Thursday, 2 August 2018

Lessons from Venezuela's calamity

Spending without saving and refusing to heed expert advice are among the factors that drove a rich country to poverty in less than a decade
By Vikram Khanna, Associate Editor, The Straits Times, 1 Aug 2018

One of the most eye-popping headlines last week was that Venezuela's inflation rate is headed for a million per cent by the end of the year, according to the International Monetary Fund (IMF).

Imagine what that means. It means if you have $10,000 in cash, a year later, you'd be left with one dollar's worth of purchasing power. You might be able to buy a cup of coffee, if you're lucky.

Bloomberg's Cafe con Leche Index, which tracks the price of a cup of coffee at a bakery in eastern Caracas, found that the price soared to 2,000,000 bolivars last week from 1,400,000 bolivars the week before. Back in late April, the price was 190,000 bolivars.

The bolivar is Venezuela's official currency, and it has gone to hell. At the start of this year, one US dollar fetched 10 bolivars. On July 30, it fetched about 173,000. By the time this article is printed, it would probably be closer to 200,000.

The minimum wage is the equivalent of just over US$1 (S$1.30) a month at the free-market exchange rate.

Reports of day-to-day life for the average Venezuelan are horrifying. The moment people get paid, they run to the nearest store to buy whatever they can. Oftentimes, they can't find what they need. Essentials like food and medicine are usually gone from the shelves. People are losing weight because they can't get enough to eat - many families survive on one meal a day. Imports are exorbitant. Toilet paper, toothpaste and shampoo have become luxury goods. There are queues for everything. Public services have collapsed. Hospitals resemble those in war zones, with people lying in corridors, on the floor. Outages of electricity and water are frequent.


People are resorting to ingenuity to survive. Car mechanics make their own car parts by melting down metals pulled from garbage dumps and then reshaping them in workshops. Beer-makers smuggle essential ingredients like hops and barley in their personal luggage when they get a chance to travel. Internet-savvy entrepreneurs use bitcoin for their transactions wherever possible. The financially savvy use the stock market as a hedge against inflation, buying shares as a means to deposit money and selling them to withdraw it. People barter their services for goods and vice versa. Craftsmen stitch handbags and baskets out of worthless bolivars to sell on the street.

But the vast majority of the population - about 80 per cent - live in poverty. Venezuelans have become the world's poorest billionaires. According to IMF estimates released on July 23, the country's gross domestic product will crash by 18 per cent this year and will have fallen by almost 50 per cent since 2016.

The great mystery is how it happened. How did a country that was one of the richest in Latin America until as recently as 2012 and even today has the world's largest proven oil reserves sink to this state? Hyperinflations are not new, but they are rare and they are usually related to wars or natural calamities, as in Germany's Weimar Republic in the 1920s, the former Yugoslavia in the early 1990s or famine-threatened South Sudan today. Unlike these episodes, Venezuela's hyperinflation is totally man-made, in peace time. How did it happen and what can we learn from it?


Although Venezuela's history of economic instability goes back to the 1970s, we can pick up the story with the election of the populist demagogue Hugo Chavez in 1998, amid high inequality and popular discontent.

He promised to redistribute Venezuela's oil wealth to the poor, which he did with some success - at first. Helped by a boom in oil prices, he used Venezuela's oil revenues - which account for about 95 per cent of its exports - to provide subsidised public housing, healthcare and education. Social indicators improved. But even after oil hit US$100 per barrel in 2007, the government was spending much more than it earned. No money was set aside - there was no sovereign wealth fund, no national nest egg.

An early warning came in 2009, when oil prices collapsed to around US$40 a barrel because of the global financial crisis. But there was no let-up in spending; the difference between receipts and expenditures was covered by borrowing and by monetising the deficit.

As inflation started to take off as a result, Mr Chavez refused to recognise the real source of the problem - unsustainable spending - and instead blamed hoarders and speculators for rising prices, as well as multinationals and the United States. He imposed draconian price controls, which led to shortages of basic goods as supplies collapsed, exacerbating inflation further.

