Why Exchange Rates and Interest Rates are the Al and Peg Bundy of Economic Policy


But Peg…I debauched you last month.

Did you hear? The government is going to liberalize the dollar-bolivar market! It’s huge news!

On paper, the Convenio Cambiario #27 setting up what’s known locally as SICAD2 – a legal, market-driven alternative to exchange controls – looks like the most significant economic reform in 15 years. What’s more, it looks like the first pro-market reform we’ve seen from chavismo…ever.

Still, color me skeptical.

The whole concept of allowing buyers and sellers to interact freely to determine an important price looks impossibly radical in a chavista policy-setting context. More importantly, there are powerful economic reasons to doubt this thing can work.

It’s easy to get lost in the details, so it’s best first to establish the principle: there’s a reason economic reforms usually come as a package. Various bits of the economy are deeply interconnected in complicated ways, and if you mess with one part of the system without adjusting the other bits at the same time, the whole thing is liable to break down.

If those dreaded paquetes are usually implemented at once, it’s not out of some intrinsic neoliberal perversion, but because the alternative is like dropping a much more powerful engine in a car without upgrading the brakes and the suspension at the same time: you end up with a dangerously unbalanced beast liable to crash and burn in short order.

The easiest of these interconnections to grasp is the one Miguel Angel Santos has been droning on about at some length: the link between lifting foreign exchange controls and interest rate controls. These two are very much the love-and-marriage of the economic reform world:

This I tell you brother

You can’t have one without the other. 

It’s easy to see why. Right now a good many Venezuelan people and companies keep savings in bolivar bank accounts (and in government bonds) that pay less than 20% interest, even though inflation is running at over 50% per year. Real interest rates are crazy negative: put Bs.100 in a bank account today and the Bs.120 you end up with a year from now buys much less than Bs.100 buys today.

So saving in bolivars is sort of like keeping dollars under your mattress, taking them out once a year and putting about a third of them through a paper shredder.

Why do people put up with this? Because they don’t have a legal way to turn Bs.100 into assets that can be relied on to hold their purchasing power over time, like dollars. But if you give people that option, nobody sane is going to hang on to those fast self-destructing bolivars.

The one way to persuade them to hang on to those bolivars is to pay much higher rates on deposits. Either interest rates go up sharply or we’re going to see an almighty stampede out of the bolivar zone, with potentially dire consequences for the banks, the public treasury and everyone else, too.

So we’re calling for interest rates rise sharply, right?

If only it was so easy. When rates rise fast, a bunch of people who borrowed from the banks face much more onerous payments than they had foreseen. You borrowed at 15%, now suddenly you have to pay 50%. Lots of creditors are going to default. Enough to compromise the solvency of the big banks?

I have no idea, but I don’t want to find out.

Perhaps the bigger question is what the shock would do to the biggest borrower of them all in the bolivar zone: the government. It’s piled up huge mountains of bolivar denominated debt over the years. If the cost of that debt triples overnight, what happens to the budget deficit? And how do they cover that hole?

The temptation will be to just print more money, but the inflationary impact of that would be grave…and little by little you start to grasp why “fiscal reform” (i.e., bringing government spending broadly into line with what it can sustainably raise in tax) is usually thrown into the paquete too.

What’s worrying is that even though these three policy areas – exchange rate, interest rate, fiscal – are so intimately tied, we’re basically only hearing about one leg of that stool. Rafael Ramírez has spoken hazily about how the system will be “complemented by other measures”, but that makes it sound like they need a tweak here and a tweak there to make SICAD2 work, rather than the wholesale rethinking of chavismo’s political economy model.

It’s taken 12 years to convince chavismo of the need to overhaul exchange controls. I suspect it’ll take 12 more to get them to understand that you need interest rate liberalization at the same time. And another 12 years after that before they’ll grasp that those two together force a fiscal reorganization.

As it stands, we’re about to undergo an economic adjustment process of a brutality undreamed of in 1989: a neoliberal ajuste run by economic stalinists.

How to make sense of it all? To me – and this is obviously a bit of a conspiracy theory, but bear with me – SICAD2 is designed to fail.

Even an economic troglodyte can see that as people beat down the SICAD2 doors desperate to turn their fast-depreciating bolivars into dollars, the exchange rate is likely to overshoot, going way higher than anyone in the economic cabinet would consider acceptable.

Let that process run for more than an auction or two and bank balance sheets are going to start to look distinctly shaky, spooking the hell out of everybody.

At that point, the radicals inside the economic cabinet (paging Dr. Giordani) can step in gallantly and say, “see, I told you this stuff about liberal adjustment was a dangerous fantasy.”

And that’ll be the last you’ll ever hear of SICAD2.

93 thoughts on “Why Exchange Rates and Interest Rates are the Al and Peg Bundy of Economic Policy

    • Ha! Do you think that those stupid Chavistas can understand any English?

      And that part was priceless:

      “At that point, the radicals inside the economic cabinet (paging Dr. Giordani) will step in gallantly and say, “see, I told you this stuff about liberal adjustment was a dangerous fantasy.” And that’ll be the last you’ll ever hear of SICAD2.”

