CAMBRIDGE – Around the world, several countries are currently undergoing “demonetization,” or currency reforms in which the government removes banknotes of a certain denomination from circulation and replaces them with new notes. Governments pursue demonetization for a variety of reasons, and some of the recent initiatives are going better than others.
When demonetization is particularly dramatic and disruptive, it is often a signpost on the road to hyperinflation. This seems to be the case in Venezuela, where President Nicolás Maduro recently recalled the 100-bolivar note, and will replace it with new notes denominated at 500-20,000 bolivars.
Economists define hyperinflation as a pattern of monthly price increases that exceed 50%, which may happen in Venezuela in the next few months. Hyperinflation has been much rarer this century than in the twentieth century, and Venezuela will be the first country to experience it since Zimbabwe in 2008-09.
The current Venezuelan episode continues a long tradition of gross currency mismanagement in Latin American and former Soviet-bloc countries, where past governments used demonetization to transfer wealth from the public to themselves. In each case, the fundamental problem is that the government cannot finance its unsustainable spending through taxation or borrowing, so it resorts to debasing the currency.