HowWealthWorks.com

[Suresh]

An explicit currency devaluation like Venezuela's may not be possible in a country with the world's reserve currency. But, it's worth noting a couple things.

First, consider the rationale for the bolivar devaluation. The devaluation will cut Venezuela's budget deficit, permitting greater government spending on entitlements to the masses. It will curb imports by making them more expensive in bolivar-terms, necessitating more domestic production. More insidiously, it lets the government create a bad guy: greedy corporations that attempt to increase sale prices to compensate for the devaluation.

Second, consider the ramifications of the bolivar devaluation: a high consumer price inflation rate and shortages. An RBS analyst estimates that the consumer price inflation rate in 2010 will be around 40%. At that rate, every year and 10 months, the purchasing power of your money gets halved. Shortages will increase, as businesses get squeezed between de facto price controls and increased production costs.
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Bloomberg: Chavez’s Three-Tiered Currency System May Spur Inflation Surge
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President Hugo Chavez, struggling to stem an outflow of dollars and rein in a budget deficit, has adopted a multiple-tiered exchange-rate system that fueled corruption, food shortages and inflation in the 1980s.
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He set a rate of 2.6 for imports of items such as food and medicine, a rate of 4.3 for “non-essential” products and committed to defend the bolivar in the unregulated market, where it traded last week at 6.25.
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Chavez, who said the weaker currency will stimulate economic growth, runs the risk of creating an inflation surge and swelling corruption, said Harvard University’s Ricardo Hausmann.
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Venezuela’s 27 percent annual inflation rate is already the highest among the 78 economies tracked by Bloomberg. Finance Minister Ali Rodriguez, who has been forecasting 2010 inflation of between 20 and 22 percent, said the devaluation may add as much as 5 percentage points to the rate while Chavez, 55, threatened yesterday to seize any stores that raise prices.

“The bourgeois are already talking about how all prices are going to double,” he said on state television during his weekly “Alo Presidente” program. “People, don’t let them rob you. Denounce it and I’m capable of taking over that business.”
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The devaluation will cut the budget deficit in half by giving the government more bolivars for each dollar of export tax revenue from state oil monopoly Petroleos de Venezuela SA, said Boris Segura, an analyst with RBS Securities Inc.

The deficit will equal 3.2 percent of gross domestic product this year, rather than the 7.4 percent of GDP it would have equaled without a devaluation, according to RBS forecasts. The revenue windfall will help Chavez boost spending 30 percent ahead of congressional elections in September, Segura said.
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While the devaluation will ease the government’s financing needs, stagflation may worsen, said Segura. He raised his inflation forecast for this year to 40 percent from 28 percent. He predicts the economy will shrink 6 percent in the first quarter after contracting an estimated 2.9 percent last year.
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Wall Street Journal: Devaluation Sparks Chaos in Caracas
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Mr. Chávez, 55 years old, is gambling that the benefits of a weaker currency will offset faster inflation.
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However, the devaluation does little to assuage the deeper problems plaguing the Venezuelan economy, economists say. Devaluation isn't enough to revive the domestic manufacturing base. Few investors are willing to brave Venezuela's maze of price caps, currency controls and the ever-present fear of nationalization.

Higher inflation from the move will also keep chipping away at the value of the bolivar, even at its new peg.

What is more, by keeping a subsidized dollar rate for importing food, medicine and essential items, Mr. Chávez removes any incentive for Venezuelans to produce what they need most.
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Suresh

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[Suresh]

Bloomberg: Chavez Currency ‘Burn’ Failing as $93 Billion Leaves Venezuela
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The central bank, under orders from Chavez to “burn the hands” of speculators betting against the bolivar, said it sold $179 million since Jan. 13, the first dollar auctions since trading restrictions imposed in 2003 spawned the unofficial market. Chavez said on Jan. 15 he wanted to strengthen the bolivar more than 30 percent in unregulated trading, where it fetches 6.3 per dollar, to contain inflation after he devalued the official rate as much as 50 percent to 4.3.

The plan will fail because Chavez’s nationalizations and land seizures are prompting Venezuelans to pull money from the country, said Alberto Ramos, a Goldman Sachs economist. More than $93 billion has left the South American nation since 2005, according to the central bank’s capital account data.

“You have a problem that can’t be resolved by throwing reserves at it,” Ramos said in a phone interview from New York. Venezuelans “pay a huge premium to get their assets out of the country, out of the reach of the government, so that they can’t confiscate them,” he said. “Under that situation, $20 billion, $50 billion or $100 billion is not enough. The entire capital stock of the economy could leave.”
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Companies and individuals in Venezuela, the fourth-biggest supplier of oil to the U.S., turn to the unregulated market to buy dollars when they can’t get authorization from the government to make the purchases at the official rate.

Demand in the unofficial market swelled last year as the government said it cut the amount of dollars provided at the fixed exchange rate by 38 percent to preserve foreign reserves after crude tumbled 54 percent in 2008. Private companies bought about 30 percent of their imports in 2009 with dollars acquired in the unregulated market, according to Asdrubal Oliveros, an economist at Caracas-based Ecoanalitica.

Devaluation

On Jan. 8, Chavez devalued the bolivar for the first time since 2005, saying he aimed to shore up a slumping economy by stimulating exports and cutting imports. He weakened the official exchange rate by 17 percent to 2.6 per dollar for “essential” imports and by 50 percent to 4.3 for “nonessential” items.

Morgan Stanley forecasts the devaluation will push inflation to a 14-year high of 45 percent this year from 27 percent in 2009, the fastest pace among 78 economies tracked by Bloomberg.

The central bank began selling dollars in the unregulated market on Jan. 13, driving the bolivar up 10 percent to 5.87 per dollar in the first week after the devaluation. Those gains prompted Chavez to say on Jan. 15 that he was “revaluing” the bolivar, not devaluing it, and that he planned to drive the unofficial rate to 4.3 per dollar.
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The bolivar has slid 6.8 percent since then.

Central bank dollar sales of about $100 million a week are insufficient to drive the unofficial rate to 4.3, said Alejandro Grisanti, an analyst at Barclays.
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Venezuela’s foreign reserves have slumped to $31.3 billion from a record high of $42.5 billion a year ago, in part because of Chavez’s transfer of $15 billion to a government development fund, according to central bank data.

Ecoanalitica’s Oliveros estimates the central bank would have to sell at least $11 billion to get the unofficial rate close to Chavez’s 4.3 target.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.