Archive for January 24th, 2007

Of fools, the Politician’s Trap and exchange controls or wishing will not make it so

January 24, 2007

(Versión en español aqui)

Politicians are certainly a different breed. They can lie, pretend to be stupid, be stupid as well as cynical and they keep a straight and even a smiling face all along. This applies to all politicians in Venezuela from IVth the Vth. Republics, this is nothing new and not exclusive to the Chavez Government, but the spectacle of the last few days with respect to the parallel market and exchange controls has certainly been one of the most pathetic ones I have ever seen.

The first thing that is amazing about politicians, and I repeat this applies to those in the past as well as the present, is their naiveté in believing that if there is a problem you just legislate and magically it will go away. Venezuela has had a judicial system which is almost inoperative and corrupt, for years. Despite this, the emphasis in Venezuela by politicians is always on creating new laws, rather than the enforcement of them. You can just go to any street light in Caracas and watch to see how irrelevant laws can be for both the authorities and the citizens.

But a better example is corruption. Venezuela has one of the most strict and modern ant-corruption laws in the world, the “Ley de Salvarguarda del Patrimonio Publico” which was approved in the early 80’s. Despite this, and the fact that there has always been huge levels of corruption and that corruption is rampant today, only one person in history has ever been jailed under this Law and he was let go.

In February 2003, the Chavez administration established exchange controls in Venezuela. Exchange controls have always proven to be a losing proposition for Venezuelan and Latin American Governments, due to the lack of discipline in spending as well as the many distortions they create. They can be short-term tools, but very, very seldom have they been used that way in Latin America and certainly never in Venezuela. In fact, each and every one of the controls imposed in Venezuela has lasted too long and ended up badly and the current one does not seem to be any different as distortions have surfaced and by now this is the longest lasting exchange control in the country’s history by far.

To begin with, when the Chavez Government imposed exchange controls in February 2003, all it did was to limit access to Government foreign currency. While it forbid operations with foreign currencies, there was no legislation that forbid it, thus, you could not do it, but if you did, there was no punishment for it.

But additionally, the decrees did not and could not forbid certain type of transaction such as the conversion of local shares of companies to those that trade abroad, essentially creating a possible mechanism for getting money out or bringing it in. A second possibility was to do a “swap”, simply purchasing a bond in Bolivars and swapping it for one in US$ once again converting from one currency to another.

Soon after the exchange controls were imposed, the Government introduced a Bill in the Assembly in April 2003 to declare certain operations with foreign currency illegal, but the Bill was curiously not approved until October 2005 and then explicitly allowing both the share conversion and the swaps, by saying that all capital market securities were exempt from that Bill.

At the same time, a parallel legal market to trade foreign currency developed, which used both the conversion of shares and swaps. As this market became more organized, its volumes expanded. Since the net flow is out, pressure on the parallel exchange rate got stronger and the value in this parallel market for the dollar increased. At this point, some clever Wall St. adviser to the Government (Yes, they use them!) suggested to the Government in July 2004 that one way to reduce this pressure would be to issue a Venezuelan Sovereign bond in dollars, but sell it to local investors in Bolivars, as a legal and one time shot for getting money out and at a cheaper price than the parallel market.

And it worked! It worked so well, that the Government did this many times, relieving the pressure in the parallel market and keeping that second rate down. Basically, these issues remove or “sterilize” monetary liquidity, thus there are fewer Bolivars available for buying dollars.

Then the Development Fund Fonden was created by law and given part of the international reserves with the mandate that it could only spend it in foreign currency. Another clever fellow then suggested that Fonden could buy bonds from Argentina, which could not place them directly in the international markets and turn around and sell them to local banks, which would then sell the dollars in the local parallel market. This then accomplished three things at once: It helped Argentina politically (good for Chavez!), it allowed Fonden to get local currency without violating the law and finally, it provided US$ to the parallel market, thus the Government was directly intervening in the parallel market to keep that rate down.

But there was a fourth reason to make this interesting: it became a racket in which only certain “friendly” and paying institutions would get the bonds, with both sides making a bundle. Remarkably, except in Tal Cual or here, you read very little about this huge corruption racket in the media.

The government sold in this manner some US$ 3.6 billion in Argentinean bonds in the parallel market and later it came up with another scheme using structured notes that accomplished almost the same purpose.

