Almost every news article about Venezuela in the past months claims that protesters are in the streets because they are fed up with high inflation, shortages of basic consumer goods, and crime. As an empirical matter, the relationship between the protests and these three problems is not clear. The history of the protests shows them to be much more political and ideological.

The initial surge of the protests appeared to be related to a split within the opposition, with hard-line right-wing leaders Leopoldo López and María Corina Machado calling for “la salida” or “the exit” of the recently elected government.¹ They used this call for regime change to try to push aside the opposition leader and recent presidential candidate Henrique Capriles, who also comes from the right but campaigned on a more moderate program and does not support an attempt to overthrow the government. Another indicator that economic conditions are not the driving force of the protests is that the people most affected by the shortages of consumer goods are not protesting: in Caracas especially, the protesters and their supporters have been concentrated in the wealthiest neighborhoods. Nonetheless, the shortages and inflation are major issues according to polling data. It is important to look at their origin and possible solutions.

All economies have major structural and policy problems, but some problems are more important than others at particular times. In Venezuela, the most important economic problem at present is in the exchange-rate system. A fixed exchange-rate system with periodic devaluations tends to be more crisis-prone than other exchange-rate regimes, especially in a country like Venezuela, where inflation has historically been higher than that of its trading partners.

As recently as two-years ago, in the first quarter of 2012, the exchange-rate system did not generate crisis. The economy was growing at a healthy pace and inflation was falling, coming in at an annual rate of just 10.1 percent in the first quarter. However, in the fall of 2012, inflation began to rise and so did the black-market rate for the dollar, which went from 12 BsF per dollar in October of 2012 to a peak of 88 in late February 2014. This was mainly a result of the government cutting back on the supply of dollars. To many people, it seemed like Venezuela was suffering from an “inflation-depreciation” spiral, a situation when the domestic currency loses value against the dollar, causing inflation, which then causes the currency to fall further, and so on. In extreme cases such a spiral can end in hyperinflation, and government opponents, including much of the domestic and international media, promoted the idea that this is where the Venezuelan economy has been headed.

Of course hyperinflation was never a real threat—and it still isn’t, because a government with ninety billion dollars of oil revenue and international borrowing capacity is not going to end up with the kind of balance of payments crisis that could lead to hyperinflation. But the relation between the rising cost of the black-market dollar and the inflation rate was a serious problem, because the two imbalances can feed off each other. In other words, the rising price of the dollar on the black market increased the price of imports and therefore pushed up inflation, and the higher inflation pushed up the black-market rate. The shortages—including for some basic foods and household items—also took off around the same time that inflation and the black-market dollar rate surged. There is reason to believe that the increase in shortages is also related to the dynamic of increasing inflation and the black-market dollar. As the cost of imports rises, some price-controlled goods can no longer be sold at a profit.

In February 2014, the Maduro government announced a new exchange-rate system, called SICAD II, to break the cycle of inflation-depreciation. As part of this initiative, private banks and brokers began selling dollars at a market-determined rate to anyone who wanted them, thus undercutting the black market, on March 24.

Will the new exchange rate system work? So far, it seems to have tamed the black market. There was a huge drop in the black-market rate after the announcement of the new system—it fell from 87.91 BsF/dollar on February 19 to a low of 57.06 on March 21. It has bounced around since then and at this moment (May 30, 2014) is at 70.86. We can expect fluctuations in the black market due to speculation, as participants try to figure out how that new system is going to affect the price of the parallel dollar. But it does seem like the upward trend of the black-market dollar over the past year-and-a-half has been arrested. Most importantly, the SICAD II exchange rate has thus far been stable, settling at a rate of about 49 BsF per dollar.

So far, the SICAD II system is off to a good start and may succeed in drawing currency exchanges away from the black market, and putting a circuit-breaker into the inflation-depreciation cycle that we have seen over the last year or so. It is still too early to tell whether the new exchange rate system will succeed in stabilizing the currency and enabling the government to bring down inflation. And additional measures will be needed to eliminate the shortages. But the measures taken so far have shown that it is possible to stabilize the economy, and that it is not headed toward an escalating crisis as many have maintained for years. As the economically disruptive protests wind down, it will become easier to stabilize the economy and resolve the most important problems.

Note

1. Both López and Machado were involved in the U.S.-backed military coup against the democratically elected government of President Hugo Chávez in 2002.