With attention now being focused on El Salvador for it being the first country to accept bitcoin as legal tender, it’s important to examine how the country got here in the first place, and what may have motivated the country to adopt bitcoin.
Start with the country’s very roots: its beginnings as a territory with a rich mix of indigenous peoples, from the Nahuas to the Lenca. The earliest peoples of the region would often use cacao to serve as a means of exchange and a unit of account, and commodities such as coffee still play an important role in El Salvador’s economy today.
Spanish colonization shook the region: after tentative unions with Mexico and other central American states, El Salvador became part of a collective of states that declared independence from Spain in 1821, able to wrestle their freedom away from Napoleon’s occupation of their colonizing power. At that time, the coins circulating at the time were either from Spain or small irregular silver pieces called macacaos. It was only in 1880 with the Banco Internacional that the first truly Salvadorian piece of money was issued.
Why El Salvador took on the US dollar is an important matter here. Panama and Ecuador are central American neighbours that did the same, yet the results for them have been quite different (though Panama has long had a dollarized economy, while dollarization is more recent in El Salvador).
What binds the three countries is not only their history, but the consequences of being so close to the world’s preeminent superpower. This has led to a history of political, economic, and military interventions in El Salvador that have wrought their toll — displacing the Salvadoran population into other countries, while cementing a gradual then stark rapprochement to the US dollar.
The first gradual step was the creation of the colón, named after Christopher Columbus. This happened in 1892, a century before El Salvador’s full adoption of the US dollar, yet already, it was pegged to the US dollar at a rate of 2 colones to one US dollar, showing how the currency was related to the growing American economy in the first place.
The central bank of El Salvador released a financial history of the country leading up to its complete dollarization in 2001 (it’s in Spanish). After the Colón was implemented, it was left to float in 1931 when El Salvador left the gold standard. Then, in 1934, the Central Reserve Bank of El Salvador was created in order to manage monetary policy and to issue Colones, though at first it was a public company with private profit as a motive, rather than a directly controlled state entity. This was a centralizing exercise: plenty of private banks, including the aforementioned Banco Internacional issued notes. Now all of them would exclusively work through the Central Reserve Bank.
This exercise was mostly pulled forward by the 1929 “Great Crash”, a disaster for El Salvador’s financial system, and a reminder that financial crashes in the American ecosystem have crushing and surprising effects abroad.
This entire period was marked by the 1931 military coup that meant El Salvador’s economic institutions and the entire country was run by the military until 1979 — presaged by a 1932 massacre of civilians during a Communist uprising.
During this period, the Central Reserve Bank of El Salvador was reorganized into a government entity in 1961 with the passage of the Law of Reorganization of the Central Bank, resembling a traditional central bank, and in 1970, was given supervisory powers over the entire financial system. In 1973, in a rather MMT-like set up, the Central Bank was consolidated with a fiscal entity of the state to create the ability for the State to run financial, credit and monetary regulation in one consolidated entity.
El Salvador was rocked by civil war in the 1980s, as political elites split off from the armed forces and both sides committed fresh human rights atrocities to maintain control — including the assassination of noted dissident Archbishop Romero during mass. One key tipping point here: active American intervention. The Reagan Administration, newly inaugurated, showed a much steeper interest in El Salvador than previous administrations, providing the military training and giving billions of US dollars in aid to El Salvador. Left-wing guerrillas organized under the banner of the Farabundo Martí National Liberation Front or FMNLF — later on to become the foundation of the political left in El Salvador.
This turmoil not only reflected in deaths, but in economic reorganization, with the military regime first nationalizing private credit in 1980, then paving the path for re-privatization in the early 90s — by which time in 1989, the banking system was technically broke.
A decade-long civil war went on, with guerilla attacks on urban centers, and atrocities committed by both leftist guerillas and the US-trained military. By the time a peace accord was signed in 1992 between the military and the guerillas, over 75,000 people had lost their lives and El Salvador’s economy lay in ruins. Many in El Salvador fled the country and went to the United States, more deeply integrating El Salvador into the American currency and trade system. Meanwhile, the turmoil, both political and economic of the last decade, would lead to a secular slowdown in GDP growth.
Why did El Salvador go through the process of dollarization then? A marquee decision of Francisco Flores, part of the conservative ARENA (National Republican Alliance in English, or Alianza Republicana Nacionalista in Spanish), the decision has been commented on as driven by reducing El Salvador’s interest rates, and more tightly integrating it with the American (and thus global) trade system. Interestingly, inflation compared to a domestic currency seen as weak and unrelaible, often cited for why Ecuador adopted the dollar (with runaway inflation totaling nearly 25-30%) and a primary reason for why a country might want to dollarize, was not really a factor in El Salvador, where inflation had been reasonably stable for quite some years. In many senses, this was a proactive decision that wasn’t driven by a crisis per say, but rather to juice the domestic economy.
