Monday, January 11, 2010

The Venezuelan devaluation

The Bolivar has been pegged at 2.15 to the dollar for about 5 years. Over those 5 years, Venezuelan inflation has ranged from 15 - 30 percent per year while US inflation ranged from 0 to 5 percent per year. That is to say, unless the Bolivar was massively overvalued when pegged in early 2005, it has become way overvalued. Yesterday, President Chavez ordered the devaluation of the Bolivar to 4.3 per dollar (2.6 per dollar for some specific imported goods).

Chavez did a pretty good job of explaining the Venezuelan situation as one of a country suffering from the Dutch disease. It heavily exports a primary commodity, which supposedly causes currency appreciation and hurts manufacturing. He emphasized that the country needed to overcome this problem and produce stuff, not just pump stuff out of the ground. Here is a relevant fragment from his TV show:





The devaluation is good policy for sure. I am not crazy about the tiers and controls, and opposition leaders in the country say Chavez will use the increased local currency revenues from oil exports to boost domestic spending in advance of elections, but it is the correct move for the country at this time (and should have been done much sooner). Fixing the nominal exchange rate to a country whose inflation rate you are unwilling to match is a recipe for economic disaster that we have seen cooked up over and over again in Latin America.  Venezuela is getting out before the disaster hits, at least this time.

3 comments:

Eric H said...

"The devaluation is good policy for sure, ceteris paribus."

Where ceteris paribus means not sending armed thugs around to check spaghetti prices!

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