Take physic, pomp

Venezuela Parallel Exchange Rate Update

Here we go with the latest in this semi-regular series.

First the main chart, that of the VEF/USD parallel (permuta) exchange rate…

…and as things stand, you need VEF6.49 to buy a dollar on the streets of Caracas today. The recent news has been that Chávez&Co is now studying a new multibanded exchange rate system to take pressure off the official 2.15-to-1 fixed rate. Or put into simple English, as this blog predicted Venezuela is in the process of a currency devaluation. We also predicted that the deval wouldn’t happen in the first half of the year, but run the risk of getting Argentines shouting “¿Che, no tenés abuela?”* if we start preening too much.

Anyway, back to the subject in hand. The driving force of the weakness in the VEF (as we’ve explained many a time) isn’t inflation. The cause of inflation is the problem, and that’s a monetary thing known as M2, which measures the amount of currency in circulation inside the country. Here’s how M2 stands right now..

..with the VEF equivalent of U$101.79Bn sloshing round inside Venezuela. This amount of money is up from under U$90Bn (equivalent) at the beginning of April and explains why Venezuela’s inflation rate stays stubbornly in the high 20s to 30% range. Put in the most basic terms, if you add 30% more money to a country there are 30% more pieces of folding paper trying to buy the same amount of goods, which means you’ll find you’re using 30% more of those folding pieces of paper to buy that thing you want to buy. Just good ol’ fashioned supply and demand stuff, ask Adam Smith.

However, the Central Bank keeps a store of wealth that backs up the money in circulation. Called International Currency Reserves, it provides backbone to the fiat system. So if we look at the amount of reserves in Venezuela right now….

….we see they’ve tucked away U$31.45Bn. This means (and the calculation is pretty straightforward), for every single dollar the Central Bank keeps in reserve, there are 6.96VEF circulating in the country. This gives us our theoretical equilibrium point for the VEF/USD exchange rate.

So right now the rate is lower than the theoretical rate by about half a Bolivar Fuerte. This indicates that the financial brains out there in Venezuela expect good things from the government and its plans to tame the permuta. What IKN can say right now is that if the Vz gov’t does devalue (or stealth devalue by adding different exchange bands…it’s the same thing, really) the parallel rate will drop further as people see arbitrage value in buying dollars at a lower price and selling them higher. However if the Vz Econ team make a SNAFU of plans and the new devaluation system brings no extra flexibility to the exchange rate, the VEF parallel rate will certainly float back up to 7:1 and probably go higher still.


*“Hey, don’t you have a grandmother?”, an expression that says ” grandmothers kiss you and love you, but it seems like you have to love yourself, so presumably you don’t have a grandmother to do all that for you”

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