Archive for September 9th, 2006

Pictures from Chavez’ swearing in of his campaign, a few hundred thousand missing

September 9, 2006

With pictures at 2:00, 3:30 and 6:00 PM looking both ways on Avenida Bolivar (concentration was at 11 AM to be at Avenida Bolivar by 2 PM), Megaresistencia shows us how few people went to the Chavista marxh today, the one in which Chavez would swear in 300,000 members of its campaign and would be attended by 1.5 million people. This was 35,000 people tops despite the buses, the resources and the presence of the autocratic leader. He was not pleased.

September 9, 2006

(Sorry for the length, could not help it)

The term
Devilís Excrement, was created by Juan Pablo Perez Alfonso to dramatize the
difficulties that a country may have in implementing the necessary economic
measures for its development when a natural resource exists which strengthens
the currency and allows policy makers to postpone unpopular measures because
their urgency can be hidden by the wealth itself. In The Netherlands it is
referred to as the Dutch Disease, because of the effect that natural gas prices
had in that countryís economy in the 60ís.

But it may
more properly be named the Politicianís Trap, because it allows them to
postpone important decisions in order to boost their short term popularity, but
somehow it always ends up blowing up on their faces, with dire consequences
which are always paid first by the people via devaluations, unemployment and

Venezuelaís case is one of the best examples
of this. Politicians past and present, have always believed that they could
innovate on economic matters and that the surge in prices and/or steady stream
of income from oil could support their ignorant creativity on the economy.
Somehow they knew the day of reckoning would come, but by then they would
likely not be around and somebody else would be blamed.

Venezuelan who was an adult in 1982 likely remembers the calls by the then
President of the Venezuelan Central Bank Diaz Bruzual for people to take their
money abroad, as that would reduce the pressure on inflation. Six months later,
the country lived through its first maxi-devaluation. (The same policies are
being encouraged today) It was no different when Jaime Lusinchi was President.
He imposed exchange controls and Venezuelans began importing cars (remember the
Ford Sierra?) as Lusinchiís popularity remained above 60% up to the last day of
his Presidency, except that the incoming administration found liquid
international reserves of less than US$ 300 million and the economic adjustment
that followed was one of the worst in our countryís history.

Caldera in his second Government was no different. He thought he could impose
his ignorant economic policies and his will on the country. He began by firing
a well respected Central Bank President, which drove the currency down, created
a financial crisis and within months, Caldera imposed exchange controls and
price controls which eventually began blowing up. When Caldera realized that inflation
was running at a 100% clip if you annualized it, in December 1995, he got rid
of his economic team full of friends with little economic knowledge and
appointed Teodoro Petkoff as Minister of Planning. Petkoff imposed the second
economic adjustment in the three years of the Caldera administration and things
began to improve until oil prices went down, derailing any attempt at changes.

In each
and everyone of these cases, the imposition of exchange controls, price
controls or creation of economic rules which are simply outside the realm of
economic theory, created distortions which eventually led to a big adjustment,
as they could not be sustained. In each and every case, it is the poor that
pays for these adjustments and devaluation is typically the simplest solution
to solve most of the problems, remove the distortions and deflate the pressures
that have been built into the system. It is a the Politicianís Trap.

The laws
of economics are not too different than the laws of other sciences, except that
in those one can isolate a system, do an experiment and reduce the problem to a
couple of variables that you can use to prove these laws. In economics, there
are so many variables and the system takes time to react in such a way, that
the distortions and causes may take some time to manifest themselves.

The Chavez
Government has not been any different. We can divide its economic policy in two
stages, before the devaluation in 2002 and afterwards. Before the large devaluation
in 2002, the Government ran contradictory and distortionary policies that were
trying to contain inflation, save excess funds into the Macroeconomic
Stabilization Fund (FIEM) and borrow money internally while holding the
currency stable to reduce inflation, It did not work. The moment oil prices
dropped, the FIEM was used, rather than saved and then discarded and the weight
of the ballooning local debt was too much for the Government to sustain its
constant exchange rate policy. In February of 2002, Chavez was forced to allow
for a maxi-devaluation which together with the strike in 2003, induced a crisis
which was once again paid by the poor via inflation and devaluation.

The second
stage began in February 2003 with the imposition of exchange controls which
combined with high oil prices has allowed the Chavez administration to
introduce what is likely to be the biggest distortions in the countryís economy
ever and which eventually will lead to a huge crisis which will be once again
paid by the poor via inflation and devaluation. Up to now, these distortions
have been covered up by the sharp increase in oil prices, but are now beginning
to be felt as a sharp increase in consumer prices. The seams are beginning to
show some rips, and they are ugly.