      This is what they do here in Brazil, they privatize companies and create so many regulations and taxes that those companies end up not delivering. And then they say: “See? Privatizations don’t work! Let’s go back to the the State monopolies system!”

      You got to have a very strong stomach to deal with this kind of people…


  1. In the same way you made references to an old TV show such as “Married… with children”, I will have to make reference to a favorite of mine (Seinfeld) and say, with all due respect, that your article is whole lot about nothing!

    You seem to assume that under SICAD 2 anyone will be allowed to buy as many dollars as wanted. What makes you think that? They already said they will sell only 30 million dollars a day. This is nothing but SICAD 1 at a higher exchange rate, with a few other minor changes. They are not really liberating the currency exchange market.

    Now, as a “Gedanken experiment” where you ask the question “what would happen if they liberated the exchange market without doing anything else?”, then yes, your article is right on the mark, but that’s not what is happening.


    • $30 million is just the government’s contribution. But the point of the reform is that they’re going to let the rate float until the market clears. That implies private dollar holders joining the fray and selling their dollars, just like they did under the old permuta system.

      I find it *really* hard to believe that they’re really going to go through with this when they start to grasp the systemic consequences. But that’s what they’re saying.


      • I was expecting you to answer that. I just don’t think that many private holders will be interested in selling their dollars. I only see a tsunami going in the other direction (people wanting to buy dollars). To say it more clearly, absolutely no one will sell dollars under SICAD 2 until its rate becomes similar to that of the black market rate, which may never happen because of the aforementioned tsunami. So, for all practical purposes, I expect the market to be just as starved of dollars under SICAD 2 as it is (was?) under SICAD 1, unless I’m wrong and the SICAD 2 rate becomes comparable to the black market rate from the start (I don’t think they will allow that).

        The old permuta system relied on the use of bonds, and they mentioned that this time they will use bonds as well. However, I don’t think there are many bonds around either for them to use (there are many bonds out there, but if those who own them hold on to them, they are not available for the system). Will they issue new debt so that there are more bonds in the market? That’s the question.


      • Sorry, while I was writing my reply, a lot of things were discussed on this topic in the comments below. To summarize my position, I don’t really believe they will allow the rate to float freely (they already mentioned they will intervene if the rate becomes too high). So when people wanting to sell their dollars under SICAD 2 find out the rate, they will say “what? 30 Bs. per dollar? No way! Let me go back to my old black market provider who will give me 80 Bs.”, and that will be it. The only ones offering dollars will be the government. Hence what I said, this is just SICAD 1 at a higher rate.


        • The intervention may be a “normal” intervention which is basically burn reserves to increase the offer and keep the market price low.

          If you cap price then you will do two things: Keep people from selling reducing offer and adding more pressure to the black market. The other thing is that they will have to resort to arbitrage.


          • Except there aren’t any (liquid) reserves left…

            Oh, wait! They just borrowed 2 billion $ from Russia. I wonder if they will use it to…


          • It will probably last on, since it will probably be a Sicad I type managed rate, not a free float. The BCV has already said that it will “intervene” if the rate gets out of hand; any rate much greater than 20 will be a tremendous embarassment to the Govt. In any event, the rate “published” will be an “average” of all real negotiated rates on any given day. This is simply another way for PDVSA/BCV to squeeze a few more Bs. from a small proportion (the much larger proportion will continue to be given through Cadivi/Sicad I) of their scarce $, and to further benefit Regime cronies, with the resulting Bs.thrust back into the economy on social giveaways , further bloating the money supply, and, after a temporary setback, propelling the parallel rate upward to new highs.


  2. Why don’t you try to find a bright side in this? For example, maybe cutting off a leg of this stool is just what the government needs to drive it out of power.

    Besides, when desperate for change of any kind, the pendulum often must be swung too far to the right to effect the change before settling in the middle. Often times this is the only way to break the resistance to change.


  3. Good explanation.

    But I am curious how they are going to go back on this. The devil is always on the details.
    They will probably announce some fascists have misused the system, which will need some extra controls and those controls will mean the new “reform” will be valid only for a very selected group of people, blabla, and everything remains the same but there will be a need for a SICAM or SICAS or SICAP 1 and then 2 and then 3 in saecula saeculorum.

    We need a writer – someone like Carlos Díquez – to write a Venezuelan saga,
    a book with the title “Low Expectations”, the story of a Venezuelan orphan, Pipo,
    who becomes minister of economy or finance…”porqué fracasamos donde otros triunfan”.


    • Pick at least one option between each set of brackets:

      “Hemos detectado que unos {empresarios,especuladores,saboteadores,usureros,guarimberos} estaban abusando del SICAD 2 para {desangrar al país,crear zozobra,especular con los precios,manipular la moneda}”.


  4. And apart from that, consider how do you balance this with something like the Law on Fair Prices, a stalinist law launched at the same time as a market reform. At least they discover a way to transform shit into the dollars that they don´t have this is doomed.


    • This sentiment is traced to Napoleon at Austerlitz, when he learned that the opposing forces were attempting a flank march:

      “In that case,” said Napoleon, “let us wait twenty minutes; when the enemy is making a false movement we must take good care not to interrupt him.”


