Currency Devaluation and Development

Venezuela's currency, the bolivar.

Venezuela’s currency, the bolivar.

The government of Venezuela last week cut the value of its currency, the bolivar, by 32 percent against the U.S. dollar. The move, intended to boost the economy’s sluggish performance, was the fifth devaluation by Hugo Chavez’s government since 2003.

Governments usually devalue their currency in an effort to address balance of trade disparities. Because most commodities (including Venezuela’s primary export, oil) are priced in U.S. dollars, devaluing the local currency boosts exports and cuts imports. A country that exports more and imports less will experience an improvement in their balance of trade and a reduction of their trade deficit.

But will it work? Devaluation generally works best when the country is exporting commodities for which there is steady demand and importing luxury goods. Countries which depend heavily on imports for basic commodities like food or gasoline will often not benefit from devaluation, because in the relative increase in the cost of imports offsets any increase in exports. This was the case, for example, when Rwanda devaluated the Rwandan franc in 1993. Because Rwanda exported primarily coffee (for which there was already excessive supply) and imported foodstuffs, devaluation of the Rwandan franc failed to result in any real improvement in the economic situation in the country. Venezuela, on the other hand, exports primarily oil and imports primarily machinery and construction materials, suggesting devaluation may have a positive effect.

But Venezuela also faces some real challenges. The Venezuelan bolivar was already trading at four times the official exchange rate on the parallel market, suggesting that even with the recent devaluation it remains overvalued. And price controls have left many basic consumer commodities in short supply. Still, Venezuela is in far better straits than Zimbabwe, which last week reported that the country had just $217 (yes, that’s $217.00, not $217 million, or even $217 billion) in its coffers.

What do you think? Will Venezuela’s devaluation of the bolivar help turn the country around? Or is it too little, too late? Take the poll or leave a comment below and let us know what you think.

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