Losing Trust in your Currency
A rational incentive for bitcoin adoption
This is part II of a continuing series. Part I can be found here.
Edit: It’s been an exciting week in Argentina as the US Supreme Court rejected Argentina’s plea to ward off the vulture fund holdouts. This decision mildly increases the risk of default in Argentina, but even in that case, it would likely be a technical default, not nearly as violent as the 2001 event.
On December 21st, 2001 the president of Argentina, Fernando de la Rúa, fled La Casa Rosada by helicopter. His vice-president had already abandoned his post in October so Ramón Puerta the President of the Senate took office for the rest of December 21st and December 22nd. On the 23rd, he passed the baton to Adolfo Saá, who defaulted on Argentina’s debt of $134 billion. Saá‘s own party withdrew support before the 31st and Eduardo Duhalde was appointed successor. It wasn’t until Nestor Kirchner took office in 2003 that things returned to normal.
The riots that lead to this revolving door started three weeks prior to de la Rúa’s escape, on December 2, 2001, when his government announced a ‘corralito’ or limited access of bank accounts. The corralito was a last ditch attempt to postpone default and maintain dollar reserves by capping the number of pesos citizens could take out of the bank at $250 a week. One-to-one convertibility with the US dollar that reigned for the 90s had come to a violent end. Argentinians who had enjoyed a cheep dollar over the past decade and easy international travel took to the streets in protest, bearing banners insisting that the government abandon their posts: “¡Que se vayan todos!”
Every single Argentinian bitcoiner I’ve spoken with has referenced this lack of trust as a reason for their adoption. “There’s huge uncertainty between different governments,” lamented Matias Bari one of the founders of SatoshiTango, a new bitcoin exchange in Buenos Aires. “Why make a decision today if the government’s policies might totally reverse tomorrow?”
In default, provincial banks and the central bank attempted to curb the damage of financial illiquidity by temporarily paying employees with cuasimonedas such as the Lecop and the Patacón in Argentina. Despite being the same size and color, these notes were’t pesos, but emergency bonds issued by government to try and keep the economy crawling along, even when they had no ‘real’ money to distribute. These cuasimonedas depreciated in value as Argentina regained control and today they are worthless, except as souvenirs.
Argentina’s case is a rather odd case, but it is not singular. I’m not referring to the bank runs in Mary Poppins or A Wonderful Life, but to Cyprus. Cyprus is frequently cited as being the source of the March-April 2013 bitcoin bubble. Like Argentina’s 2001 Corallito, debt in Cyprus grew to a point where citizens lost faith that the bank could be trusted to hold their money, resulting in an all out bank run. The run in turn made default more likely and thus the central bank of Cyprus froze access to savings accounts to try and slow the damage. As distrust grew in Cyprus, the bitcoin price surged from $47 on March 17th when banks closed, to a staggering $266 on April 11th, shortly after its open. Cypriots fleeing their banks are certainly not solely responsible for the jump in price, but the search for alternatives is undeniable.
It’s worth reviewing the past to understand where Argentina is going today.
Distrust makes historical sense in Argentina. Common knowledge is that economic emergency is due every ten years. Looking back within the past few decades, this sadly holds true. Coming out of a mismanaged military dictatorship in 1983, Argentina faced deteriorating economic conditions and high inflation. In 1985 the Plan Austral favored shock over orthodox monetary control by chopping off a few zeroes from the currency. It failed three years later in 1988 and was replaced with the Plan Primavera. Inflation in Argentina continued to climb, peaking at 5000% in 1989. At this point Domingo Cavillo, a young, charismatic, Harvard educated Argentine economist offered the country what they were looking for: stability through convertibility. He promised the country that a US dollar would be worth a (new) Argentine peso. Argentinians could take out loans in US dollars, buy houses in US dollars, or store their life savings in US dollars in the local bank just as easily as they could with Argentinian pesos. This promise hinged on the trust that the central bank would maintain a reserve of US dollars large enough to cover its debts. Inflation evaporated nearly overnight, but without monetary flexibility, Argentina’s reserves began to dwindle as the real exchange rate appreciated rapidly. It became cheeper to fly to the United States or Europe for a vacation, than other parts of Argentina. The ‘riesgo pais’ climbed daily, reported on TV each morning alongside the weather. Every point higher meant another percentage point return on investments in Argentina. The higher it climbed, the more dollars left the country as foreign investments, and the higher the risk of default became, causing more dollars to leave the country. The vicious circle was impossible to maintain and as it sucked the reserves dry, the IMF balked at bailing out Argentina again. Today, the blue exchange rate (black market) hovers between 10.5 and 12, roughly 8% of it’s purchasing power in 2001.
It’s worth noting, that risk of inflation is utterly different from an outright freeze on bank accounts. The situation that lead to the 2001 Argentinian collapse is very different from what where the country is today. While devaluation was impossible in 2001, it is a tool to maintain reserves today. Each devaluation, while increasing inflation, also increases the revanue the government collects from exports and reduces the outflow tied to imports.
Meanwhile, it’s an especially interesting week for bitcoin. With a very real threat of a 51% attack by GHash.io and the announcement that the US Martial Service will be auctioning off of just shy of 30,000 bitcoins later this month(roughly half the normal daily transaction volume), bitcoin prices have plunged roughly 11 percent in the last week. As a point of comparison, in January, to avoid dwindling reserves of dollars and bolster exports while reducing imports, the Argentinian central bank devalued the peso 20%. In the short term, bitcoin in a crash seems to be holding up better than the peso, even when faced with armageddon.
I mentioned in a previous article that the Argentinian bitcoin community is already vibrant and growing quickly. With inflation for 2014 projected to be around 38%, Argentina’s central bank wants to avoid devaluing again (thus spurring on more inflation), but with dwindling reserves and a rising black market dollar, it seems inevitable. The perceived risk of bitcoin is much lower when high inflation eroding your savings is certain.
And here’s the central question: which is worse, the evil you know or the one you don’t? While many in Argentina ‘invest in bricks,’ or collect dollars under mattresses, a core group in Buenos Aires is certain that the unknown is better than the known and are vehemently defending bitcoin for it.
For those interested in reading more on the 2001 crisis in Argentina, I recommend “And the Money Kept Rolling In (and Out)” by Paul Blustein.