Letís look
at some of the major distortions on the Venezuelan economy today:

Exchange Controls: Exchange controls
have always proven to be damaging in the long run. They create numerous
problems from corruption surrounding approvals, to all sorts of gimmicks to buy
dollars at the official rate. When first imposed, the Government claimed it
would stop any possibility of a black market, but then it took two and half
years to approve the law punishing it. By then, the Government had not only
realized that it needed a escape valve, but it had become the biggest supplier
of dollars to the parallel market via the Argentinean bonds, another one of the
biggest corruption scams in the Chavez administration. By now, CADIVI, the
exchange control office, has become a bureaucratic office, which approves
anything from foodstuffs to luxury cars, as few things are actually banned. But
at the same time the criteria for approval are somewhat mysterious. Individuals
get an allotment to travel, which also began with lots of controls, but by now,
they have realized how difficult it is to monitor it. Thus, you only need to
prove you are traveling once, after that you can request your $4,000 annually
without proving you are going abroad. But the mian problem is the corruption it
generates and the burecracy imposed on everyone.

Price Controls: A number of basic
staples have had their prices controlled. Periodically producers have a battle
with the Government and the controlled price is increased. Controlled items are
typically the ones that you canít find at the markets, with chronic shortages
in many staples, with sugar being the predominant one, since its retail price
is below production price. The solution? The Government imports some of these
products when shortages intensify. But the consequences are clear, producers,
when they can, migrate to other unregulated crops or simply donít produce. Add
to these controls the threat of expropriation of farms under the Land Bill and
what you have is less local production and higher prices. Consider the case of
meat. Between price controls and the actual confiscation of farms (few cattle
ranch owners were paid, but they donít have their land) the number of heads of
cattle is down by two million since Chavez took over. Just last week, the price
of meat went up by 10% (yes, in one week).

Interest rate controls: The Government
is regulating the minimum amount you can be paid and the maximum amount you can
be charged. It has also created multiple subsidies to various sectors like
agriculture, mortgages, tourism and micro credits. Some are not Government
sponsored subsidies but rates are fixed and it is banks that have to make up
the difference, which is obviously paid by the rest of the depositors and/or creditors.
It reaches the point that this week the Government lowered, for no reason, subsidized
mortgage rates to 4.9% and 9.7% for the two lowest levels of loans, while it increased
the minimum amount that banks can pay on either savings rates or CDís for
banks. How can it justify interest rates moving in two different directions?

–Gasoline subsidy: Gasoline is sold at 4.46 US$
cents per liter or 17 US$ cents per gallon, with the total subsidy at 14.5% of
the National Budget as proposed last Fall or three times what is spent on the
“Misiones”. This is a very unfair subsidy as those that have cars
receive the largest share. My share of the subsidy as one that is in the top
25% of the population by income is ten times larger than that of those in the
bottom quartile. In fact, while I strongly disagree with Rosalesí proposed ďMi
NegraĒ card to distribute people money, if the oil subsidy were to be removed, the
card would certainly be more just and cost about the same.

–Removal of Central Bank excess
: The
Government has decided that there is an ďoptimumĒ amount of international
reserves at the Central Bank and any amount over it is periodically removed and
given to thee Development Bank Fonden. This idea is simply nuts and would one
day come to haunt the Government. If you donít consider the liability side of
the Central Bank (Itís debts!), there can be no ďoptimumĒ level and if the
Central Bank creates liquidity every time they get dollars from PDVSA and give
it Bolivars, when you remove those dollars from the Central Bank, those Bolivars
have less backing that they did before.

All of
these distortions can last a while, as long as the price of oil continues to go
up, but behaving like a good Devilís Excrement, as time goes by each of them
becomes harder to remove from the system and the different combinations of them
will eventually lead to the economic system coming apart at the seams. The
entrapment begins and nothings is done about it. And it is beginning to happen

Effects of the distortions:

The most
important effect that can already be seen is inflation. Particularly rapidly rising
prices on essential items that are produced in Venezuela. During the last four
months inflation, only in those months,
for foodstuffs has been 19.9% (4.7%,
5.5%, 5.1% and 4.3%). This is not
annualized, this is what the official level of inflation has been for food
prices, including controlled prices and all of the tricks the Government uses
to convince us that inflation is not as high as we feel it on a day to day
basis. Given that people in the C and D levels of the population spend 70% of
their income on food, this means that the impact on their daily lives since May
of this year has been huge! So huge, that it has eaten
away 14% of the other 30% that they had to spend on other things.

problem is that this increase in inflation will be really hard to fight. First
of all, it is simply a result of the laws of economics: The Government has
increased liquidity by 100% in 12 momths and its own spending by 85% so far in 2006, but local production
of food is barely up and imports by the Government can not be planned
sufficiently ahead of time to compensate. Thus, by the time a shortage occurs
and prices go up, it takes at least two months for the Government to approve
the foreign currency and import the foodstuffs to have an impact. Thus, prices
will continue to go up at similar levels and inflation for the year for foodstuffs
could reach unmanageable levels. (Add to this the fact that the minimum salary
was increased this week by 10% and that September tends to be the worst month
of the year for the CPI and you get the picture). If the rate of inflation for
food stays constant between now and the end of the year, prices will go up
another 20% by Xmas time.

problem is that there is no short term or simple solutions to this. This week
we heard supposed experts on economic matters from the National Assembly blame
CADIVI for the jump in prices. Their logic went something like this: CADIVI has
been reducing foreign currency outflows by some US$ 500 million in the last
three months. What he means is that by not removing US$ 500 million in Bolivars
from the system, inflationary pressures were unleashed. Well, not in their
wildest dreams can a 10% reduction in foreign currency approvals create such a
problem. They are trapped in their own inconsistencies by now.