  5. Economic unraveling was the undoing of the Brazilian and Argentine juntas in the 80s. It was the catalyst (along with Sendero Luminoso) for Fujimori in Peru. The only government that has survived such a calamity, that I know, is Mugabe in Zimbabwe.

    I’ve heard it said that Chavismo is the africanization of Venezuela…


      • And people in Timbuktu or Lagos have Internet speeds that Venezuelans cannot even dream about.
        And their murder rate is a fraction of what Venezuela has now.


      • CAR, Zimbabwe, Nigeria, Sudan, Southern Sudan (your project), Somalia, etc have a basket case persona in the news, like Venezuela. This in opposition to Chile, Peru and Colombia, even Ecuador and Bolivia.

        Ultimately, the historic achievement of tanking the economy during a commodities boom is one for the records.


  6. One HUGE important point is missing: Venezuela has about $2bn in liquid foreign reserves. Let out all the pent up demand for dollars through this system and you’ve got huge problems. Hence the scarcity issues we’ve seen lately as the government tries to ration the scarce foreign exchange reserves it has.


  7. Yes, Quico, how to do you figure in the cap on currency exchange into your explanation? How is that going to further distort the regime’s twisted fate?


    • People are so used to SITME/SICAD/CADIVI type mechanisms that they assume that if the government says it’ll only provide $30 million a day, then that’s the total that can be transacted. But in SITME/SICAD/CADIVI style systems the reason ONLY the government would supply foreign exchange is that the exchange rate was fixed at a crazy low level, and only the government was dumb enough to decapitalize itself aggressively by selling $20 bills for ten bucks.

      The point of SICAD2 is that the rate is supposed to *float* – they insist they’ll let it rise to whatever price will clear the market. If that’s the case, the government will be just one entity supplying dollars along with private players.

      The post explains why I don’t think this can work. The $30 million government supply cap is not the key reason for that.


        • Hey, if the price is right, basically anyone!

          Besides how are you going to buy the gasoline you’re going to smuggle to Colombia if you don’t have any bolivars, smart guy?!


          • Well, the thing is that I get my bolivar’s from this wayuu old lady in Maicao who gives me close to parallel, asks no questions and gives me the protection of her community.

            But jokes aside, a kosher way (i.e. not having to carry cash in a suitcase) to trade at an attractive rate would probably be welcome by loads of people in both sides of the border. That makes sense.


          • I also realized something on Twitter, there are a few Venezuelan companies doing really well in Colombia right now (Farmatodo and Locatel come to mind) and of course they’re COP income can be readily traded for greenbacks. If they can use some of that forex to better cover bolivar costs (say wages or properties) they’ll sell some greenbacks.


        • Same reason people sell dollars today in the parallel market.

          Ladies and gentlemen. This is the legalization of the parallel market. Instead of doing wires transfers you may just go to your bank an trade currency. Why is people making this so much more convoluted than it is.

          It will influence the price because it will be (I hope) more efficient in terms of price transparency than DolarToday. Also because the government will trade in it as well. One should clarify. $30m is what the BCV will put out there at first. I think PDVSA and other state own companies will also trade there.


          • >This is the legalization of the parallel market. Instead of doing wires transfers you may just go to your bank an trade currency. Why is people making this so much more convoluted than it is.

            Yes. I realized that it was that simple after the comment exchange I had yesterday with you, Quico and Chuberto. It’s just a market and the govt. is going to contribute as a big seller. Yes, that’s it.

            Why are we making it more convoluted than it is? Well, basically what Quico says. I mean:

            1. This is such an unexpected move and we’re so used to their way of doing things that we expect it to be a more complicated system mixing elements of CADIVI/SITME with some tightly controlled market stuff.

            2. The information out there is quite obfuscated, possibly on purpose because they don’t want to make it seem like they capitulated to the parallel market.

            After re-reading all the conversations and posts, I ended up accepting the opinion that, since no one wants to hold BsF, banks will become the new supermarkets, with hundreds of people lining up to buy some of that (green) paper.


            • I also can’t imagine they’re going to just roll with it when the rate starts to peek much beyond 50. They’re going to lose their nerve and call the whole thing off, in particular after their banker buddies call and say “chamo, mis depósitos están cayendo 30% a la semana con gente desesperada por comprar dólares, con un mes de esto quiebro.”

              It’s too stupid, it can’t last.


        • 1. Exporters. At first, they had to sell all dollars to BCV at the official (CADIVI) exchange rate (since 2003). http://www.bcv.org.ve/ley/convenio1.asp

          At some point they were allowed to keep 30% of the export dollars but were still forced to sell 70% to BCV at CADIVI rates. http://abs.com.ve/2012/09/exportadores-podran-retener-mas-divisas-para-invertir/

          Then, in March 2013 they were allowed to keep 40% of the dollars, but were still forced to sell the rest (60%) to BCV at the official exchange rate. http://www.eluniversal.com/economia/130315/exportadores-pueden-retener-hasta-40-de-sus-ventas-en-divisas

          Now they’re going to let exporters sell keep 60% of their dollars and reduce the forced sale to 40%, at the SICAD 2 rate instead of SICAD 1 or the subsidized rate. http://www.ultimasnoticias.com.ve/noticias/actualidad/economia/exportadores-podran-vender-sus-divisas-en-el-sicad.aspx

          The likes of Chocolate El Rey, Ron Santa Teresa, Ron Cacique and several other non-oil exporters will benefit a lot from having more VEF per export USD.

