Is Dollarization a Solution for Venezuela?

By: Guest Contributor - Mar 18, 2015, 11:11 am

Bolívar No Longer Credible

By Luis Espinosa Goded

A “healthy” currency does not guarantee a prosperous economy. However, an unhealthy currency does, in fact, guarantee a poor and dysfunctional one.

The monetary system is only the foundation on which an economic system is built. Despite all the attention that economists devote to it based on its importance and complexity, the monetary system should not be our primary focus. We should be able to take for granted that the currency we use serves as a medium of exchange, unit of account, and store of value.

Venezuela, unfortunately, is in a desperate situation. The country uses a currency that has little value, since it is “managed” by the regime and the government has tried to generate revenue through devaluation. This means the central government has diminished the purchasing power of all citizens who use the currency, in order to finance its exorbitant spending and inefficiency.

Without mincing words, the Venezuelan bolívar has no value, because the government devalued it. In other words, the regime depreciated, degraded, distorted, and corrupted it.

It should be abundantly clear what it really means to “devalue” a currency, even though many economists who get lost in “sophisticated” arguments and continue to defend it as a good economic policy.

Money is an institution. It is an agreement generally accepted within a society as to what is acceptable as a means of payment, such as a debt cancellation. And the bolívar no longer has any credibility in Venezuelan society. The government must be prevented from continuing to “manage monetary policy” by devaluing the bolívar.

Therefore, the best alternative that Venezuela currently faces is to adopt a credible currency with significant value. The US dollar is internationally accepted as a means of payment, recognized as a common unit of account, and (more or less) retains its value in an acceptable manner.

The US dollar is far from an ideal currency. I am well aware of the serious problems it has. But perfect is the enemy of the good, and the ideal is impossible and unattainable. Adopting the dollar is a feasible solution, as the economies of Ecuador, Panama, and El Salvador can demonstrate.

Therefore, the best monetary alternative that Venezuela has is to allow its citizens to use the dollar as a means of payment. Give Venezuelan society the freedom to choose which institution to adopt as currency, and their monetary situation will significantly improve.

Unfortunately, the currency is just one of the many problems that Venezuela faces, but it is at least a step in the right direction: the path toward freedom and reliable institutions.

Luis Espinosa Goded is an economics professor at the San Francisco University of Quito and a PhD candidate in the Austrian school of economics. A native of Madrid, he is a liberal and an advocate of the ideas of liberty and prosperity. Follow @luisesgo.

Dollarization Leaves Venezuela Vulnerable

By Luis Oliveros

EspañolUnbelievably, there is a group of analysts — no renowned economist among them — who have begun a campaign to sell us the benefits of dollarization.

According to them, the dollarization of the Venezuelan economy would have an instant impact on our country, and almost immediately, all of our problems would be over.

Apparently, there is a lack of understanding within this group as to what the consequences of dollarization would actually be for our country.

Among the disadvantages, first is the loss of flexibility in monetary policy, given the mismatch of economic cycles between the issuing country and the dollarized country. This situation could lead to shocks for the dollarized economy.

Moreover, when a country adopts a foreign currency as its legal tender, it sacrifices the seigniorage revenues coming from the primary issuance. Also, by not having a central bank, the country loses the role of lender of last resort, which prevents it from addressing problems of liquidity in the banking system (requires lines of credit with foreign banks).

Furthermore, the financial systems become more vulnerable to external shocks, and the possibility of using the exchange rate as an adjustment variable to face them is eliminated.

Dollarization is far from the solution to the country’s economic problems. It would mean having no options in the face of a crisis, such as a drop in oil prices. With full-on dollarization, there is no exit strategy, no Plan B. Control over monetary and exchange rate policy is completely transferred.

The successful examples of regional nations like Colombia, Chile, Peru, and Uruguay, who overcame inflation and exchange rate instability, demonstrate that with fiscal and monetary order, and strong institutions, an economy can recover without resorting to extreme measures.

Three final questions: If one of our main problems is strong currency restrictions, how can we possibly dollarize given the enormous lack of foreign currency?

If the amount of money in the economy dictates the amount of dollars we need, wouldn’t the monetary adjustment be too large, given Venezuela’s few foreign assets?

And finally, is dollarization consistent with low-quality institutions, such as those in Venezuela, or will dollarization itself generate the institutions we need?

The answers are obvious. Venezuela cannot dollarize.

Luis Oliveros is a Venezuelan economist and university professor, with graduate degrees in Petroleum Policy, International Finance, and Financial Management. Follow @luisoliveros13.