Tuesday, January 12, 2010

Two sounds of financial crisis to the south 

The financial crisis may be subsiding in the U.S. -- may be -- but I am much less sanguine about its effects on our neighbors to the south. Friends send along to me two stories. In Argentina, a highly inflationary act by the government was opposed by the central bank, and so the government tried to get its governor to resign. When the governor refused, President Christina Fernandez fired the governor -- which it does not appear the law allows her to do. Monday a judge reinstated the governor and did not allow the reserves to be taken to pay off Fernandez' profligate spending. The battle continues. (h/t: Margaret Martin.)

This is not the first time the government has treated the BCRA as its piggy bank. It took $9.6 billion from reserves to pay off the IMF for its loans from the 2001 recession (during which the 1990s monetary reforms were lost.) For those who argue against central bank independence, this current crisis is a cautionary tale.

To the north, Venezuela is devaluing its currency. (H/T to both my former student Norm and to some of my show's Twittizens.) Angus at Kids Prefer Cheese thinks this is a good move; undoubtedly, the country could not afford to use its oil revenues to defend an overvalued exchange rate. But why does Venezuela have a 30% inflation rate?

I think the answer can be seen in part by its initiation of a dual exchange rate regime. As Caracas Chronicles shows, the dual exchange rate allows preferred businesses -- those with connections to Hugo Chavez -- to receive extra earnings from their exports, and potentially to screw those who are not preferred.

But as Caracas Chronicles puts into an earlier post, it has played the very same game the Argentines are trying to now. It receives dollars for the oil it sells and converts it to bolivars ... which the state oil company gives Chavez to spend. Then, when it wants to spend more money, it has to borrow it. How to pay for the borrowings? With the dollars they left at the central bank. Eventually there is inflation, and fewer international reserves supporting the bolivar. So what to do? Devalue, and any imported goods Venezuelan citizens were buying are suddenly much more expensive. In short, they are paying for Chavez' profligacy by loss of purchasing power for imports.

The Argentine story will get a little ink because it's a conflict between immediate needs and the law in that country. In Venezuela the law is simply one guy, and it's not news.

UPDATE: Price controls, Chavez-style. (h/t: Munger.)