The Venezuelan economy has been unraveling. Last year growth was -3.3% of GDP while official inflation was close to 26%. The Government was forced to issue US$ 12 billion in new dollar denominated debt in the last five months of the year and as the New Year began was forced to devalue, creating two rates, thinking that would take care of some problems. Instead, this introduced new distortions in the economy, as there was now a new level of discretion at CADIVI, which concentrated approvals at the lower rate of Bs. 2.6 per US$. This led importers and manufacturers to the swap market, which rose all year for the simple reason that demand (from importers and capital flight) simply outstripped the supply which was provided largely by the Government. (Nobody investigates this part!)
But these are just the consequences of what began way back when Hugo Chavez decided to take out “a millardito” (a little billion) out of international reserves, while allowing the Central Bank to print money in order to promote consumption. That was Chavez’ original sin and it is coming back to haunt him. Since then, Chavez took out US$ 60 billion in reserves,while increasing monetary liquidity by a factor of almost eight, while international reserves have barely increased from US$ 20.6 billion to US$ 27 billion, a scant 31%, versus the 800% increase in the amount of Bolivars in the Venezuelan economy (M2).
Since nobody trusts the Bolivar, everyone (including Chavez) wants some of those dollars at the Central Bank and allowing Chavez to take international reserves simply debased the Venezuelan currency.And you can see the folly on it, the 2003 exchange controls were established to control who you gave dollars to in order to protect reserves. In January of this year two rates were created to give preferential treatment to “political” goods: Food, medicines and, of course, Government expenses, once again in order to protect reserves. The first control did not work, the second one did not either. The solution? Start a third controlled rate, try to move the parallel market to BCV to once again establish who should and/or not get the foreign currency. How can it work? Experience shows these schemes never work.
The problem is that controls are always very inefficient, as the failure of CADIVI shows, it owes billions of dollars to importers and the Central Bank has very limited resources to provide to this market what it needs unless, of course, it supplies this market more than it supplies CADIVI, a sort of masked devaluation, but I don’t think this is what they have in mind.
Why didn’t this happen earlier? Well, it did, but in slow motion because the sharp increase in oil prices covered the mistakes. Higher oil revenues gave the Government funds to keep the rate somewhat in check, which was accompanied by issuing of debt to allow capital flight via Government and PDVSA bonds. But the rate always rose after the Government “intervened” with bonds and directly.
Like all crisis, you could see it was coming, but you did not know when it would explode, as it seems to be doing now. There has been no growth for over a year and inflation is accelerating very fast. It is stagflation at its best. And the solution chosen by the Government, to restrict the market rate that gave fluidity to the economy, will affect negatively both the “stag” and the “flation” side of the equation.
Because, to begin with, we will spend ten days to two weeks without a parallel market of any form, this slows down the economy. This will also result in some scarcity of products for companies that can not either import or manufacture because one component is missing. This adds to inflation, because it pressures prices up. Thus, both the “stag” and the “flation” will go up. To top it all off, there will be the repressed demand of two weeks without a market, which will certainly add to the “stag” side of things.
Once this new market at the Central Bank is formalized, not everyone will get dollars at these sales. If you are not one of the lucky few, or you don’t get the amount you need, you have to decide: Either you stop doing business, less employment, less economic activity, more “stag” or you find some way to get your hands on dollars at a higher price, which increases the “flation” side of things.
All of this would have been avoided if the Central Bank had not given Chavez international reserves that the Bank and the country sorely need today. If US$ 10 billion of the US$ 60 billion taken by Chavez were available, the swap rate could have been brought down in an instant. But the Central Ban should just not sell dollars, it should act on both sides without people knowing which side it is taking, but “markets” is a dirty word in Chavista-land and does not exist in Giordani’s brain.
So, if there are not enough dollars, what can you do?
Exactly what Chavez refuses to do:
1) Increase the price of gas from the cheapest in the world (1.1 US$ cent per liter) to cost (still the cheapest of the world at 12.6 US$ cents per liter if the barrel costs $20 to produce). This yields US$ 4 billion in savings to PDVSA, which is financing it.
2) Create a single official currency that floats, the equilibrium would be below Bs. 6, if not lower.Or
3) Have a controlled rate and a “market” value in which the BCV participates either buying or selling.
Of course, the Government is not ready to do any of this.
The consequences in the near future will simply be more stagflation. The commerce sector is likely to be hit more than the manufacturing sector, as the Government gives priority to large corporations. But things like spare parts and non-essentials will become scarce at any price, going up in price and stalling the economy.
Meanwhile Chavez wants to convince the “people” that this is not his fault, this is the consequence of speculation/US mortgages/Greek Crisis/US Conspiracy. Unfortunately, few Venezuelans realize that oil is u, but inflation is almost non-existent in the underdeveloped or developed world. Despite the oil windfall, Chavez and his economic team have managed to screw up the economy so much that Venezuela is one of the few countries showing very high inflation and a contraction of the economy, as the world recovers and oil prices have increased.
In fact, a country like Venezuela that has such a precious commodity like oil should be like Australia, Canada or Brazil, enjoying a strong currency and growth. Except that in Venezuela we have had Chavez and his empty XXIst. Century Socialism.
(Note added: To those that like graphs,Henkel Garcia published today the graphs for M2 and international reserves in his Blog de Economia y Finanzas:
as you can see, reserves have been essentially flat since 2006, while M2 has increased four fold.
Henkel also plots the “implicit rate” that rate, which arises from dividing all the Bolivars (M2) by international reserves in the same period:
Obviously, creating Bolivars at will, while holding reserves constant is dangerous to your currency. You can think of it in two ways, either there are too many Bolivars chasing too few dollars or the Central Bank does not have the dollars to satisfy the demand for foreign currency. The only caveats is that I usually don’t take into account the FIEM dollars in reserves, because the Central Bank can’t use them, they belong to PDVSA and the Government.