Archive for November 26th, 2005

On bonds, gifts to the rich and economic distortions in Venezuela

November 26, 2005

Politicians in Venezuela have always been fairly
ignorant about economics. In fact, it does not appear as they ever had a clear
idea about the difference between economics and economic policies, believing
you can violate well established economic principles in order to implement their
creative economic policies. Time and time again, one mistake in policy is built
on top of another leading inevitably to an economic crisis in the country.

Such is the case of the exchange controls currently in place
in Venezuela.
What should have been a temporary measure has now introduced so many
distortions that they become harder and harder to remove. The Government has
increased spending by over 40% from 2004 to 2005, and so has the monetary
liquidity, all of the circulating money in the country, creating problems of
various sorts, such as pressure on inflation and liquidity that has nowhere to
go as there is no demand for it.

Thus, this week, the Government resorted to a solution that
has been used already a few times in the last two and a half years, which
represents nothing but a huge gift to the wealthy of the country, the issuing
of a dollar denominated bond sold to local investors in Bolivars.

The idea is quite clever and simple: issue a bond in dollars
with a low coupon and offer it to Venezuelans who are hungry for foreign
currency which is restricted. Sell it to them at the official exchange rate of
Bs. 2150 then they turn around and sell the bonds to foreign investors, hedge
funds and the like at a discount, effectively purchasing dollars a rate
somewhere between the official rate of Bs. 2150 and the “parallel” rate which
is around Bs. 2650 at this time.

In the other bonds, not all conditions were clear when the bonds
were announced or the parallel rate and the official rate were sufficiently
close that there was an element of risk to it. Not so in this case, which is in
reality a combo of two bonds, one maturing in 2016 and the other one in 2020.

Because there is a Venezuelan sovereign bond which matures
in 2018, then it becomes very easy to predict what yield foreign investors
would want from the new ones being issued. From this, it is equally easy to
know at what discount you will be able to sell the dollar denominated bonds in the international markets. In
this case it is somewhere around 87% for the combination of the two bonds,
which tells you will be buying the foreign currency at Bs. (2150/.87) = Bs.
2471 per US$ or so.

While many companies and individuals will use this simply as
a mechanism for purchasing cheaper foreign currency, for many, this is simply
free money courtesy of the Venezuelan Government. You either have the money,
like the banks, or you borrow the money to purchase the bonds. You get the
bonds, sell them and turn around with the US dollars and sell them in the
parallel market at a tidy profit of 7.2% in just a few days using the numbers I
gave you above. Thus, the revolution is simply giving a gift of money to the
rich as a way of solving an economic problem they face.

Of course, the ideal solution would be to remove the
controls, which would simply reduce liquidity by itself. But because the
controls have been in effect so long, there are too many distortions in the system
and removing them would imply that some banks would be in trouble, interest
rates would have to go up to be above inflation and last but not least, the
Government would lose an important weapon of control over the people and the
private sector.

The example I gave above in terms of profits for the transaction will likely be even better than
described for those that buy the bonds. Because there are rumors that the
Government plans to use the funds raise in part to repurchase some of the
country’s debt, Venezuelan bonds went up after the announcement. If this rise
is sustained thru Monday then people will likely make more like 10% in this
quick, riskless and profitable trade. Nice gift, no?

This gift is well received by the banking system, which has
so much money from depositors, but can’t lend it all, so they use that excess
to participate in this as well as to lend to clients to purcahse the bonds. The other big players are obviously speculators.
Curiously, other distortions also help others in purchasing these bonds: The
Government regulates the rates at which banks lend money to agricultural and
tourism enterprises below market artes, some of them have excess credit which they are tapping this
week to make a little money in the side.

In the meantime, Venezuela’s external debt goes up, yearly
interest payments go up in foreign currency and the distortions in the economy
increase. Of course, this also means that one day it will blow up again and the
longer it goes on, the less oil prices will have to drop to create a crisis. Only
this week, President Chavez announced a five year US$ 100 billion investment
program to be financed by PDVSA (US$ 10 billion a year) Pequiven (US$ 2 billion
a year) Fonden (US$ 2 billion a year) and the Miranda Fund (US$ 3 billion) a
year. These are funds additional to the excess spending that is being carried
out by the Government in the regular budget which is an all time high in the
country’s history in real terms as well as a percentage o GDP..

Where the money will come from for this plan obody knows, what is clear
is that distortions and expenditures are being stretched to the limit, which
bodes badly for the country were oil prices to drop by even a relatively small

And as usual, it will be the poor that suffer with another
crisis as the rich can save these easy profits given to them by the revolutionary
Government for a rainy day. The poor just can’t.

Boston Globe on Chavez’ donations

November 26, 2005

Two days ago there was a somewhat distressing Editorial in the Boston Globe
entitled Venezuela’s largesse, thanking Venezuela for the cheap oil given to the poor of
Massachusetts. Distressing because we were surprised that that paper
could be fooled by Chavez’ strategy of self-promotion. Well, a Globe
staff reporter was not fooled and while I have yet to see any of the
letters written to the Globe that have circulated through my email, it
was quite satisfying to see that someone does get and was allowed to get
his point across in the same pages that praised Chavez ‘ donation
in a sort of rebuttal entitled “Cost is high for largesse”. I
found two of the arguments quite compelling, one, that of the
differences in per capita income between Venezuela and some of the
beneficiaries of Chavez’ largesse, the second one, the examples of how
people would react to similar donations from poor African countries
which the average American understands quite clearly are too poor to give gifts to rich Massachusetts:

We appreciate the help, of course. But Chavez has
plenty to do at home rather grandstanding in the United States.

For instance: Venezuela’s per capita income is
$4,768. Massachusetts, the object of Chavez’s largesse, has the nation’s
second-highest per capita income, $41,801.

According to the World Bank, 49 percent of all
Venezuelans lived in poverty in 2000 — meaning they got by on household income
of less than $2 a day. That’s $2 a day, the price of a gallon of gasoline here.
About 24 percent lived in extreme poverty — or on less than $1 a day. The
poverty numbers are up substantially from a decade ago.

Maybe Congressman William Delahunt could arrange
for Somalia to send discounted beef, the desperately poor African country’s
leading export. Its poor neighbor, Ethiopia, could help out by sending cheap
coffee. And Afghanistan could send heroin. (But, then, it already