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Currency Crisis in Venezuela

Feb 5, 2020 at Other Essay Samples

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The low oil prices have highly affected the oil-producing countries, particularly those who depend mainly on oil as their main source of foreign currency. Venezuela is one such country and it has been experiencing a currency crisis recently. Their currency, bolivar, has been significantly affected: in November 2016, it lost 55% of its value (Gillespie, 2016). In order to better understand the situation regarding Venezuela’s currency crisis, the analysis starts with the explanation of the currency crisis in the Venezuelan case. The background information discusses potential factors that could have led to the recent currency crisis. The Venezuelan currency situation forms the next phase of the analysis where the factors that have characterized the recent crisis are discussed along with the reasons and the current and future impact on the Venezuelan government and citizens. In addition, the key findings concerning the primary factors behind the crisis are outlined accompanied by the recommendations of how best for the government to solve this challenge.

Keywords: Venezuela, crisis, currency, bolivar

Recent Currency Crisis in Venezuela

A currency crisis is a situation where there is significant doubt whether a country’s central bank has enough foreign exchange deposits that can be used to sustain the country’s fixed exchange rate. One of the primary causes of the currency crisis is a huge deficit associated with the balance of payment. Moreover, a financial crisis is usually accompanied by an economic crisis that is ultimately brought about by the massive balance deficit. It makes it difficult for the concerned country to engage in international trade when the home currency value has declined sharply. In addition, there is also a sharp rise in foreign-denominated debt since the country becomes more of an importer rather than an exporter. As a result, both the government and the financial institution face difficulties meeting their debt obligation, which, in turn, the economic crisis. This situation is familiar to Venezuela since the country has been facing shrinking cash and gold reserves (Gillespie, 2016). The value of Venezuela’s currency has also been dipping accompanied by an ever-worsening inflation rate. Therefore, the currency crisis causes a country not being able to maintain the stability of its currency, thus making it impossible to tame the element of inflation. As a result, the inability to service its debts leads to a country depending exclusively on the imports, a phenomenon that ultimately leads to the closure of many local firms. These detrimental effects for the country’s local firms result in the worsening of the balance of payments deficit due to the reduced levels of exports. Moreover, the lack of a robust manner of engaging in international trade makes it impossible for the affected country to improve its cash reserves since more is spent on its imports than the reserves. Therefore, any currency crisis affects not only a country’s currency value but also the entire economy. In providing an in-depth understanding of a currency crisis, the paper analyzes the recent currency crisis in Venezuela determining the variables that have caused this crisis.

Background Information to the Venezuelan Currency Crisis

The currency crisis is inextricably intertwined with the economic situation in any country. Similarly, the discussion of the situation in the current crisis affecting Venezuela cannot be discussed without referencing the economic decisions that the leadership of Venezuela has made over the years. One of the mistakes that the leadership of the country has been repeatedly making is continuing to depend on oil as its major source of export revenues (Rust, 2016). This mistake has disadvantaged the country with the current trend on the oil market where the demand has been subsiding due to the saturation of the market. The saturation has been caused by the lifting of the sanctions directed against Iran and the increased exploitation of oil fields in the United States and Canada among other reasons (Rust, 2016). Therefore, the increased supply of oil has resulted in low prices, which means an enormous loss of exports for Venezuela. With approximately 90% of its economy depends on the oil exports gains (Rust, 2016), the sharp decline has made a huge impact on the country’s ability to sustain its spending in the line of avail social amenities of its citizens.

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Another key aspect of any currency crisis is the confidence that the economy encourages in its trading partners. The greater the confidence that an economy enjoys, the more stable the value of the currency of the country is, and vice versa. However, the economy’s confidence level is heavily dependent on the nature of the political environment that the country is experiencing. In contrast, the situation in Venezuela is different where political discourses are common. The government and the opposition have been fighting over the control of the country’s affairs making it more difficult for the country to find a sober solution to the current currency crisis. Besides, with one of the characteristics of an economy that suffers from the currency crisis being the reduced levels of export, the continued political tension in Venezuela has also played a major role in the current situation. Political instability discourages potential investors from committing their capital, and it leads to the country suffering from the reduced level of output. In turn, it means that the country lacks surplus that it can export in the line of attracting extra foreign reserves.

The Current Currency Situation in Venezuela

The Shortage of Local Currency in Circulation

One of the challenges associated with the currency crisis facing Venezuela is the lack of enough currency in circulation in the economy. It has led to the government turning to the tool of monetary policy that has been leaning more on the money supply. The high scarcity of the currency has not only affected people’s capacity to buy the essentials but also the government’s ability to afford basic commodities, such as medicines and food for the citizens. This problem is largely caused by the fact that the country is doing little in order to generate local income regarding huge earnings in the export front. Therefore, even though the government continues to print more money in line with the supply aspect of the monetary policy, the scarcity is expected to persist as long as the country continues to depend on the imports rather than improve its domestic capacity.

