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El Salvador’s volcano bond — where froth becomes lava

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Irrational investment decisions are nothing new. But danger lurks in El Salvador’s Bitcoin bond plans

El Salvador needs money. Fitch Ratings reckons the government’s 2022 funding gap could be close to $1bn. Conventional bond markets are not going to provide it — the sovereign’s 2023s yield 27.5%. Neither is the IMF, for now. Though authorities allege a programme is under discussion, nothing about recent policymaking suggests an agreement is feasible.

President Nayib Bukele knows this. So why would he turn down an offer from Blockstream to arrange a $1bn bond, issued on its Liquid Network and linked to Bitcoin to fund what’s being dubbed “Bitcoin City” at a coupon of just 6.5%? What’s more, he even gets to be beamed down onto a stage from a spaceship, with AC/DC as a soundtrack, in front of thousands of adulating cryptocurrency fanatics.

Buying El Salvador’s existing sovereign debt is a far more lucrative way to bet on the government’s creditworthiness than the Bitcoin bond is. And buying Bitcoin itself gives you far greater upside in the event of a massive crypto rally than this new-fangled instrument. You would only buy this if you want to be part of Bukele’s aspiration to transform El Salvador into the “Singapore of digital capital markets”.

People invest in far-fetched projects for all sorts of reasons. This is not a novelty. And it might work, for a while. Such is Bukele’s digital marketing nous that if every El Salvador sovereign bond were sold to Twitter addicts, it would probably be breaking oversubscription records every time it turned to the market.

But El Salvador’s Bitcoin bond — half to be used to buy Bitcoin and half to build volcano-powered energy infrastructure to mine crypto — is the point at which the froth isn’t funny anymore.

This is not a serious proposal to grant El Salvador independence from the machinations of the international financial system, as Bitcoin maximalists would have you believe. Bukele admits it was inspired by a Tweet sent to the president’s account, not a thorough analysis of the country’s economic troubles. The authorities didn't even tell the IMF of their plans on its recent Article IV staff visit.

The risks of the Bitcoin experiment — ranging from consumer protection, to money-laundering, to financial stability, to unsustainable energy demands — are an afterthought compared to the amount of time put into the design and presentation that does a brilliant job in cultivating the personality cult of Bukele, the self-styled “CEO of El Salvador” and “coolest dictator in the world”.

El Salvador is one of the poorest countries in the already poor region of Central America. Sure, the corruption and self-interest of the traditional political class deserves to be highlighted, as Bukele regularly does. But solving this requires serious economic policies — not for the country to be the site of a financial and social experiment that, if it goes wrong, could have a huge humanitarian cost.

Several serious economists would argue there are genuine reasons not to want to fully toe the IMF's line, which is what bondholders really want to see. But loosely thought out gimmicks are not a sustainable way of financing an economy. And better governance requires greater checks and balances on power and stronger institutions. The road to Bitcoin City runs in the opposite direction.

If the Bitcoin bond happens, and we only have 60 days to wait to find out, crypto froth could soon be turning to lava for the people of El Salvador.