The Bolivar Crisis - Mary Kissel and Steve Hanke on Venezuela's devaluation and how money dies
Mary Kissel Venezuela devalues its currency Turkey's Lira continues to have problems. What sparks these currency crises what happens when money dies and what does it mean for U.S. foreign policy. Welcome to Foreign edition. I'm Mary Kissel with The Wall Street Journal editorial board here in New York City and I am very pleased to welcome a special guest today Steve hankie professor of applied economics at the Johns Hopkins University and director of the troubled currency project at the Cato Institute. He is the author of many many books op ed's for us and other publications and has advised multiple governments on currency policy. He is. Ladies and gentlemen the world's expert on currency crises. So Steve welcome to the show.
Marion it's wonderful to be with you.
Let's start just by talking about Venezuela where dictator Nicolas Maduro rolled out his latest economic reform plan and I'll put that in quotes earlier this week the Senate price of which was a giant devaluation of the local currency called the bolívar in the launch of a new currency called the quote sovereign Bolívar. Steve what is the thinking if there is thinking behind this devaluation and how is it supposed to work.
When a country hyper in plates marry the monthly inflation rate exceeds 50 percent per month. So in Venezuela today I use high frequency data to measure the inflation rate both on a monthly and annual basis and today the monthly rate is one hundred and thirty seven percent and the annual rate is fifty one thousand eight hundred and thirty six percent. So Venezuela is hyper inflating. That's a rather rare thing in history. There's only been fifty eight hyperinflation in world history. And Venezuela out of the 58. It comes a. about number 23. So it's it's kind of a modest one but but it's still very nasty.
So what happens with these things is that you end up with what I call a wheelbarrow problem and that is to buy a hotdog. You have to take a wheelbarrow full of bolivars and to the end of the shop in that shop won't even count the bolívar as a way them and see if you have roughly enough to buy the hotdog so as it is a result of that wheelbarrow problem you have to read to nominate the currencies you have to take it you have to exchange your old Bolívar for in this case. Sovereign bully bars and it required a hundred thousand old bully bars to be exchanged for one sovereign Bolívar. So that was the that was the so-called reform plan. The essence of it is it is taking zeros off in this case five zeros were removed from the old Bolivar.
And now we have the sovereign Bolivar so the currency that good currency is basically becoming more and more worthless by the day. Therefore prices are going up because it's going to cost you more of those devalued boulevards to buy the same asset. But Steve just by cutting zeros off that doesn't change the underlying economic fundamentals. Has there ever been a case where cutting zeros off has actually ended or fixed that hyper inflation.
No. You have to do something more than the cosmetic kind of change that you've talked about. Maria it would be the same thing if you want to end a plastic surgeon today and had a facelift.
You might look a little different than you do today but nothing would really change. It's still going down. It's still it's still going down now in the case of I can give you some examples of this.
And the world's hyper inflation record was in July of 1946 in Hungary.
And the panko was the currency at that time and it was exchanged for the fora which is a currency now used in Hungary and that and during that exchange of Pangaea for Florent they took twenty nine zeros off of the thing in Yugoslavia where I was actually the chief advisor to the Markovic government on when communism fell. They wanted to reform the economy and the currency and everything else. And they brought man from 1990 until the civil war started there. I was in Belgrade observing what was going on and they had experienced 20 years of inflation prior to 1990 in which the inflation rate average average was 79 percent per year in Yugoslavia. So they did just exactly what Madeira did in Venezuela and in January of 1990 against my advice by the way totally against my advice. They did a so-called currency reform in which they introduced what they called a convertible dinar and they took four zeros off at the time. By the time 1994 rolled around they'd taken twenty seven zeros off and they'd done five of these so-called reforms renaming the currency read nominating and so forth. It didn't do a thing. They didn't change the monetary regime and the rules of the game and the inflation rate in January of 1994 and Yugoslavia was three hundred and thirteen million per cent per month on month.
People people can't live under those conditions Steve. My my understanding in Venezuela and please correct me if I'm wrong is that the Venezuelans have both a monetary and a fiscal problem because the prior government the Chavez government and the current government the Maduro government spent way beyond their means. They thought the oil price was going to stay high forever. So they they expanded the social welfare state took on a lot of debt. And on the monetary side of course inflation is always and everywhere a monetary phenomenon. We know that from Milton Friedman. They they simply printed too much currency they've devalued the currency.
What say you to that analysis.