          2. IF the rate isn’t capped, anyone interested in getting VEF out their USD would consider it an attractive venue, because SICAD 2 would become a legalized parallel market.


      • Correct me if I’m wrong, something very possible due to the fact economy makes my head hurt.

        – IF on this mechanism we assume that to escape inflation people will be willing to buy $ at whatever price they can… who is the private dollar holder that is going to go to the market and sell? I mean, sounds stupid, right, you selling when everybody is buying because they want to be safe… what private agents do we think will go and play in the SICAD-2 pen? What private players have dollars and need bolivares so much? I’m sure there are, but cant imagine they will be a lot of them.

        – If the goverment goes with this and only puts 30 million $ and said private players are no where to be found or at least with enough $ to make the pool bigger… that sounds like a recipe for having the price skyrocket, fast. Everybody can “bet” to buy, but there is only this much, so do you really want those $? Better bet higher…


          • I’m thinking more on who is the kind of private player that will reliably, day by day, put a huge amount of $ into the market. Of course at crazy prices is a good idea if I’ve $ around, but who is getting right now a constant, big enough flow of dollars that they would want or need to put into bolivares? Or are we expecting external speculators to come play for.. what? What can they do with the bolívares?

            The only one I can think of is PDVSA. And that and saying “goverment” is almost the same thing.


              • The problem for me is that the only factor of demand that they’ve addressed is the price mechanism.

                As you note, by not addressing some of the other factors, demand will push the price much higher than they likely anticipate and they must have some threshold that will freak them out. They’ve doomed the whole process before it ever starts.


              • Just wondering , what do private companies selling their dollars for large amount of bs do with their bs ??, there isnt much to invest them in with current regulatory climate and private company bashing policies , there are few things to buy in bs and export . So what do they do with those bs. Do they go back and buy dollars ? but isnt that kind of absurd. If you are not a company engaged in some kind of investment in Venezuela and your selling dollars in Sicad 2 for a great many bs , what are those Bs good for ??


  8. Most basically, and most immediately, and most politically significant, if they loosen the exchange rate control so that more of the market clears (say 20 bolivars to $1) or the market clears completely (50-60 bolivars to 1$, then inflation within 60-120 days will rise to 200-250%. How long do you think they will survive then?


      • Won’t charging absurd interest rates postpone the fall of the banks – not really save them? In a thoroughly unstable market with crazy interest rates, who would be crazy enough to borrow??


        • That’s right. Any time you’re seriously considering a reform likely to be catastrophic unless interest rates spike, chances are you’re missing an important piece of the puzzle.

          Follow through the economic logic, and you realize that none of it is really likely to be stable without a serious fiscal reform: much higher taxes, much lower spending, and just swallow the recession that that generates.

          The debate we’re having here isn’t that different from the debate Miguelito Rodríguez and Moisés Naím probably had in January 1989. As you think it through you realize that any reform in isolation can’t work. That stool won’t stand on one leg. Or on two legs. It needs three legs.

          The question is, where inside the government today is that kind of conversation happening? I’d like to think the answer isn’t “only between Felipe Perez and his pillow” because if that’s the case we’re properly fucked.


          • Have you tried to read of the latest reports at the Banco Central de Venezuela site?

            14/03/2014: Hugo Chávez rescató los valores culturales en Venezuela
            14/03/2014: INPC desaceleró significativamente en febrero, al registrarse una variación de 2,4%
            14/03/2014: Agenda cultural del mes de marzo incluye canto larense y obras teatrales
            14/03/2014: “Chávez y el deporte” próximo tema en ciclo de foros organizado por el BCV
            13/04/2014: Chávez, el comunicador es el foro de este viernes en la plaza del BCV
            13/03/2014: Concurso abierto N° 2014/05 – Contratación del servicio de recolección, traslado y bote de materiales de desecho en edificaciones del BCV Caracas
            13/03/2014: Chávez sigue vivo en el corazón de cada revolucionario

            I think we may consider ourselves lucky if at least Felipe Pérez is talking about the issues you mentioned to his pillow.


          • Quico, how sure are you that a banking crisis will ensue? How many banks collapsed in Argentina after 2001? I’m skeptical about this…


    • Manfredo,

      If Venezuela were to implement DAILY “correcção monetaria” – like Brazil did from 1964 to 1994 which resulted in Brazil having a relatively stable non-monetary economy during 2000% hyperinflation – then all salaries, wages, rents, taxes, trade debtors, trade creditors, issued share capital, retained profits, etc would all rise 250% within 120 days. So, the constant real value non-monetary economy would be stable.

      The only people who will lose are the people holding Bolivars now – at the time of the increase.


    • Manfredo,

      Next if Venezuela were to apply DAILY “correcção monetária” to all Bolivar monetary items and all Bolivar monetary balances in the banking system, then the monetary economy in Venezuela would be relatively stable – in REAL VALUE, not in nominal value. There would be 250% inflation in 120 days, but that does not really matter: all monetary values would be updated by 250% too. So, there would be NO REAL EFFECT of inflation, while there would still be inflation. Today USD 3 Trillion of government inflation indexed bonds are inflation-indexed DAILY in terms of country-specific DAILY CPI´S in low inflation and HIGH inflation countries: these countries have low and HIGH inflation, but, there is NO EFFECT of inflation in that USD 3 trillion held in many different countries world wide.


