Archive for September 12th, 2013

What’s Up With Merentes’ Proposed “New” And “Improved” Currency Swap System?

September 12, 2013

swapFor the last two weeks the Government has begun talking about the possibility of reviving the swap (permuta) market, given that Sicad has been a gigantic failure, in that it has done nothing to lower the parallel black exchange rate and the Government has discovered all sorts of scams in it, aided from within.

So, are we to believe this talk about a new foreign exchange swap market, where people will be able to go and buy foreign currency at prices determined by free market forces and without any limitation?

Well, call me skeptical, dubious and  incredulous. I just don’t think so.

Not under the current conditions of limited foreign currency, excess monetary liquidity (and growing!) and artificially low official exchange rate.

Just as a reminder about swaps, when the Government imposed exchange controls in 2003, it banned the use of Brady bonds as a foreign exchange mechanism, which was the parallel mechanism in the Caldera exchange controls in the 90’s.

But then a clever guy, realized that the permuta (swap), whereby you can exchange an object for another, was an instrument which is part of Venezuela’s Codigo de Comercio (Commercial Code) and had nothing to do with securities. Thus, you were forbidden to buy or sell dollars, but you were not forbidden from swapping your house in Caracas for one in Madrid, or a chocolate ice cream for a vanilla ice cream, like the picture above, or more importantly a dollar denominated bond for a Bolivar denominated bond, at a rate determined by you.

And thus the permuta or swap market was born.

Almost three years later, the Government gave its Seal of Approval to the permuta market, when it approved the Foreign Exchange Illicits Bill,in which the Government, recognizing the need for a escape valve, exempted securities explicitly in the Bill. Before this, there was no punishment for the swaps, after this, the Government was acknowledging that it was legal.

The market boomed, until May 2010, when Chávez, upset over how much the swap or parallel rate had gone up, decided to intervene that market, which was mostly supplied by Government dollars, and in the process, jailed a dozen brokers and intervened and shut down some 48 brokerage houses.

So now, the Government wants to revive this relief valve, but it is clear that it does not want the rate to be public or to go up. Furthermore, it wants official rates, those of Cadivi and Sicad to be lower than they should be. When they launched Sicad, there were all sorts of expectations that the Government would make that exchange rate higher and instead, the Government sold the dollars lower.

But suppose the Government overcomes this, decides it does not care at what price dollars go. Well, the problem is that I don’t think they have the foreign currency to supply this new market so that it does not go up.

Let me explain…

When the Government stopped the swap market in 2010, multi-nationals had not been given any foreign currency to repatriate dividends at the official rate of exchange for three years. It has now been six. These companies have lots of Bolivars just sitting there losing value, day after day. The moment the Government creates a legal foreign exchange parallel market, these companies are going to want to go to it and buy dollars. At almost any price.

Add to that the many Venezuelans that have savings. The many companies that would see such a market as a way of reactivating their business. The arbitrage between the official rate and the parallel rate.

And what you have is a lot of pent up demand to buy dollars.

But the Government has given signals that it does not want to give dollars to the private sector. It has given signals that it does not have as much money in parallel funds as it did in 2010. To top it all off, it would be very costly for the Government to issue debt, as it did in 2009 and 2010 to sell bonds to ease off demand in the parallel market.

Thus, I believe that if the Government really created a legal parallel market, the black (now) parallel rate (then) would move up. Strongly.

And thus my skepticism…

But let’s suppose I am wrong. The Government has realized that things are getting worse. It does not mind if the rate goes up. It is willing to sell lots of dollars into the new swap market.

What will happen?

Well, let’s do the following Gedanken experiment:

Let’s assume that the conditions in 2010, prior to the shutdown of the swap market, were “equilibrium” conditions. That is, the swap market, which was roughly a free market, provided a good measure of supply and demand, in the context of the exchange controls, which kept the official rate at Bs. 4.3 per US$. All the Bolivars that did not get US$ at Bs. 4.3, went to the swap market for imports.

What would be the equivalent Gedanken “equilibirum” be today?

Well, let’s use May 1st. 2010 as the reference date for that moment. On that date, international reserves stood at US$ 28.2 billion and M2, monetary liquidity stood at Bs 238 billion, so that the “intrinsic” exchange rate stood at Bs. 8.3 per US$. That is if you compare how many Bolivars there were for each dollars in reserves, there are Bs. 8.3 per US$, fairly close to the swap exchange rate of Bs. 8 at the time the swap market was closed.

If we do the same today, international reserves sit at US$ 22.17 billion, while monetary liquidity sits at Bs. 912.9 billion, so that the same “intrinsic” value is at Bs. 41.18.

Thus, going back to our Gedanken experiment, if we think that the conditions in 2010 were those of an ideal equilibrium, with a fixed official rate of exchange at Bs. 4.3 per US$, what should be that same rate today, to make conditions in terms of M2, international reserves and the official rate of exchange identically the same to those of May 2010?

The answer is that the official rate of exchange should be today at Bs. 22 per US$! ((4.3/8)xBlack Rate)

And therein lies the problem. By holding the official rate so low, the Government has created an artificial system, in which any item that gets officials dollars is so cheap, compared the huge amount of Bolivars that have been created at a rate of 65% increase per year and the inflation rate of over 20% per year for the last three years, that everyone wants to buy it.

Thus, if the Government created this fantastic new swap market, all you can buy, and absolutely legal, it would have to devalue to Bs. 22 or near that, in order for conditions to be similar to those of 2010.

Except that things are worse:

-The Government has fewer dollars.

-Pent up demand is much higher.

-The Government could issue much less to in bonds to supply the new market

-The Government is not ready to devalue to Bs. 22, nor does it want the unmentionable parallel rate to be higher than it is.

This, my friends is why I am such a skeptic of all these announcements about the newfangled swap market.

Thus, I think the Government will set up a controlled, regulated, limited, maximum, minimum, rules, regulated “market” at a rate much lower than the current black rate, which in the end will do nothing to stop the other rate from rising. Maybe, just maybe, after this new market fails, will the Government will be ready to implement something more realistic.

And this would require both a sharp devaluation and a slow down in the growth of monetary liquidity.

Thus, I find nothing in these announcements that makes me excited.