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On Venezuela’s Death Spiral

Steve H. Hanke

With the arrival of President Hugo Chávez in 1999,
Venezuela embraced Chavismo, a form of Andean socialism. In 2013,
Chávez met the Grim Reaper, and Nicolás Maduro
assumed Chávez’ mantle.

The Grim Reaper has also taken scythe to the
Venezuelan bolivar.
The death of the bolivar is depicted in the
following chart. A bolivar is worthless.

The fall in the value of the Venezuelan bolivar

With the collapse of a currency comes inflation. By the time
President Nicolás Maduro arrived, inflation was in triple
digits and rising.

It’s time for
enlightened, practical politicians in Venezuela to embrace the
dollarization idea. The public already does.

With the acceleration of inflation, the Banco Central de
Venezuela (BCV) became an unreliable source of inflation data.
Indeed, from December 2014 until January 2016, the BCV did not
report inflation statistics. To remedy this problem, the Johns
Hopkins-Cato Institute Troubled Currencies Project
, which I
direct, began to measure inflation in 2013.

The most important price in an economy is the exchange rate
between the local currency and the world’s reserve currency —
the U.S. dollar. As long as there is an active black market (read:
free market) for currency and the black market data are available,
changes in the black market exchange rate can be reliably
transformed into accurate estimates of countrywide inflation rates.
The economic principle of Purchasing Power Parity (PPP) allows for
this transformation.

I compute the implied annual inflation rate on a daily basis by
using PPP to translate changes in the VEF/USD exchange rate into an
annual inflation rate. The chart below shows the course of that
annual rate, which peaked at 800% (yr/yr) in the summer of 2015. At
present, Venezuela’s annual inflation rate is 150%, one of the
highest in the world (see the chart below).

Venezuela’s annual inflation rates

To stop Venezuela’s death spiral, it must dump the bolivar
and adopt the greenback. This is called
“dollarization.” It is a proven elixir. I know because
I operated as a State Counselor in Montenegro when it dumped
the worthless Yugoslav dinar in 1999 and replaced it with the
Deutsche mark. I also watched the successful dollarization of
Ecuador in 2001, when I was operating as an adviser to the Minister of Economy and

Countries that are officially dollarized produce lower, less
variable inflation rates and higher, more stable economic growth
rates than comparable countries with central banks that issue
domestic currencies. Dollarization is, therefore, desirable. The
chart below shows the normalized values of real GDP in terms of
U.S. dollars between 2001 (index value = 100) and 2016 for nine
Latin American countries. Three — Panama, Ecuador, and El
Salvador — are officially dollarized, while Peru is
semi-officially dollarized (read: both the Peruvian sol and USD are
legal tender). In the three officially dollarized countries, real
GDP growth has been more stable than and generally superior to
growth in the countries that issue their own domestic

Dollarized vs. Undollarized Latin American GDPs

So, not all the news from Venezuela is grim. After all, there is
a tried and true way to stabilize the economy, which is a necessary
condition required before the massive task of life-giving reforms
can begin. It is dollarization.

Just what does the Venezuelan public think of the dollarization
idea? To answer that question, a professional survey of public
opinion on the topic was recently conducted by Datincorp in
Caracas. The results are encouraging. Sixty-two (62%) of the public favors
It’s time for enlightened, practical politicians
in Venezuela to embrace the dollarization idea. The public already

Steve Hanke is
a professor of applied economics at The Johns Hopkins University
and a senior fellow at the Cato Institute.