Venezuela's Currency Idea Won't Work: David DeRosa (Correct)

<a href=quote.bloomberg.com>Bloomberg Columnists

David DeRosa , president of DeRosa Research & Trading, is an adjunct finance professor at the Yale School of Management and the author of "In Defense of Free Capital Markets." The opinions expressed are his own.

Venezuela's Currency Idea Won't Work: David DeRosa (Correct)

(Corrects January to February in fourth paragraph. Commentary. David DeRosa, president of DeRosa Research & Trading, is also an adjunct finance professor at Yale School of Management and author of ``In Defense of Free Capital Markets.'' The opinions expressed are his own.)

June 25 (Bloomberg) -- Venezuela is studying adopting a dual exchange-rate system for the bolivar to relieve dollar shortages. It won't work.

If the government really wants to end dollar shortages there is a simple solution. It can let the bolivar become a floating currency against the dollar.

That may not fit into the larger political strategy of President Hugo Chavez to dominate the economy. In January he restricted sales of dollars after the conclusion of a bruising two- month strike against his administration.

Venezuela's main source of dollars is its state-controlled oil export industry. This gives Chavez a lock on dollars coming into the country. In February he fixed the bolivar at the rate of 1,598 to the dollar -- the rate being trumpeted as necessary to allow Venezuelans to import essential commodities.

The black market value of the bolivar is about 2,500. So Chavez is selling his dollars cheap. The real point isn't the rate at which he is selling dollars, but to whom. Chavez controls the supply of dollars to reward his friends and punish his enemies.

He can decide what goods and services can be imported since imports require payment in dollars. About 60 percent of Venezuela's economy relies on imported raw materials.

How It Might Work

For the lucky few who can buy dollars from the government, the rate is a bargain, making it no surprise that there is a shortage of the U.S. currency. Shortages occur when governments force prices below their market-clearing levels.

One of the central bank's seven directors, Domingo Maza, said Monday that the dual exchange rate system is ``under study and consideration.'' An educated guess can be made at how it might work.

One component would sell the government's dollars at the official rate of 1,598 bolivars to the dollar. Another part of such a system would auction dollars at a market rate. Theoretically, the auction would allow supply and demand to eliminate the dollar shortage, an improvement over the current arrangement.

Some important questions would include: How many dollars would be sold at auction? Would only certain eligible parties, such as friends of Hugo, be allowed to buy them?

Debt Upgraded

You have to wonder if the people who would be allowed to buy at the official rate will be selling all or part of the dollars in the free market.

In other words, wholesale arbitrage of Chavez's foreign- exchange system is going to be very tempting. Friends of Hugo will get very rich very fast buying dollars at 1,598 and selling them for something like 2,500 bolivars.

Chavez, meanwhile, got some good news from Fitch Ratings on Monday. ``We don't think there's going to be a default anytime soon,'' Fitch sovereign analyst Theresa Paiz-Fredel said.

Fitch upgraded Venezuela's debt rating to B-, six levels below investment grade, from CCC+. It also raised Venezuela's long- term bond rating to B- from CCC. Venezuela has $22.4 billion in foreign debt and $7.4 billon in domestic debt.

The problem is that Chavez has made a perfect hash of the economy and the bolivar, in particular. When you mess around with exchange-rate regimes you can get unpredicted outcomes. That's why it is hard to believe anyone can know what will happen next in Venezuela.