What Kind of Wizardry is This?

by Milan Sime Martinic

While currently fluctuations versus the dollar affect every floating currency in the world, the Boliviano behaves very much like a fixed currency and is one of the pillars supporting the country's world-leading double-digit growth and economic stability. Currencies from the Euro to the Yen and the Yuan and everywhere in between plunge and rise against the dollar, sending markets, economies and even the politics of the countries into turmoil. So why not the lowly Boliviano?

The answer is both fascinating and reassuring.

First, let's establish that the Boliviano is a floating currency, as opposed to a fixed currency which would be artificially kept pegged to the dollar at a constant rate and subject to manipulation as well as running risks such as deflation and loss of investor confidence. Floating currencies are subject to the laws of supply and demand-- the more supply or less demand, the less the currency is worth and vice-versa. So control the supply and demand and you fix the problem of wild fluctuations. While the concept is simple, its implementation is not. Counties from the US to Britain and every currency ever has struggled with how to do this best.

Let's look at the tools the US, through the Federal Reserve Board of Governors, has as its disposal to manage its money supply: 1) The amount of reserve that banks are required to keep in relation to the amounts out on loans; 2) Interest rates, and 3) the buying or selling of bonds to the banks by the Fed a.k.a. Quantitative Easing (QE), to use the American euphemism now in use all over the world. It is the play of these three tools, and particularly the clever use of the last one that has allowed the United States to control inflation and do the best job of any country ever in controlling and managing the value of its money.

So, let's understand what QE is, and what it does. Simply speaking, it is adding or subtracting money from the economy. When it is adding it could be called "printing money," because the Fed tells the banks that is going to buy a certain amount of bonds, for which it pays with new money it makes out of thin air. This has the effect of injecting money into the economy and regulating the money supply. But more money would create inflation and much more money would create hyperinflation. Yet, since the value of money is in essence a function of supply and demand, the US does have an advantage over the rest of the world: The Dollar is the world's reserve currency, the one currency used for most international financial transactions, thus creating a need for countries and companies to hold reserves of dollars, and so creating a demand for dollars that absorbs the huge amounts of money injected into the money supply (and economy) by QE programs ($89 billion a month during most of the Obama presidency). Of course the US does this masterfully and so it keeps its currency stable and secure. Let any other country try that and the laws of supply and demand take over and so does inflation or deflation at hyper levels.

So it is through disciplined understanding and application of principles developed through decades of trial-and-error, through depressions and recessions, booms and busts, through the delicate balancing of reserve rates, interest rates and QE policies, and through sheer luck of circumstance, that the US has cracked the code on regulating the value of its currency and thus manipulates money supply to affect its economy and those of other countries.

How does Bolivia keep its currency stable versus the mighty dollar?

Through a clever political move and honest, disciplined hard work and understanding of these very same principles, it turns out.

When former President Gonzalo Sanchez de Lozada was run out of the country, the main beef against him was an oil deal that yielded some $239 million a year to Bolivia. The renegotiated deal yielded billions of dollars instead. And instead of lining the pockets of government officials, the new government made a number of wise and responsible decisions which account in great part for its stable currency and the economic success of Bolivia today.

The surplus dollars were placed under the Bolivian financial authority, ASFI (Autoridad de Supervision del Sistema Financiero), which has the charge of watching over the stability and health of the country's financial system and protection of public savings while "promoting the conditions necessary for credit and productive growth of the banking sector." The agency is a combination of the Fed, and FINRA, the US Financial Industry Regulatory Authority, and it also acts as the Consumer Financial Protection Bureau. To advance its purposes, the government also bought and operates Banco Union through FINRA.

Taking its charge seriously and acting as does the Fed, ASFI set out to regulate the money supply and stabilize the exchange rate. It deposited the billions of excess dollars in the US which it could now move in and out of the country through its corresponding bank to Banco Union.

In an exercise similar to the decision-making process at the Fed, ASFI then mimics the American QE process, injecting and withdrawing dollars from the Bolivian economy instead of buying and selling bonds. It is this careful manipulation of the supply of Boliviano vs, the dollar that accounts for the stable exchange rate and the economic benefits it begets.

Currency fluctuations are, after all, a matter of supply and demand. The US had developed and fine-tuned a program that works and works well, and Bolivia has downloaded and adapted the succesful American application into its system.

By Milan Sime Martinic

Click here to post comments

Join in and write your own page! It's easy to do. How? Simply click here to return to Bolivia News 2014-15.