Robert Murphy

Venezuelan President Hugo Chavez has decided to devalue his country's currency and impose price controls. These actions will provide U.S. politicians, economics professors and the public with a textbook demonstration of how bad government policies hurt consumers.

In early January, the Chavez government announced that it was devaluing the Venezuelan currency against the U.S. dollar. The bolivar is on a fixed exchange rate, meaning that the government determines how many U.S. dollars it officially trades for. The official exchange rate had been 2.15 bolivars per dollar, but now the Chavez government will allow international trades at a rate of 4.3 bolivars per dollar.

In and of itself, this devaluation is arguably a good move that will promote economic efficiency. The previous official exchange rate was completely divorced from reality, because the bolivar was trading at a much lower value against the U.S. dollar in the black market.

For various reasons (including national prestige) the Venezuelan government had been overpricing its currency. Before the announcement, it had insisted that one U.S. dollar would only fetch 2.15 bolivars, whereas in reality one U.S. dollar should have been able to purchase double that amount. In this respect, the "devaluation" was an acknowledgement of economic reality. If this were the only change in policy, it would have eased imbalances in the foreign exchange market, and more transactions could have been conducted at the official rates rather than being driven underground by the absurdly overvalued bolivar.

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Unfortunately, the Chavez government didn't make this announcement out of devotion to economic efficiency. Rather, by increasing the number of bolivars that trade for one U.S. dollar, the decision effectively will double the amount of foreign revenue the state-controlled oil company PdVSA will earn.

When Venezuela exports oil to the world market, it receives the world market price -- denominated in U.S. dollars -- for every barrel. These dollar earnings are not affected by the decrees of the Venezuelan government. However, when the dollars are converted back into bolivars to be spent domestically, they are now allowed to fetch twice as many units of the local currency. This consideration seems to be the motivation for Chavez's decision, and indeed PdVSA officials (quoted anonymously) are wondering how much of the windfall they will be allowed to reinvest in the state oil company, and how much the government will spend on other budget priorities.

Robert Murphy

Robert Murphy has a Ph.D. in economics and is the author of The Politically Incorrect Guide to Capitalism (Regnery 2007).

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