The Venezuelan Deval: dos centavitos

Bizarrely, I'm now getting crits from readers wondering why I haven't written anything on the Venezuelan devaluation. Well, in fact I have.



1) This time last year I was saying that Venezuela would devalue in the second half of 2009 (here's one example post, plenty of others if you're that bothered to check back). So I missed my prediction by nine days. Bite me.



2) This weekend your scribe put together a note on the deval as part of IKN37 that was published yesterday to subscribers. So ahhhh, what da hell..here it is below. But really, with the world and his wife all throwing in their opinions (from the smart to the stupid to the downright dishonest revisionist theories of the Caracazo), I really don't see why you need this humble corner of cyberspace chipping in, too. But hey...that's just me.



Anyway, here are the mumblings that came as part of IKN37 yesterday.

Venezuela: The fixed currency moves

So, I missed on my forecast of “Venezuela will devalue the VEF in the second half of 2009” by nine days, having said on plenty of occasions that I thought Venezuela would deval in the second half of 2009 ( example (6)).

The surprise here is not the fact that Venezuela has devalued its currency, the Bolivar Fuerte (VEF), as it was obviously overvalued against peers and fighting a parallel rate nearly three times its official face value. After all, I’m writing for an audience that understands gold the metal here...I feel no need to explain how fiat currencies naturally devalue over time as the concept is clear to all and any attempt to artificially prop up a currency value is doomed to failure over time. Neither is the surprise those shills that call it a humiliation for Chávez, as the real humiliation would have been to hold the status quo and watch the country go to the dogs. For sure Chávez has been stubborn about not devaluing the VEF for about a year or so (because he’s really not very good at economics) but he’s finally bitten the bullet. Finally, there’s no surprise about the sudden rise in pseudomath around this subject; as just one example we have Venezuela’s El Universo newspaper (opposition bias) telling its readers that the basket of goods needed for basic needs will exactly double in price as of tomorrow (7). The kind of silly stuff written by people that don’t understand money’s role. Expect plenty more.

The surprise here is the depth of the deval. The new official rate (to be used for certain infrastructure and food related imports) of 2.6/1 is basically for show, as the real new rate is the so-called “oil dollar” rate of 4.3/1, the one used for oil revenues brought in to Venezuela by PDVSA. This revenue is the lifeblood of the economy, and suddenly PDVSA will be adding plenty more VEF into the local economy for every dollar deposited. Many were expecting this deval, but not as drastic a measure as a doubling of the forex. In effect, Venezuela has, in one fell swoop, turned its currency from “expensive” to “reasonably cheap”.

It smacks of getting all the bad news out of the way in one go. The main bad news will take the form of an immediate dose of high inflation for Venezuela (perhaps ‘even higher’ is a better term, as 2009 CPI came in at 25.1%). This is the bitter pill for ordinary José Q. Citizen to swallow in 2010, but macroeconomic theory says that the inflation bump should be a temporary hurdle. Venezuela has neglected its local economy and has been running on imported goods, thanks to the cheap dollar prices brought about by the 2.15/1 rate. Up to now it’s been between difficult and impossible for local manufacturers to compete on a price basis against imports. Now that the forex rate has doubled, this means imported goods should get expensive compared to locally produced goods and the Venezuelan internal economy should reactivate. True also for exports, and given time Venezuela can start making inroads into the heavy reliance it has on oil as its main export good. The problem is that such a reactivation takes time and the lag in firing up factories means that in the meantime people are obliged to buy the price-bumped goods from abroad. That’s called price inflation.

Next problem: Fiscally, Venezuela runs the risk of overstoking the economy at a governmental level. With more VEFs for every dollar, the temptation to spend its way out of trouble will be high, perhaps even irresistible. This is another aggregate to inflation that has to be watched in the medium term and the prudence (or not) of central government will be key in reining in any extra inflationary impetus.

On a monetary level, the move is positive. With U$7Bn now coming out of CenBank reserves this will leave around U$27.8Bn in the reserves. This still needs to climb compared to M2 levels in Venezuela (currently VEF236Bn is in circulation in the country) but the move to cover VEF 4.3 with every dollar brought in will help bring that under control in the medium term.

The bottom line to this quick’n’dirty on the Venezuelan devaluation is that it might be late coming, and Chávez&Co is certainly setting itself up for political flack from the inflation in the immediate pipeline, but the move is the correct one economically speaking. It would have been better perhaps last year, but doing it in 2010 is a mile better than doing it in 2011. However the inflation that Venezuela will suffer in the short term due to higher prices for imported goods may turn into a longer bout due to governmental spending spree of the extra available VEF funds. Time will tell on that score.