    • Manfredo,

      The government would – normally – survive by collecting taxes updated in terms of the DAILY CPI in Venezuela. This is a new paradigm: the constant purchasing power paradigm, not the current historical cost paradigm. Workers would be able to pay the 250% higher prices for all goods linked to the parallel rate because their wages and salaries would have risen 250% over the next 120 days. They would be able to pay rents and mortgages that are increased by 250% – because their wages are up 250% too in 120 days. Companies would make real profits because trade debtors would increase by 250% over the next 120 days. The buyers of the goods on credit would be able to pay the debts at 250% more because they would be able to increase their selling price by 250% over the next 120 days. Etc, etc, etc.

      Obviously everybody has to do it – throughout the whole economy – like they did for 30 years in Brazil from 1964 to 1994.

      This is not something new. Brazil has 30 years of experience of DAILY “correcção monetária”. So has other Latin American countries.


      • It seems to me that Brazil, in the period of the correcao monetaria, produced a lot of its own basic consumption. Venezuela imports a startling amount of its own consumption, having asphyxiated much domestic private business and enterprise. The weakening of the Bolivar is going to raise the price of imported goods immediately, and it seems to me that there is going to be a steady lag in the adjustment of payments to importers (versus their acquisition costs) and salaries to rapidly accelerating prices for consumers. I believe this will alarm working class Chavistas as salary increases lag purchases. Things are becoming politically ripe for the opposition to broaden its base of support, but sadly they are not seeing and preparing for this opportunity. A pity the opposition is reacting to events, rather than building a simple powerful persuasive politico-economic narrative pointing out the utter economic incompetence of Chavismo, as you can see hyper-inflation coming, and you can see oil going to 80-90 dollars a barrel in the next 18-24 months. Basically, Venezuelans are going to get poorer, and that will likely including the working class Chavista base of support. There is space to honor Saint Hugo’s memory among the poor, and eviscerate his advisers and successors… and their Cuban masters, and to ask why, as they become poor, Avin International shipping company of Greece is taking 60K per day equivalent barrels Venezuelan oil to Spain for the personal account of Raul Castro. The poor in Venezuela are susceptible to appeals to their nationalism, catholic faith, personal dignity, and consumption patterns. Yet all I see is the protesters going mano a mano with the regime, forgetting that the real target are the millions of silent onlookers


        • Manfredo,

          You stated:

          “The weakening of the Bolivar is going to raise the price of imported goods immediately,”

          Yes, and also DAILY increase the prices of the imported goods being sold in Venezuela by the importer by means of DAILY”correcção monetária”. He/she will ALWAYS make the 30% gross margin IN REAL (CONSTANT PURCHASING POWER) VALUE: it will be updated DAILY. Consumers´ salaries and wages will also be updated DAILY in terms of the DAILY “correcção monetária”, so they will always be able to buy what they bought last month, this month. It would be at higher NOMINAL prices, but, the REAL prices will stay the same – ALL ELSE BEING EQUAL.

          “and it seems to me that there is going to be a steady lag in the adjustment of payments to importers (versus their acquisition costs)”

          No, lags are IMPOSSIBLE because ALL items are updated DAILY. Payments to importers are (i) cash/spot payments for sales of imported goods: these prices are updated DAILY, and (ii) trade debtors. Trade debtors will also be updated DAILY. There is never any loss in REAL value because of the stable measuring unit assumption as currently being implemented under the historical cost accounting model currently being implemented in Venezuela.

          “and salaries to rapidly accelerating prices for consumers.”

          No, there will NEVER be a lag in updating salaries: they are updated DAILY exactly the same as the selling prices.

          “I believe this will alarm working class Chavistas as salary increases lag purchases.”

          No, as already stated. Prices and salaries will ALWAYS increase at the exact same DAILY rate.

          This happens – more or less – under 2% inflation too. Under 2% inflation prices and salaries are not updated daily, but, in general, once a year.

          When REAL (CONSTANT PURCHASING POWER) VALUES in the constant real value non-monetary economy and the monetary economy are stabilized with DAILY “correcção monetária” then the external exchange rate should also stabilize – all else being equal. Whatever change in the external exchange rate will immediately be reflected in the monetary and constant real value non-monetary economy via DAILY “correcção monetária.”


          • Under the current historical cost accounting model in Venezuela, all business items have (i) a historical nominal value and (ii) a date. Under DAILY “correcção monetária” all items updated will have (a) an initial reference value (b) a date and (c) a DAILY “correcção monetária” reference value.


