Should Colombia chop three zeros off the peso?

UPDATE (June 13): The Santos administration just announced that it intends to redenominate the currency by the end of 2014.

President Juan Manuel Santos has long wanted to chop three zeros off the Colombian peso, which trades around 1,800 to the dollar. Except for Paraguay, the next weakest in Latin America are the colón and the Chilean peso, which bounce around 500. (Wikipedia has a list of the smallest-value currency units here.) In October 2011, the proposal failed in the Senate by a vote of 41-15. In September 2012, the President reopened the idea, but by February 2013 it was clear that it was not going to happen in this legislative session. The idea remains current, however, and I will not be surprised if it comes back after the peace talks with the FARC are sorted out.

Redenominating the currency is not crazy: France got rid of two zeros in 1960; Israel revalued by a factor of 1,000 in 1986 as did Russia in 1998; Peru hacked off six zeros when the sol replaced the inti in 1991; the next year Argentina cut four zeros off when the peso replaced the austral; Mexico sliced off three in 1993; Turkey hacked off six in 2005; Mozambique redenominated by three orders of magnitude in 2006; Ghana introduced a new cedi at 10,000-to-1 in 2007; and Venezuela chopped off three in 2008 with the introduction of the bolívar fuerte.

The direct cost of introducing a redenominated currency would not be insignificant. In 2010, the Colombian government estimated it around $123 million. (In a sign of the problem with high-denomination currencies, that number turned into $123 thousand on an English-language website!) Printing new bills is cheap: 84% of the cost would come from minting new coins. There would also be an additional $32 million spent in advertising and explaining the change, for a total cost of $155 million.

(Side note: in Ghana, coins were basically out of circulation by the time the government proposed redenominating the cedi. Since coins had to be reintroduced anyway, the monetary cost of redenominating was tiny.)

So why bother? The issue is understudied, but the economics literature (such as it is) focuses on credibility. Few currencies (I am tempted to say none) are denominated in hundreths or thousandths of a euro for long-standing historical reasons. Rather, it comes about either because of a burst of triple-digit inflation (say, Mexico in the 1980s), outright hyperinflation (say, Argentina) or a long period of relatively moderate double-digit inflation (like Colombia; see the below chart.)

So the big economic reason to redenominate, then, is to reiterate that the inflationary period is over, kaputsky, finis. Over here, the Banco Central de Venezuela states four reasons that boil down to making mental math easier and one which says “Leave behind the consequences the history of inflations of the past had on the currency.”

Layna Mosley at UNC-Chapel Hill tried to figure out why countries redenominate. She hypothesized that credibility might be a reason, of course, but she also thought that conservative governments would be also be more likely to redenominate for reasons of national pride. Her evidence was supportive, but not compelling.

Colombia, however, mostly fits her model. (You can read the Colombian authorities’ reasons for wanting to change.) In addition to standard discussions about credibility and easier math, the central bankers mentioned the feel-good pride effect from having a serious currency valued at around half a dollar (or euro or real) instead of some teeny tiny amount. “There is possibly a positive psychological impact since it reduces the gap between local and foreign currency denominations.”

That fits the Mosley model. The final reason, however, does not:

“A countrywide redenomination exercise would also mean all citizens had to exchange their currency, and this could potentially shed light on the country's vast shadow economy. It is thought that drug cartels which operate in Colombia trade mainly with greenbacks. However, officials do not have any definitive figures that prove the extent to which pesos are used in drug trade, and a wide-scale currency exchange could help in this respect.”

And that, ultimately, is why I think Colombia should redenominate.

Comments

[shah8]

Heh, and I was thinking about inflation!

I was reading about Venezuelan issues, including the latest OMG! Hyperinflation! (I paid no mind, hyperinflation is hard to happen, and a war is usually the underlying reason) stuff, and I got to wondering how it could not affect Colombia seriously--like all those Venezuelans hopping on a plane to Bogotá with the intent to bring in the items of low supply.

How does inflation and scarcity in one country impact those of neighboring areas, assuming reasonable mobility? My usual lens is with China-Hong Kong, but what about Panamanian borders? Is this a factor in why Panama and Ecuador have such long-lasting dollar policies? What resources online could I read about this?

[Noel Maurer]

Good question. It's not the inflation, it's the inflation plus price and capital controls. Inflation feeds pretty rapidly into the exchange rate; nothing in particular happens to the border.

But what you've got in Venezuela is weird. You've got massive smuggling of subsidized gasoline out of the country. You don't have too many planeloads of Venezuelans trying to bring stuff in, for three reasons.

First, the border regions are underpopulated and rather dangerous. Even around Maracaibo, it is neither safe nor easy. http://www.insightcrime.org/news-briefs/kidnapping-gangs-shift-from-venezuela-colombia-border

Second, once you've got to jump on a plane, you might as well go to Miami. The connections to Colombia are rather expensive. (That is political, of course.)

