Why I would not want to be the next president of the Bolivarian Republic

Reader Shah8 asks about the problems is Venezuela’s economy. It’s a good question.What are the time bombs waiting to go off?

Before I start, let me present the case for the defense. The linked paper argues that Venezuela’s economic expansion is sustainable. The linked paper, however, is incorrect.

First, the authors sustain that payments on Venezuela’s foreign debts are manageble. They are correct. (Figures 3 and 4.) The problem is that the interest burden is not the problem. The problem is that government of the Bolivarian Republic requires capital inflows around $15 billion every year to stay in balance. If those inflows drop, then BLAM ... sudden stop.

(The authors are convinced that China would not allow Venezuela to collapse. I am unclear as to why they believe that.)

Second, the authors argue that the bolívar is not overvalued. They base this on a scatterplot of countries. On the Y-axis they put the ratio between the official (or market) exchange rate and the exchange rate at which a basket of goods and service would cost the same as in the United States. Venezuela is not out of the pack.

The problem is that this measure has a lousy track record of predicting currency movement.

There is better measure of the bolívar’s overvaluation: the difference between the official rate and the black market rate. (The black market rate is tracked, more or less, at this website.) The gap has now approached three-to-one. It hard to see how Venezuela can sustain that without worsening shortages of imported goods or a major devaluation.

The only other country in the hemisphere in a similar situation is Argentina. When I was in Argentina in May and June of 2012, I was very tempted to blog about the controls despite a lack of time. (I wish I had; perhaps I still will.) Pesos were pegged at 4.5 per dollar, but while I was there the “blue market” rate hit 6.15.  A Brazilian couple was arrested by dog-using police teams practically in front of me; they were carrying several thousand dollars. (The papers reported that they were acquitted.) That was legal, but the dollar-sniffing dogs were hunting black marketeers. The controls made (and make) life difficult for small manufacturers, which often find it difficult to buy the dollars they needed to import specialized goods.

But Venezuela’s exchange controls are in a whole different level from Argentina’s. The Argentine blue rate is around 60% above the official rate; the Venezuelan parallel rate is almost three times the official rate. Argentine controls hurt some importers who cannot get dollars, but they are not noticeable in the shops and streets. Venezuelan controls, on the other hand, cause cooking oil, margarine, and toothpaste to disappear. Venezuela has been plagued by periodic shortages for years, but they are now becoming pervasive.

That is not sustainable. Well, it is ... but at the cost of ever-worsening import shortages. Either Venezuela will develop an extensive set of import-substituting industries (a la Mexico circa 1980) or most Venezuelans will lose access to manufactured goods. There is no sign of the first thing happening.

Both these problems — a dependence on foreign borrowing and unsustainable capital controls — come together in the electricity crisis. I blogged about it in 2009: it is not getting better. Other countries have experienced temporary shortages (Ecuador in 2009) but none have suffered ever-more-erratic service for four years. (Ecuador has resolved its problems.) Installing thermal generators requires the government to borrow to get the dollars, and the refusal to charge market prices for energy drives up the budget deficit. Then, to make things worse, the exchange controls drive up construction costs. (I explain why that happens here.)

In other words, there are three ticking time bombs waiting to hit the next Venezuelan administration. First, capital inflows could slow; at some point they will slow. Venezuela is not in a position to handle that without a severe recession. Second, at some point either the shortages will become unsupportable or the bolívar will be devalued. Shortages will not be good for the party in power. A devaluation is equally problematic. With inflation already running north of 20%, it could (oh, heck, almost certainly will) cause large price spikes with all the ensuing damage to living standards. Third, the electricity crisis shows no sign of abating. Maduro blamed the blackouts on gringo sabotage; I do not think that is an effective political strategy.

There is a fourth time bomb: crime. Hugo Chávez was seemingly immune to criticism on the topic; the next administration will not be.

And there is a fifth: Chavista foreign policy. More on that in a future post.