            • The “correção monetária” was a highly complex institution developed through many years and created and ran by competent people (most of the time). It is not something that you can create on the short term. It was also an awfull way to manage a currency, since it caused inflation today to be equal to inflation yesterday plus any shock. So, if inflation today was running at 250% but, for some reason (including public deficits that needed to be financed in a inflationary way) there was some shock that brought you to 280%, then, that would be the new level and it would be almost impossible to bring it down again. It was a way to postpone hiperinflation, basicaly.
              But, in order for it to “work”, the first and most important condition was to keep society thinking (and keeping assets) in terms of the local currency. The case of Brazil was unique because of that. In most countries, once you were heading towards hiperinflation, people started to think (and trying to invest) in terms of “hard currency”: the dollar now, the sterling in the past. Once a critical part of society starts to readjust their prices in terms of the hard currency, inflation start to follow the exchange rate and not past inflation anymore. And then the rate of inflation becomes exponencial, because the searching for hard currency created inflation by itself. This is all to say that there is no way to use “correção monetária” in the situation of Venezuela. The end result would be hiperinflation and, yes, probably a banking crises.

              But, an important point that was not discussed here is the fact that they are floating about this not because they have converted to liberalism. It is because the current path is no longer sustainable: it will require either more and more rationing or a default on the external debt (which will also create a bank crisis). I also dont think that they can try just a litle bit of floating and then come back to the way things are now. The economic situation is going to deteriorate very quickly and very sharply, no matter what they do now, even if they started to do everything right (floating and controlling the deficit and liberalizing interest rates and creating some sort of back up for the banks). It is hard for me to understand how the regime will survive this, unless they become way more repressive than Cuba…


              • Vladimir,

                You state:

                “This is all to say that there is no way to use “correção monetária” in the situation of Venezuela.”

                “Correcção monetária” is the same as Capital Maintenance in Units of Constant Purchasing Power or Restatement or Inflation Accounting or monetary correction IN TERMS OF A DAILY INDEX. International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies which Venezuelan listed companies have been implementing since 2009, requires restatement in terms of the MONTHLY published CPI. That is why it does not work. It has to be in terms of the DAILY CPI. I am trying to get the International Accounting Standards Board to correct IAS 29 to REQUIRE daily indexing. This will take a very long time. If IAS 29 were to REQUIRE daily indexing then it would be implemented in Venezuela without the government having anything to do with the matter. So, there is a way to use “correcção monetária” in Venezuela.

                You state:
                “The end result would be hiperinflation and, yes, probably a banking crises.”

                Venezuela has been in hiperinflation since November 2009. I suppose you mean severe hyperinflation.

                Daily indexing is similar to dollarization with no negative consequences. Dollarization means you have no national currency, the central bank has no autonomous monetary policy and your government has to come up with enough US Dollars to substitute the money supply in Venezuela.

                With DAILY INDEXING of monetary items and constant real value non-monetary items you will have the stability of dollarization plus a fully functional central bank with all sovereign powers of money creation and autonomous monetary policy.

                2% inflation is 98% DAILY INDEXING.

                The simplest way is to state that DAILY INDEXING is similar to dollarization. See above.


              • Weel, you are talking about accouting rules, while “correção monetária” in Brazil involved many ohter things. It was used to all prices and wages, for start. But let me correct you in two points. First, hiperinflation as defined by the IASB is not the same as the one defined by economists. While it is an arbitrary level, most economists that study hiperinflation talk about a level of 50% inflation PER MONTH…that is the hyperinflation that I am talking about…
                Secondly, Brazil only had daily correção monetária during a very short period of time (three months if I am remember right) just before the launching of the Plano Real, which put an end to the hiperinflation. The reason for that was that it was an well known fact at the time that the shorter the perido of correction, the more unstable the system was. In fact, going from bimonthly adjustmente to monthly adjustement for example caused an aceleration in inflation. One of the main fears of the economic team preparing the real plan was that the daily correction, however briefly, would cause an aceleration of inflation such as to create inflation on hte new currency… So, daily correção monetária does not solve anything, it only postpone (briefly) a problem…


  9. Francisco: bear in mind that there’s a major roadblock for people and companies to enter sicad2, namely the (until now) requirement to have an USD account in Venezuela. Now going got the same figures thrown by Dafaelito, there are only 100k of these accounts, 60k of them are Banco de Venezuela clients. I’m not entirely sure if these figures are regular accounts for people or companies or both. Any universal bank could open these accounts prior to ll this and not many of them paid attention to it (minus El Venezuela and Bicentenario) so there’s boud to be a stampede of people and companies trying to open the accounts. Now per each transfer El Venezuela charges 25$ if it’s going to el imperio and 35$ if it’s going to Europe, no matter the amount. Don’t you think there’s something sinister that’s beind all this? I think I know how you feel: “this is too easy” – but i digress. I think there’s still something else (perhaps your paquete) that we are not seeing just yet. All in all I don’t think sicad2 is ready for everyone unless they are fully ready to bid. So that stampede might take some time to build.


  10. This could be comparable to the 1923 Weimar hyperinflation. It began with the government issuing “papiermarks” to buy foreign currency with which to make reparations payments. The more papiermarks issued, the more the government had to pay for the foreign currency, requiring even more papiermarks.

    In this case, one will see people moving to sell bolivars, which will drive down the value of the bolivar, causing more people to sell bolivars, driving the value down further. It is quite possible that within a few months, the bolivar will be valueless.

    Note that this will benefit the chaverment by erasing all its bolivar-denominated debt.

    That could be a feature, not aa bug.


