The bolivar has taken another sharp drop this past month, decreasing nearly 30% and falling as low as 423 bolivars per dollar, down from 279 at the start of the month as Bloomberg recently reported. The current exchange rate of nearly 400 bolivars means the currency has weakened 82% in the past year alone. This of course is the black market exchange rate, as the legal exchange rates still stand at 6.3, 12 and 199 bolivars per dollar (the government has instituted a three tier exchange system).
Unsurprisingly, Bloomberg noted inflation stood at 69% last December, but a recent report by investment bank Bank of America/Merrill Lynch indicates inflation may have reached just over 100% year-over-year this past April. Of course, the analyst of the report had to use both official and private sources to compile the data, as Venezuela’s central bank stopped publishing the consumer price index in December. Even more troubling is a recent analysis by the Cato Institute’s Steve Hanke who found that, using the principle of purchasing power parity, Venezuela’s year-over-year inflation will likely be 510%!
This is nothing new as the bolivar’s severe debasement has been going on since as early as 2011 (and even in the 80’s they were experiencing double-digit inflation already.) What is new according to the Bloomberg article is that the black-market rate is no longer tracking the so-called “implicit rate” which is the number of bolivars in circulation divided by foreign reserves. Starting last year, the black-market rate began to diverge sharply from the implicit rate and is now about three times higher.
Why? Venezuelans believe the debasement will continue far into the future, perhaps even at accelerating rates. As Bloomberg News notes, “To put it simply, it appears that Venezuelans have lost all faith in the bolivar and seem willing to pay whatever it costs for greenbacks.” Indeed, when the last vestige of faith disappears from paper currency, nobody wants to hold any of it at any price. Some people may wonder why you wouldn’t want to hold a currency that is “undervalued” compared to the reserves (such as gold) the country has in the bank to back the currency. Wouldn’t this be like buying a company that is trading for less than what it holds in cash? Yes, in a sense. But if a company is selling for less than the value of its assets or even the cash it holds, then the market is saying something – namely they expect the company to burn through most of that cash or assets, making it worth even less in the future. The same is true for Venezuela. Its citizens now believe its government will continue to print money and deplete any remaining reserves.
The bad news is this will continue to be a disaster for Venezuelans who have already been coping with food and essential goods shortages. But perhaps a silver lining is that the end appears to be near, which will hopefully bring about change and an end to their worthless paper money.
Chris Kuiper, CFA is currently a student and researcher at George Mason University pursuing a Master’s of Economics. His previous experience includes asset management, investing and banking.