Venezuelan President Nicolas Maduro made a point of downplaying his foreign exchange reforms last Wednesday, and good thing he did. The reforms are bound to do little to curb Venezuela's economic problems, despite the fact that genuine changes to the exchange system are urgently needed.
Why Venezuela's Foreign Exchange Escapades are Seriously a Big Deal
Don't get me wrong, Venezuela's economy isn't the basket case its depicted as abroad. Far from it – the huge strides made by the government in recent years in boosting living standards are well documented. Nor is the current situation comparable to the economic crisis of the late 1980s and 1990s, when the country was buckling under an epidemic of extreme poverty and a suicidal neoliberal regime. Just compare human development indices or inflation figures from the 1990s to today, and you'll get a hint of what I'm talking about.
Nonetheless, Venezuela's current economic concerns shouldn't be understated. Yet it's important to note Venezuela's foreign exchange regime isn't the only economic problem the country is facing; nor is it the biggest issue. Instead, it is one of four key economic hurdles. However, action is most urgently needed on foreign exchange because it is the only key hurdle that Maduro can seriously improve in the short term. Bear with me, and allow me to explain.
Venezuela has gone to OPEC, and lobbied individual petro-states for reductions in petroleum output to almost no avail. Unfortunately, the voices of countries like Saudi Arabia are overpowering calls from Venezuela for restraint to stabilize prices. In the short term, world oil leaders won't curb production, and oil prices won't go up. In other words, Venezuela can't do anything about low prices.
The opposition loves to claim Venezuela's low productivity is due to Chavismo, but in doing so they ignore the fact that the country has struggled with low productivity for decades. It's largely because of Dutch Disease – an awkward situation when one sector of the economy is so profitable, it strangles other sectors. Venezuela's agricultural sector first started to collapse in the late 1920s, as the oil industry was enjoying its first big boom (a bit before Hugo Chavez's time). In the decades that followed, most sectors of Venezuela's economy unrelated to oil likewise suffered. Chavez himself recognized the government needed to adopt strong policies to promote non-oil sectors to gradually ward off Dutch Disease. It's a perfect example of a situation where state action is needed to correct a market problem. Although Chavez made progress in some areas, the oil sector continues to be a problem for economic growth across much of the economy. This isn't an issue Maduro will solve in the short term (and no matter what they say, neither will the opposition if they ever gain power). Rather, it's a phenomenon that will take decades to gradually reverse.
Venezuela's opposition and old business class like to pretend they're for the free market, but ironically have been intervening in the economy for over a decade – by trying to sabotage it. It began with the oil lockouts of 2002-03, and has continued since in various forms. When businesses have been nationalized, former owners have all too often adopted a scorched earth policy – smashing factories and stealing what they could carry. Every election, scarcity spikes as businesses try to ferment public discord by withholding basic products from consumers. When the opposition protests, they attack small businesses and public transport in efforts to further slow the economy. At times these things look like individual acts of opportunism, while other times it seems like a collective dummy spit. But today – like in 2002-03 – it's a coherent policy aimed at overthrowing the government. The opposition may slow this campaign under the right conditions, but it will never stop trying to drive Venezuela into the ground until it retakes power. Improving public security and negotiating with the right-wing can help mitigate this problem, but these are long term problems.
As we can see, in the short term Maduro can't lift oil prices, overcome a historic tendency towards Dutch Disease or end the opposition's sabotage efforts. But, he can fix foreign exchange quickly.
But Will He?
Unfortunately, Wednesday's reforms themselves are little more than yet another round of tinkering around the edges of an exchange regime that has long needed a fundamental overhaul. Under the new reforms, Maduro said he plans to keep the strongest official exchange rate of Bs6.3 to the dollar, merge two weaker pre-existing exchange tiers, and open yet another exchange mechanism that will include private sellers. At the time of writing, there were hints that new exchange mechanism could be a free floating rate – or something similar.
Like previous economic announcements, Maduro shied away from going into the nuts and bolts of the changes. But without knowing the details, it's clear they don't change the two biggest problems with the foreign exchange system.
First, they won't make Venezuela's exchange controls more enforceable (including reducing corruption and cracking down on black market trading). Second, they won't restore confidence in the system. I cannot emphasize this enough: enforcement and confidence are the only two ingredients the government needs to make the foreign exchange system work.
This new system will keep the various tiers of exchange firmly in place, but the government can't enforce them. For years, Venezuelan authorities have struggled to police controls, stop currency speculation and stamp out the black market. Many government supporters will argue this is due to a concerted economic war against Maduro – and they undoubtedly have a point. Inflation has gone wild since Chavez died, and scarcity has been accelerated by opposition destabilization efforts in the streets. The opposition and many critical government supporters alike will blame government incompetence and corruption – and it's true the government has made plenty of mistakes. Neither argument changes the fact that the black market is booming, while inflation is swelling despite currency controls. It doesn't matter what factor you blame inflation on – clearly currency controls aren't standing in that factor's way.
Neither perspective changes another key fact: that without enforcement, unscrupulous businesses will continue to buy bolivars through official channels, and sell them on the black market for windfall profits. It doesn't matter if there are three official exchange rates, four or 4000. Nor does it matter if the new exchange system will be free floating as the rumor mill suggests. If there is a major discrepancy between an official exchange rate and the black market rate, fraudsters will continue to exploit this unless the government can crack down on illegal trading, or find some other way of dissuading the practice. Currently, this is mostly done by importers, who claim they need dollars to import products. Yet instead of importing anything with their dollars from Sicad – or any other official channel – they just sell their greenbacks on the streets of Caracas for bricks of bolivars. This mechanism feeds into the long term productivity problem by denying the domestic economy the imported goods it needs. This essentially means the government is subsidizing businesses that undermine productivity, and are eroding the value of the bolivar by feeding the black market. Obviously, this kind of black market economy also benefits the criminal gangs that run the illegal dollar trade, and promotes corruption.
