Issue: 

The inflation rate in Venezuela averaged 32.42 percent from 1973 until 2017, reaching an all-time high of 800 percent in December of 2016. Because of deep mistrust of the Bolivar, the greenback has been in circulation in Venezuela since the 2000s. The question is whether Venezuela should formally adopt the greenback officially and renounce the Bolivar as its national currency. Considering the benefits that dollarization can bring, Venezuela should dollarize by adopting the greenback to pull itself out of economic recession, but with carefully planned policies to mitigate the confusion and costs associated with the transition.

Cost:

Protesters of dollarization argue that dollarization relinquishes independent monetary policy, thereby abandoning the option of currency depreciation to boost the exports industry and the Seigniorage revenue, which is equal to the value of the currency minus the cost of physically printing it. However, 95% of Venezuela’s export revenue comes from oil production, and the remaining 5% coming from the manufacturing industry which could benefit from currency depreciation only accounts for 2.5% of $404.1 billion GDP.

Furthermore, the value of Bolivar has recently plummeted to the extent that the official rate of conversion is 710 per US dollar but 3,000 Bolivar per US dollar in the black market in March 2017. In June 2017, the rate has even reached 7,980 Bolivar per US dollar. In other words, there is a relatively small cost of dollarization because the value of Bolivar is too low and Venezuela’s export industry is too small to benefit from maintaining its currency. There are also other intangible costs, such as loss of national identity and American encroachment on domestic policies.

 

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Benefit:

Adoption of the Dollar would give credibility to Venezuela’s monetary policy that is conceived to be unpredictable with Bolivar. Politicians in Argentina and Venezuela financed public spending by increasing the money supply indefinitely in the past, which led to a rising inflation rate, and contributed to destabilizing the economy. Dollarization could get rid of such a problem because the independent Fed could implement sound monetary policies that are not subject to the political whims of the administration, and thus effectively stifle the hyperinflation.

Ecuador, likewise, has adopted dollar and abandoned its Sucre in 2000, and the inflation rate in Ecuador did go below five percent in 2004. In addition, dollarization would drastically diminish exchange rate volatility risk and transaction costs. Venezuela would be exposed to less risk in exchange rate volatility by directly using the Dollar to make transactions for petroleum products because they are also denominated in the Dollar. There are also intangible benefits associated with dollarization, such as increased accountability and confidence in doing business in Venezuela as it is now more anchored toward US policy and regulatory norms.

 

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Status as of 2018 November:

In 2018 August, Venezuela issued the new “Bolivar Soberano” currency which is worth 100,000 “old” Bolivars. The rebranded currency will be pegged to a cryptocurrency called the Petro, Venezuela’s cryptocurrency, which is supposed to be anchored to a barrel of oil. Steven Hanke, an applied economist at the Johns Hopkins University called this a facelift, because, in reality, nothing changes. It is simply a makeshift because it has not touched upon the fundamental problem of the Bolivar: it is still a fiat currency backed by the dysfunctional Venezuelan government and economy, which are not trusted.

Policy Recommendation:

In the short term, the loss of independent monetary policy in setting the exchange rate and Seigniorage revenue may seem significant. However, in the long run, restoration of credibility in monetary and macroeconomic system, reduction of risk of volatility in exchange rate, and stabilization of inflation greatly outweigh the costs. But in order to minimize the confusion and chaos, it would be wise to set a phase-in period of 5 years as the article mentions, so that the Venezuelans would have enough time to fully prepare for dollarization. At the same time, the Venezuelan government should initiate structural reforms and allow the entrance of new banks to the country to make the economy productive rather than speculative to better deal with the aftermath of dollarization.

 

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