Venezuela’s Devaluation Doom-mongers

Venezuela’s recent devaluation has sparked quite a bit of discussion in the international press. The Venezuelan opposition has naturally framed it as desperate move to head off inevitable economic collapse.

The opposition argument, supported by most of the international media (which relies on opposition sources), goes like this: Venezuela had to devalue because the government has run out of money. But the devaluation is too little and too late, inflation will get out of control, there will be more devaluations and more money will leave the country and the government will go broke and collapse.

Opponents of the Venezuelan government are hoping for an “inflation-devaluation” spiral that will help bring down the government. In this scenario, the devaluation raises the costs of imports, fueling inflation; with higher prices, the currency is more overvalued in real terms, and another devaluation follows, and so on. As people lose confidence in the currency, more people exchange their domestic currency for dollars, building more pressure for devaluation and causing the country to run out of foreign exchange reserves – a balance of payments crisis.

Of course, to the extent that the opposition can convince people that this is actually happening, it can help the process unfold – just as rumors of insolvency can cause a bank run. In both Venezuela and Argentina, the media is mostly opposition, and so it is not surprising that these views get prominent coverage in both countries.

Let’s examine the argument. The first premise – that Venezuela had to devalue in order to get more domestic currency (the bolivar fuerte) for each dollar of oil revenue – has been the foundation of most news reporting. But this does not make much economic sense. When the government devalues the currency from 4.3B to 6.3B per dollar, what does it do? It credits itself with two additional bolivares for each dollar of oil revenue that it receives.

Of course, it could create the same amount of money, without devaluing; opponents would object, “but creating money increases inflation.”

But the government’s creation of two additional bolivares for each dollar received is also creating money, no different from creating money without the devaluation. The main difference is that, in addition to any inflationary impact of creating more money, the devaluation also adds to inflation by raising the price of imported goods.

Creating money, though, does not always add to inflation. The US Federal Reserve has created more than $2tn since 2008, and inflation has not significantly increased. But if the Venezuelan government just wanted to have more bolivares to spend, it would be less inflationary to just create the money without the devaluation.

Why devalue, then?

Devaluation has other effects. Although more expensive imports add to inflation, they also help domestic production that competes with imports. And, perhaps more importantly, devaluation makes dollars more expensive, and therefore increases the cost of capital flight. This helps the government keep more dollars in the country.

Not surprisingly, a lot of what passes for analysis in the press is based on wrong numbers and flawed logic. The award for wrong numbers this time goes to Moisés Naím, who writes in the Financial Times that “during Hugo Chávez’s presidency, the bolivar has been devalued by 992%.”

Fans of arithmetic will note immediately that this is impossible. The most that a currency could be devalued is 100%, at which point it would exchange for zero dollars. Apparently, a very wide range of exaggeration is permissible when writing about Venezuela, so long as it is negative.

But, for a number of reasons, inflation-devaluation spirals in Latin America are a thing of the past – and a devaluation every few years is a far cry from such a spiral. In fact, despite press reports that inflation would reach 60% after the January 2010 devaluation – which was larger than the latest one – core inflation did not even rise, and headline inflation rose only temporarily. Inflation then fell for more than two years, even as economic growth accelerated to 5.2% last year.

The amount of inflation that follows this devaluation will depend on what other measures that the government takes and how effectively they are implemented: price controls, the provision of dollars for importers (including food), and capital controls. But if the past few years are any indication, the government will do what it needs to do in order to keep inflation and shortages from getting out of hand.

As for Venezuela’s public debt, the government is a long way from having a problem of unsustainable debt. The IMF projects Venezuela’s gross public debt for 2012 at 51.3% of GDP (as compared to more than 90% for Europe). A better measure is the burden of the foreign part of this debt, which in 2012 was about 1% of GDP, or 4.1% of Venezuela’s export earnings.

There are a number of distortions and problems with Venezuela’s economy – including recurrent shortages – and some of them have to do with the management of the exchange rate system. But none of these problems presents a systemic threat to the economy, in the way that – for example – real estate bubbles in the US, UK, Spain and other countries did in 2006. Those were truly unsustainable imbalances that made an economic collapse inevitable.

Despite the wishful thinking that is over-represented in the media, Venezuela’s economy will most likely grow for many years to come, so long as the government continues to support growth and employment.