Can "New" Currency Abate Venezuelan Inflation?
By Ibsen Martinez
In March, 2006 and enabled by a Especial Powers Act, the executive branch issued a decree that knocks three zeroes off the bank notes and orders a large amount of coinage representing cents and fractions of cents.
Consequently, Venezuelans are only seven months away from a new currency called bolívar fuerte (Bs.F)—that is, “strong bolívar”.
Almost everywhere in the world, citizens are so used to viewing money solely as a medium of exchange that should facilitate transactions in the economy—by helping to attain parity in those transactions, among other functions—that any other use that governments might give it falls beyond our daily scope. Yet money can also affect people’s identity and enhance—or diminish—the legitimacy of governments.
It is a known fact that the building up of national identities was one of the goals involved in the creation of territorial currencies. It is also a matter of course that when a large part of the population treats its own currency with disdain and engages in currency substitution—as in the “underground” dollarization, growingly popular in Venezuela—boosting its credibility may or may not become a priority to the monetary authorities. After all, condoning currency substitution is a monetary policy. Of course, there are costs involved in it, as with any policy.
On this respect, Benjamin Cohen points out that, “when an instrument that was intended to symbolize the power or nobility of the nation becomes instead a daily reminder of inadequacy and impotence—not sound currency but ‘funny money’, an object of derision and disrespect—governments that issue such currencies are not apt to command much respect either.”1
Currency redenomination is not totally a new experiment in Latin America. After all, ever since the early 1960s, a host of developing countries all over the world have redenominated their currencies on approximately seventy occasions.
The most visible of these is Zimbabwe’s recent currency ‘revaluation.’ The revaluation wiped three zeroes off the $ 20.000 Zimbabwean bill into a $20 bill. The local currency had been rendered almost worthless by years of inflation that hit 1,200 percent a year. Zimbabweans had to carry large satchels full of banknotes to pay for even the most ordinary trifle. The $20 bill actual value after the redenomination—10 American cents at official rates, less than 3 cents at black-market rates—remained unchanged. So has hyperinflation.
To be sure, not all currency redenominations mean failure. Unlike Zimbabwe’s, in some Latin American cases, currency redenomination has capped off high levels of inflation and heralded the abating of hyperinflation.
Ever since the Bretton Woods system’s crisis came about in 1970, Latin America has witnessed a significant number of currency redenomination measures. But in most cases governments have been forced to repeat the experience, time and again, within a relatively short span of time, until results finally show up.
In less than 25 years Brazil has gone through six currency redenominations while Argentina saw four revaluations between 1970 and 1991. Nicaragua had its banknotes changed twice in less than three years, starting in 1988. Bolivia and Peru have redenominated their currencies twice since the 80s. Mexico’s 1993 revaluation put an end to one of the worst financial crisis that, at times, became continental.
Most of these currency redenominations took place during the institutional reform of monetary policy that came about in many Latin countries America since the early 1990s.
In those days, average inflation in Latin America reached a high of nearly 500 percent. Brazil, Argentina and Peru (all three among the largest countries in the region) posted quadruple-digit inflation rates.
Strong macroeconomic policies, however half-heartedly advanced by the bureaucracy, and a relative strengthening of central banks’ independence reduced three-digit annual inflation rates—which plagued the region in the 1990s—to more manageable single-digit figures in the early 2000s. To be true, we had our share of banking crises, and suffered spates of capital flows, too. Wherever reforms were achieved it was only amidst a fierce struggle for fiscal discipline and under executive agency’s pressure to subsidize public expense with inflation.
Taken as a whole, Latin American central banks were created more than a century after our nations achieved independence. Most of them were created in the 1920s and 1930s, long after their counterparts in Europe and the United States. Well into the 1950s, they still could not operate independently of the governments’ plans to foster economic growth. During decades they were used almost exclusively as development banks, unable to design monetary and exchange rate policies. Price stability, id est, keeping inflation at bay, was not among their chief goals.
Discussing the 1990s institutional reform, former IMF’s high ranking officials Agustín Cartens and Luis I. Jácome say that, “following the institutional reform, Latin American central banks are more autonomous from governments although there is still room for improvement in a number of countries. In severing the link between the central bank and the executive branch, in some countries the reform expanded central banks’ decision-making horizon [in such a way] that monetary policy is not subordinated any more to the countries’ electoral calendars.
Today central banks board of directors are appointed for a tenure that exceeds or overlaps with the countries constitutional term, rarely including private sector representatives or from other public sector entities. What is more important, the law requires in many countries that the Congress confirm these appointments or, in some cases, to appoint them following executive branch nominations.”2
Historically, monetizing the fiscal deficit has been in the origin of chronic inflation afflicting the region. A regional consensus achieved in the 1990s reflects in current severe restrictions that keep central banks away from financing public expenditure.
However, the spirit of this consensus can be overruled on legal technicality grounds and Venezuela is a case in point. Venezuelan law, for example, requires the central bank to transfer to the government unrealized profits associated to the revaluation of international reserves.
The operational autonomy of Venezuela’s Central Bank (BCV) has been further reduced in 2006, as the implementation of an amendment of the BCV Law strengthened government’s influence over the institution.
BCV’s independence and monetary transparency shows now at least three major areas of concern. First is the continuation of foreign exchange government controls that have been going on for four years now. Stiff exchange controls not only undermine BCV’s capacity to implement monetary policy; they have boosted black market and corruption. Venezuelan private companies have only controlled access to U.S. dollars while individuals have access to foreign currency only on a limited yearly quota basis.
Then come the extraordinary losses BCV has incurred in trying to stem, at huge costs, the liquidity generated by a highly inflationary fiscal policy. Finally, a “parallel budget” is administered by a new government agency called “National Development Fund” (Spanish acronym: FONDEN) which draw funds away from both BCV and Petróleos de Venezuela (PDVDSA, the state-owned oil company) converting them into yet more liquidity in the economy. No wonder Venezuela shows the highest inflation rate in the region: 19.2%, only second to that of Haiti’s. And still growing.
Not every country with high levels of inflation has chosen to redenominate its currency. Many of their citizens can put up with paying, as we Venezuelans do, 1600 Bs. for a cup of spresso. Those countries that have taken the road to redenomination have first of all put into effect strong, painful packs of measures to abate hyperinflation.
Erasing zeroes off banknotes cannot do the painless miracle. It is not a crucial element of a well-conceived adjustment plan, but rather a signal a government sends to its citizens that inflation is finally within manageable limits.
If demagogically implemented as a ploy to show false currency strength without first successfully reducing inflation, it can only add even more fuel to inflation, as Argentinian and Brazilian experiences have shown in the past.
The initial psychological effect—that welcome sense of relief that accompanies a cup of coffee paid with small change money, just as in the good old days—will give fatefully way to hyperinflation and its devilish whisper in everyone’s ears to start hoarding goods, add zeros to scarce goods prices—the most valuable first!—and keep hurting the poor for whose sake this ineffectual tampering with zeroes began only to render national currency even worthless.
For more articles by Ibsen Martinez, see the Archive.