PDVSA bonds and Central Bank Law changes: Printing money to address the political problem

October 25, 2009

printing_money_for_aig

While all of the attention was on Chavez’ press conferences on water and electricity, the Government was toying with the economy, setting us up for a crash like never before as the country’s debt goes up and the mishandling of the economy reaches new levels of irresponsibility as the Chavez administration continues to look for stop gap measures that will one day come to haunt it.

Recall PDVSA was issuing a trio of bonds that were not very attractive if your goal was to acquire foreign currency. With this issue, PDVSA would have outstanding bonds in the amount of US$ 13 billion, up from barely US$ 4 billion when Chavez took over. Those bonds were retired by the Government because they were issued under US regulations which requires filings by PDVSA for which the Board was responsible. They have now been replaced by US$ 7 billion in bonds issued under US law, but not registered in the US and the Petrobonos which are issued under Venezuelan laws. That means that investors would have to go to Venezuelan Courts in any dispute, which makes these bonds less attractive to foreigners (i.e. they yield more than the others)

While people were expecting the Government to change the terms to make the bonds more attractive, the Government took a different route. First of all, it made the interest payments tax exempt, which they were not when the bonds were first announced. The Government was going to withhold 4.95% of all interest payments, which implied that the coupons (The amount paid by the bonds every six months on their face value) would actually be lower. This was solved by given the interest payment (not capital gains) tax exempt.

But more importantly, the Government also announced that the bonds would not count as part of the foreign currency position of banks. Let me explain this for the uninitiated: In Venezuela, banks can only have a certain percentage of their equity in US$, that amount is set at 15%. Therefore, banks can not cover (hedge) themselves against the devaluation of the swap market except for a fraction of their equity. They can protect themselves form a devaluation of the official rate of exchange by buying bonds called TICC’s which are denominated in US$ but only trade in Bolivars and their face value will chnage only if there is a devaluation of the official rate of exchange.

So, what the Government did was to make the new Petrobonos exempt from this limit. What this means is that these are extremely attractive for local banks, not as a away of buying dollars and making a profit, but as a way of protecting themselves against future devaluations of the parallel swap rate. This means that banks will buy these bonds in US$ instead of buying Bolivar denominated bonds, which yield the same or less than the Petrobonos. But on top of that the Petrobonoz give the banks devaluation protection.

What is so laughable about this is that ten days earlier when Giordani, Merentes and Rodriguez held their Ferrari press conference, they said exactly the opposite. At the time they talked about limiting how much banks had in Government paper, so that they would lend more. That is long term policy under Chavez: Less than two weeks.

As if this were not enough, the illustrious Deputies of the National Assembly rushed a bunch of changes to the Central Bank’s Law. The first one, surprise, surprise, was to allow the Central Bank to buy PDVSA’s debt, something that was expressly forbidden before. This alone guaranteed that the placement would be successful, even if it has yer to become law. Additionally, the Central Bank will now be able to accept Venezuela’s bonds as guarantees for loans from the Central Bank. (The Central Bank is expressly barred from financing the Government). Finally, the changes force the Central Bank to establish what is an “adequate level” of foreign reserves every six months and transfer the excess to the development fund Fonden. But then, in the most creative change to the Law, it allows for Fonden to sell dollars to the Central Bank for Bolivars. Thus, the Law will allow each dollar to be converted into Bolivars many times, which guarantees that some time in the future there will be an explosive devaluation of the currency.

Why? Because every time the Central Bank gets foreign currency, it creates Bolivars for the Government. Thus, suppose PDVSA gives the Government US$ 1 billion, immediately, the Central Bank creates Bs. 2.15 billion in local currency. This has gotten so bad, that the IMF gave Venezuela US$ 3.5 billion in drawing rights, which increased the countries reserves by 11% and the last week in September monetary liquidity went up 10%, i.e. the Bolivars were created and these are not even dollars the Central Bank has, these are special drawing rights that Venezuela can use when it wants.

The problem is, that then the Central Bank gives Fonden dollars from the reserves, so that the Bolivars that were created have not backing. There are currently Bs. 7.4 for each dollar in the Central Bank. This is in part what has created what the Government calls “structural” inflation, these huge number of Bolivars is not backed by dollars or the result of higher production, thus there are too many Bolivars chasing few goods, which results in more inflation. This is simply printing money to survive a few more months. At that time a new “solution” will be found or tried.

Except now the Government will even have more freedom to create Bolivars as the Fonden will be able to convert the same Dollars back into new Bolivars: A recipe for disaster! When? That is the tough question. There is no experience in doing that, but clearly the official rate of exchange can not stay at Bs. 2.15 per dollar with so many Bs. around looking for dollars. The more Bs. they create holding the reserves constant, the bigger the adjustement will one day be.

And on top of that, allowing the Central Bank to buy PDVSA bonds simply becomes a way to circumvent the fact that the Central Bank (which is broke by the way) can not finance the Government. It will now do it indirectly via PDVSA. Of course, the President of the Central Bank Nelson Merentes, a Mathematician, sees no inflationary effects from all this, because he has no clue. Somehow they blame the “structural” inflation as the source of the problem, without realizing that they created the “structure” that makes Venezuela the country with the highest inflation in the Americas at close to 30%, when everyone’s has fallen into single digits. This is simply the result of printing money and now they set up the tools to print even more.

So, tomorrow they will gloat at having placed all of the bond (they did today already), as the new bonds yield in the gray market close to 17% in a world of dropping yields. But even to sell it all, they had to all these shenanigans that we will all have to pay for one day.

