President Nicolas Maduro of Venezuela has just announced another new series of drastic actions aimed at stabilizing the country’s hyperinflation and crumbling economy. But the plan is reminiscent of the many failed attempts to end the hyperinflations in Brazil, Argentina, and other South American countries in the 1980s. Like those futile endeavors, Maduro’s proposals amount to palliatives that do not address the root causes of Venezuela’s problems. They are bound to fall flat.
There is no quantitative threshold for hyperinflation, but when prices start doubling every four weeks as they are in Venezuela—i.e., when inflation hits 100 percent per month—economists and the population alike know that something is gravely amiss. Although it is difficult to forecast by how much prices will rise during any given period in a hyperinflationary environment, the International Monetary Fund has recently estimated that annual inflation in Venezuela may reach as much as 1,000,000 percent in 2018. Therefore, something that could be bought for 1 bolívar today would cost about 10,000 bolívares by the end of the year. Virtually nothing at the moment costs 1 bolívar in Venezuela because the currency is practically useless. Currencies become useless when institutions entrusted with preserving their value are completely destroyed. Hence, hyperinflations are the result not just of severely mismanaged fiscal and monetary policies but also of seriously compromised underlying institutions, such as a central bank that no longer exists or a finance ministry and treasury that have become so politicized that they serve no purpose other than to support a particular political regime.
So how does Maduro intend to address Venezuela’s hyperinflation? His proposed monetary reform has three pillars: (1) slash five zeros from prices—so a product that costs 100,000 bolívares would now cost 1 bolívar—and give the currency a different name, the “sovereign bolívar”; (2) devalue the currency by 95 percent; and (3) peg the bolívar to the petro, Venezuela’s digital currency backed by oil introduced in February 2018. The first two pillars have been tried in Latin America before. Brazil alone changed currency denominations and slashed zeros no less than nine times during much of the 20th century. The different currencies were also substantially devalued and then pegged to the dollar. Devaluation was meant to address the dollar shortages and external constraints faced by countries like Brazil at the time—in Venezuela’s case, dollar shortages may be attributed to sanctions imposed by the United States, to the persistent decline in oil production over the past 12 quarters, and, most obviously, to Maduro’s severe economic mismanagement, which has led to substantial capital flight. The public sector and state-owned companies such as oil giant Petróleos de Venezuela, S.A. (PDVSA) also have sizable debt service obligations in dollars, placing further pressure on the currency.
Where Maduro’s plan deviates from the 1980s playbook is on the novel idea of pegging a currency with no credibility to an asset that also severely lacks credibility. As explained here and here, the petro is supposedly backed by Venezuela’s rich oil and gas reserves, an arrangement that mimics currencies backed by gold reserves. However, such backing is credible only when the currency can be redeemed at a fixed rate for gold and when the government is widely trusted to do so. If there is no confidence that the government will redeem the natural resource value of investors’ petro holdings, the asset has no credibility. Curiously, the petro was introduced with the promise that it would serve as a solid alternative to the ruined currency. However, the petro and the bolívar have now become fully intertwined because the digital asset and the currency are now pegged to each other, undoing the initial rationale for the petro’s creation.
Maduro has also proposed increasing the minimum wage by 3,000 percent and cutting back on some fuel subsidies. There is no substantial fiscal reform in the works, no attempt to rebuild dismantled institutions, and no announced shifts in economic policymaking. In the absence of these measures, Venezuela unfortunately looks set to beat Zimbabwe, a country that managed to have an annualized inflation rate of 79 billion percent in November 2008. Macroeconomics may not be a hard science, but certain rules simply cannot be bent.