The government has made efforts in recent years to try to tackle many of these issues, but there just hasn't been enough progress. Today, enforcement mechanisms of Venezuela's currency controls look a bit like Swiss cheese.
So far, we've looked at the weakness of the official foreign exchange system; now let's look at the flip side of the coin. The black market reigns supreme. So much so, that as one journalist I recently spoke to put it, Venezuela's economy is already dollarized – it's just not official. While importing goods at the official rate, businesses jack up prices with the excuse that the black market exchange rate fell. Meanwhile, the rich engage in a kind of underhand form of capital flight, by storing their savings in dollars, and spend their surplus cash in Miami duty free stores. Dollars are viewed as a safe haven, while the bolivar is perceived as unstable. The more this perception is enforced, the more the economy is effectively dollarized by the rich corporate elite that feel more at home on the deck of a yacht off the coast of Florida while gently clasping a glass of Scotch neat, than in the barrios of Caracas.
For other less gringo-fied but equally parasitic bourgeoisie, excess bolivars are spent hoarding products. After all, why keep bolivars in your bank if they get eaten by inflation, when tins of sardines will keep their value better in a warehouse?
Speculative pricing, capital flight and hoarding all further contribute to a growing perception that the bolivar simply isn't safe. It wouldn't matter if bolivars were on the gold standard – heck, it wouldn't matter if bolivars were made of pure gold – if people think they're losing value, then the bolivar will inevitably lose value. It's a collective mind game.
Years ago, this currency problem could have been resolved with overhauls of the exchange regime to reassure the public and businesses. However, that window of opportunity has slipped away, because confidence no longer exists. Very few people still have confidence the foreign exchange system is fair on everyone, is effective at distributing dollars and is enforceable by the government.
So if the system cannot be enforced, and if people cannot be made to believe in it, then we have a nasty pickle.
So What Now?
Some people may suggest Venezuela adopt a stable foreign currency. The US dollar is an obvious choice. The only problem is that if Venezuela ever faces a balance of payment crisis, the dollar could quickly turn from a safe haven to a straitjacket. If you're not sure why it's a bad idea to face a balance of payment crisis without your own sovereign currency, ask a Greek. The next suggestion I've heard is for the government to devalue the official rate and try to close the gap with the black market. The problem here is that due to that lack of confidence (plus speculation and of course, anti-government sabotage), each devaluation pushes the black market rate lower. Also, remember: the government is simply does not have the resources to enforce a fixed rate. So long as there is an official rate, the black market isn't going to be reined in within the near future by carefully timed devaluations of the official rate.
So what's the solution? The short answer is there isn't one – at least, not a good one. The Venezuelan government should have developed and implemented a framework to gently wean the economy off exchange controls years ago. This should have been a slow, gentle process. A rushed float would inevitably spur a sudden spike in demand for US dollars on the black market, and drive the bolivar lower, at least in the short term. Now, the government needs to close the gap with the black market more than ever, but needs to avoid the impact on ordinary Venezuelans. Moreover, people who need dollars for legitimate purposes need to be able to access them easily. The old foreign exchange regimes need to be shed as quickly as reasonable, and exchange more-or-less liberalized.
The options now appear obvious, and can more-or-less be divided into two camps. The first option is to float the bolivar, and find ways to cushion the immediate blow. Such a strategy could involve generous subsidization plans for importers of priority products (food, medicine, etc) to offset the disappearance of the official exchange rate. The government could deepen investment in social missions to better insulate poor Venezuelans. This would double as a confidence boost for observers skeptical of the government's means. The costs of these immediate investments could imaginably covered with more international oil-for-loan deals, and a selloff of select state assets not directly related to public welfare. A half-decent sale of Citgo would be nice, but perhaps not all that likely anymore. In all likelihood, this will still be a rushed float. It will still hurt, but it won't be shock treatment. If this happened a year ago, it would have hurt less. If it happens after another year like 2014, it will hurt even more.
The second option is for Maduro to basically keep things as they are in the short term, with plans to aim for a gentle float sometime in the future. The problem with this approach is that Maduro has already missed the best opportunity for a gentle float – at least in the foreseeable future. From here until the visible horizon line, that Goldilocks moment for bold reforms just isn't visible. If inflation, scarcity and speculation don't slow, major currency reforms will never get any less painful than they would be today.
I Guess We Could Just Pray...
There is also a third option: pray for oil prices to skyrocket. The only problem with this option is that prayer is notoriously unreliable, and differing to God generally makes for lousy government policy.
The Status Quo isn't Stable
By presenting these meek reforms, Maduro is hinting his government isn't thinking about seriously overhauling the exchange regime in the near future. Indeed, in his speech last Wednesday, he argued the country needs to stick with the status quo for stability's sake. The problem is that the exchange regime's status quo isn't contributing to national stability anymore.
Invariably, dramatic changes tend to bring risks of their own, but that shouldn't dissuade Maduro from realizing that doing nothing is riskier. After all, Maduro is Chavez's hand-picked successor, and Chavez wasn't the kind of leader that shied away from shaking things up (except maybe this).
Chavez was at his best challenging the status quo. He took courageous action when needed and banked on risks when reasonable and appropriate. Today, people want to see Maduro make a bold move and fix the foreign exchange system. Now is the time for Maduro to do something courageous, and make a tough call for the good of the country and the revolution.