this dynamic causes expectations of falling prices to be self-fulfilling and self-reinforcing. The more holders of money postpone their purchases, the more unsold goods & services pile up in search of purchasers, the more prices fall, and the more holders of money have even more incentive to hoard. This is the reason why modern economies are always prone to periodic episodes of stagnation and collapse. There is a built-in dynamic in the monetary DNA of the economy which causes money to stop circulating any time prices are expected to fall. This causes small problems to turn into big ones and amplifies transitory disruptions into intractable crises.
As Gesell pointed out, the solution to this problem is actually quite simple. We just need to separate the two functions of money. We need to acknowledge and accept the fact that it is irrational and counterproductive to use the same instrument as a medium of exchange AND a store of value. In order to function properly, an economy needs an instrument that is designed purely and exclusively as a medium of exchange.
And this brings us back to the fundamental problem with cryptocurrencies and why it is irrational for the country of El Salvador to adopt Bitcoin as legal tender.
Virtually all cryptocurrencies currently in existence are designed primarily for the purpose of storing wealth. Bitcoin, for example, becomes increasingly difficult to “mine” over time, thereby putting a limit on the amount of it in existence. It was intentionally created this way so that it would “hold value”.
As Warren Buffett’s Vice Chairman, Charlie Munger, recently observed, Bitcoin is like artificial gold. Gold holds its value because it is scarce and its supply is limited. This makes it a good store of value but a terrible medium of exchange. There is a very good reason why gold has been abandoned as legal tender by every country that has ever attempted to use it as money. It fails to circulate in an environment of falling prices. And the same will be true of Bitcoin.
A properly functioning medium of exchange is literally a matter of life and death in a modern economic system. Economic self-sufficiency simply isn’t an option for 99% of humanity. We depend on economic exchange to procure virtually all of the goods and services we need to survive. And this cannot be accomplished without a properly functioning medium of exchange.
Any hoardable form of money will fail to circulate whenever there are expectations of falling prices. This is why we periodically witness economic crises despite the fact that we have more than enough resources to comfortably support every human being on earth. The problem is not one of productive capacity. The problem is the disruption of the process of exchange caused by the hoarding of money. And, because cryptocurrencies like Bitcoin are deliberately designed to be hoarded, they will never function properly as media of exchange.
This is why it is irrational and destructive for a country like El Salvador to adopt Bitcoin as legal tender. By doing so, they are virtually guaranteeing that their economy will collapse sooner or later. The self-reinforcing nature of the incentive to hoard makes this a certainty. We can’t say for sure when or why it will happen, but a time will inevitably come when prices start to fall. And when that happens Bitcoin will stop circulating and the negative feedback loop of money hoarding will cause a disastrous economic crisis. It is not a question of whether this will happen. It is only a question of when.
By adopting Bitcoin as legal tender, the government of El Salvador is condemning its people to future economic insecurity and peril.