For good measure, he also nationalised large parts of the food industry, which made the problem even worse, as bureaucrats had no idea how to run farms or food businesses. Other industries, such as utilities and banks, were also nationalised, with similar results. Unreliable power and water supplies hit industries and led to further declines in production.

Even the oil industry, the single source of Venezuela's wealth, suffered. Thanks to a lack of investment and maintenance, oil production has roughly halved between 2011 and this year , and now stands at its lowest level in more than 50 years.

The currency market was also thrown into turmoil. In 2003, Mr Chavez imposed capital controls to prevent capital flight and fixed the value of the bolivar against the US dollar.

But the demand for dollars was so high that this led to a black market - actually, a free market - where dollars were more expensive, but at least available. Black-market dollars then became part of the cost structure of goods, adding to inflation. As time passed, the gap between the official and black-market rate widened. By January last year, one US dollar was officially worth 10 bolivars, but on the black market, its value was close to 8,000 bolivars.

Regime insiders and cronies who had access to dollars at the official rate resorted to currency arbitrage by reselling their ill-gotten dollars on the black market. Venezuela's former finance minister and adviser to Mr Chavez, Mr Jorge Giordani, who was later dismissed, estimated that as much as US$300 billion could have been embezzled as a result of currency arbitrage between 2003 and 2012.

After Mr Chavez died of cancer in 2013, his chosen successor, Mr Nicolas Maduro - a former bus driver and unionist - piled mistakes upon economic mistakes. Despite a 70 per cent oil price collapse in 2014, the spending binge continued, with deficits monetised by a pliant central bank.

Inflation rose exponentially. A freeze on firing, while ostensibly protecting workers' jobs, led to soaring absenteeism as workers discovered they could earn more working in the black market than in their regular jobs.

Emigration also soared - close to one million people emigrated between 2015 and last year, according to the International Organisation for Migration.

To ward off criticism of his policies, Mr Maduro dismissed Venezuela's elected legislature last year and replaced it with a handpicked constituent assembly which has little popular support and is beholden to the regime. There is thus no official opposition in Parliament; only street protests.

Venezuela's government refused to take the advice of international institutions. In 2007, it cut off relations with the IMF, which has not been able to do an on-the-ground review of the economy since 2004. Mr Maduro's government has instead tried a variety of homespun remedies. In February, it launched its own cryptocurrency, the petro, supposedly backed by Venezuela's oil reserves. It has gained no credibility and is, in fact, viewed as a scam.

In March, the government came up with an even zanier idea: It simply lopped off three zeros from its currency, so 1,000 bolivars were redenominated as one bolivar. This cosmetic measure will, of course, do nothing to curb the country's hyperinflation.

One day, it will end, as all hyperinflations do, but nobody knows how or when. Meanwhile, Venezuela continues to slide into the abyss of poverty, violence and chaos.


So what lessons can we draw from this tragic tale of economic mismanagement on such an epic scale, whereby a rich country was made poor in less than a decade?

Here are five.

One is that a mono-industry economy is risky, especially if that industry happens to be a volatile commodity such as oil. When oil prices crashed, Venezuela had little else with which it could replace the lost revenue.

Two, a government must not ignore Budget constraints. If it does, those constraints will impose themselves anyway - in Venezuela's case, this happened through inflation, when the government responded to deficits by printing more money.

Three, policymakers must not double down on even a successful policy when circumstances change. Mr Chavez's well-meaning social programmes were initially successful. But when they became financially unsustainable after oil prices crashed, the government did not change course, not even to change the way the programmes were financed.

Four, it is critical to set aside resources to cope with unexpected economic setbacks, and this is best done in boom times. One of Venezuela's cardinal economic sins was that it created no financial nest egg, even though it enjoyed an oil boom for almost 10 years.

Five, do not ignore expert advice, as Venezuela did, and is continuing to do. While received wisdom is not always correct, unorthodox, homespun remedies are usually worse.

Venezuela's calamity holds a lesson for electorates too. Beware of populist leaders who make extravagant promises, who never acknowledge their own policy mistakes but blame outsiders for problems, and who disregard established institutions, insisting that they alone have all the answers.

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