The Roots of the Current Situation in Venezuela

Venezuelanalysis's Gregory Wilpert breaks down the causes of the current difficulties in Venezuela, arguing that they can be traced to the currency control measures implemented in 2003 - designed to defend the government against a capitalist attack on its currency.


The current economic, political, and social situation in Venezuela is very complicated, which makes it somewhat difficult for outsiders to make sense of. On the one hand there are many people who defend the Bolivarian revolution, pointing to the successes it has had in reducing poverty and inequality and in increasing citizen participation and self-governance. On the other hand, there is a chorus of critics, not just from the usual suspects on the political right, but often from the left, who criticize the Maduro government’s economic management of the country, corruption, the high inflation rate and shortages, and the trial of a high profile opposition politician, who the government accuses of fomenting violence. How did Venezuela get here? What happened since Hugo Chavez’s death? Did the project derail, get stuck, hit a speed bump, or crash altogether? In order to answer this question, I will first analyze the origins of the current economic situation. Future articles in this series will explore what this history means for the present and immediate future of Venezuela.

The Bolivarian revolution in Venezuela is no doubt undergoing one if its toughest periods at this time. With inflation reaching an unprecedented 160-200 percent for 2015, nearly constant long lines at subsidized supermarkets, and sporadic shortages of many consumer goods, the entire population – whether Chavista, opposition sympathizers, or “ni-ni” (neither one side nor the other) – is frustrated with the situation. While the Maduro government says that the problems are the result of an economic war that is being waged against the government, the opposition argues that it is government economic mismanagement that is to blame. The truth, as usual, is more complicated.

The roots of today’s economic problems can be found in Chavez’s efforts already in 2001, to fundamentally reorganize Venezuela’s economy and polity. That is, back then Chavez proved to the country’s old elite that he would not be their pawn and do their bidding as so many presidents before Chavez had done. Instead, in late 2001 he introduced land reform and oil industry reform legislation that touched on the elite’s two most important sources of economic power. In reaction to this move, the opposition launched the April 2002 coup attempt and the December 2002 oil industry shutdown. These efforts at political and economic destabilization provoked a massive bout of capital flight in early 2003. At first, the government tried to counter the capital flight by intervening in the currency market, using its dollars to purchase the bolivar, in order to keep its price stable. However, this caused the central government to lose dollar currency reserves precipitously and so it abruptly changed gears and introduced a fixed exchange rate in March of 2003.

Ever since then, the currency has been fixed and adjusted very rarely. Only those who meet government conditions to buy dollars with bolivars are allowed to do so. The conditions for gaining access to the official exchange rate include international travel, supporting a son or daughter with their studies abroad, or – most importantly – importing essential goods into Venezuela, among several other types of uses. Of course, almost immediately a black market for dollars sprung up, with an exchange rate that was very different from the official one. At first the official exchange rate was 2.15 bolivars per dollar, while the black market rate quickly reached double or triple that rate.

For a long time, from 2004 to 2008, the Venezuelan economy did quite well, growing at a very rapid rate of, on average, 10 percent per year. This was in part possible because the price of oil was quite high (and climbing), which meant that the government could accommodate most requests for dollars at the official exchange rate. Also, the government’s policies of capturing a far larger proportion of the dollars that the country earned and then reinvesting that money in social programs, education, and in efforts to diversify the economy also made a difference. 

However, in mid-2008 the global financial crisis struck and drove the price of oil down from US$140 per barrel in mid 2008, to less than US$40 per barrel in early 2009. Suddenly the government could no longer cover all of the imports with its oil industry earnings and so in June 2010 the government introduced a new exchange mechanism, SITME, which sold dollar-denominated bonds that could be bought in bolivars at an exchange rate that was double that of the previous rate. The combination of SITME and the borrowing to cover the budget deficit meant that total foreign debt increased rapidly in the period from 2006 to 2014, from 10% of GDP to 25% of GDP. Nominal external debt (private and public) went from US$41.8 billion in 2006 to US$134.5 billion in 2014, a 320 percent increase in eight years. The percentage of GDP is indicated on the basis of GDP PPP. The debt to GDP ratio is fairly low compared to the rest of Latin America.

Another measure that the government took during this time was to restrict access to dollars at the official exchange rate. That is, the conditions under which Venezuelans could access dollars were significantly tightened. Fewer dollars were available for travel, for study abroad, and for a more restricted list of imports. The consequence of this action was that the black market exchange rate shot up during this period, going from about 8 bolivars per dollar in 2011, and to 16 in 2012.

Also, since fewer goods could be imported at the official exchange rate, more and more importers began to use the black market to import goods, thus driving up inflation. Even if they used the official exchange rate, rather than undercutting importers who had to pay for goods at the black market rate, people knew that they could make a killing by pricing goods at the far higher black market rate and thus did so. In short, inflation began to heat up too, going from a fairly moderate (for Venezuela) 13.7 percent in 2006, to 31.4 percent in 2008 and holding at 20-21 percent, on average, between 2010 and 2012.