  11. If Sicad2 were really a float of the Bolivar, then the price on Sicad2 and on the parallel market would eventually equate at the black market rate. Arbitrage would ensure that it happens.


    • This is like saying that if you legalize cocaine, the price on the free market will eventually converge with the old, pre-legalization price.

      Legal markets are fundamentally different from illegal markets. Legality itself will bring in a whole bunch of dollar buyers (and sellers) who aren’t currently active in the illegal black market. Whether this means the equilibrium price will end up being higher or lower than the current black rate is fundamentally unknowable ahead of time.


      • I know nothing about the price of cocaine, so I cannot say whether I agree or disagree with you.

        I understand and in terms of logic, I agree with what you state about additional buyers and sellers in a legal market as opposed to an illegal parallel market. However, it is a fact that in most hyperinflationary economies it happened that the official (held back government-) rate eventually equated at the parallel rate.

        I think I have seen a paper on the subject, but I would not be able to find it that quickly. Maybe google can help.

        It is almost a type of standard behavior in the case of hyperinflationary economies. I will ask Prof Steve Hanke what his knowledge is about the matter.


  12. For people buying dollars Sicad 2 offers greater security , in black market transactions , bs are usually deposited ahead of the equivalent dollar deposit so buyers have to go through some uncertain moments until the transaction is accomplished , also the rate should be lower. For sellers having to prove the lawful origins of the money offered and letting the govt know you have greenbacks ( so that you can later become the target of govt measures demanding that you bring your money back to the country or become the subject of criminal attacks or special currency taxes ) can be a drawback. Francisco is right in that anyone holding bs savings in local banks will want to convert into dollars which will impact severely the bs holdings of ordinary banks and hike the demand for dollar purchase beyond its normal level . The inflationary effect also can be considerable if Pdvsa and BCV put too much of its Forex for sale in Sicad II except that it might ultimately allow for less organic to be printed which should reduce inflationary pressures .Wonder how the SICAD transaction will be taxed, if A´´ brings 1000 dollars to SICAD and sells it for 40.000bs how much of that will be considered taxable income?? If the reply is the difference between the .6.30 rate or the Sicad I rate and the 40.000 Bs the tax is bound to be considerable , wonder if anyone has thought of these details !!


    • I know neither the opposition or Chaverment would do this… but,

      At this point, would it make sense to simply dollarize? If everyone is trying to get ahold of dollars anyway this seems the simples solution.


    • This is exactly what I mean. This guy thinks he can know what market forces are going to do within SICAD2, so he thinks he can know what the exchange rate is going to be. But it doesn’t work like that. You establish a market to *discover* what the price might be. It isn’t knowable ahead of time. If it was knowable without a market, YOU WOULDN’T NEED A MARKET and forex controls would be fine!

      But no. Ramírez cree que tiene a Dios agarrado por la chiva. So he “floats” with a clear idea in mind of what an acceptable level for the currency to float to might be. But what if reality doesn’t cooperate? What if they fuck up the “complementary reforms” and the exchange rate starts to go way beyond what he thought it would be? How does he react *then*?

      Chances are he freaks out and backtracks…


      • Oh, absolutely. The guy’s statements are laughable. And he said a few days ago the system would work according to “supply and demand”.

        Aristóbulo Istúriz stated in October 2011:

        “El control de cambio para nosotros es político, si lo quitamos, nos tumban”
        “se lo van a calar hasta construir el socialismo”

        He was so shamelessly blunt.
        In principle I have never thought Aristóbulo understood much about economics but in the last few years I have wondered whether he might have a grasp about it at more than one level.


      • You establish a market to *discover* what the price might be. It isn’t knowable ahead of time.

        Okay, copy that, but can’t you use the implicit rate (60ish ?) and tack on a bit of profit to get to a starting point?

        Allowing of course for interest rates and the future price of exports…

        Hell never mind….


  13. I agree with your assessment, however, the 2 week time frame seems pulled out of your… out of thin air. Also, there are many ways to flex the interest rate controls, in order to avoid the shorting of the Bs. (borrowing massive amounts in Bs at low interest rate to buy dollars).

    I guess your point is that they haven’t thought this through.

    But you are also not tackling the whole picture:
    1.- What about price controls?
    2.- What about FDI generated by buying cheap assets in Venezuela? or by the confidence inspired by the private sector and the government peace accord. ( i know this seems like major BS, but it might just might take off)
    3.- What about the incentives to produce nationally, now that exporting is not banned.

    All these things have different implications and different timeframes, but my point is, you are also not considering the other legs there are more than 3.

    In my view, the most important “leg” missing is Trust/Credibility, you cannot enact these reforms, without the private sector on your side, or without the private sector’s trust. Which is why governments use the IMF and WB, they don’t just lend money, the lend what the governments (such as ours) lack, credibility.

    I keep going on and on here…

    The issue is, as a Dear professor of Dev Economics would say, SEQUENCING. What comes first interest rate flexing, Exchange controls, price controls, Fiscal contraction????

