Venezuelan money supply may be signalling accelerated inflation

This one is slightly wonkier than usual because I'm missing out some theory explanations behind the facts offered (feel free to ask questions if something isn't so clear). However it's hardly Krugman-like and I'm not even worthy to polish the dude's boots, so there's the context.

Here's a chart of Venezuela's M2 money supply (the calculation that measures the amount of national currency in circulation) as registered over the past 12 months.


The move from around the 70 billion Bolivares Fuertes (VEF) level to the present VEF89.07Bn means that M2 has moved up by around than 30% in a year...that's a big jump in any currency (that doesn't have Mugabe ruling its destiny). It also comes as no surprise to econ-wonks to note the way the 30% in M2 growth neatly matches the 30% or so annual inflation rate Venezuela is currently running (making percentage-point assumptions in either direction, so no corrective mails necessary, thanks in advance).

But the thing that's caught my eye is the final uptick move on the right-hand side of that chart. In the week ended Feb 27th, M2 moved up 1.68% (from U$87.6Bn to U$89.07Bn); not only is that a large move in just one week, but it's also atypical for the 'normal pattern' (if such a thing exists) for Venezuela. Over the last three years, M2 has held steady in Venezuela for roughly the first six months of the year, only accelerating when other methods of mopping up excess liquidity have been used up, chief among those being dollar bond emissions (check this Feb '09 post for further details). However, chances are that this year there will be no new dollar bonds coming from the Venezuelan government , mainly due to the lower oil price and ensuing lower revenues at PdVSA.

It remains to be seen whether the weekly uptick at end February is repeated throughout March, but it's certainly one to watch. I for one would definitely not like to see M2 breach the U$90Bn level in the next couple of weeks. Add the fact that last week the Venezuelan government dropped its base interest rate from 13% to 11% and more upwards pressure on money supply is likely. The bottom line is that if the pattern is confirmed and M2 keeps rising quickly at this relatively early time of year, inflation in Venezuela is likely to accelerate even while world prices are dropping. That's not good, people. Not good at all.

Venezuela's currency slide: Mo' Moris

Well, I marked your card on this last week, so if you didn't do anything about it you've only got yourself to blame. The Venezuelan Bolivar Fuerte (VEF) has sunk around 20% in the space of just two weeks (click on any chart to enlarge).........

VEF parallel currency evolution, May 2006 to date

Here's the currency year to date. We can see the
exchange rate came down sharply, but has
recently started moving back up

The one month chart, with the recent rise clear to see

......with the slide coming right after the interview Moris Beracha gave Venezuelan newspaper 'El Nacional' on August 18th. Your dutiful Otto even translated the interview into English for you (link right here) last week, so readers here are on the cutting edge of intel, that's for sure.

The interview was one of the most interesting I've read for a while, and is almost certainly the catalyst for the 20% slide in the VEF since then. Really...I'm not joking. That's cos Beracha is the number one top dog king of the hill main man in Venniefinances these days, and his word is law. There's plenty to take away from the Nacional report, but maybe the main consequence was from this Beracha line

"...I don't think there will be another debt emission this year, unless it's in Bolivares (VEF)...."

because as soon as the VZ money minions read that single line they knew there was only hope and wishes holding the VEF down at the 3.2 to 3.4 range. The currency immediately (like that same day) moved to 3.5, and here we are with the VEF at 4.05 ask this afternoon. Yes, Moris really is that connected and that powerful.

Beracha was the catalyst for sure, but as this next chart shows, there are fundamental reasons behind this currency weakness, too.
Venezuelan Central Bank (BCV) stats show that M2 money supply (without getting boring on you, M2 is basically the money in circulation in any given economy) has ratcheted up sharply in the last few weeks, as the BCV has not been neutralizing the extra VEF by buying them back for dollars (as was the Beracha/Isea plan of previous months). Basically, the Gov't has been at the printing presses, and that means the currency comes under pressure.

The current U$75.18Bn (converted into dollars at the official 2.15/1 rate for convenience purposes only) in VEFs circulating in the Venezuelan economy marks a 5.7% increase in M2 in just 10 weeks. Now that may not seem like a lot to you, but currency-watchers know that's a seriously big move for M2 numbers in a relatively short space of time.

But the big question is, "Where is the VEF going in the next few days/weeks?" My best guess answer to that is "I think we'll see VEF4.5/U$1, then it will come back down a bit", and here's why:

With Venezuela's International Currency Reserves currently standing at U$37.49Bn, this means that we can do a very basic calculation and say there's an equilibrium point between the VEFs in circulation and the dollars kept in reserve that points to VEF4.31 as an optimum parallel exchange rate at present (you do this by dividing M2 by reserves, and then taking the resulting inflator ratio and multiplying the VEF's official exchange rate of 2.15 to the dollar...it goes like this: 75.18 / 37.49 = 2.005 X 2.15 = 4.31).

This calculation doesn't take into account any psychological influences of a population that's watching the VEF slide, of course. Therefore we may well see the VEF go lower before rebounding, and that's why I'm calling 4.5 to 1 right now. But as always, DYODD on this, dude.

Related Post
Moris Beracha and the Venezuelan Parallel Exchange Rate