Borrowing in order to pay for the low official exchange rate had another side effect, which is that it increased the volume of bolivars in circulation, relative to the country’s foreign reserves. The M2 money supply figure (which includes circulating cash and bank savings) increased by a factor of 28 (2,800 percent) between the end of 2006 and the end of 2014, while foreign reserves dropped by more than 50 percent during the same time, from around US$30 billion to US$15 billion, according to the Venezuelan Central Bank. Although there is some debate among economists about the importance of this ratio for the exchange rate, it is undeniable that in a context of high inflation, where many ordinary Venezuelans and most businesses seek to buy dollars in order to protect their savings from devaluing, a low demand for bolivars and a low supply of dollars will mean a declining black market exchange rate between dollars and bolivars.

All of these trends became accentuated when President Chavez died of cancer on March 5, 2013 and new elections were held a little later, in April, resulting in Nicolas Maduro’s election by a 1.5 percent point margin of victory. The wave of violence following the election, which opposition candidate Henrique Capriles Radonsky encouraged when he called on people to demonstrate “with all of their rage,” in which 14 people died, only made the perception of political and economic instability worse. Further destabilization attempts, the violent street blockades known as “guarimbas,” between March and June 2014, and which resulted in another 43 dead and over 100 wounded, further exacerbated the economic problems.

That is, the destabilization created further pressure on the black market exchange rate, which, in turn, meant that there was a growing gap between the official and the black market exchange rates that could be exploited for massive profit-making. Anyone who had the opportunity to take advantage of this gap faced enormous temptations to do so. 

While the official exchange rate was fixed at 6.3 bolivars per dollar since early 2013, the black market rate had reached three times that, at 18 per dollar. In other words, someone who traveled to the U.S., for example, could buy up to US$4,000 dollars at the official rate (paying 25,200 bolivars). If they did not use this cash up or if they purchased equivalent goods abroad, they could trade that at the black market back into bolivars for a 300 percent profit, earning 75,000 bolivars.

A vicious cycle thus began in early 2014, where an ever-widening gap between the official and unofficial exchange rates created ever-greater incentives to profit from that gap, thereby further widening that same gap. The black market exchange rate thus began to increase exponentially in the course of 2014 and 2015, reaching 100 bolivars per dollar in late 2014 and 800 bolivars per dollar by late 2015, creating a 125:1 ratio between the black market and the official exchange rates. Massive profits of up to 12,500 percent were thus possible. 

As a result, more and more people became involved in efforts to acquire dollars at the official rate, mostly by purchasing subsidized goods in Venezuela and (re-)exporting them across the border for an enormous profit (people known as bachaqueros). Of course, major companies are involved in this process too, claiming that they need to import essential goods, and then either not importing these or re-exporting them to acquire dollars. In mid-2014 president Maduro estimated that up to 40 percent of all goods imported into Venezuela (at the official exchange rate) were smuggled right back out again. 

A logical consequence of all of this was that more and more goods became scarce at the price-controlled prices and in massive inflation for unregulated goods. That is, already early in Chavez’s second term in office, in 2006, the government had begun to introduce price controls for most essential goods, in order to counter the retailers’ tendency to price things based on the black market exchange rate instead of the official rate. Over the years, the government gradually expanded the number of goods that the price controls covered, which, if adhered to, also meant that more and more products were priced far below what these could be sold for in neighboring countries, thereby adding these products to those that could generate massive profits by re-exporting them.

The big question that everyone asks—both within Venezuela and outside—is, if the low fixed exchange rate is leading to so many economic problems, why has the government not raised the rate? There are two main explanations for this. First, raising the official exchange rate so that it is more in tune with the black market exchange rate and with the prices in neighboring countries would mean raising prices for products imported at the official exchange rate, thereby further stoking an inflation rate that is already far too high. And unless wages are raised correspondingly, changing the exchange rate would also mean a corresponding decrease in incomes and thus an increase in the poverty rate. Second, changing the official exchange rate would represent an admission of defeat in the context of what the government is calling an economic war against Venezuela. While an exchange rate adjustment or devaluation will probably have to happen sooner or later, it is out of the question that such a move (and the implied concession) would be made before the December 6 National Assembly elections. Note, #there is some debate within Venezuela as to whether it makes more sense to call a change in the exchange rate an “adjustment” (the government’s preferred term) or a “devaluation.” I prefer to call it an adjustment because technically the currency has already lost a tremendous amount of its value due to inflation, so, in effect, a lowering of the exchange rate is more of adjustment to the reality that inflation has already devalued the currency – this is especially true if you consider that very few people have access to the official exchange rates, thus making the black market rate more real for most people than the official ones.

In other words, the current situation in Venezuela is a result, first, of the exchange rate control that was meant to defend the currency against the destabilization attempts of 2002, which themselves were the result of the Chávez’s government’s attack on capitalist class interests. Second, an already relatively fragile exchange rate control became worse in the wake of the oil price declines of 2008 and again in 2014, which made it increasingly difficult for the government to meet the demand for dollars without going further into debt. Third, the opposition’s new destabilization efforts against the Maduro government the day after Maduro’s election in April 2013 and again in early 2014, turned the existing economic volatility into a vicious cycle of inflation, shortages, black market devaluation, and renewed inflation. The situation is thus quite difficult for the government and very frustrating for the population.