The problem was, that 2006 was an electoral year and the Government refused to devalue the currency and spent like crazy to keep its popularity. Thus, monetary liquidity increased by more than 70% in 2006, while reserves barely went up by 16% creating extraordinary pressure on the parallel market, which I predicted would go up, only up! While the parallel currency stood at Bs. 2700 to the US$ in August, it jumped to Bs. 3,000 by November, Bs. 3,400 by Christmas and is currently around Bs. 4,100 to the US$.

Which brings us to our story.

After weeks of saying this is irrelevant, because the parallel market is too small, the Government is clearly concerned by now. The main reason is that the parallel market is not that small and merchants mark prices up using the parallel rate. To makes things worse, since December the Government has not provided any foreign currency to the market and interest rates are so negative that people want to buy foreign currency to preserve their savings.

So yesterday, the National Assembly held a hearing to discuss the issue. The first thing they talked about was the fact that after they wrote the law, they somehow did no put anyone in charge of enforcing it. The police apparently has not been told to do it and the Tax Office says it has not tools to fight it. So, the law is only as good as the paper it was written on, because nobody even thought of connecting the dots from law to enforcement. Some Government!

The second thing they discussed yesterday was the fact that the parallel rate should not be where it is, that it is all “speculation” as CADIVI, the Foreign Exchange Control Office is giving plenty of dollars to all importers. Well, this may be true, but not all imports are given dollars to begin with and right after the election, 3,500 items were placed in a special list, which requires that you provide a certification that a specific item on that list is not manufactured in Venezuela.

But more importantly, it has been quiet a while since the Government has given many companies foreign currency at the official rate to repatriate dividends, which is making these companies nervous as the currency depreciates either in the parallel market or simply because inflations closed 2006 at 17
%, the highest in Latin America and they fear a devaluation or two this year.

And that in itself creates a problem. The Government has been promoting an artificial drop in interest rates, with a 90 day Treasury Bill rate currently below 4%, below the equivalent rate in the US$, while inflation is running at 17%, well above the US CPI. Thus, savings rates in Venezuela are deeply negative, which makes people want to….buy foreign currency.

And that is where the so-called “speculation” comes from.

But they blamed the “opposition” and the “speculators”, but obviously, it never occurred to them to blame the incoherent and stupid economic policies of the Government. Incredibly they will continue the “show” in the next few days asking a bunch of people to come to the National Assembly to be “interrogated”. Among them, the Assembly will invite the President of Banco Venezolano de Credito to inquire why it occurred to him to go to the Supreme Court to ask that they nullify some of the articles in the Exchange Control illegalities Bill. Once again, it did not occur to the illustrious Deputies that Mr. Garcia Mendoza, one of the few outspoken men in the private sector, thought somebody’s rights were being violated by the Law or that the law had too many discretional penalties, which is really what that suit is all about. Or even that he had the right to go to Court if he thought something was illegal. That’s what teh rule of law is all about. But they will harass him anyway.

But today, it even got more bizarre when the new Head of the Finance Committee of the National Assembly as well as none other that Deputy Amoroso, the same man that proposed the first foreign exchange bill, said they wanted to investigate “where” the dollars to the parallel market are coming from, as if the US$ 3.6 billion in Argentinean bonds came out of nowhere, together with some US$ 6 billion in structured notes. In fact, the problem is that the Government has not sold anything since about Dec. 10th. leading to the sharp rise of the last few days and not all of the spurious reasons they want to come up with. Maybe they should investigate themselves or stop grandstanding.

The truth is that they are caught in another corollary of the Devils’ Excrement: The Politician’s Trap, which I defined in this blog last September:

“But it may more properly be named the Politician’s 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 inflation.”

And it is a trap, because damn if you do it and damn if you don’t. If they allow the rate to devalue it fires up inflation, if you hold it back, the decision will have to come later down the line at an even higher exchange rate, fueling inflation even more.

And thus, they all wish it will go away, but it won’t, they are trapped by their foolish economic policies, which violated basic principles of economics, which can be done, but only for so long. It has now come to haunt them and there is just no easy way out.

The proposals are the usual, the first, change the law to maybe even make the parallel market illegal, which will push the rate even higher, the second one is more bizarre or fascist, but so typical of their mindset: Ban the media from publishing where the parallel rate is at, as a way of limiting speculation. Of course, you may have El Nacional, El Universal, or even RCTV, stop publishing the parallel rate, but can they really stop internet media like Veneconomia or this US-based website from doing it?

I doubt it, so that maybe the Politician’s Trap should be renamed and called the Fool’s Trap, but I could get into trouble for that under the muzzle law, I would be insulting the so-called “majesty” of Parliament. Or some equally strange concept like that.