The Venezuelan Bolivar: A Catastrophe

The bolivar has gone through a long history of change. In 1934, the bolivar became fixed to the U.S. dollar at a rate of 3.914 bolivares to 1 U.S. dollar. However, a fall in the price of oil and reduced exports damaged the country’s currency. By 1983, with a central bank nearly empty of foreign exchange reserves and mounting debt, the president devalued the currency by 100%. Soon after, the government declared a ban on the purchase of dollars. Inflation skyrocketed and brought the VEB to its knees, forcing the change to the bolivar fuerte (VEF). The Venezuelan government began putting strict controls on their currency in 2003 to limit individual’s access to dollars further. As inflation continues to devastate the Venezuelan economy, the government and central bank have again decided to redenominate its currency. The new money will be known as the sovereign bolivar (VES). Under the country’s official fixed exchange rate to the US dollar, VES was devalued by roughly 95% compared to the old VEF. One USD is now worth approximately 18,852 VES.

 

Having a fixed exchange rate has some advantages. First of all, being pegged to the US dollar, the world’s most held reserve, the sovereign bolivar should have strengthened considerably. Doing so should solve Venezuela’s problem of hyperinflation, as it should share the strength of the pegged currency. A pegged exchange rate usually brings stability and high degree of certainty. This means that the currency would be able to attract investors, which most likely include companies, investment funds, and individuals. A strong and stable currency is also able to increase the volume of international trade.

While a fixed exchange rate could potentially benefit the Venezuelan economy, this exchange rate system could have certain drawbacks. Monetary policy is extremely crucial to managing a country’s aggregate demand, but if they want to peg their currency, the government would not be able to manipulate the value of their currency or interest rates to control aggregate demand. In the case of an LEDC such as Venezuela, this is not ideal since economic growth should be one of their top priorities. Maintaining a pegged currency also requires the Central Bank of Venezuela to hold large reserves of foreign currency in order to purchase and sell large amounts of currency, which would potentially be costly and hard to maintain.

 

Though the system usually works well to stabilize and strengthen a currency, the sovereign bolivar is a special case. Though currency pegging is supposed to minimize inflation and stabilize a currency, the introduction of the sovereign bolivar was not successful in preventing hyperinflation. According to inflation analyst Steve Hanke, between 18 August and 21 August 2018, the inflation rate increased from 48,760% to 65,320%. This is most likely due to Venezuela’s corrupt and dysfunctional government in an attempt to counter government budget deficit.

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