Saturday, October 20, 2007

But is the friend really drunk? 

As a rebuttal to the preceding post let me just state one thing, it is difficult to ascertain the exact value of a currency. Comparing inflations can come close, but not precise enough (for starters Mark does not know what it was in 03). Comparing exports year by year is not good at all given growing internal demand.

The best method to date is using the Power Purchasing Parity index, not extrapolation. The reason why this works is because it goes to the heart of the matter rather than taking unnecessary steps, a devalued currency is attractive for exports because the non-fixed costs of producing two items of identical quality comes from labor and materials/parts etc, the latter is price dependent itself on more labor and material/parts etc. Leading labor to dominate this equation. If you can pay your workers less it means you can sell your item for less, but the only way they will tolerate being paid less is if their quality of life is comparable.

Here is where PPP comes in if a worker can pay cheaper rent, buy cheaper big macs, pay cheaper labor himself then the currency is devalued and he can be paid less than a worker in the US with a comparable standard of living. That is why China can crank out so much, their currency is way undervalued which means their workers get paid less while remaining content while they drive the US competitors out of business.

The Venezuelan government is not pursuing this strategy of heavily undervaluing the currency, but it does not mean that it itself is standing on the edge. There are a few things to keep in mind regarding the budget pronouncement:

1) They are trying to lower inflation, while I would be content that they just kept inflation at a steady annual rate, they clearly are interested in dropping it to single digits. Devaluing the currency would create a ripple effect, and an immediate effect on a lot of the food we import, which is a big deal.

2) When they do devalue they are not going to tell anyone, it will be sudden and fierce.

3) New currency will be undermined by the propaganda coup.

4) PPP indecies show we are close to dollar parity, but this gulf will grow wider.

5) Lastly the dollar itself is slipping, by having our currency pegged to the dollar it means that our currency is itself devaluating with regards to the Euro, Yen, Canadian, Australian $ etc. In 2003 the Euro was close to dollar parity. This is why the export gauge does not hold. We should be exporting more to the rest of the world.

The whole point is to increase manufacturing, and while you could belittle its 10% growth average, it is not really comparable to Telecoms or construction. Manufacturing is the BIGGEST slice of GDP (It is bigger than Oil). This is the key index to look out for, if it keeps increasing at a similar clip (big if) then we are golden regardless of exports. The government will likely devalue the currency if they notice a negative trend, they have done it twice before under the CADIVI regime, and it will probably be enough.


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