Above you can listen to a brief interview (from 13:30-18:00) I did with the Texas Standard regarding Venezuela issuing higher denomination notes. Below are the notes I wrote up to prepare.
Will this improve the situation?
Issuing higher denomination bills will alleviate the daily struggle Venezuelans encounter in simply carrying out their transactions. With 20,000 B notes you can carry 100,000 Bs as five bills in your wallet instead of a duffle bag of 100 B notes. This could actually revive parts of the economy which work on cash and have been seriously depressed by the fact that people simply don’t have enough cash on hand, even if they have it in the bank.
But it will not impact the underlying problem of inflation, in fact it will most likely exacerbate it. The fact that transactions are suddenly facilitated will allow sellers to charge higher prices. And having the sudden emergence of higher denomination bills on what was originally called the “Strong Bolivar” will underline the deterioration of the currency and further undermine confidence. Indeed this is likely one of the reasons the government took so long in emitting new bills. For example, the hyperinflation of Weimar Germany was facilitated by the continual emission of new bills. They actually had a two trillion mark banknotes. It demonstrates like nothing else that the government is not backing the currency and is simply printing it.
And in fact perceptions have a huge role in the collapse of Venezuela´s currency and inflation. One way of calculating the value of a currency is by taking the total monetary mass and divide it by the foreign reserves. If you do that you will find that the value of the Venezuelan Bolivar should be around 1,000 per dollar (see my friend Girish Gupta´s handy Venezuela Econ webpage and app). But the actual black market exchange rate is about 3,700 per year. This is in part because it simply is not easy to find dollars to purchase and some people need them now and are willing to pay more than they are really worth. But it is also because people simply have no confidence in this government’s economic policy and effectively factor future declines in to current prices.
What explains Venezuela´s shortage of currency?
The standard explanation of inflation and hyperinflation looks at the monetary supply and shows that a government that is running a large budget deficit prints excessive inorganic (i.e not backed by foreign reserves or other value) money. This essentially means you have more money chasing the same or fewer goods and leads prices to rise.
But there is another element—the velocity at which money circulates through the economy—and it too has to do with a lack of confidence in the currency. In an inflationary economy people generally want to use their cash as soon as possible. Nobody wants to save money in a bank account or stuff it in their mattress when it is continually losing its value. When this happens it creates more inflation. When this happens in an economy in the largest bill is worth 3 cents, it taxes the entire economic system.
In Venezuela, the most you can currently get out of an automatic teller machine is from 12-18,000 Bs, about $3-5. The ATMs that work have huge lines until they are empty. But they frequently breakdown since they are not made to continually emit large stacks of bills. Banks themselves cannot even keep relevant cash in their vaults. Most have withdrawal caps of 30 or 50 thousand per day, which seriously impedes commerce in cash.
Electronic transactions are a solution. But not all of the economy is electronically connected. Taxis, for example, do not accept credit or ATM cards, nor do most street sellers. And the entire system can be overwhelmed when 70% of transactions take place electronically, in a system that only has capacity for 30% of them. Finally, as one gets further away from Caracas into the interior and rural areas, electronic pay points are less common.
· The fundamental motor of Venezuela´s inflation is the printing of inorganic money.
· But the lack of confidence in the government´s economic policy is probably a bigger cause.
· It leads not only to more depreciation of the Bolivar, but increases the velocity of transactions which in turn creates more inflation
· Add to this a monetary supply in which the largest bill is worth 3 cents and the entire system is overwhelmed.
· Higher denomination bills will alleviate some of this.
· However, bigger bills will also reinforce perceptions that the currency will not hold its value, and thereby increase inflationary pressure.
· If something doesn’t change, we will have the same problem a few months down the road.
What needs to be done to address Venezuela´s economic meltdown?
A lot of things need to be done, but the sin qua non is to get ahold of the foreign exchange chaos. With a parallel rate that is almost 4000% higher than the official rate, there are incredible incentives for exchange arbitrage and capital flight meaning much of Venezuela´s scarce foreign currency earnings do not get used to import the goods Venezuela needs. Over the long term the overinflated currency has undermined local production by making exportation impossible and imports impossible to compete with. Doing so would provide some confidence in the government´s economic policy, facilitate national and foreign investment, and provide the groundwork for reactivating domestic production. No attempts at reviving the latter or diversifying the economy will get off the ground without first straightening out the foreign exchange market.