Fixing the Dollar Drought

Say you are a socialist, and you have intervened heavily in the economy. Suddenly, things don’t work as you thought they would. Somehow, economic laws seem to refuse to bend to your will. However, you cannot really believe that since according to your convictions, wealth is a byproduct of government plans and decrees. Moreover, your predecessor (also a socialist revolutionary) had the best advice oil money can buy – even from people who are now advising socialist parties over in good old Europe. So the solution to the unintended consequences of the initial intervention is to intervene further, in an attempt to refine the plan, so to speak.

You may have heard about a certain proverb attributed to Einstein about insanity, but you can’t quite recall what it was. So you try again. And again. And again. Chances are, your name is Nicolas Maduro. But eventually, you quit trying – sort of.

Image via diyconfessions.com

As Bloomberg reports, Maduro wants to fix the dollar shortage in Venezuela by introducing the fifth parallel currency market in 12 years – Venezuela will end up with three different official exchange rates as a result, one of which should actually track what was hitherto the black market rate (i.e., the real market exchange rate):

“Venezuela will create its fifth parallel currency market in 12 years to boost U.S. dollar supplies as plunging oil revenue worsens food and medicine shortages and pushes the nation deeper into recession.

The new market will allow private companies and individuals to trade the greenback through brokerages, President Nicolas Maduro told Congress in a televised address Wednesday night. The government will continue importing essential products at the primary exchange rate of 6.3 bolivars a dollar, while combining two other existing currency auctions into one, he said.

“This is the decision I have taken: a system of three markets,” he told lawmakers after being welcomed by live salsa, ceremonial cannon shots and chanting supporters. “This exchange system is a transitory system to attend the country’s development needs” while oil prices stabilize, he said.

Maduro has preferred tighter currency controls to ease economic strife as he seeks to avoid cuts to social spending. A 61 percent drop in the value of Venezuelan oil since June has brought it to the brink of a debt default, according to prices in the swaps market. Oil provides 96 percent of revenue to the country, which imports almost everything it consumes.

“The set of reforms announced in the annual report were incomplete and insufficient to disentangle accumulated distortions over 15 years,” Hernan Yellati, Miami-based head of research at brokerage BancTrust & Co., wrote in a note to clients after the speech. “Plus an unanticipated plunge in oil prices.”

Venezuela last sold dollars at the two secondary auction markets for 12 and 52 bolivars.

Maduro said he has approved $8.1 billion of food purchases this year at the preferential rate. This compares with the $11.4 billion allocated to importers at 6.3 bolivars per dollar in the whole of 2014, according to Barclays Plc estimates.

Below is an updated chart of the Venezuelan bolivar’s exchange rate against the US dollar on the black market in Cucuta, a town near the Colombian border. Interestingly, it seems to have temporarily stabilized in a volatile trading range since November last year. This is interesting mainly because the US dollar has continued to rise against almost every other currency, but then again, the bolivar has already plummeted rather precipitously for most of 2014:

Venezuelan bolivar vs. USD, black market rate (data via dolartoday) – click to enlarge.

Making free trade in bolivars legal is undoubtedly one of Mr. Maduro’s better ideas, quite possibly the best one he ever had. It is a result of desperation, and it appears it is also a case of too little, too late. Venezuela’s foreign currency reserves amount to slightly over $20 billion, while its total foreign liabilities amount to approx. $135 billion as of Q3 2014 (of which $11 bn. in government debt are coming due this year). After many years of heavy-handed regimentation of the economy, characterized by expropriation/nationalization and price controls, Venezuela has indeed not much it can export besides oil – and even oil production has steadily declined.

The inflationary regime has moreover undoubtedly pulled resources from the consumer stages to higher orders in those parts of the economy still in private hands, so that consumer goods production is likely especially subdued. According to Professor Steven Hanke, Venezuela’s implied consumer price inflation rate is around 194% at the moment, which is about three times what the country’s central bank has lately admitted to. While the ‘general level’ of prices is inherently impossible to ascertain – as there exists simply no fixed yardstick that can be used to measure it – Venezuela’s money supply growth has definitely exploded into the blue yonder:

Venezuela’s narrow money supply M1 since 2004, in millions of VEF – click to enlarge.

Maduro even admitted that the official consumer price inflation rate of 64% was a little on the high side, and announced he would only approve a 15% minimum wage hike this year and would ponder whether to cut fuel subsidies. Even such tentative reform proposals may once have been received quite positively by the markets. However, due to the decline in oil prices, markets have refused to budge. Implied annual default probabilities for Venezuela’s government debt remain at a record high near 20% (based on 5 year CDS spreads and a 40% recovery rate), in spite of government debt only amounting to about 50% of GDP at the current juncture (this is set to rise even if no debt is added, as GDP is set to shrink sharply this year).

Venezuela’s sovereign debt sports the highest CDS spreads and default probabilities in the world – click to enlarge.

Effects of Price Controls Are Getting Worse

Maduro would have to adopt a radical program of economic liberalization if he wanted to effectively counter the increasingly acute economic crisis Venezuela is faced with. However, even if he were aware of that – which he possibly isn’t – he seems to be afraid that cutting subsidies would worsen his already sharply declining popularity further.

Not surprisingly, price controls have denuded the shelves of shops of even the most basic goods, with the result that people are these days forced to queue for hours to buy food and other necessities – reminiscent of Soviet times. The situation is evidently becoming more desperate by the day, as the government has just announced it will deploy the military to “protect shoppers”. Meanwhile government officials are telling people with a straight face that the bare shelves are actually “full”, in an Orwellian twist that would be quite funny if it weren’t so sad for the citizenry.

