January 18, 2009

The Great "Excess Reserves" Swindle

Quico says: The idea that the Central Bank's International Reserves are a kind of "rainy day fund" where the government puts away some of its dollars so it can spend them later is what Steven Pinker calls a "conventional absurdity": something everybody vaguely "knows" and nobody much questions...but happens to be utterly, demonstrably absurd.

Think about it. How often have you heard people say words to the effect that, while the global economic downturn will create some problems for Venezuela this year,
"A budgetary crisis is very unlikely, since the government has more than 50bn $ of international reserves it can draw upon in a crisis."
This kind of thing sounds so natural, so straightforward, we hardly slow down to ask whether it makes any sense at all. But lets be clear: treating central bank's international reserves as government savings is an economic non-sequitur, a simple blunder that betrays a basic misunderstanding of what currency reserves are, of what their underlying economic sense is.

A worthwhile rule of thumb is that when you hear a supposed expert conflate reserves with savings, you know for sure you're dealing with a a hack.

And now, with Chávez vowing to "spend" $12 billion worth of "excess reserves" this year, the fallacy of currency-reserves-as-rainy-day-fund is only becoming more relevant and much more dangerous.

The issues get pretty abstract, though, so I think the best way to explain the basic fallacy is with some pretty slides (adapted from a similar post from a while back).

Here's how it works:

Download the PowerPoint here.

Descarga el PowerPoint en español aquí.

The key thing to grasp is this: the mere fact that a dollar is sitting in BCV's international reserves account is not a sign that the government is "hanging on to it" for later. Just the opposite: it's a sign that the government has already traded that dollar in for bolivars...bolivars that it has, most likely, already spent!

In other words, it makes more sense to think of international reserves as a kind of fossil record of past government spending than as an indicator of its future spending capacity.

The "a-ha!" moment, for most people, comes when they fully grasp the Central Bank's unique role as an interface between Venezuela's "bolivar economy" and the international "dollar economy". Once that penny drops, you can see clearly why PDVSA's petrodollars have to show up in BCV reserves before the government can spend them: only BCV can transmogrify dollar earnings into the kind of currency the government actually spends.

If you remember nothing else about this post, remember this: when you hear someone talk as though international reserves were government savings, reach for your wallet. You're being swindled.

The gibberish you hear about Fonden and "excess reserves", in particular, is just a way to cover up a kind of asymmetrical devaluation. Why asymmetrical? Because the government is double counting its own dollars, but it sure isn't about to double count your dollars!

Think about it. BCV will trade the government's petrodollars for bolivars as many times as Chávez wants. But if you're a private company that exports widgets, the Central Bank is not likely to be amused if you walk up to them and say "hey BCV, here's this dollar I got for selling widgets abroad, please trade it into bolivars for me...twice!"

Or, to take an already ridiculous analogy all the way, what do you think would happen if you walked up to the Central Bank and said "hey BCV, remember that widge-o-dollar I gave you in exchange for Bs.F 2.15 a year ago? Yes? Well I've been thinking, and I've decided you already have more dollars than you really need, so, erm, gimme my dollar back!" and then snatched your dollar, walked out, and came back three minutes later, big grin on your face, saying, "hey BCV, it's me again. Listen...um...funny thing: seems I have this shiny new dollar in my pocket. How about giving me Bs.F 2.15 for it?"

If that sounds totally absurd to you, that's because it is. But, when you get down to brass tacks, last week Chávez announced that he's planning to pull precisely this swindle twelve billion times over this year!