    This is a sequence that might work:

    1.- Signal a radical change in economic policy, (make the reforms credible)
    2.- Remove exchange controls, promise they will never come back.
    3.- Enact a Fiscal Contraction (deal with debt) as FDIs coming into the country to buy cheap assets and of course investment opportunities (assuming an overshoot of the exchange rate) and of course that your reforms are credible.
    4.- Interest rate flexing.
    5.- Remove price controls, except for Cesta Basica, which you can keep subsidizing in Bolivares.
    6.- Use a chunk of the Fiscal windfall to transfer cash directly to the population instead of subsidies. A la Moncho Morales et Douglas Barrio.
    7.- Pray that people will believe you it will all work out.

    Most analyst believe that only a change of government (or the face of government). Would make a transition to sound economic policy feasible as the most important thing required for ANY sequence to succeed is TRUST AND CREDIBILITY.


    • I think I agree with all of that, give or take. I’d maybe switch around the emphasis a bit: you don’t target Trust/Credibility. You target fiscal reform first, and trust/credibility follow.


    • The FDI won’t change much, despite the “cheap” price of the assets.


      Historical behavior of the government and its tendency to hijack productive assets for the revolution.

      When the battlecry of 21st Century Socialism has been “Expropriar!” for more than a decade, it tends to give multinationals the heebie-jeebies when debating whether to invest or not. Couple that with stupid economic-cum-market-unfriendly policies, and no one wants to invest; if they could dump the assets without a writedown, they would. Some are already taking the writedown anyway (cf. Toyota). This is why, barring oil, there’s little FDI currently in Venezuela, and why so much of the oil FDI is SOEs from China to Russia to Indonesia.

      Additionally, consider, if you will, where the float will go, assuming no backtracking and none of the needed modifications such as elevated interest rates. Would you, making the decision as an MNC, invest $10,000,000 to produce something in Venezuela only to see the value of your investment go down (relative to the dollar) as the bolivar floats ever upwards? Why would you invest now, rather than in 6 months when you could purchase the same asset for $5 mil? A year for $2 mil? Two years for $100,000? You buy the cheap assets at the bottom of the trough, not on the down slope.

      At this point, no one knows where the bottom even really is or when it will be found. Combine that with the government’s tendency to take assets and you have a massive risk premium. And that sort of uncertainty dissuades/terrifies investors.


      • I would also add that, if you want FDI, you need trust and credibility first. So as far as sequencing goes, tail that on to Mr. Toro above.


  14. Good piece…
    I’d take a more detailed look at a couple of things though:

    “Perhaps the bigger question is what the shock would do to the biggest borrower of them all in the bolivar zone: the government. It’s piled up huge mountains of bolivar denominated debt over the years. If the cost of that debt triples overnight, what happens to the budget deficit? And how do they cover that hole?

    The temptation will be to just print more money, but the inflationary impact of that would be grave…and little by little you start to grasp why “fiscal reform” (i.e., bringing government spending broadly into line with what it can sustainably raise in tax) is usually thrown into the paquete too.

    The biggest borrower has been Pdvsa, biggest lender: BCV. What would actually back up all these transactions is Pdvsa’s collateral: dollars they receive for oil production.
    So, it is actually a very good trade for Pdvsa (when they sell USD at a much higher rate and old debt in VEF becomes pretty small), and not so risky for BCV. Suppose u lend bolivars to someone who guarantees the debt with dollars… And it applies to the public sector in general, besides Pdvsa.
    This has been the main reason for recent excitement on Venz/Pdvsa USD-denominated bonds in international markets, actually (after months of fast-declining prices, of course)
    So, the question here is wether Pdvsa’s production can bear both the VEF debt and the demand on the fx side.
    Besides BCV-Pdvsa loans there are huge amounts of VEF-denominated bonds by the Treasury, although at a fixed coupon rate.

    So it’s hard to believe their debt cost would triple, or rise sharply. Actually, this is a great measure for them to reduce their deficit… Financially speaking, public sector is the big (short term) winner here, but a cost of even higher inflation… and, of course, big losers are we, ‘el pueblo’, ‘el ciudadano de a pie’…
    Actually, they wouldn’t have the needs to print money as they’ve been doing last years.

    On the banking system side, and liquidity, i agree… and these are the kind of things that make you believe it won’t start as open and unregulated (on the fx rate) as we believe or want it to be.


    • You make a decent point about the DPN and Treasury Letter coupons being nominally fixed, but again this just shifts the burden of adjustment onto the banking system. Now banks have a balance sheet top heavy hold assets that earn a fixed 15%, but they have to pay 50% interest on deposits! Ah de pinga…


  15. Why was there no banking crisis with Lusinchi even though you had negative real interest rates and a flexible parallel rate?


  16. OT: There’s some reshuffling going on in MUD parties, behind the scenes.

    First we learned of three deputies leaving UNT, Montoya and Marquina left for a yet unspecified opposition party, while Hiram Gaviria left UNT and his assembly seat. http://www.ultimasnoticias.com.ve/noticias/actualidad/politica/tres-diputados-se-separan-de-unt.aspx

    Now, there’s news an exodus to PJ, that appears to come from Avanzada Progresista’s ranks (HF’s party), including Ismael García and Pizarro. http://www.ultimasnoticias.com.ve/noticias/actualidad/politica/ismael-garcia-se-sumo-a-las-filas-de-primero-justi.aspx


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