Venezuela is preparing for the debut of a new currency. On January 1, 2008, the ‘strong Bolivar’ will substitute for the current Bolivar, although businesses have already started to get ready for the conversion, which involves removing three zeroes from the current Bolivar. According to Juan Carlos Martínez Lázaro, a professor at the Instituto de Empresa (IE) business school in Spain, this initiative involves “adopting a new monetary scale for all prices, salaries, pensions and taxes.”  From October on, businesses will have to display the prices of their goods and services in both currencies. “Something similar to this occurred for months with the euro before it was introduced on January 1, 2002,” Martínez Lázaro adds. Although the new currency, the ‘strong Bolivar,’ becomes official on January 1, 2008, the two currencies will co-exist in the interim.


Whenever a monetary unit loses so much value relative to major currencies such as the euro and dollar, it makes daily economic transactions more difficult, says Martínez Lázaro. It also feeds inflation. The idea behind the new plan is to simplify transactions and deal with inflation “because when a currency doesn’t have any value, prices rise more than they would normally rise if the monetary units were large.”


Venezuelan Jaime Sabal, a professor of corporate finance at ESADE who left his homeland four years ago because he disagreed with the current government of populist Hugo Chávez, believes that this measure makes a lot of sense. “For many years, and this is not the responsibility of the government, Venezuela has had very high levels of inflation. There comes a time when the numbers are unmanageable; a million Bolivars means nothing now. Everything has a lot of zeroes, and you begin to lose any sense of how much things are worth.”


A Chronic Evil


Inflation is a problem in Venezuela because its public finances are not in order, Sabal says. “The government has always spent more than it takes in. It devalues the currency in order to finance its spending. The central government has always been very strong, and there has been no other way it could control it [inflation].” Martínez Lázaro agrees, adding that inflation has been a chronic problem for more than 25 years. From 1998 through 2006, the cumulative rate of inflation was 440%. “There were years during the 1990s when the inflation rate was above 100%. This problem is deeply intertwined with the Venezuelan economy, and it has a lot to do with income derived from the oil industry.” Currently, Venezuela is ranked eighth among the world’s petroleum exporters. Last year, its oil revenues exceeded $45 billion.


According to Sabal, the situation has worsened since Chávez took office. The Venezuelan economy, he notes, “has always been very dependent on petroleum which is in the hands of the State. Over the years this dependence has increased.” With the rise in oil prices, the government’s earnings from oil have become astronomical. “And they have spent it. They have injected that money into the economy for what some people consider social measures but others consider wasteful. What’s clear is that there haven’t been any controls on how the government used that money.” The result has been a stronger acceleration of inflation. The government “is very autocratic, almost dictatorial, and there is no one who can control it. A balance of powers doesn’t really exist. The government feels free to do what it wants and to spend in a way that is out of control,” he says.


Sabal believes that this measure, if isolated, could be justifiable. However, to succeed, it would have been necessary to balance the economy beforehand. “You have to have an inflation rate that is moderate, with public spending that is controlled and everything balanced. But this hasn’t happened.” As a result, Sabal doesn’t believe that Venezuela will ultimately be able to control inflation. The government is “going to make the monetary conversion and, soon after that, prices are going to continue to rise.” Martínez Lázaro is equally skeptical about the success of this measure beyond its initial psychological impact. “Everything makes me believe that prices are going to continue to rise and that we’ll watch the ‘strong Bolivar’ lose its purchasing power relative to other currencies.”


According to Martínez Lázaro, when governments take these sorts of measures, they are usually accompanied by restrictive monetary and fiscal policies, or they occur during periods of economic depression. In this case, however, the Venezuelan government will continue to apply its expansionist public spending policies after the new currency goes into effect on January 1. Although the government has reduced its value-added tax by five percentage points (from 14% to 9%), Martinez Lázaro does not foresee good things for the Venezuelan government’s crusade to control inflation.