The recent case of the money supply policy enacted by the Venezuelan government has been this month. The country received 252 crates of 50,000 and 500 bills that the government said were printed in Sweden (Deutsche Welle, 2016). It was the intention of the Venezuelan government to present these new bills as the means of cautioning the country from reducing reserves. However, the introduction of these new bills has been accompanied by the withdrawal of some bills, which has angered the masses across the country leading to further unwanted political tension.

Furthermore, when there is a shortage of currency, it is almost impossible for the central bank of the concerned nation to influence the value of the currency. Therefore, with the currency being of low value, the country would be spending more in terms of the imports. Such is the situation in Venezuela where its current currency is of very low value with $1 being equal to 1567 bolivars.

The currency of Venezuela, bolivar lost 55% of its value in November. Such a huge loss of value within a month demonstrates how weak the Venezuelan currency has recently become. Besides, with this low local exchange rate and the country has concentrated on the oil ventures as the sole sustainer of the country, it is evident that the country needs to use almost all its reserves to make dismal purchases for its provision of social amenities. Among the aforementioned variables, the challenge of currency scarcity has become a reality and the incumbent government is offering no solutions. Therefore, with the shortage of currency, it is now difficult for the people and the government to satisfy their spending demands. Moreover, if this trend continues, Venezuela will soon be faced with a situation where bolivar will be even of less value than it is at the moment. Besides, in the economy where there are not enough local and foreign reserves, it becomes almost impossible to boost the economic output. In Venezuela, the shortage of local currency is expected to continue making it hard for the country to improve its dismal economic performance over the coming years.

Inflation

Another aspect of the currency crisis in Venezuela is inflation. The country has been facing what the financial experts are naming the worst rate of inflation. The high level of inflation has been accompanied by the poor decision making of the government that has resulted in the withdrawal of the low denomination bills and their replacement with the high ones. For example, the government withdrew the 100 bolivar notes replacing them with the 500 and 1000 bolivar bills, thus continuing the inflation (Hernandez, Charner, & Gillespie, 2016). However, the financial analysts are of the opinion that the introduction of new bills is just cosmetic solutions to inflation and more effort needs to be made. Similar sentiments are coming from the Venezuelan opposition who state that the government action of withdrawing the 100 bills is misplaced. It is their view that the government needs to channel its efforts into handling the challenge of fiscal deficit. Figure 2 demonstrates the seriousness of the inflation facing Venezuela as the IMF predicts that in 2017, the country is likely to be facing the inflation of about 1660% (Hernandez, Charner, & Gillespie, 2016). Besides, at the end of 2016, the country is likely to be facing inflation of 470%.

The greatest problem regarding inflation is that it leads to a currency crisis by making the local currency useless for the local people. The situation has not been any different for the Venezuelans when their traditional highest bill of 100 bolivars has been rendered useless over time due to the high inflation (Hernandez, Charner, & Gillespie, 2016). Moreover, with skyrocketing inflation, the Venezuelans have now been forced to use stacks of cash when buying small quantities of essentials, such as medicine and food. In some incidences, the Venezuelans have been forced to weigh cash rather than count the bills, which is a clear indication of the currency becoming useless.

Furthermore, the action of countering inflation by printing more money does little to help the problem and might be contributing to inflation, thus worsening the Venezuelan economy. According to the quantity theory of money, MV = PY where M is the supply of money, V is the velocity of the money within an economy, the speed at which money exchanges hands, P stands for the price levels, and Y is the national income (Mishkin, 2013). Therefore, if MV is not equal PY, then inflation becomes the inseparable part of that economy. In the case of Venezuela, the national income (PY) has been declining due to the oil’s low prices. Moreover, the current shortage is also common in the country meaning that the money velocity (V) is very low in its economy. Therefore, the situation in Venezuela can be summarized according to the quantity theory of money the following way: (>M) (V<)? (<PY) which means the increased money supply (M) and reduced velocity (V) is not equal to a declining national income (PY). Therefore, the increase in the money supply by the Venezuelan government has done little to bring an eventuality characterized by MV-PY. The result is high inflation, which is likely to remain the same if the government does not introduce the necessary policies to boost the value of bolivar through the increased output by the country (See Table 1).

