Monday, January 11, 2010

The Venezuelan Devaluation & What It Means To You

There isn't much talk about it, but our fine neighbor down in Venezuela has decided that a devaluation is in order. The currency is being devalued by 50%. This doesn't mean much to most Americans and it is interesting that it is not getting much play in the U.S. media. With the announcement came threats from Chavez that he would use the National Guard to seize ANY business that raised prices domestically.

While I did teach International Finance for one semester at University I must acknowledge that I have much too learn. But I think I can demonstrate in short order for you why prices would rise in a devaluation.

First, the devaluation in this instance means that "stuff" imported into Venezuela will now cost twice as much. That bottle of wine from Napa Valley that cost 20 Bolivar would now cost 40 Bolivar to the consumer. Now, if there were domestic producers of wine in Venezuela (I don't know if there is) the competition they had before the devaluation has been obliterated. They no longer have to compete with foreign imported wine and thus could raise their price. If they just raised their price to 30 Bolivar per bottle (keep in mind I have no idea how many Bolivar it takes to buy a bottle of wine, this is for demonstration purposes only) they would still be 25% cheaper (or the foreign wine would b 33% more expensive) than their foreign competitor, yet they would receive an extra 50% in revenue and could see big profit. Eventually what would happen is prices would rise, thus inflation. But of course Chavez has this all under control as he will seize your business if you decide to raise prices (even if you weren't making any money at the previous price).

The devaluation is supposed to make Venezuelans exports cheaper, which it will in the short term - the hope is that the domestic economy will pick up and have stronger demand from the outside world. The problem is that with stronger demand you usually in the short term get inputs that are more costly as well....which forces you to raise prices, which is illegal. Perhaps they'll be allowed to sell products to other countries at higher prices, just not to their own people.

Any way you look at Venezuela it is clear that this country is on a crash course for anarchy, social unrest, revolution and mass murder. These are not the inevitable outcomes of devaluation, our currency will eventually continue its downward devaluation trajectory (which is not good), but hopefully without the bloodshed.

My main point was really that a devaluation doesn't solve long term problems, it simply is a short-term band-aid.

Scott Dauenhauer CFP, MSFP, AIF