Venezuela needs a dollar peg

Redenomination doomed to fail in hyperinflationary environment

Already ravaged by economic mismanagement, corruption, and incompetence, Venezuela is now embroiled in history’s 57th hyperinflation crisis. Since the beginning of November, the bolívar has lost 42% of its value, worsening conditions for a country in which wheelbarrows have replaced wallets. In response, Venezuelan officials announced a misguided and foolhardy plan to issue higher-denomination bills to mitigate the damaging effects of hyperinflation.

If the Banco Central de Venezuela does not redenominate, then the people are stuck. If you go to a market in Caracas today, you either need to carry an unseemly amount of cash, or bigger bills – much bigger. President Nicolás Maduro and the BCV hope that, by printing Bs20,000 notes, they can skirt around the hyperinflation problem until it disappears of its own accord. That is a brainless undertaking.

In the early 1990s, the former Yugoslavia tried to combat its own hyperinflation by printing larger bills, and failed horribly. That episode of heavy inflation continued throughout the decade, and the Yugoslav dinar was devalued 18 times between 1991-99. 313,000,000% monthly inflation transformed Yum500bn bills into small change before the ink had dried.

Redenomination achieves nothing if elevated inflation levels persist, as Zimbabwe’s infamous Zwd100tn note has demonstrated. Venezuela will be no different. When inflation rises uncontrollably, reserve banks cannot physically redenominate bills quickly enough. Countries are then left with valueless notes with many zeroes and a ‘wheelbarrow problem’.

Yugoslavia’s inflation episode only stopped when its printing office ran out of capacity – they couldn’t redenominate and print notes fast enough, so stopped. This sent the real value of notes in circulation to zero, ending the inflation episode. However, this is a painful way for hyperinflation to end. A currency crunch leads to starvation and riots, and would certainly diminish Maduro’s tenuous grip on power.

The only solutions for ending Venezuela’s inflation episode painlessly, fanciful as they may be, are to either dump the bolívar and replace it with the dollar, or make the bolívar a clone of the dollar via an orthodox currency board. In the latter case, the bolívar trades at a fixed rate with the dollar, is totally convertible with the dollar, and is completely backed by US reserves.

If a Venezuelan leader could, against all odds, announce the implementation of dollarisation or an orthodox currency board, he would become a national hero on par with revolutionary leader Simon Bolívar. International currency markets would instantly regain faith in Venezuela and recommence trade. If the bolívar were either replaced or backed by the world’s most trusted reserve currency, a commodity not seen in Venezuela for years would return: stability.

Steve Hanke is Professor of Applied Economics at The Johns Hopkins University and a Member of the OMFIF Advisory Board.

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