Table 1. The impact of inflation (Hernandez, Charner, & Gillespie, 2016; Deutsche Welle, 2016).
Inflation level/Year Impact Government intervention
470% in 2016 100 bolivar bill is worthless Printing of lager nomination bills
1660% in 2017 Higher prices The government’s intention to print 1,000, 2,000, 20,000 bolivar bills

One of the characteristics of a country experiencing inflation is high prices for commodities, which has been a common phenomenon in Venezuela. On the other hand, the higher the prices continue to be, the less valuable the currency is since it is an indication that the currency has a low purchasing power (Mishkin, 2013). Therefore, the printing of more bills clearly has done little to save the country from inflation and certainly will yield little if any help to the country in the future. The impact of such a high level of inflation means that the majority of people are not able to meet their expenditure demands due to the high prices (Mishkin, 2013). Moreover, if inflation continues to balloon, the bolivar currency will continue to be of low value to the extent that the locals will prefer keeping other currencies rather than the bolivar. It will hurt the economy both in terms of the continued shortage of currency and the unsustainable level of prices for both the citizens and the government.

Inability to Pay Debt

One of the ways for the country to solve the challenge of foreign reserves is to take out a loan or obtain a grant. A good example of how a loan can help a country reshape its foreign reserves is in the case of Greece when the European Union helped it. However, with the Venezuelan government lacking cash to make basic expenditures, it has been difficult to win the confidence of any render. Currently, Venezuela has failed to make a small debt payment (Gillespie, 2016), and it has profoundly tarnished the economy’s creditworthy confidence, which discourages not only the potential lenders but also investors. As a result, Venezuela’s ability to boost its local output has continued to be suppressed making it impossible for the country to attract any foreign reserves. Thus, the country lacks enough dollars to sustain its import demands making it impossible for the government to meet its obligation as a member of international trade and that of safeguarding the interests of its citizens.

Price Control

Price control is another phenomenon that has led to the country experiencing the recent currency crisis. One of the ways, in which the government tried to protect the Venezuelan from high prices due to inflation, is setting price ceilings. It has been associated, in particular, with basic commodities, such as food, when the government has set the prices for these commodities even below the production costs (Clarke, 2016). As a result, the local manufacturers have reacted by shutting down their production and forcing the country to depend more on imports even on things that have been previously being produced in the country. In turn, it has caused additional demands for foreign currency as the government views the import as the means of providing the country with the essentials. Besides, in order to understand how price control has led to the currency crisis, there is a need to analyze the increased level of demand for the available foreign currency in the environment of low oil prices. In this context, the increased demand for foreign currency means that the country has depleted its reserves quicker since the balancing tradeoffs gain through oil has not been availing any significant gains.

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On the other hand, the closure of local firms has also suppressed Venezuela’s export capabilities as the local firms export their surplus in exchange for the much-needed foreign currency. Therefore, the government’s action to curb the prices has led to the same people experiencing more problems due to the lack of currency and, at the same time, reduced supply points of the basic commodities. Thus, it is common to find people in long lines as they wait to receive food due to great shortages (Robins-Early, 2016). Therefore, through the forces of demand and supply, the commodities can only be accessed by paying huge prices, which is common in the economies suffering from a high level of inflation. Thus, the government’s introduction of price control with the intention of protecting the citizens from exploitative prices has ultimately led to the worsening of the situation. It has exposed the country to an eventuality where it is even more dependent on the imports, and it can only be sustainable if the country has enough foreign reserves, which is not the case with Venezuela.

Black Market

The government’s lack of capacity to provide for its citizens has resulted in the rise of the black market that is engaged in the supply of commodities and the financial markets. These black markets have also played a huge role in the skyrocketing of the prices. People running these black markets charge high prices, which leads to the shortage of currency in the economy. Moreover, these black markets were also engaged in money hoarding, which resulted in the president closing the border with Columbia in an attempt to stop people from going over and exchanging or spending the money (Hernandez, Charner, & Gillespie, 2016). In addition, only those who have dollars are able to access the black market where there is not rationing (Robins-Early, 2016). That is why, people started using dollars more often than bolivars, and it has also played a huge role in the devaluation of the currency. Consequently, the hoarding of the foreign currency by the individuals undermines the velocity of the currency making it harder for the government to access these currencies.

Any black market leads to the government losing taxes, and the continued existence of these black markets means that the Venezuelans will continue to be exposed to exploitative prices. Moreover, the continued loss of revenue by the government accompanied by the low oil prices means that the government will continue to be unable to avail the needed social amenities. On the whole, the existence of black markets undermines the growth of legitimate businesses needed in Venezuela as the country tries to improve its local output. Therefore, the continued existence of this unregulated and exploitative market will undermine the existence of similar legal businesses that have already been highly affected by the regime of price control initiated by the government. Ultimately, if the government does not develop solid regulations to eliminate the black market, there will be high inflation and a huge loss of tax revenue, which will lead the country into a worse crisis in terms of the currency and the entire economy.