Yet, the reasons are not just economical. Some of the political turmoil of living next to the United States, including the bloody civil war, led to many Salvadorians emigrating to the United States — building upon extensive trade and remittance ties, with transfers of USD home. For example, in 2016, El Salvador received $4.6 billion in remittances, which made up about 17 percent of GDP at the time. To put that into perspective, the United States government only sent $88 million in aid that same year, a fraction of that amount. The United States also accounted for about 60% of El Salvador’s exports around 2004, though since imports were greater from the United States, El Salvador actually built a trade deficit with its neighbour, and soon-to-be currency manager.
Once dollarized, the path out becomes much harder. The choice was made in 2001, and by 2004, the colón had stopped circulating, leaving the US dollar as the only way to meaningfully transact. Initially the Monetary Integration Law of 2001 allowed colones to be exchanged with US dollars at a rate of 8.75 colones to one US dollar, and by 2004, meaningful circulation of the colón in El Salvador’s economy had ceased. De-dollarization also de facto restricted the central bank’s functions, with it no longer responsible for any monetary policy decisions (which would now rest in the Federal Reserve’s hands).
De-dollarization has been a hard sell for political elites, with the political left (in El Salvador, traditionally represented by the Farabundo Martí National Liberation Front, formed out of the leftist guerilla groups that fought in the 1980 Civil War) focused on it in alignment with states resisting American influence (some of them tyrannies of their own) in the region such as Venezuela.
Yet many ARENA members, conscious of the legacy of Francisco Flores, and honed by their pro-business instincts and alignment with ANEP (in English, the National Association of Private Entrepreneurs, and representatives of the financial and manufacturing industries), resist de-dollarization. This is despite the fact that GDP growth rates have lagged behind different neighbours in the region and developing countries as a whole — and some of the unpopularity of dollarization, with one survey noting more than 62% of the population thought it was damaging.
The current President, Nayib Bukele, is the second President to be elected that doesn’t come from either the political left or the political right since the military gave up power. The party he represents, GANA, is a center-right coalition with members of ARENA mostly incorporated. In this vein, he represents a trend around the world of “ni gauche, ni droit”, neither right or left — perhaps most famously exemplified by French President Macron, but also in a variety of many states that are bending away from traditional duopolies in politics.
He has been accused of consolidating power, and marching troops into the legislative assembly to get a bill passed among other things. His views on de-dollarization also align with the traditional right, of which his party GANA, has absorbed somewhat. Emphasizing that bitcoin and the US dollar would operate with one another side-by-side, his public statements are in alignment with this being an experiment that doesn’t seek to displace the fundamental economic ties El Salvador has with the United States trade system.
The specifics of it led down to a path where bitcoin was adapted in certain parts of the region, with wholescale collaboration with Jack Mallers and his company Strike the specific vector. Strike offers the combination of the Lightning Network and bitcoin to offer instant remittances across borders with fixed fees, leapfrogging other approaches to the same problem such as TransferWise’s shift in physical ledgers, and SWIFT’s established way of transmitting information between national entities into a supernational framework for sending value.
Yet SWIFT suffers from high fees and high settlement times, as well as the political pressure that comes from the economic powers of the time.
If one traces the history of El Salvador, a country where dollarization and political/economic integrationalism with the United States system has come at stark costs and mixed benefits, it can’t be hard to read between the lines and wonder if this represents another soft experiment to test the bounds of US economic influence despite public words to the opposite effect.
When dollarization was proposed, the small size of El Salvador’s economy meant that it got a passing complement from the US Treasury Secretary at the time (Lawrence Summers) and a neutral acknowledgement from the Federal Reserve. Yet now that it is embracing bitcoin, a new standard, in much the same way it went around implementing the US dollar, it is attracting the ire of all of the institutions devoted to the international financial system, from the World Bank to the IMF.
Yet, in being proactive to try to unlock lagging growth, El Salvador is showing the same pattern of thought it once did when it embraced dollarization proactively to seek economic growth in the first place — and hoping to be a first mover rather than a speck in the US Treasury’s press releases.
The democratic legacy of its struggles with military rule, and economic centralization then de-centralization, has led to a situation where the legislative wing and the executive wing have both blessed bitcoin’s ascent in El Salvador.
El Salvador’s adoption of bitcoin shows the intersect of economics and politics, how domestic politics shape groups and individuals towards policy outcomes that can affect the world, and how Latin America has started to chip away at a financial system that doesn’t work well for the region.
It is no surprise that this neglect has led to countries in the region thinking of alternatives, with dramatic geopolitical consequences: for example, Panama and El Salvador, two fully dollarized economies, recently flipped their recognition of Taiwan to the “One China” principle the People’s Republic of China has favoured. In its own backyard in the Trump years, El Salvador rapidly flirted with Chinese economic overtures and is still paying the costs through sanctions.
It also shows how bitcoin’s advantages in circumventing some of the frictions of the international financial system, from remittances, to digital wallets for individuals, can help push it to the forefront of geopolitical alternatives.
In sum total, this analysis may lead one to believe that El Salvador’s somewhat unique history is playing a role — and yet also offers insight that its dynamics, motivations — and yes, sometimes, costs, can be replicated elsewhere for bitcoin-leaning states.
By Roger Huang