This year, the government’s goal is a 12% rise in the consumer price index, compared with 17% in 2006. By the end of this year, Martínez Lázaro believes that the inflation rate for all of 2007 could be about 14%, given that it reached a cumulative rate of 10.9% through September. Nevertheless, Martínez Lázaro notes that “the government has created a very bad precedent by lowering taxes in order to control inflation. What can happen if inflation continues to rise and they continue to lower taxes? Ultimately, you wind up being unable to collect indirect taxes. The result accentuates the trend toward high dependence on petroleum. If the price of petroleum were to drop at some point, the Venezuelan government’s tax revenues would continue along the same road.”


D. Richard Obuchi of Venezuela’s IESA business school doesn’t believe that the country will achieve its official goal of 12% and that there will be a substantial reduction of inflation next year. “In the short term … this measure freezes prices. But soon after, products with controlled prices begin to become scarce or begin to be traded on the black market. That will have a negative effect on the economy and on consumers.” In this sense, he says, “you can anticipate that the inflation problem will persist until the government takes structural measures that enable it to stop inflation, rather than measures that are related to the current moment and the exchange rate.”


Sabal says that some people “maliciously” believe that after the monetary conversion, there will be an attempt to disguise what is, in effect, devaluation. Currently, he notes, “the government sets the exchange rate at about 2,500 Bolivars to the dollar. However, there is a free, parallel market where the exchange rate is above 5,000 Bolivars to the dollar. That is more than double the official rate.” Sabal predicts that the exchange rate will have to be devalued in order to get closer to the market exchange rate. “A devaluation from 2,500 to 5,000 [Bolivars to the dollar] is very disturbing. There are people who believe that when the exchange rate is 2.5 [to the dollar], it will be much easier to devalue without having people notice it so much. I don’t know if that is true or not; it is purely speculation.”


For all that, Sabal is certain that public spending is excessive and out of control. He compares the current government to a person who wins the lottery and, because he is uneducated, it doesn’t occur to him to save that money, only to spend it. Sabal does not believe that the monetary conversion will lead to a confrontation between the government and the opposition because, among other reasons, the opposition has been greatly weakened.


The New Constitution


The strength of the opposition will be put to a test in a referendum on constitutional reform in December. Chávez presented his plan to the Congress in August. From an economic point of view, the text will eliminate the autonomy of the Central Bank of Venezuela (BCV) and reduce the work day to a maximum of six hours. The new constitution also prohibits large landholdings and monopolies.


According to Martínez Lazaro, “All of Chávez’s economic logic runs counter to the commonsensical practices that are being applied lately.” Doing away with the formal independence of the Central Bank is simply a way of formalizing an already acknowledged fact. In 2003, Chávez got his fingers burned by the Central Bank’s opposition to foreign exchange controls when a strike in oil industry tested the Venezuelan economy and its president. By approving the new constitution, Chávez guarantees that this doesn’t ever happen again.


Nowadays, Martínez Lázaro says, “It has been shown that when you provide independence to your Central Bank and make it autonomous, that has a very positive impact on growth over the medium term. We can see this happening everywhere.” What Chavez wants, he adds, is precisely the opposite. He wants the Central Bank to subordinate its own interests and embody the new constitution. “What is that going to accomplish? You are going to continue to feed inflation and increase liquidity, precisely the goals that you should not be pursuing.”


Obuchi believes that while it does not appear likely in the short term that the government intends to use the Central Bank to finance expenditures, the government could try to finance spending through devaluations and by using the financial resources of the Central Bank. That is likely only if conditions become adverse, perhaps because of a fall in petroleum revenues. “The government would have powerful incentives to stimulate short-term growth through increases in the money supply. If the Central Bank is not autonomous, the government would have total freedom to carry out short-term and medium-term policies that could generate even more inflation.”