Rational Consumer Behavior

For a rational consumer, a commodity with more utility is more appealing than that yielding less utility. Thus, the Venezuelans are quick to protect themselves from a potential loss due to the bolivar’s loss of value. It is the main reason why the government has closed its border with its neighbors: people move to these countries in order to exchange their bolivars for a more stable currency, such as the dollar. The impact of people preferring a different currency to the local one makes it more difficult for the government to sustain enough of its currency circulating in the economy since more people are willing to trade it as soon as they receive it. It has been the case of Venezuela whereby the selling of bolivars has been rampant to the extent that the government has closed its borders in order to ensure that it contains its currency within its borders. However, it has been only a short-term solution since the reopening of these borders is accompanied by the influx of people demanding dollars and depletion of bolivars from the economy (Gillespie, 2016). Therefore, as long as the problem of bolivar losing its value at a high rate exists, any effort of trying to curb the problem of accessibility of currency (V) will yield little result since people will still be willing to exchange it for a more stable and valuable currency. It means that the country will continue to experience bolivar shortages now and then when the supply cannot compete with the rate, at which the citizens will be exchanging them for a more stable currency (See Table 2).

Table 2. The factors and their effects.
Factor Impact on the Currency
The shortage of local currency Greater inflation because of the government’s printing more bills
Inflation Bolivar’s loss of value
Loan Repayment Default Reduced sources of foreign reserves
Price Control Reduced national output = low foreign reserves
Black Market The loss of tax revenue = Reduced local reserves by the government
Rational Consumer Behavior The shortage of local currency in circulation

Key Findings

The currency crisis in Venezuela has been caused by a series of inappropriate decisions and a hostile environment that has led to a great devaluation of the local currency. The origins of the recent crisis can be traced to the fact the bolivar value has sharply declined with one dollar being equivalent to 1567 bolivars (Gillespie, 2016). This phenomenon has extremely disadvantaged the country because the prices continued to decline due to the low oil prices being set across the world. Thus, the dependence on these low gains for imports has left the country with not enough foreign reserves. Moreover, as far as Venezuela’s engagement in trade is concerned, with the local currency inferior to the dollar, it becomes difficult for the government to access enough foreign currency to import the needed amenities into the country. It is the case of Venezuela, which is now experiencing acute shortages of medicine and food.

Another principal cause of the currency crisis in Venezuela’s heavy reliance on imports. A strong reliance on imports as the means of sustaining many of the country’s demands, including agricultural products, is another problem that has resulted in the currency crisis. The reason is this approach forcing the country to continue to exploit its foreign reserves on expenditure that is not capital generating. In the end, the country has found itself in a situation where it has no more reserves to sustain its economy that depends on oil as its main source of foreign currency and relies almost exclusively on imports. Moreover, the currency crisis has also been a result of the lack of diversity within the economy that has restricted the country’s ability to expand its capacity regarding exports. The impact of the lack of diversity has been the reduction of the foreign reserves that have affected the ability of the country to meet importation expenses.

Recommendations

The only way the Venezuelan government can solve the challenges of the currency crisis is to engage in the interventions that will help improve the value of the bolivar currency and expand the economy in order to enhance its output. In the line of gaining sustainable results, the government needs to utilize the following approaches. First, there is a need for the government to invest heavily in the agricultural sector in order to guarantee food stability and, at the same time, reduce the use of foreign reserves for recurrent expenditure. Second, it is necessary to handle the problem of inflation using both fiscal and monetary policies. In addition, there is also a need for the government to develop a robust way of eliminating the black market within the economy. Besides, it is important to ensure that the government desists from using the tool of fixed pricing as the means of protecting the public from high prices. It will be necessary for empowering the local firms, which would allow the country to improve its output and ultimately gain more foreign reserves.

Conclusion

To conclude, Venezuela is facing one of the most severe currency crises, which has rendered its local currency almost valueless. One of the key characteristics of its recent crisis is the acute shortage of foreign reserves. In addition, the local currency and related issues have forced the government to start printing more bills of higher denomination. Furthermore, inflation is another challenge that has brought about the currency crisis since it has forced the people to look for another currency rather than use large stacks of bolivars in order to make small purchases. In turn, it has forced the country to face cash scarcity frequently, which has led to the government sometimes closing its borders with the neighboring countries with the aim to contain the currency within its borders. Moreover, the country’s extreme dependence on oil as its major foreign earner is one of the reasons Venezuela has fallen short in terms of having enough foreign reserves, which has been caused by low oil prices. As a result, if the government is to change the current predicament, then the Venezuelan economy needs to be expanded. In addition, the mixture of fiscal and monetary interventions aimed at curbing inflation should be introduced. On the whole, the government needs to abandon the means of price control to ensure that the local firms are more empowered, thus enhancing the much needed national output.

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