Fisher Investments Editorial Staff
Currencies, Emerging Markets, Politics

Submerging Market

By, 01/12/2010

Story Highlights: 

  • President Hugo Chavez announced Venezuela's currency, the bolivar, will be devalued against the US dollar.
  • Chavez announced the devaluation will boost export competiveness. More likely, this move was done to satisfy international creditors, as it boosts the government's ability to make good on foreign currency debt.
  • However, devaluations tend to help in the short term, but exacerbate problems in the long run.
  • Emerging markets will likely continue to lead the global recovery, but not all emerging markets are equal.

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Venezuela isn't big—it has a population of 28 million and GDP of $353 billion (versus the US with a population of 307 million and GDP of nearly $13 trillion). Yet, it made a lot of noise last Friday—aside from whimsical allegations of American aircraft violating its airspace (they have a picture of the plane and everything)—President Hugo Chavez announced Venezuela's currency, the bolivar, will be devalued against the US dollar for the first time since 2005.

The bolivar was previously pegged to the dollar at the fixed rate of 2.15 bolivar/dollar. Chavez announced plans for a dual currency system, which pegs the currency exchange rate to either 4.30 or 2.60 against the dollar…depending on the transaction. (How's that for arbitrary?) The more favorable 2.60 rate applies to trading dollars for "priority" imports (including food, medicine, and industrial machinery). "Non-essential" products will be imported at the higher 4.30 rate. Chavez claims the devaluation will boost economic activity by making exports relatively cheaper to foreigners, while making "non-essential" imports pricier—to encourage folks to buy domestic. 

In theory, it doesn't sound malevolent, just misguided. But Chavez's aim was most likely satisfying international creditors—a devaluation can improve the government's ability to make good on foreign currency debt. Venezuela's economy is heavily tied to oil exports (priced in dollars). By devaluing the bolivar, every dollar of oil revenue for its state-owned oil company translates to more bolivars for the government to help repay foreign obligations. And an influx of cash could also boost government spending ahead of September's elections to win back some modicum of good will. (Incidentally, Chavez is polling at a mediocre 50% popularity rate.) 

However, we know of few devaluations that were largely positive (for example, Mexico and Argentina in the 1990s). Devaluation tends to help some in the short term, but exacerbates problems in the long run. Devaluing the bolivar makes imported goods more expensive for Venezuelans (doubly so for "non-essential" goods) and could add to already high inflation rates—essentially cutting purchasing power and wealth. No wonder Venezuelans are lining up to spend their money as fast as possible—buying TVs, refrigerators, and any large ticket items they can. There are few actions in history that have such clear, defined cause and effects. These events will likely be a perfect case study, for decades to come, on what happens when you devalue currency. 

Chavez likely thinks he's making nice with his creditors at the expense of his "constituents" (recall, Chavez didn't win a very transparent election), but devaluation could actually lower his credibility (if that's possible) and make foreign firms less inclined to do business with Venezuela. This could hurt domestic companies as well if they are dependent on imported materials. The dual exchange system also increases the possibility for corruption—there's already a robust black market for dollars due to the country's strict currency control system. 

As the world charges into 2010, emerging markets will likely continue to lead the global recovery—but not all emerging markets are equal. It's likely Venezuela will continue to suffer from heavy government intervention, and Chavez will continue to do what he wants despite being unpopular at home.

 

 

 

 

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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