Solving Caracas Currency Chaos

If the bolivar were either replaced or backed by the world’s most trusted reserve currency, a commodity not seen in Venezuela for years would return: stability.

December 23, 2016 • Commentary
This article appeared on OMFIF Bulletin on December 23, 2016.

Venezuela is embroiled in history’s 57th hyperinflation crisis — on top of the existing problems of economic mismanagement, corruption, and incompetence.

Since the beginning of November, the bolivar has lost 42% of its value, worsening conditions for a country in which wheelbarrows have replaced wallets. In response, Venezuelan officials announced a misguided and foolhardy plan to issue higher‐​denomination bills to mitigate the damaging effects of hyperinflation.

If the Banco Central de Venezuela does not redenominate, then the people are stuck. But redenomination by itself is insufficient. If you go to a market in Caracas today, you either need to carry an unseemly amount of cash, or bigger bills – much bigger. President Nicolás Maduro and the central bank hope that, by printing Bs20,000 notes, they can skirt around the hyperinflation problem until it disappears of its own accord. That is a brainless undertaking.

In the early 1990s, the former Yugoslavia tried to combat its own hyperinflation by printing larger bills, and failed horribly. That episode of heavy inflation continued throughout the decade, and the Yugoslav dinar was devalued 18 times between 1991–99. 313,000,000% monthly inflation transformed Yum500bn bills into small change before the ink had dried. Redenomination achieves nothing if elevated inflation levels persist, as Zimbabwe’s infamous Zwd100tn note has demonstrated. Venezuela will be no different. When inflation rises uncontrollably, reserve banks cannot physically redenominate bills quickly enough. Countries are then left with valueless notes with many zeroes and a ‘wheelbarrow problem’.

Yugoslavia’s inflation episode stopped only when its printing office ran out of capacity – they couldn’t redenominate and print notes fast enough, so stopped. This sent the real value of notes in circulation to zero, ending the inflation episode. However, this is a painful way for hyperinflation to end. A currency crunch leads to starvation and riots, and would certainly diminish Maduro’s tenuous grip on power.

The only solutions for ending relatively painlessly Venezuela’s inflation episode and the currency chaos, fanciful as they may be, are to either dump the bolivar and replace it with the dollar, or make the bolivar a clone of the dollar via an orthodox currency board. In the latter case, the bolivar trades at a fixed rate with the dollar, is totally convertible with the dollar, and is completely backed by US reserves.

If a Venezuelan leader could, against all odds, announce the implementation of dollarisation or an orthodox currency board, he would become a national hero on par with revolutionary leader Simon Bolivar. International currency markets would instantly regain faith in Venezuela and restart trade. If the bolivar were either replaced or backed by the world’s most trusted reserve currency, a commodity not seen in Venezuela for years would return: stability.

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