Bolivar Slipping Through Chavez’s Fingers

rpsmith — Mon, 11 Jan 2010 18:43:31 +0000

A few days ago, Venezuelan president Hugo Chavez devalued the bolivar. This comes as no surprise. As I wrote in this space in November,

Buffeted by the fall in oil prices and high inflation, there are signs that the Venezuelan economy, and with it Chavez himself, is almost certainly going to implode. He may be able to buy time with various measures to stabilize his currency (the bolivar), such as the sale of dollar-denominated bonds to those willing to risk the investment, but the long-term outlook for the economy is dim…

Inflation is the highest in Western hemisphere, officially around 30%, but likely higher. All this drives demand for a more stable currency such as the dollar. The recent issuance of dollar-denominated Venezuelan bonds, purchasable in bolivars, is intended to soak up the demand for dollars and allow the purchaser to obtain a rate somewhere between the official and the parallel market rate. The big question, of course, is whether Venezuela can make good on the promise…

This weekend, Chavez devalued the bolivar right on cue, sending the people of Venezuela scrambling to buy goods which will spike in price once the measures take effect. The country actually has two exchange rates now – one of 4.3 bolivars/dollar, close to current black market rates, and the other subsidized at 2.6/dollar. The second rate applies to a few classes of goods deemed necessary for the country, including heavy industrial equipment, food and medicine, reported Reuters.

As usual, this will create privileged class of well-connected cronies who snag contracts to buy at 2.6 and sell at 4.3. This has been a recurring problem with the current CADIVI (the government office which controls foreign exchange policy in Venezuela) regime, and it remains a serious criticism of Venezuela’s tightly managed currency regime. Dual exchange rates have a long and ignominious history in Latin America, from Mexico to Argentina. Indeed, Venezuela used to have a body called RECADI in the 1990′s, which established preferential exchange rates to strengthen certain sectors of the economy. As the black market adjusts to the new system and people strive to take advantage of the difference in rates, Chavez will find that the dual rate is not a sustainable system.

The move will benefit certain politically and economically vital industries, said several Venezuelan officials. State oil company PDVSA will get relief from stagnant oil prices, as each barrel of oil sold in dollars yields more local currency with which to pay many of its outstanding debts. Export industries like coffee will find their competitiveness increasing as Venezuelan exports become cheaper.

Chavez’s popularity may take a hit as prices rise. Indeed, the president has threatened to deploy the army in order to shut down and seize the stocks of speculators seeking to take advantage of price differences and shortages, according to the Financial Times. “Go ahead and speculate if you want, but we will take your business away and give it to the workers, to the people,” the British financial paper quoted him as saying.

At this time last year, Chavez did not even acknowledge the existence of a parallel market in the bolivar. For him to now create a dual-rate exchange scheme set near the level of that same black market deals a serious blow to the regime’s credibility and confidence.

Control of his planned economy is slipping through Chavez’s fingers. Eventually, he may realize that trying to strangle private enterprise and market forces will simply delay the inevitable. Hopefully, that realization comes before the country suffers too much more, as Venezuela faces a long and painful road back to economic health no matter what it does.

Sovereign Bonds Move RMB into International Markets

admin — Thu, 10 Sep 2009 13:18:17 +0000

Is it time to write the dollar’s obituary?

The past five decades have seen the dollar achieve and maintain an unprecedented position as the leading reserve currency in the world. Reserve currencies are those which are held in large quantities by investors worldwide — essentially, dollars, yen and Euros. From long experience, I know that every nation with fixed currency controls breeds a class of money-changers furiously buying and selling greenbacks for tourists, entrepreneurs and even governments.

Ironically, the collapse of American financial markets in 2008 actually resulted in a surging dollar. Investors worldwide ‘fled to quality,’ pouring their holdings into the perceived value and stability of the dollar. The dollar’s most important buyer is undoubtedly China, with $2.1 trillion dollars in foreign exchange held chiefly in U.S. Treasury bonds. Indeed, China is financing the U.S. deficit, leaving us precariously dependent on their government.

The Chinese government seems to have taken a notable step back from their enthusiasm for the dollar, however. For the first time, it is issuing sovereign bonds denominated in Renminbi (RMB), the national currency that some believe China hopes to develop into an alternative to the dollar as the global currency.

Of course, the Chinese government still has a significant stake in a stable dollar – $2.1 trillion dollars worth, in fact. They’re caught between a rock and a hard place. Any slide in the value of the dollar will hit them hard, and the harder they push the RMB, the more they will weaken the dollar.

That’s why it is unlikely the RMB will be replacing the dollar as an international hard currency any time soon. For one thing, no one is stockpiling RMB notes under their mattresses in Buenos Aires or Lagos. The market lacks depth – there are few physical RMB outside of China, and investors cannot sink large amounts of money into the market without drastically affecting it. The dollar, on the other hand, is the deepest and broadest currency market in the world.

Furthermore, the Chinese government has always tried to maintain tight control over its currency. As it internationalizes and becomes more common in markets, they will find the law of unintended consequences coming into play. Their currency will move in ways they don’t want and can’t predict. There isa great deal of internal pressure in China to let the RMB’s value rise, as its artificially low level ends up hurting a growing class of Chinese consumers in order to stimulate exports.

The dollar is still king, even as its value fluctuates. The financial world has prophesied the collapse of the dollar before – when it sank against the yen in the 1980′s, or when the Euro debuted in the late 90′s. Although its value may rise and fall, its place as a reserve currency remains unchallenged.

I have confidence that the fundamentals of the US economy are strong, and with a quarter of the world’s GDP being generated in dollars, it will take more than Chinese bonds to threaten our currency. If the Euro, backed by all of the developed economies of Europe, could not dethrone the dollar, the RMB will have a hard time doing so. For now, the RMB is just one more currency on the market.

Where the RMB bonds may come into play most strongly is the Chinese financial sector. Increased exposure to international markets will drive newly wealthy and even middle-class Chinese citizens to invest more outside in foreign exchange and international markets. In the end, how and where the Chinese people invest their money will end up determining the fate of the RMB.

Riches Among The Ruins » currency

Bolivar Slipping Through Chavez’s Fingers

Sovereign Bonds Move RMB into International Markets