Money

Will a New Cryptocurrency Solve Venezuela's Economic Crisis?

The bolivar has lost 99.9% of its value in two years, but President Nicolas Maduro claims to have just the solution.
August 21, 2018, 7:50pm
Canadian Press Images

After years of severe economic turmoil that has sparked one of the biggest refugee crises Latin America has experienced in decades, the beleaguered nation of Venezuela is set to fall further into a tailspin of hyperinflation, according to experts, thanks to a rather strange move by the country’s president, Nicolas Maduro, to devalue his nation’s currency by 96 percent in order to peg it to the “petro”, a cryptocurrency purportedly created by the Venezuelan government.

It’s a policy tool that has never been employed by any other country in the world, but Maduro’s hope is that the bolivar — which has lost 99.9 percent of its value in the last two years — will regain some of its credibility by being pegged to an oil-backed cryptocurrency.

But let’s backtrack: Why is Venezuela’s currency practically worthless?

It all goes back to the years of Hugo Chavez, Venezuela’s former President and socialist icon who died in 2013, only to be replaced by one of his biggest supporters and key allies, Maduro. When Chavez came to power in 1999, most of Venezuela’s major institutions — ministries, the court system, law enforcement, the media — were controlled by just a few families that made up a powerful oligarchy. Chavez began dismantling those institutions, including the country’s central bank in order to wrest away power from the oligarchs.

Indeed, Chavez’s initial intentions, in theory, were solid — narrow the gap between the rich and the poor, nationalize Venezuela’s oil sector so that there would be sufficient revenue to finance social development programs, provide free healthcare and free higher education for all. In practice however, only some of these initiatives worked.

Venezuela’s economy has always been highly dependent on oil — in the early 2000s, roaring oil prices were able to mask the effect of Chavez’s mishandling of the Venezuelan economy. By 2014, with global oil prices at a decades-low, Venezuela’s revenue started to dry up, and the volume of foreign dollars flowing into the country started to tumble. In a conventional scenario, governments facing an economic problem of this nature would allow their country’s exchange rate to fall in value — a weaker bolivar would have made Venezuelan exports less expensive, mitigating the effect of a loss in oil revenue. But Maduro, with no advice from his nation’s non-existent central bank, did not allow the bolivar to fall in value — his concern was that a weaker currency would be politically unpopular. Instead, he allowed the bolivar to remain overvalued which very quickly led to soaring prices of goods across the country, more commonly known as inflation.

With falling oil revenues, and rising domestic prices, Maduro’s government struggled to keep up with its bills. They resorted to a tempting but ultimately futile solution — printing money. “It was a situation where there were no checks and balances in the system. Maduro printed money in the hope that he could set prices domestically — that just plunged Venezuela into a hyperinflationary spiral,” Karl Schamotta, a currency strategist at Cambridge Global Payments.

The problem with printing money is that it creates false revenue — there isn’t tangible economic output that can justify having more paper currency in a country’s economy. As more and more money is printed, the value of a single dollar — or bolivar, in this case — starts eroding. If your currency is worth less, your purchasing power declines. That’s the spiral Venezuelans have been caught up in over the past four years. Once middle-class Venezuelans have found themselves on the brink of poverty because of hyperinflation. A forecast from The Economist predicts that inflation might exceed 1,600 percent in 2018 alone, and that one US dollar will be equivalent to 6 million bolivar within the next few days.

So how does a “petro” cryptocurrency combat inflation?

Indeed, it’s all rather complicated, and many experts have labelled the entire initiative a “scam”. “This is a smoke-and-mirrors operation typical of Venezuela — I'll believe it when I see it," Steve Hanke, professor of applied economics at Johns Hopkins University told CNBC recently. “The whole premise of the petro is questionable. Maduro calls it a cryptocurrency, but it really is just a digital currency backed by a physical asset,” Monica DeBolle, a senior fellow at the Peterson Institute for International Economics told VICE Free.

Maduro introduced the “petro” in February, lauding it as the solution to the country’s currency woes. His idea, premised in an overall disdain for institutions like central banks and treasury departments, is that buyers will find the currency appealing because it is backed by a tangible commodity: oil. The Venezuelan government is valuing the petro at $60 or 3,600 sovereign bolivars, the country’s brand new currency that is set to replace the bolivar.

“The only way this currency will be bought by investors and begin to have some credibility is if you can produce a sustainable amount of oil that will back up the currency. Right now, oil production in Venezuela is at the lowest it has been in 12 months, because of mismanagement of PVDSA (the country’s national oil company). Who’s going to trust this currency?” said DeBolle.

And indeed, it’s unclear how the “petro” even works. In March, investors were offered $60 “tokens” at a discount that they could then use to exchange for petros. Maduro called it an “initial coin offering” or ICO, but cryptocurrency experts were dubious. “It honestly sounds like they don’t really understand how any of it works,” Alex Van de Sande, a Brazil-based developer for the Ethereum Foundation told the Washington Post back in February.

“No one has clearly explained what it is and how it works,” agreed Schamotta. “The assumption is that people will be using paper currency that is indexed to the value of the petro, that they somehow have to believe is stable. So then are you telling me this cryptocurrency is more stable than a fiat currency?”

What then, is the solution to Venezuela’s economic crisis?

“The first step is to make your central bank independent. People who are going to run the central bank can’t be listening to Maduro,” Schamotta said. “The second step is to raise interest rates dramatically, so as to dissuade money from leaving the country.”

But for DeBolle, as long as Maduro is at the helm, and Venezuela’s institutions are undermined, the country’s future will remain bleak. “You need a hard fix. You need all the institutional rebuilding possible, and Maduro is not inclined to do any of that,” she said.

“There are ways to boost the credibility of the bolivar, which will eventually reduce people’s perception that their currency is going to be worth less tomorrow that it is today. But that will require a central bank, a treasury that is run by competent people who understand fiscal policy. This country needs more than just a standard IMF package.”

Follow Vanmala on Twitter