Bolivia: Price hyperinflations
l The government was printing money to finance a large budget deficit. But the government was not creditworthy enough to sell bonds to private sector at home and aboard. Therefore, it sold the bonds to its central bank, BCB. Because the government printed too much money to pay bills, it was driving down the value of money and driving up the prices of goods.
l The destroyed value of money made people of Bolivia exchange for dollar. Therefore, the exchange rate of peso-dollar was soaring, from 500 peso per dollar to 2 million peso per dollar, rising more than 30 times in 2 years.
How and why:
l Professor Sach found that the price of oil, $0.03 per liter, was much less than international market price, $0.28 per liter; that oil was priced by the state petroleum company, YPFB; that the price of oil was major source of government revenue; and that the low price of oil was destroying the budget.
l The solution was that raise the price of oil from $0.03 to $0.28 per liter. The increase itself closed most of the budget deficit.
l The one-time sharp rise in oil price closed budget and stabilized the exchange rate of peso-dollar, because prices were set in dollar while they were paid in peso. Within a week, the soaring hyperinflation was under control.
Bolivia: Crack in the edifice
Countries are shaped profoundly by their location, neighborhood, topography, and resource base. Adam Smith had thought widely about, but I didn’t read Adam Smith for years.
l On Oct. 24, 1985, the London Metal Exchange suspended trading on tin. Because of the plummeted tin price by about 55%, the tin cartel, of which Bolivia was a member and as a main supply of jobs, social support, political support and tax, went bankrupt. Thus it opened another huge hole of the deficit.
l Stabilize the economy
l Bolivia sold its foreign exchange reserves into currency market in return for the just-issued peso, to stabilize its money value.
l IMF bought the reserves. So, the turnaround succeed.
Afterward: Professor Sach found 4 huge obstacles:
l The collapse of tin price was eating away the stabilities of budget and macroeconomic.
l Bolivia was facing up to debt crisis. Professor Sach insisted that Bolivia had to refuse to the debts services of IMF and negotiate with creditors for debt cancellation, because he thought that writing debts off allows countries to get back their feet and either repay part of debt or at least be less of a burden to the international system in term of future foreign assistance.
l Bolivia needed a tax reform. The polite debate was touch and go, in the end, the tax reforms passed and they helped to consolidate a fairer fiscal base.
l Bolivia was to build an emergency social fund, helping finance local infrastructure like water harvesting, or irrigation, or road improvements.
What were learned?
l Stabilization is a complex process.
l Macroeconomics tools are limited in their power.
l Successful change requires a combination of technocratic knowledge, bold political leadership, and broad social participation.
l Success requires not only bold reforms at home, but also financial help from abroad.
l Poor countries must demand their due.