Well I say you're right. I agree with that. I would add a couple of points and that is the hyper inflation. Milton Friedman of course is exactly right. Inflation is always a monetary phenomenon. But you'd have to look at how why why the printing press the term gets turned on. And ultimately it's always a really a fiscal problem because the government spends money and they don't have adequate financing sources. In other words in this case the tax base is drying up the international bond market is cut off the domestic bond market is cut off so they can't borrow to fund the physical. They can't borrow from anyone except the central bank. So they go to the central bank and they say we've got some wonderful paper we want to sell you. And the governor of the central bank says of course it early looks great. And he turns on the printing press and at the extreme this is what this is what's going on in Venezuela. But again at the extreme. And I observed this very carefully in Yugoslavia and by the end in January of 1994. Inflation 313 million percent a month. Ninety five percent of all Yugoslav government expenditures were being financed by the Central Bank and the printing press. 95 percent. So we're not talking about a small five or six percent and these hyperinflation. You're talking about huge chunks of the government expenditure that discredit the central bank.
You know Steve it reminds me of that classic history of Adam Ferguson when money dies Dick chronicled the German currency crisis of 1923 I believe in what I took away from that book was not just the mechanics of how money dies which you've just described to us in Venezuela's case but also the human toll in people just unable to buy basic goods.
Elderly people with their savings just completely inflated away a lifetime of work young people unable to find work because the economy of course collapses when money dies.
And you see this again again today in Venezuela well you really can see it Mary when you look at the money dies aspect of the thing you've got at least four or five million Venezuelans have emigrated out of the country because they're literally starving. And that's one aspect of the problem. Now they're creating so much trouble. And Brazil and Colombia Ecuador that they're shutting the borders so so these poor people are like they're trapped in a cage. And Emma and money is dying on them. So it's just a terrible situation from a human point of view.
We're talking about Venezuela currency crises. And when money dies and you're listening to foreign edition from the Wall Street Journal The Wall Street Journal podcast are brought to you by Trunk Club when it's time to work.
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From the opinion pages of The Wall Street Journal. This is for an edition. Now. Mary Kissel.
Welcome back to foreign edition Mary Kissel here in News Corp headquarters in the middle of New York City and I'm on with Johns Hopkins economics professor Steve hanky the world's expert in currency crises Steve. We were just talking about the problems in Venezuela. The bolívar on its deathbed. But we also have currency crises in Iran with the real and Turkey with the lira. Is there a chance here that we'll see contagion a global panic or these crises really confined to these nations borders.
It's a little bit hard obviously to predict that contagion. But Venezuela is a special case. So I think I would take that on kind of off the table though the ones that are of concern are we earlier this year we we've had a big plunge in the peso in Argentina and Turkey.
We've had a plunge in the Turkish lira. Both of those things have lost about 38 percent of their value this year. Then South Africa we're down about 15 percent Russia is down about 14 percent. Even Chile is down about 8 percent this year.
Now the overall picture is one area in which the U.S. dollar is is very strong right now. And the most important price in the world is the dollar euro rate. Why is that. STEVE Well the dollar euro rate today is and I'm looking at the we're at one point six right now in real time.
And my comfort zone is for that rate is about 120 to 140.
Why do you look at that rate specifically Steve for listeners who might not follow currency markets.
Well if you don't follow the currency market you have to realize that everything most things are actually priced in dollars. Almost all commodities are priced in dollars. Most of the foreign reserves held by central banks are in dollars. The big payment systems in the world are denominated in dollars. The dollar is the international currency. And by the way there they're always up we go back twenty five hundred years you find there always was one international currency through all history. Their average lifespans are about three hundred years. But at any rate the dollar right now is the international currency. And the second currency and importance is zero. So that rate between the dollar and the euro happens to be very important. That's a very important price. And right now that with the with the the the US dollar at one point six. It's it's strong. It's it's lower than the one to 20. Right.
If it were a few years ago it was weak as it was over the 140.
So with the dollar strengthening that means that countries like Turkey that have borrowed a lot of money in dollars and overextended themselves and now see their local currencies falling in value versus the dollar that makes it harder for them to pay back those debts. That's a bad cycle to get into.
You put your finger exactly on the nub of the problem and that is that once the dollar gets strong and in my view overly strong because I think the Fed is overly I'd actually right now and that's indicated also by the price of gold my comfort zone for gold is is about twelve hundred dollars to fourteen hundred dollars an ounce and today it actually dropped a little below twelve hundred a few days ago.