I make no predictions about which will blow up first or how badly. But at least one of them almost certainly will. The next administration will have to fix the problems or deal with the aftermath ... but there are no painless fixes.

Comments

[shah8]

Most interesting, many thanks for allowing me to discover settysoutham's blog.

I think I will lead off my contribution by stating:

Venezuela's key problems derive from a lack of talented, capable people. They didn't really have enough of it in the first place, lost a lot of it in the lost decades due to skill erosion and generational turnover, and these days, many of them are batshit teabaggers. I was really disappointed by the violence after election day. The best fix for Venezuela is a functional right wing people would trust not to instantly engage in class warfare should they have power again.

Now, I do not think that Venezuela is particularly uniquely susceptible to a currency crisis, and I do strongly suspect that one of the broad sentiment behind their current activities (cleared of corruption, misunderstanding, inability to follow through) *is* an intent for a passive import substitution effort. Moreover, I also suspect that Venezuela has to come to some sort of understanding with the US and Europe in order to access specialized personnel that could assist with rebuilding the oil and other resource extractive industries (and they don't want to, or want it on Venezuelan terms). And of course, lastly, resource curses lead to cronyism that frustrates genuine economic dynamism.

Going back to the whole unique element here. What do you really think would happen, on a world-wide level, if oil was to drop by $40-$60 such that Venezuela could not service international debt? Say in an algo-led flash crash, or some other unpredictable event that reveals global economic torpor? Dude, Algeria would just about go bananas--they have far more serious and fundamental issues wrt need for foreign currency. Most MENA countries would be affected, economically and politically, more than Venezuela. The broad world-wide lowering of economic activity necessary to lower oil that much (remember, no North Sea oil taking out the Soviets!)would further introduce problems most likely to be graver than what would be happening in Venezuela.

Now, also, Venezuela has many tools, even if unpleasant ones, to deal with crisis, like decreasing subsidies, bringing about a wage deflating recession, etc, etc. Thus the worst that can happen is a *short* period of bad times. This should be taken in light of a key reason why neoliberalism was rejected in SA. Washington Consensus led to decades long recessions. The resulting policy mix of pretty much the entire SA outside of Mexico, Colombia, Paraguay leans towards distancing their national economies from being especially friendly to Western corporations and being more proactive about setting an appropriate currency trade for the local socio-political matrix. No more direct pegs, no more hot money inflows and outflows, etc.

I think one of the points many analysts from outside the region refuse to get is that Chavismo is just not very far outside of the broad SA consensus--such that they think Chile is genuinely friendlier than it actually is to international business, for example. Therefore, I think the prevalent implicit assumption that people will tire of the basic premises of Chavism, as opposed to the cronyism and other failures of Venezuelan insitution will reveal itself as insufficiently granular. Venezuelans will make distinctions, and even from the right, it will be the nationalist right of an aged Perón. Internationalists like Menem (w/Cavallo), Fernando Cardoso, de Lozada, Papandreou in Greece, I think the Venezuelan equivalent has zero shot--at best, the unhappy experience of Piñera where presumably Bechelet will be triumphantly returning, more socialist than ever. So...pain will happen, but I think the policy matrix will only shift just enough for immediate sustainability, with public support.

I'm dubious about the power thing. Most places with large groups of new consumers suffer from long term pernicious power cuts--thinking of India. Both India and China cope with it through disastrous ever-expanding coal burning. South Africa isn't much better. Russia only cares about two cities. Ecuador can allow the end of drought to solve their problems because Ecuador doesn't really provide access to electricity to all and industrial centers gets dibs.

Indubitably, I have more to say, but this is long enough! Also nice and free-association-y...

[Noel Maurer]

I have only three comments; I agree wholeheartedly with your first paragraph. But I would stress two things:

(1) Venezuela already is in a currency crisis. The foreign exchange market is uniquely out of whack: there is no other current parallel. (Argentina is the only other place with binding exchange controls, and they are small beans comparatively.) This cannot be overstated.

(Some people in the Venezuelan government clearly want a return to import substitution ... but by God they have made a hash of it!)

