By Moises Rendon

Venezuela has the highest inflation rate in the world, with an estimated annual rate of as much as 700 percent as of this October. The Venezuelan economy is also due to shrink at the world’s highest rate this year – about 10 percent, according to the International Monetary Fund (IMF). With high inflation and a shrinking economy, Venezuela is facing one of the worst economic crises in the world, and a solution is urgently needed.

The Bolívar, Venezuela’s currency, has lost its credibility among Venezuelans, and is viewed with even less respect abroad.  An alternative is needed to reset the Venezuelan economy, improve trust, and provide a reliable store of value. Dollarizing the Venezuelan economy is a compelling possibility.

The current Venezuelan administration is one of the worst in the world when it comes to economic and monetary management. Each year Steve Hanke, a John Hopkins Professor and Cato Institute scholar, assembles a Misery Index – an economic indicator that takes into account inflation, lending rates, unemployment rates, and year-on-year per capita gross domestic product (GDP) growth. It assumes that both a higher rate of unemployment and a worsening of inflation create economic and social costs for a country. The Misery Index is used to construct a ranking for 108 countries. For 2014, Venezuela holds the top spot in the world with an index value of 106.03, considerably higher than the next worst country on the list.

One of the main causes of Venezuela’s misery is its byzantine exchange rate system. In a typical economy, you would know how many bolívars it takes to buy a U.S. dollar by going online or reading the newspaper. In Venezuela, the exchange rate depends on what you want to use the US dollars for, how well-connected you are, and even the day of the week.

In fact, the Law on the Currency Exchange Regime published in February 2014 established a multiple exchange rate system, creating three different “official” exchange rates, in addition to the illegal black market. Venezuela’s government sells dollars for 6.3, 12 and 172 bolívars per dollar. The first two rates are used for imports of government-authorized priority goods including food, medicine and car parts. The third rate is for anyone who does not receive authorization to buy dollars at the first two preferential rates.

The Bolivar has seen steep devaluations since President Chavez’s death in March 2013, rising from 21 Bolivars per U.S. dollar to 820 per dollar today.

The current official “preferential” exchange rates, 6.30 and 12 bolívars for 1 U.S. Dollar, is far from reality. The current black market exchange rate (and that means the price that someone is willing to pay, not what the government says it should be) is approximately 800 bolívars for 1 US dollar. In an economy that exports little besides petroleum and imports just about everything else (including over 70 percent of food consumed), the exchange rate is a crucial factor in the domestic market. Even though the government increased the minimum wage by over 60 percent during 2015 alone (from 5,622 bolívars in February to 9,648 bolívars in November), it is still under $15/per month. One pair of athletic shoes can cost half of the monthly official minimum wage, or 4,400 bolívars.

Adopting the dollar is one solution to the problems posed by Venezuela’s unstable currency. Other economies in the region such as Ecuador, Panama, and El Salvador are promising examples:

• Panama dollarized its economy in 1904 and has been one of the best performing countries in Latin America in recent years (see the Misery Index table). In 2014, economic growth in Latin America and the Caribbean was a mediocre 0.8 percent. In contrast, Panama’s growth rate was 6.2 percent in 2014. All of the top regional foreign direct investment (FDI) destination countries experienced decreases in foreign investment in 2014, except for Panama.
• Similarly, Ecuador’s relative success has been due in part to its dollarization in 2000. At the time, Ecuador could not sustain the value of its currency, the Sucre. The Ecuadorian Sucre jumped from trading at 6,825 per U.S. Dollar at the end of 1998 to 28,000 per U.S. Dollar the first week of January 2000. Today, Ecuador’s dollarization remains highly popular (about 85 percent approval), and it’s a straitjacket for President Correa’s populist policy ambitions.
• Likewise, El Salvador has enjoyed a stronger economy and favorable growth rates since its dollarization in 2001, according to the World Bank. However, El Salvador is still experiencing many challenges. Crime and violence threaten social development and economic growth and negatively affect the quality of life of its citizens.

Dollarization won’t magically fix Venezuela’s problems, nor is it the ideal monetary system. Dollarization would mean a loss of flexibility in monetary policy with no central bank to act as “the lender of last resort”; instead, Venezuela would depend on foreign banks. However, by dollarizing the Venezuelan economy, Venezuelans would have the freedom to use a stable means of payment for products and services. By not relying on the Venezuelan Central Bank, dollarization will shift power from the bureaucratic and corrupt domestic institutions to market actors, namely merchants and consumers.

A stable currency – such as the U.S. Dollar – does not guarantee a prosperous economy. But, an unhealthy currency almost certainly guarantees a deprived and dysfunctional system. Venezuelans have lost almost all trust in the Bolivar. The U.S. dollar is internationally accepted, retains its value, and is far less volatile than its Venezuelan counterpart. Dollarization will free the market by allowing people to buy and sell products and services with a stable means of payment. This will free Venezuelan citizens from the downward economic spiral created by the government, making everyone better off.

Moises Rendon is a research intern with the Project on Prosperity and Development at CSIS.

Photo courtesy of Flickr user Shai Barzilay under a Creative Commons Attribution-NonCommercial 2.0 Generic license.