Now it's slightly over twelve hundred so that that indicates da strength. Gold.
Gold price weakness you see in dollar terms and what happens is you say you've got the debt burden on these emerging market countries goes up and up and up and it becomes more difficult on them and also capital starts flowing out of those emerging market countries on their currencies get weak.
And that brings by the way local inflation to the countries that are experiencing currency weakness and human misery and suffering and potentially potential instability that does create a foreign policy challenge for the United States Venezuela being the most obvious in our hemisphere just a couple of hours flight from Miami and also the source of what I would expect to see major refugee flows as people try to flee. They'll they'll be the next boat people. STEVE It's interesting though when all those countries that you named it's the same fundamental problem. It's fiscal overreach and or government overreach. In the case of Turkey for instance or on building bridges and roads and promising social welfare spending in South Africa. The leaders there of the ANC threatening to expropriate private property kind of arbitrarily sending foreign investment fleeing. So you know that the the individual causes may be different but the underlying themes are exactly the same.
And the thing is back to your point in question that you raised you said Well is there a possibility for contagion. I said it's a little bit hard to predict. However we're in kind of a vulnerable zone once once a dollar gets a little bit out of balance and relationship to the euro and gold and Amazon is very strong. You have a situation where OK we've had we've had problems in Argentina. We've had problems in Turkey.
And then when you go on down the line. And isn't it going to be one of these things that pops up. That is the straw that breaks the camel's back and you just never quite know. You know see right now it's been contained but we don't really know.
Well you know we published an editorial here at the Wall Street Journal a couple of weeks ago about Iran and actually maybe Iran is the exception to my hypothesis because Iran's currency troubles are a direct result I believe not just of the corruption and economic mismanagement of the regime in Tehran which is undeniable large swaths of it are controlled by the Islamic Revolutionary Guard Corps it's a classic case of kind of a criminal syndicate running a country and we're having control over it. Think about you know Suharto's Indonesia but U.S. sanctions have also played a role there and sparked that withdrawal from the real into the dollar correct.
Well yes the sanctions have. And speaking of the you've got the internal criminal element or Mafioso type thing or the Revolutionary Guard as well as not forget the religious foundations are exactly the same thing as a result that the private sector is very tiny in Iran it's been squeezed down since the revolution of 1979. So so everything is vulnerable. Everything is mismanaged there oh there's a tremendous amount of corruption if not criminality. And when you put the sanctions on that does tighten the noose there's something called the Afghan effect. This is Bob Mandela's observation in 1980 the Soviets and Japan had invaded Afghanistan President Jimmy Carter was in office in the White House and its national security adviser was Brzezinski and Brzezinski advised that we should weaponize food and to do that and we end to punish the Soviets and the weaponization was as follows.
We would prohibit the export of U.S. grain to the Soviet Union. And as a result of that we we have the Afghan effect that Mandela observed and the Afghan effect is if you put sanctions on somebody if you're beating somebody with a stick. What's the recipient of that beating want to do. They want to escape and they escape. In this case in Afghanistan and Afghanistan the Soviets escaped the grain embargo by going to Argentina and buying grain at a very good price. It was a very good deal for the Argentines farmers it was a good deal for the Soviets. It was a very bad deal for American farmers. And on top of that it was a very good deal for remember the hunt. The hunt was in power then the bad guys were in power and and they were they were flooded with foreign reserves as a result of these grain sales and the economy boomed. So that's the Afghan effect. Everything is connected to everything else. You put sanctions on somebody. They try to escape. So in Iran back there and in the current day the Afghan effect is that you put sanctions on. And and what does it do. They try to escape. And the escape routes are all manned by international criminal organizations. So so these routes are spawning and generating huge profits for the international mafias that run the channels. It also has geopolitical implications and that is obviously the Iranians go from the prohibited suppliers of things like total the big French oil company that was done in the in the south part of southern part of Iran and the gas field and now they're prohibited from being there or they have decided they wanted to avoid secondary sanctions by the United States. So they got out and who. Who fills a vacuum.
China right. And there are still more sanctions to come in the coming weeks. That was just the fall in the real happened after in anticipation rather of the first tranche of reimposed sanctions. So the messages sanctions may have many unintended consequences. And we should be on the lookout for contagion perhaps as money dies in Venezuela and elsewhere. That's it for foreign edition today. On behalf of Steve hanky and me Mary Kissel thanks for listening.