(2) The energy crises are much greater than elsewhere. Ecuador is the parallel. Both countries were hit by the drought; one adapted, the other did not. The blackouts are on a scale simply not seen in other parts of Latin America, let alone countries as rich as Venezuela.

Much more than ideology, what made the Chávez government unique was its awe-inspiring incompetence. President Correa makes a good counterfactual. Agree or not with his goals, the man knows what he's doing. His missteps (and there have been many) can be understood.

But I stopped trying to understand Chávez sometime around 2010. Thank God for elections; was there anything but the desire to win them constraining his actions?

[shah8]

Alright, quick reply:

1) When I think of a country in a dire currency crisis, I will normally think of the North African countries, particularly Egypt. Syria and Iran, for different reasons, have their own currency issues. As such, when I compare Egypt, who may not even be able to finance its own harvest, as a whole, come fall, let alone import wheat for bad public bread for the poors, with Venezuela, it just pales, you know? I don't even have to stay in Africa--the debt and currency structure of most of Eastern Europe is also dire in far more immediate senses than in Venezuela. Cyprus is already down to nothing, but Slovenia is next, and Hungary, Slovakia, and the Ukraine aren't really far behind Slovenia. Venezuela is in currency crisis in only but a very peripheral sense, and the structure of their assets and options suggests to me that everyone turned insta-poor or mobs-in-the-street sorts of crisis are pretty unlikely to *uniquely* happen in Venezuela.

2) At the end of the day, Ecuador is a smaller country, with lower capital intensity, and lower per capita gdp than Venezuela. Going out and buying fuel for thermal plants when it's dry, on an economy with no domestic currency but using a pretty hard dollar (in terms of what goods are only bought with dollars)--that's pretty simple calculation. It came at a pretty high cost in the wake of nasty inflation and afterwards, though. Remember, though, that Ecuador did default, even though it wasn't really profitable nor necessary. As a consequence, China and the World Bank has those guys by the balls in terms of foreign sources of loans. Ecuador is quite a bit more breakable than Venezuela, and the lesser amount of corrupt stupidity simply reflects that awareness.

The high currency valuation of the bolivar more or less is the same deal. Venezuela can get away with three times the black market value. Argentina cannot, for a multitude of tenacious reasons. Again, I think it needs to be strongly emphasized that for internal social and recent political history, neither country will easily let up on goosing consumption through the use of artificially high currency valuations.

3) When talking about incompetence, I routinely read more crazy stuff about the Philippines or Hungary. In general, governments outside of select areas of first world governance are usually stuffed full of incompetent time-servers. Venezuela under Chavez has never been as incompetent as China when smarter folks couldn't manage to stuff the old lech in a closet somewheres. Venezuela under Chavez has managed to achieve *some* things, and build a few complex projects. If they were truly, staggeringly, incompetent, then Chavez probably couldn't win fair elections no matter how much oil money he has. Also, I do think that the low amount of foreign expertise in Venezuela makes the incompetence far more stark compared to peer countries than it really is. Do you think Fahd's grandkids have the remotest ability to run a country?

what happened in 2010?

Dang, this comment got long again...Also read lots and lots of stuff online while writing it. T'was fun.

[shah8]

I was also doing a lot of reading comparing Turkey's trade and currency balance with Venezuela's. Venezuela simply just doesn't import enough to be in much danger--there is clearly some degree of international capital strike. However, even modestly better governance in terms of getting refineries built and repaired, more transportation and more houses would probably just dive the bolivar higher, prompting more skill needed in protecting non-oil industries.

On the flip side, Turkey doesn't have the healthiest of trade balances, and they are very, very, exposed to the softening of trade with Europe, Iraq, and Syria. The central bank has a pretty big currency warchest, though.

A later cursory look at Malaysia shows another huge warchest at their central bank. Also shows the state collecting a pretty small share of the overall economic activity. This could be good, vibrant private sector and all, but it could also just a very highly exploitative system. Won't know unless I really did.