What all
these “experts” refuse to accept and admit is that it is the excess liquidity and
85% increase in Government spending this year which is responsible for the inflationary
pressures. It is a textbook case of too much money going after too few goods,
the laws of the markets at work!

Even worse
is how short term solutions are searched for: Three months ago Chavez told
CADIVI to reduce outflows because too many luxury goods were being imported
with CADIVI dollars. This week, exactly the opposite was told to CADIVI: Please
give out foreign currency more efficiently so that inflationary pressures are

The Central Bank distortion: There is
no optimum level of international reserves, just their management

At the
same time that the Government was pushing CADIVI to increase outflows to reduce
monetary liquidity, the Central Bank changed conditions on its CDís this week such
that it will promote excess monetary liquidity in the system, because it
reduced the interest it pays on excess liquidity to the banks.

In plain
terms, the Central Bank issues CDís so that there are fewer Bolivars in the
economy, going after more goods, which helps reduce inflation. But all its
decisions this week go in the opposite direction. Why?

the Central Bank is worried about the Central Bankís balance sheet, which has its
own distortions, mostly created by the removal of its own reserves.

When the
Central Bank makes operations in order to absorb excess monetary liquidity, it
pays banks interest on these funds. Where does the Central Bank get the money
to pay the interest? Easy, from the interest it gets from the international
reserves. A few years ago, these operations did not amount to more than one or
two billion dollars and the Central Bank could easily pay for the interest. But
as more and more money was created, the Central Bank issued more CDís so that
today there are more than US$ 18 billion of them! Unfortunately, the Central
Bank does not get that type of interest on its current international reserves
which amount to US$ 35 billion. So, the Central Bank is actually losing money
now and it has to restrict these absorption operations, so it can not help
fight the Governmentís inflation battle, it has to do exactly the opposite of
what is required!

This is a
good point to look at the magic ďoptimumĒ level of reserves. The Government is
quite proud of the current level of international reserves which are near US$
35 billion. Reportedly Chavez wants them really high. But what good are they if
the Central Bank has liabilities of US$ 18 billion? Moreover, what good are they
if the countryís debt has also increased sharply as it has gone from US$ 22
billion in 1998 to US$ 45 billion in 2006?

difficulty is the same as with other distortions, it is not easy to solve the
Central Bankís problem. Either you let reserves go up soon, or you reduce spending
or the price of oil doubles. In fact, this will get worse, the Government is
already talking of taking away US$ 6 billion in reserves in early 2007.

Of course,
there is always the magic solution: Devalue, you reduce the Central Bankís debt
by that amount and the problem eases. Until the next time.

Financial Distortions: Something has
to give!

There are
so many of these that I donít even know where to start. Letís simply make a

mostly make money on commissions they charge clients and their investment on
Government bonds, not spreads.

–It is
possible to borrow money at rates lower than inflation.

high oil prices, the Government is running a deficit.

exchange controls are removed, banks would lose half their deposits

rates are negative, that is, people lose by having money in the bank. Thus,
they spend.

–If interest
rates ever become positive, going to the current levels of inflation, all banks
but maybe two or three, would lose all their equity. Will the shareholders
replace it?

have so much excess money that they are giving people credit without checking
any credit history, salary or record. It is better to lend it with risk, that
not have it doing anything. Just today
someone told me that getting such a loan was so easy, that she got it within a
day and would be unable to pay it based on her cash flow except that her
insurance company owes her the money. Perhaps the funniest gimmick is the ďSurgery with your plasticĒ campaign.
Yes, it is simple, get an instant loan to have your plastic surgery done. Billboards
even show which part of your body you may want fixed, sort of obvious, no?

who can get an agricultural loan, borrow from a ďgoodĒ bank at the preferential
rate and deposit it at another ďbadĒ bank at a higher rate.

borrow Bolivars, buy dollars in the parallel market, invest the dollars and
wait for the devaluation to come. Pay 10-12% per year for an upcoming 100-200%
devaluation, not bad, no?

will likely reach US$ 30 billion this year. (Whatever happened to endogenous

investment was US$ 65 million (no
typo) in the fist six months of the year (From the US all of $200, yes two hundred
dollars, no typo)

in the first half was 9%, but Government spending was up by 85%, not very efficient,

I could go
on and on, but you get the picture. If the price of oil stays constant or drops even a
little this will all come apart at the seams. Only higher prices can sustain
this. Unfortunately, in the lower oil prices scenario, the easiest solution to
patch things up will be the usual one: Devalue and you know who gets hurt the
most with that, simply the poor.

And that
is why the Devilís Excrement becomes the Politicianís Trap. Nothing will be done
on any of these distortions until it is too late. In fact, this Government has
created most of them, even if some are simply exaggerated replicas of things we
have seen before.

if the price of oil drops by a significant amount, the consequences will be
simply catastrophic. We will see a financial crisis, the largest devaluation in
history and poverty levels never seen before in the countryís history.

Makes you wonder
why anyone would want to be President, let Chavez get out of his own trap
first! No?