Third, capital controls! It isn't that simple for a Venezuelan to obtain lots of dollars to spend overseas, at least at the official exchange rate. Those that can are also able to obtain most of the missing goods at home, albeit at a price.

It's not related to dollarization in Panama or Ecuador. (Or El Salvador, for that matter.) Those decisions have been domestically-driven.

[Noel Maurer]

This is annoying, my response disappeared.

Briefly, then, with apologies: the issue with Venezuela are the price and exchange controls, not inflation. In a world of floating exchange rates, relative inflation usually feeds through pretty quickly into the value of the currency. When there's hyperinflation you might see people on the border using the neighboring country's currency --- when I drove from Santiago to Mendoza in 1990, there was no need to change Chilean pesos to australes --- but no smuggling.

There is large-scale smuggling of gasoline and other refined products from Venezuela to Colombia, but that is due to Venezuela's insistence on selling the stuff cheap at home. (See http://www.ipsnews.net/2012/09/smuggling-freely-across-the-colombia-venezuela-border.)

There isn't (so far) large-scale movements of people taking goods from Colombia to Venezuela for three reasons:

(1) The border is faraway and crime-ridden. (See http://www.insightcrime.org/news-briefs/kidnapping-gangs-shift-from-venezuela-colombia-border. For a more pleasant --- and accurate! --- picture see http://www.happinessplunge.com/2012/01/crossing-the-colombia-venezuela-border-another-nightmare-but-i-rode-a-motorcycle.)

(2) Once you're going to hop on a plane to Bogotá, you might as well head to Miami. It's less expensive.

(3) It isn't that easy for Venezuelans to get the dollars needed to buy stuff and bring it home in bulk. It's those exchange controls again. Get pesos illegally and Colombia is expensive; get them legally and you are strictly limited as to how many you can buy.

Dollarization in Panama and Ecuador (and El Salvador) has been driven by (rather different) domestic factors in all three places.

[shah8]

Given how prevalent and the diversity of exchange controls there are in Latin America, let alone the rest of the Global South, we could do with more talks about mechanisms. I'm pretty sure Venezuelan exchange controls don't work the same way as Argentina's, and they definitely don't work like Brazil or Chile. At least I've a glimmering on how exchange controls in Venezuela works, but I don't understand it well.

What I definitely don't have a handle on is what the price controls are, how they are applied, and what goods have controls. I feel as if I need to have a good idea because there are pretty strong inflationary pressures in certain consumer goods in all of South America, even in places where the money is definitely a bit tight.

I think I'm interested in Venezuela mostly because having a good grip on how Venezuela is reported vis á vis the situation on the ground there allows me to understand what the US general stance is in Latin America. I compare and contrast with other third world countries, and it really helps me understand the difficulties of resource management. India has many of the same problems of Venezuela, and many of the same industrial/retail attitudes, and it's illuminating to compare the antipoverty programs, the indian coal vs Venez heavy oil, etc

Of course, there's also the rooting for the underdog against the hegemon thing as well.

[shah8]

p.s. the links above don't work.

[Bernard Guerrero]

"Few currencies (I am tempted to say none) are denominated in hundreths or thousandths of a euro for long-standing historical reasons."

Did you mean to use "euro" above? Considering oddball denomination schemes, the Yen pops to mind.

[Noel Maurer]

Yup, I did mean to say "euro," because it's a new currency: Europe introduced it at close to a dollar. Nobody creates a currency worth only a penny.

The rule that small-denomination currencies are products of unintended inflation holds for Japan. Between 1939 and 1956 the Japanese price level rose 173 times -- before WW2, the yen traded at 4.3 per dollar; when it again became convertible in 1956, it went for 360.

Japan, unlike France, never bothered to redenominate. My guess is that the reason is political. Mosley's data shows countries often redenominate for to increase their perceived international economic stature. Postwar Japan had a lot of reasons not to increase their perceived international economic stature.

What's weirder is the South Korean won. It crashed from 15 per dollar to 1800 before the Korean War, and then plunged again to 6,000. I can't imagine that many coins were in circulation, so I don't understand why South Korea didn't lop off three zeroes right after the war ended.

[Mike]

June 13, 2013 the Colombian minster of Finance stated that they would be dropping the 3 zeros BEFORE the June 2014 elections. They even had the redenomination plan on the Central Banks website until shortly after the June 13, 2013 article was printed. Any thoughts as to where we are actually at regarding a redenomination any time soon and does a revalue of 50 cents to the USD seem possible?

[Noel Maurer]

The latest news was in January: http://www.elpais.com.co/elpais/economia/noticias/cuarta-podria-ser-vencida-para-proyecto-busca-quitar-ceros-peso-colombiano

So far, though, President Santos has not yet introduced a bill. The Colombian senate webpage says it's on the agenda, but the link is broken.