Tag Archives: Money

The president of El Salvador is playing a dangerous game

El Salvador became internet famous about a year ago first when President Bukele declared that they would be the world’s first country with Bitcoin as a legal tender and second when their president began having his government buy Bitcoin as a “sovereign wealth fund.”  But flirtations with the Bitcoin ponzi are not even El Salvador’s biggest problem.  El Salvador owes billions of dollars in sovereign debt, and due to a large government deficit and little hope of improving economic conditions, the debt is currently at junk status.  The status of debt is basically how people express the risk of the debt not being paid back in full, and for El Salvador that risk is very high.  The money markets that have lent money to El Salvador believe it to be somewhat likely that El Salvador will default on its debt, leaving them with either nothing or less than the full amount that they lent, and because of that the debt is considered to be junk status.

What is a default?  A default is basically where a country declares it won’t pay back its debt.  It may be a partial default (we won’t pay back specific bonds) or a “haircut” (we’ll pay back only a certain percentage of what we owe) or a total default (we won’t pay back anything).  But a default leaves the lenders with less than the face value of the debt they lent to the country, and it in turn makes other lenders way less likely to lend money to that country.  Think about it, if you lend a buddy 100$ and he never pays you back, will you lend him another 100$ next time?

Now even junk debt isn’t worthless.  It may be *likely* that El Salvador defaults but it is not *certain*.  So if you hold an IOU from El Salvador, you can still try to make money off of it.  Let’s say you own El Salvador government debt worth 100$.  You think it unlikely that you’ll get back the full 100$ but someone else will buy the debt from you for 20$.  You’re taking a loss by selling the debt instead of waiting for El Salvador to pay up, but the 20$ they will give you is more than the 0$ you think El Salvador will give you, so you go ahead and sell it.  This sort of debt market happens all the time as institutions sell and buy debt based on their expectations of how likely the debt is to be paid back.  As economic conditions improve, the likelihood of being paid back increases and the price of the debt can rise, while worsening economic conditions would make it fall.

The problem is that President Bukele saw this debt market, and he hatched a scheme.  The debt markets think that El Salvador is unlikely to pay back its debt, and so 100$ of debt can be bought for 20$.  Well, thought the president, what if El Salvador just buys back the debt itself?  Now we can wipe away 100$ of debt for just 20$, genius!  Except not really, the debt is trading cheaply on the expectation that it won’t be paid back in full.  Buying it at this discount is an admittance that El Salvador won’t pay it back in full, they won’t pay back 100$ for 100$ worth of debt, they’ll pay back 20$.  In some ways that is a de facto default, and in the future when El Salvador wants to take out a loan (and remember they need loans to cover their deficit), banks will be very leery of giving a loan to a country that basically entered a partial default.  Secondly, President Bukele announced this scheme on twitter, and with this public announcement the price of El Salvador’s debt went way way up.  Obviously a lot of people holding El Salvador’s debt expected to get nothing, so with the public announcement of a buyback they now expect to get something and will raise their prices accordingly.  If the president thought he could buy back all the debt on the cheap, he’s very likely to be mistaken.

I don’t know who advises the president of El Salvador, but it seems like he does financial policy without much understanding of the effects.  By the way, this entire article is written using dollar denomination because El Salvador’s debt is denominated in dollars and dollars are an official currency (alongside Bitcoin). It’s probably one of the reasons El Salvador doesn’t have many economic levers to pull, they don’t control their own money supply.

I don’t think people understand stocks or what gives stocks value, and I think that’s why some people fall headlong into Bitcoin

Let me get one thing clear: Bitcoin is a ponzi scheme and Bitcoin “exchanges” are rugpulls waiting to happen.  There is no value in Bitcoin as an asset; anything it can do, everything else can do better.  But it’s clear that Bitcoin has a hold on people and I’ve seen many try to defend Bitcoin by comparing it to stocks.  Once you accept that Bitcoin is terrible and has no use cases, the only thing left is to claim that everything else in the world is even worse.  I’ve seen the argument made that the stock market is a legalized ponzi scheme taking money from individuals and giving it to corporations, but that argument clearly comes from a place of ignorance. Stocks are a legitimate investment vehicle, unlike Bitcoin, and I’d like to explain why.

First, why does a stock have value at all?  Two big reasons cited are ownership and dividends.  When you own a stock, you have real *ownership* of a small percentage of the company with all the property rights that come with that.  In a very real sense the stockholders can plutocratically vote (plutocracy in this case means 1 share = 1 vote) on the direction of the company. The stockholders have a sort of representative plutocracy in which they vote for the Board of Directors, who then act as the stockholders’ representatives guiding the direction of the company through their chosen CEO.  In 2021 for example, ExxonMobil stockholders led by a group called “Engine No 1” fought to make ExxonMobil commit to new environmental standards and a sustainable energy future.  There have also been cases in which stockholders such as private equity will put up a proposal to replace the board of directors and management staff with someone else in order to turn around the company and bring it back into profitability.  All these things are possible only if you can get the stockholders to agree, and this is the value that owning a share of stock has.

Another reason shares of stock have value is dividends, and here ownership comes into play as well.  If a plutocratic majority of the stockholders want it, they can demand that the company give them more and more of the company’s money in the form of dividends.  The value of the stock therefore is the value of all future dividends, divided by the uncertainty the company will stay in business, multiplied by the fact that money now is better than money later.  Say I hold a corporate stock that gives a yearly 1$ in dividend. I think the dividend is stable, so I expect to receive 1$ per year every year.  So the price of the stock is infinity because I expect to receive infinity dollars?  Well no because there is market uncertainty, I could be wrong about the company for instance, and it goes bankrupt next year. Or the market could change in ways I can’t predict and the company goes bankrupt, there’s no certainty about how long this company will stay in business.  Also, money now is always worth more than money later (even if inflation is zero, I’ll talk about that some time), so the dollars I expect to get 10 or 20 years from now are worth less than and less then the dollar I will get this year.  And so despite seeming infinite, the stock value can converge to a finite amount because there’s no guarantee I get all those future dividends. And of course different people can value a stock more or less based on their own personal appetite for risk.

So the value of a stock is based on real value.  A company has value just as much as say a factory does.  People want to buy the things that come out of it, so owning it gives you something that makes money and therefore has value.  Likewise a company gives money back to its stockholders in the form of dividends.  Now there are many reasons a company would want to give dividends, and likewise reasons stockholders would be OK with not having dividends, but going back to shares being ownership, remember that the shareholders can always demand the company give them dividends if there is a plutocratic majority in favor of it.  So dividends are demanded by the stockholders, given by the company, and the value of all future dividends plus the value of owning a part of the company itself is what gives a stock value for a stockholder.

Bitcoin does not have this value.  There is no dividend, there is no underlying thing of value that you “own” when you own a Bitcoin.  All Bitcoin has is the greater fool theory, the idea that somehow you’ll find someone to buy your Bitcoin for more than what you bought it for.  Greater fool theory isn’t unique to Bitcoin, and at least some percentage of stock market daytraders are only buying in order to sell to a greater fool, but as I said stocks have more than greater fool theory underpinning their value.  Bitcoin only has greater fools, and that’s what makes it a ponzi scheme.