It will destroy the country’s competitive currency regime and create a regulatory nightmare.
In 2001, El Salvador mothballed its domestic currency, the colón, and put it into a museum. El Salvador’s current currency regime is governed by the Monetary Integration Law. This law made the U.S. dollar legal tender and established a competitive currency regime, under which any currency that is mutually agreed upon by the parties to a transaction is legal to use.
The system has worked like a charm. Since 2001, El Salvador’s average annual inflation rate of 2.03 percent has been the lowest in Latin America. Twenty-five-year mortgages have been steady at an interest rate of around 7 percent. GDP per capita growth (measured in purchasing power parity) and export growth have both have been higher than in most Latin American countries.
Enter El Salvador’s Bitcoin law, which was hastily passed in the middle of the night of June 8. Proponents of the law, including El Salvador’s President Nayib Bukele, claim that it will make Bitcoin legal tender on September 7. As one of us recently wrote in the Wall Street Journal, it will actually make Bitcoin forced tender. Indeed, Article 7 of the law mandates that El Salvadorans must accept Bitcoin if it is offered. This will destroy El Salvador’s competitive currency regime and rob those being offered Bitcoin a choice. In addition, it will create a regulatory nightmare. The intergovernmental Financial Action Task Force (FATF) will be all over El Salvadoran banks, businesses, and other financial institutions like a wet blanket.
The FATF is the international “money laundering and terrorist financing watchdog.” It reviews countries’ anti-money laundering and counter-financing terrorism practices. If the FATF determines that a country is exposed to financial crime, the flagged country is placed on either the list of “Jurisdictions under Increased Monitoring,” known as the “grey list,” or the list of “Jurisdictions subject to a Call for Action,” known as the “black list.” When a country is placed on the grey list, it must cooperate with increased FATF monitoring. When a country is placed on the black list, the FATF urges its 39 member nations and over 200 affiliated nations to apply enhanced due diligence and impose countermeasures, such as sanctions. At present, there are 22 offenders on the grey list, with six in the Latin American–Caribbean region. Iran and North Korea are the only two countries on the black list.
From an FATF regulatory perspective, El Salvador has been as clean as a hound’s tooth. That will change if the Bitcoin law is implemented on September 7. In a Johns Hopkins Studies in Applied Economics working paper, we identified 27 FATF regulations relating to virtual-asset transactions that will be nearly impossible for El Salvadoran banks, businesses, and their customers to comply with. For example, the FATF mandates that the parties engaging in virtual-asset transactions provide complete and sufficient know-your-customer information. It also requires that senders and recipients of virtual assets obtain accurate knowledge and information about “the transaction, the source of funds, and the relationship with the counterparty.” The chances of Bitcoin transactions meeting such requirements are slim-to-none. Other probable red-flag behaviors concern bitcoin transaction patterns, exchange of Bitcoin into greenbacks, and exposure to criminal activity.
If you are wondering whether the FATF will stick its nose into El Salvador’s forced tender of Bitcoin come September 7, the answer is an unambiguous “yes.” Just look at what the U.S. State Department has recently done. On July 1, it released a list of corrupt and/or undemocratic actors from Central America’s Northern Triangle (El Salvador, Guatemala, and Honduras). Of the 55 Central Americans who are now banned from the United States, 14 are El Salvadorans. El Salvador’s rogues’ gallery is populated by high-level members of President Bukele’s administration, including his cabinet chief, minister of labor, vice minister of security, and legal adviser. They’ve been nailed for a laundry list of charges such as money laundering, accepting bribes, and undermining democracy. Bukele himself has a history of overstepping his democratic powers, including using the military to influence congressional legislation and ousting five supreme court judges who had previously ruled against him. The Bitcoin law, which was heavily supported and hastily passed by the Bukele government, promises to invite more sanctions.
El Salvador’s Bitcoin law will result in many unintended consequences and unforeseen costs. We don’t yet know the exact modalities that will be used to implement the Bitcoin law. Indeed, we learn more about the possibilities and their contradictions with each passing day. For instance, after the law was passed and facing the public’s ire, President Bukele announced that each El Salvadoran would receive a onetime $30 subsidy to start using Bitcoin. Regardless, it is highly unlikely that El Salvadoran banks, businesses, and their customers can slip through the Financial Action Task Force’s regulatory web. And, the last thing El Salvador needs is a flagging by the FATF.
Steve H. Hanke is a professor of applied economics at the Johns Hopkins University in Baltimore. He is a senior fellow and the director of the Troubled Currencies Project at the Cato Institute in Washington, D.C. Nicholas Hanlon is the chief of staff at the Johns Hopkins Institute for Applied Economics, Global Health, and the Study of Business Enterprise.