Martínez Lázaro, for his part, does not believe that it makes any sense to reduce working hours. Nowadays, he notes, people are trying to work more [not less] in order to improve their productivity and compete with emerging countries in Asia and elsewhere. In France, limiting the workweek to 35 hours has been a failure because it did not generate more employment or result in higher economic growth. Sabal agrees with Martínez Lázaro that productivity rates in Venezuela are not high. “It’s not because people don’t work hard, which they do, but because they don’t have an infrastructure for production. So now they are going to work fewer hours? This is an act of demagoguery from a demagogic government that survives by trying to get the support of the population.”


For Obuchi, reducing the work day is a measure that is going to make labor relatively more expensive. “To produce the same quantity of products,” he says, “it becomes necessary to organize production in a different way that could be more costly. Under these conditions, it is possible that businesspeople will decide to substitute capital for labor, in the form of more efficient machinery and processes. In the medium and long term, this could generate unemployment, increase labor costs, and lead to higher consumer prices and the unequal distribution of benefits.


On the other hand, Martínez Lázaro notes that Chávez can enact this constitutional law because the country’s petroleum revenues are so high. Still, this is not the way to make such a reform, he adds. “When all is said and done, an economy has to be more productive because that’s how you improve the standard of living. You don’t raise living standards by enacting a legal decree or by working fewer hours. The only thing you achieve is that the economy continues to be subsidized by income from petroleum. As long as the price of oil is about $80 dollars [a barrel], everything will be okay but the only thing that you are going to achieve is to reduce your production of goods and services. Ultimately, over the long run, the Venezuelan economy is going to pay a very high price.”


The two new measures take Venezuela in the opposite direction from what is happening in neighboring countries. “It is amazing how Brazil has managed to fight inflation more effectively and reduce its interest rates ever since its Central Bank has been independent,” notes Martínez Lázaro. He also praises Mexico’s skill at reducing its dependence on the oil sector. “Venezuela is living in a dream world but when it wakes up, the reality is going to be harsh.”


According to Obuchi, although Venezuela has experienced high rates of economic growth over the last three years, there has not been any equivalent increase in investment or in the country’s productive capacity. “In large part, this can be explained by the regulatory and political uncertainty that stems from various announcements by the government that it intends to gradually abandon capitalism and replace it with a socialist-style economy.”


What do Venezuela and its business sector think of the new constitution? Sabal says that “People in Venezuela don’t know what is going to happen. One scenario is that the country will become quasi-communist. Already, private companies are less and less important. There are almost no big private companies of importance. The few that did exist have been nationalized and the private sector is becoming merely small companies who service the government.” In addition, the few important businesspeople who did exist have emigrated, establishing themselves mostly in Colombia and the U.S. Those multinationals that had a presence in Venezuela have also been moving out. “The country is becoming practically a state-run economy,” he notes.


The people of Venezuela have until December to decide if the new text of the constitution should substitute for the constitution that Chávez enacted during the second year of his administration but which is now branded as capitalist. According to a survey Sabal has received from Venezuela, 60% of the people are opposed to the new socialist-style constitution, which would permit the president to be reelected indefinitely. Despite such opposition, Sabal believes that the plan will move ahead with the support of about 70% of the people in the referendum. That’s because the electoral apparatus is controlled by the government. “They are trying to win it the correct way, but if they see that they are losing, they will win nevertheless. That’s why a lot of people are thinking about not even voting.”


The reasoning behind abstention runs this way: “If they trap you into voting, they are using you. That way, they will be able to tell people, ‘Look, 90% of the voters approved the constitution.’ However, if only 20% or 30% of the people vote, the constitution will be approved with less legitimacy. This is the dilemma we now face. The opposition has yet to decide; whether or not to vote. Even I have not decided what I am going to do,” concludes Sabal.


Chávez became president in December 1998, which means that he will soon complete a full decade at the helm of the country. According to the Central Bank, the GDP of Venezuela registered growth of 8.9% during the second quarter of 2007, compared with the same period last year. The economy grew by nine percent during the first quarter of the year. According a report of the Econolatin Network, the country has had 15 consecutive months of economic growth.