“Shoppers thronged grocery stores across Caracas today as deepening shortages led the government to put Venezuela’s food distribution under military protection. Long lines, some stretching for blocks, formed outside grocery stores in the South American country’s capital as residents search for scarce basic items such as detergent and chicken.

“I’ve visited six stores already today looking for detergent — I can’t find it anywhere,” said Lisbeth Elsa, a 27-year-old janitor, waiting in line outside a supermarket in eastern Caracas. “We’re wearing our dirty clothes again because we can’t find it. At this point I’ll buy whatever I can find.”

A dearth of foreign currency exacerbated by collapsing oil prices has led to shortages of imports from toilet paper to car batteries, and helped push annual inflation to 64 percent in November. The lines will persist as long as price controls remain in place, Luis Vicente Leon, director of Caracas-based polling firm Datanalisis, said today in a telephone interview.

Government officials met with representatives from supermarket chains today to guarantee supplies, state news agency AVN reported. Interior Minister Carmen Melendez said yesterday that security forces would be sent to food stores and distribution centers to protect shoppers.

“Don’t fall into desperation — we have the capacity and products for everyone, with calmness and patience. The stores are full,” she said on state television.”

It seems to us the time of “calmness and patience” is long past, and we wonder how the government plans to “guarantee supplies” that evidently simply don’t exist. We were also wondering what precisely shoppers are supposed to be protected from. Evil capitalists? Actually, it seems that they by now mainly need to be protected from each other, as fights over scarce goods have become quite frequent. Good queuing behavior has also gone out of the window.

Venezuelan president Nicolas Maduro and his heavily mil-bling adorned interior minister Carmen Melendez.

Photo credit: Prensa Miraflores

But worry not, true believers, an “economic counteroffensive” is in the works – as soon as the details have been worked out. And please take no photos of the full shelves dwelling in Ms. Melendez’ imagination:

“President Nicolas Maduro last week vowed to implement an economic “counter-offensive” to steer the country out of recession, including an overhaul of the foreign exchange system. He has yet to provide details. While the main government-controlled exchange sets a rate of 6.3 bolivars per U.S. dollar, the black market rate is as much as 187 per dollar.

Inside a Plan Suarez grocery store yesterday in eastern Caracas, shelves were mostly bare. Customers struggled and fought for items at times, with many trying to skip lines. The most sought-after products included detergent, with customers waiting in line for two to three hours to buy a maximum of two bags. A security guard asked that photos of empty shelves not be taken.

Police inside a Luvebras supermarket in eastern Caracas intervened to help staff distribute toilet paper and other products.

“You can’t find anything, I’ve spent 15 days looking for diapers,” Jean Paul Mate, a meat vendor, said outside the Luvebras store. “You have to take off work to look for products. I go to at least five stores a day.”

Venezuelan online news outlet VIVOplay posted a video of government food security regulator Carlos Osorio being interrupted by throngs of shoppers searching for products as he broadcast on state television from a Bicentenario government-run supermarket in central Caracas.

Unfortunately VIVOplay is a subscription service, so we cannot post the video of government shill Carlos Osorio getting almost run over by shoppers mentioned above (he is known for regularly pronouncing that everything is perfectly fine on state-owned TV, and they prepare selected supermarkets for his appearances). Here is however a video by the FT summarizing the situation in early December:

Queues and shortages in Venezuela – note that annual imports amount to $43 billion – it will be quite difficult to pay for both imports and debt redemptions if oil prices remain near their current levels for an extended time period, hence the rising default probabilities.

Conclusion:

For many years, the Venezuelan government was able to mask the failures of Huge Chavez’ “socialist revolution” somewhat with the help of the country’s oil revenues. However, it should be remembered that shortages of basic goods in Venezuela are nothing new; the first press reports appeared about two years ago, when oil prices were still quite high (see also this late 2013 article of ours: “The Hygienically Challenged Crack-Up Boom”). As we quoted from a press report on that occasion, some Marxists – as long as they are members of the ruling class – seem actually not overly worried about scarcity:

“Not everyone thinks these shortages spell bad news. Planning Minister Jorge Giordani, an avowed Marxist, famously quipped in 2009 that “socialism has been built based on scarcity.”

Of course it was easy to make such quips, callous though they may be, back when the hugely popular Huge Chavez was still around and able to distribute large oil revenues with both hands. The situation is a lot more difficult for Nicolas Maduro, who is probably slowly but surely getting worried about the potential for a counter-revolution (there has already been intermittent unrest in Caracas – and at the time the bolivar’s black market rate was still 85 to the dollar instead of 185).

Russia’s economy is likewise suffering from the decline in oil prices , but its government has a lot more breathing room in terms of debt and foreign exchange reserves and would be able to greatly help its economy merely by getting serious about tackling corruption.

Maduro has a much bigger problem, as he would essentially be forced to abandon the very ideology he so wholeheartedly supports if he wants to turn the floundering ship around. He does have one advantage over Putin though: he has very little to lose anymore in terms of his approval ratings. He probably must worry about his party comrades though, many of whom will be reluctant to abandon the late and great Hugo Chavez’ “socialist achievements”. It will be interesting to see how things will play out, in light of Maduro lately adopting steps he would never have taken a year ago. Still, given the government’s debt situation and Venezuela’s monetary statistics, a complete loss of confidence in the currency remains a very real possibility. In other words, the thread by which Venezuelan socialism hangs may soon snap.

Venezuela’s official inflation rate is a (more or less) comforting fantasy concocted by its central bank, but it is nevertheless worth showing, as the chart illustrates that the rise in prices has greatly accelerated over the past two years – click to enlarge.

Charts by: Tradingeconomics, Acting Man, data via Deutsche bank, dolartoday.com