Of course, the day it all explodes, the Government will blame the US or some external power for it. The newly appointed Minister of Electric Energy sent his first public interview talking about the foreign campaign against PDVSA, rather than addressing the huge problem created by the inaction of the Chavez administration in the last eleven years. This is no surprise, his only qualification for the new position is his political loyalty to Hugo Chavez. He is a former oil industry worker, with no qualification for the position other than being in charge of the Energy Sub Committee of the National Assembly.

And therein lies the problem: For Chavez, it is all a political problem, but the problem is really technical and managerial and a Mathematician in the Central Bank and an oil worker in the Ministry of Electrical Energy will not solve the problems we face any more than they have in the past eleven years.

Both areas wlll simply implode or explode in their faces and Venezuelans, particularly the poor, will pay the full price. And Chavismo will pay the “political” one.

10 Responses to “PDVSA bonds and Central Bank Law changes: Printing money to address the political problem”


  1. [...] PDVSA bonds and Central Bank Law changes: Printing money to address the political problem « The Dev… devilsexcrement.com/2009/10/25/pdvsa-bonds-and-central-bank-law-changes-political-solutions-to-tough-problems – view page – cached + PDVSA bonds and Central Bank Law changes: Printing money to address the political problem + The Strange story of the FBI, a Los Alamos physicist and the Venezuelan Government + Blameless till the… (Read more)+ PDVSA bonds and Central Bank Law changes: Printing money to address the political problem + The Strange story of the FBI, a Los Alamos physicist and the Venezuelan Government + Blameless till the end, Teflon Hugo works the crowd… + Chavez realizes nobody watches VTV or TVES… + From charlatan to charlatan: Venezuela has lots of Coltan + Here we go again: We now get a trio of PDVSA bonds + Brazil’s Bndes loan to Venezuela: Too much ado about nothing + Why was the Margarita Hilton nationalized?…Hugo was pissed off! + Blackouts Jorge Giordani by Teodoro Petkoff + The revolution looks to outside enemies while refusing to look at its own dramatic failure * Categories + Digressions + DissidentMilitary + El Excremento del Diablo + GranmaLies + LatinAmerica + MaletagateTrial + Orchids + Pictures + Posters + Requena Files + RR Models + Stanford Bank + Tascon's Fascist list + Technology + The Fable + The Opposition Candidates + Uncategorized + Venezuela * Blogroll + Alek + Alfredo + Caracas Gringo + Daniel + Excremento del Diablo + Feathers + Gustavo Coronel + Javier + Julia + Letter from Venezuela + Liberal Venezolano + Megaresistencia + Mi Venezuela + Pedro Mario + Quico + Recivex (Read less) — From the page [...]

  2. Mike E. Says:

    Miguel,
    What is your take on the US printing money to finance the debt and new politically driven hand-out type projects like never before (maybe WWII exception)? Do you see the possiblity for a Weimar or Zimbabwe type hyperinflation in the US or is the overall debt expressed as a % of GDP manageable?
    I realize that Venezuela’s only meaningful collateral is oil and the country therefore is extremely vulnerable unless oil prices will be on a sustained upward trend.
    The US on the other hand has, at least still for now, a wealth generating economic system second to none and with it an arsenal of weapons at it’s disposal to break the inflationary spiral.

    OT: any way to shut off the annoying Snap Shots pop-ups?

  3. Mike E. Says:

    Outstanding micro-analysis of the subject – thank you Miguel.

    I find the M2 angle of looking at this issue particularly interesting: “only” an about 15% increase in the US, definitely manageable in theory – the political will to do so is another story. But, as you say, the problem is well identified plus it seems like the masses also understand it and most importantly we still do have overall fair and clean elections and are therefore able to change things.

    In contrast to Venezuela, where M2 soon will have doubled, it seems to me that the horse has left the barn and only a bullet can catch it now and stop it in its track by killing it.

    The saddest part is that I believe in Venezuela a majority of the people have not even realized what’s really happening, and I don’t just mean economic topics.

    Seems like what most matters is what’s next in terms of plastic surgery for the females in the family clan, or how many latest model Blackberries need to be purchased during the next trip to the US.

    Btw; seems like the Snap Shots are off – thanks.

  4. Alchemy Says:

    Chavez, the master alchemist , has already turned gold into lead. So why not try to turn chicken shit into chicken salad?

    Does he really think that those who have robbed the country and sent their ill gotten “profits” overseas on previous bond issues have the loyalty to the people an/or him to repatriate even one dollar or euro on this BSF)) (bullshit) PDVSA issue? Like the rest of the world, they prefer to invest in promises with some future in a convertible currency.

    They dont need no stinking refrigerators and have already seen through the smoke an mirrors. Plus, the rest of the world has cheaper access to papel de bano.

  5. Andres F Says:

    Not only is US inflation low, but it’s expected to remain fairly low in the near future.

  6. Roberto Says:

    Funny how Argentina is playing right along, using the same playbook

    Coincidence?

    http://online.wsj.com/article/SB10001424052748703573604574493541233653908.html

  7. Kate Says:

    I’m trying to work out why the implicit exchange rate on the 2014/2015/2016 combo (Bs5.39) was so much worse than the initial 2019 and 2024 bonds (Bs4.34) seeing as the price was similar (135-140%). Is this because the face value of the US$3bn combo fell more quickly as the market was already saturated?

  8. Kate Says:

    Thanks…


  9. [...] A reader asked the following in the comments, which led to an answer and then to this post: [...]


  10. [...] PDVSA bonds and Central Bank Law changes: Printing money to address the political problem [...]


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