Venezuela currency controls: Breakdown

Grafica Dolar Paralelo

Squint and you may be able to spot the trend

Venezuela has had currency controls since 2003. Today, the official exchange rate is frozen at 4.3 bolivars to the dollar, while the going rate for a dollar in free-market trading is now 8 bolivars. That means that for people who are trading on the free market, the bolivar has lost 30 percent of its value this year. For people who manage to squeeze out a few dollars from the Central Bank, these scarce sheets of green paper still cost just 4.3, or 2.6 for the luckiest duckies in the medical and food industries. Exchange control ceased long ago to function except as a means of government control; at this point, they conceal, rather than prevent, capital flight and hot money.

The real reason that Venezuela implemented a fixed exchange rate is up for debate, as the founding document (PDF, Spanish) has no “whereas” clauses explaining the reasoning. However, the goal was apparently to reduce capital flight after PDVSA and other companies walked out and collapsed the country’s economy in late 2002 and early 2003. There was also a preexisting push throughout the developing world for capital controls to moderate the surges of investment and divestment, known as hot money, that contributed to financial crises including the Asian and Mexican crises in the 1990s.

Today, the problems of capital flight and hot money have seized Venezuela as never before, this time through the mechanism of the parallel market. And there are rumors now that the government will try to shut down the parallel market as well, giving it more control over the commercial life of the country while forcing capital flight and hot money ever further underground.

Venezuelans, eager for dollars, have always been willing to pay a premium for foreign currency when they haven’t been able to score their greenbacks through official channels. That is to say, when the government offered 2.15 bolivars per dollar at the official exchange rate, people often paid 5. Now that the official rate is 4.3, people are paying 8. The chart above shows the going rate in the parallel market.

Legally, people play the parallel market by buying Venezuelan government and PDVSA bonds that can be traded in either bolivars or dollars. They buy them in one currency and sell them in the other. The ratio of market prices for the bonds in each currency works out to an implicit exchange rate — if a $1000 bond sells for $500 in New York and 500 bolivars in Caracas, that means the implicit exchange rate is 1:1. If it sells for $500 in New York and 5000 bolivars in Caracas, the implicit exchange rate is 10:1. Got it? Quiz in the morning…

That said, this market is a bit of a joke. The reality of the situation is that brokers make large cash transactions of bolivars and dollars through a bidding system, skimming a commission off each trade — the same as any other currency market; they then write up receipts for all these supposed bond transactions, even though no one in the market really wants to end up with the oft-traded bonds. For years, market participants have said that the daily trades are around $100 million. With about 200 business days a year, that adds up to around $20 billion a year — about 5.5% of GDP (measured on a purchasing power parity basis as recorded in the CIA World Factbook).

The collapse of the bolivar this year has happened faster than almost anyone expected. Once upon a time — March 11 — Barclay’s went out on a limb with a call that the bolivar may sink as low as 9 to the dollar. According to ye olde trader blog, the bolivar was at 6.85 that day; it has gone more than half of the way to 9 in less than two months.

To get a sense of just how big a move this is, look at a few other currencies against the dollar in the period of March 9 to May 5, which includes several recent days of unusual currency volatility because of some worries about Greece. All currencies are quoted from Yahoo in how many units of foreign currency you need to buy each $US:

Euro weakens 5% from 0.7353 to 0.7718
Yen weakens 5% from 89.9038 to 94.82
GB Pound strengthens 1% from 0.6668 to 0.6608
Canadian dollar weakens less than 1% from 1.0253 to 1.03
Chile peso strengthens marginally from 519.2108 to 522.95

I could go on but I think you get the point. Currencies just don’t move like the bolivar. Someone with a few bolivars to trade who bought dollars at the beginning of March has beaten not only most other currency speculators, but also the 5% rise in the Dow Jones Industrial Average, and similar increases in the S&P 500 or the Nasdaq. It’s been a great investment, assuming the person will ever again need bolivars — for payroll, to pay worker termination benefits, or whatever. The currency rise easily outpaced Venezuelan inflation.

For the richest Venezuelans, this is a great chance for speculation. It is easy and safe to put money into a certificate of deposit at Bank of America and get a few bucks in interest while gaining 13% on the currency in two months. That means that the money isn’t being invested in Venezuela. Hence, 35-year-old accountants live with their parents (and I swear, I wrote this sentence two days before Caracas Chronicles posted their item) for lack of investment in new housing. Why would a rich Venezuelan build homes, given the risk of having her wealth disappear to a nationalization or squatter camp, when great returns are a phone call away? And the same goes for everything: there’s a brew pub in Havana, but none in Caracas. Go anywhere in the world, you’ll find enough commercial competition that people stop going to places with crappy service, and the stores go out of business. In Venezuela? Not so much. As long as people can get inflation-beating returns by putting their bolivars into an insured certificate of deposit in the USA, why invest in the Bolivarian Republic?

Not only that, but there is even some hot money at play. Traders say that most Venezuelans are always moving their money out of the country; only a few multinationals buy bolivars for payroll, and then there’s this mysterious feed to the market, apparently from PDVSA. But I know at least one wealthy Venezuelan who had inside information that the parallel bolivar would strengthen a couple years ago, and bought a bunch of bolivars at 5,000 or 6,000 to the dollar (this was before we lost three zeroes) and was able to trade back to dollars a couple months later at 3,200. Easy money, and very much of it. It would be very hard to figure out if anyone is currently accumulating bolivars for 12 cents apiece in the expectation of selling them for twice that in a few months, but if the government is planning any interventions, it’s awfully likely that this is happening.

There is little the government can do to halt these games. It has already imposed capital and currency controls. It has forbidden domestic news organizations from publishing the parallel exchange rate. It would need to cancel either the dollar or bolivar trading of its international bonds to halt the parallel market, and neither is likely. Canceling foreign-traded debt would mean no more access to international capital markets, just as the country tries to finance more than $100 billion in oil and gas projects over the next eight years. Halting Venezuelan trading — and there are rumors afoot that this is the plan — would end the supply of parallel dollars for importers of everything from olives to I-zods. Importers would immediately turn to the flatly illegal, but already sizeable, black market; this would mostly serve to give huge profits to the black market brokers who tend to charge commissions about three times larger than formal swap brokers.

Calling Professor Stiglitz!

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3 Comments

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3 responses to “Venezuela currency controls: Breakdown

  1. I sort of feel you missed the thick of the parallel market action in this post, though, Setty. The real action isn’t in “speculation” – the big bucks are in ARBITRAGE!

    Speculation is risky, arbitrage is riskless. The real fortunes are being amassed here by people with the connections to buy dollars in one market and sell it in another. Riskless. Instantaneous. And, with enough leverage, almost limitlessly profitable.

    The point is that the key qualification for making the really BIG bucks – the arbitrage bucks – is not having capital, but having political connections. If you’re able to leverage your relationships into a “cupo” on the BCV’s misnamed “auctions” at Bs.5:$ and then can turn around and re-sell at the parallel rate, you don’t even need money to begin with. Cuz you can always borrow the bolivars for the deal. And if you have access to Bs.2.60 dollars, all the more!

    We need to keep our eye on the ball. The key commodity for participating in this bonanza isn’t really money. It’s access. That’s how you get your hands on the pot at the end of the rainbow. Access. Money you can borrow. Access, as the ad says, is priceless.

  2. Yeah, that’s all true. In fact, in order to speculate, you basically need inside info, so it’s still fundamentally about access.

  3. Saule

    Unless you make US dollars and sell them at black market price :)