Friday, September 25, 2009

How to run your economy into the ground: a lesson from Venezuela

What happens when you mix irresponsible borrowing and spending policies with a socialist government that is hostile to private enterprise? Then you impose exchange controls to keep the currency from collapsing. Throw on top of that a nasty dictator who disregards the constitution and you get a real mess. The answer is, you get Venezuela (although you may have been thinking of something else).

With nearly half of the country's revenues coming from oil sales (and oil being significantly down from last year), Venezuela's government is desperate for cash:
Bloomberg: Venezuelan President Hugo Chavez will likely sell dollar bonds for the first time in more than a year after unveiling a $5.7 billion local debt offering yesterday, said Goldman Sachs Group Inc. and RBS Securities Inc. The dollar bond sale may total about $4 billion, according to RBS analyst Siobhan Morden. The government announced yesterday in the Official Gazette plans to sell as much as 12.15 billion bolivars ($5.7 billion) of bonds by year-end, an offering that could swell the supply of debt in the local- currency market by more than 25 percent.

Venezuelan currency, the bolivar actually has two markets: the official exchange rate, where one needs government permission to buy a foreign currency, and the black market (offshore) where the currency trades at a 62% discount. Of course if you are a friend of some government officials in Venezuela, you too can purchase dollars at the official government rate and make a 62% profit in the black market. The chart below shows the price of a dollar in bolivars in the "official" market. The best way to create a black market of course is to impose price controls (a note for those who want to impose price controls on commodities for example).

Source: Bloomberg

All the money printing and currency controls actually do have some consequences. And they are not pretty. The chart below shows Venezuela's inflation rate compared with Colombia, Peru, and even Argentina.

Source: Bloomberg

Imagine inflation rate of close to 30% as cash dwindles by nearly a third every year. May make buying dollars at a 62% discount potentially attractive. Of course to compensate for that, Venezuelan banks must pay a pretty hefty interest rate. But only when they need the cash. At other times they pay very little, making for "jumpy" interest rates.

Source: Bloomberg

So how do you solve such dire domestic problems? It's simple, you blame your neighbors and go on a weapons purchasing spree.

Reuters: In recent years, Venezuela has bought over $4 billion in weapons from Russia including 24 Sukhoi fighter jets. Critics say Chavez is gearing up for an arms race in Latin America, but he says he is modernizing the military for defensive purposes.

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