Triple Crisis, November 25, 2014
When it comes to economic policy, the ideas of the public can matter a lot. Elected governments have to worry about being re-elected, and this is certainly the case in Venezuela, where the electorate is polarized and the last presidential election was close.
Venezuela is facing a number of economic problems right now, including annual inflation over 60 percent, shortages of some consumer goods, capital flight, and an economy that is projected to shrink for the year. Most of these problems can be traced to the country’s dysfunctional exchange rate system. Yet polls show that a vast majority of the public—in some recent polls as much as 80 percent—does not want a devaluation that could fix this system. And it appears to be this pressure from the electorate—not from special interests—that is preventing the changes necessary to restore economic health.
People associate devaluation with a number of bad things. One is inflation. Since a devaluation normally increases the price of imported goods, this contributes to inflation. However we can look at the past 5 devaluations in the last decade. For three of them, inflation over the following year was actually less than it was before the devaluation; and for a fourth it was not much higher.
The one exception was the last devaluation, in February 2013. Inflation shot up after that devaluation, but it is doubtful that the devaluation was the main cause. Inflation was already accelerating rapidly and running at a 43 percent annual rate during the three months prior to the devaluation. And if we look at where that inflation came from, it was from the shortages of dollars—and therefore many goods—that began in the fall of 2012.
Inflation, shortages, and the economic slowdown all stem from the shortage of dollars. But the dollar shortage is a result of the government giving away most of the dollars that it gets from oil revenue at a fraction of their value. Estimates of an equilibrium exchange rate for Venezuela are somewhere around 30 bolivares fuertes (Bf) to the dollar, but most of the government’s dollars are sold for 6.3 Bf. People who receive such dollars can sell them on the black market for more than 100 Bf. In other cases they can also profit from using them to buy imported goods, and then selling those goods at prices that reflect the much higher black market rate. What could the government do? It could switch to a unified exchange rate system. Instead of having three exchange rates as it does currently, it would have – like almost all other countries in the hemisphere -- only one. Of course, this would mean a large devaluation from the current official rates of 6.3 Bf per dollar at which most dollars are sold, and the government’s second, higher exchange rate of 10.6. But devaluation to what rate? Private estimates indicate a rate of around 30 if the currency were allowed to float. But what if it temporarily went even higher, for example to 40? This is known as “overshooting.”
This happened in Argentina, for example, when it devalued at the beginning of 2002. It was a very large devaluation, going at first from one peso to the dollar, to four. Then the government was able to stabilize it at a rate of three.
Of course, Argentina was facing other problems that Venezuela does not have, including a deep depression and the world’s largest public debt default. But the “managed float” exchange rate policy was a vital part of its very successful recovery, which began just three months after the devaluation.
If Venezuela were to let the exchange rate float and it “overshot” temporarily, this could have a positive impact. As in Argentina after its 2002 devaluation, dollars would stop leaving and come back into the country as people realized that the currency had hit bottom; and in the Venezuelan case, that the periodic devaluation of one overvalued fixed exchange rate after another had finally come to an end.
Then the government could stabilize the currency at a sustainable exchange rate within some range. This would not mean announcing a new fixed exchange rate or even a “band” within which the currency would move. Rather, it would mean intervening in the currency market when the government thinks it necessary to keep the currency stable. This is what Bolivia has done, for example, since Evo Morales took office in 2006, and it has been very successful.
Of course, in order to keep the exchange rate stable, the government would have to bring down inflation. But that will be easier to do when the country is no longer suffering from foreign exchange shortages that drive up prices not only of imports but also many other goods and services that depend on imported inputs.
A unified, realistic exchange rate would also put an end to the speculation that drives the black market, currently trading at 103 Bf per dollar. This has contributed to the sharp rise in inflation over the past two years.
Venezuela is not suffering from a genuine balance of payments crisis, where insufficient export revenue makes it impossible to pay for imports and service the public foreign debt.
The country is running a current account surplus, and has a more than adequate $40 billion in total foreign exchange reserves (including government funds outside the Central Bank). What looks like a balance of payments crisis is really just a dysfunctional exchange rate system generating artificial shortages of dollars and goods, as well as payment arrears.
In fact, the toughest part of the adjustment from a devaluation has already been done: Venezuela’s imports have fallen by 33 percent in the past two years, one of the biggest such adjustments in the world. Now it is prices that must be adjusted.
Of course some people will lose from a devaluation—and not just the people who make a fortune either legally or illegally from their access to cheap dollars at the 6.3 or 10.6 rate. These will be the biggest losers. But the ones who must be protected are working and poor Venezuelans who will face some price increases—instead of the current scarcities—after the devaluation.
The government can indeed protect people, since it will gain what others—including those profiting from the current system—lose. That is because the government gets more than 90 percent of the country’s dollar revenue; and these dollars will be worth more in local currency after the devaluation. The government then can, and must, use its additional revenues in Bf to make sure that the vast majority of Venezuelans do not lose out in the transition to a functional exchange rate system.