Archive for May 21st, 2008

May 21, 2008

The Government has spent about US$ 6 billion lowering the parallel swap
market rate and it ahs worked partially, not so much because it has
spent all that money, but because expenditures are down, interest rates
are up and the economy has been cooled down. Basically, the Government
has held the monetary mass constant since December while it sold US$ 6
billion in various instruments to lower the swap market rate.

Unfortunately, when you attack the effects, rather than the causes, you
really don’t resolve anything. The swap market rate is down, but prices
aren’t. Why? Because inventories were imported at a much higher
exchange rate and merchants are not ready to lose money. Additionally,
by moving Government deposits to the official banks all at once,
interest rates went up (more inflation, less credit) and while that
helped push the swap rate down (People were borrowing Bolivars to
speculate in the swap market at cheap rates), the issuing of ne
Venezuelan bonds helped push down the prices of Venezuelan bonds in the
international markets, which means that it will be more costly in the
future to issue new debt.

Essentially, the Government continues to be trapped in its inconsistent
policies, because Chief Economist Chavez has set some rules that go
against economic principles and only high oil prices are able to mask
the distortions.

At this juncture however, the Government faces a dilemma: How do you
explain to the population that the economy is slowing down at a time of
record oil prices? There are elections in November and the Government
ahs to jump start spending if it is to have any hope of winning a
majority of the Governorships and Mayoral races. And winning a majority
would in the end be a defeat, as it would be a remarkable victory by
the opposition just to be able to win more Governorships that last time

Thus, the Government has decided to take a different approach, a clever
one at that, even if as usual there are problems in execution that need
to be resolved.

Yesterday, the Government issued a resolution forbidding local
financial institutions from buying any form of securities denominated
in Bolivars and issued by foreign institutions. Not only that, but it
ordered these institutions to get rid of the ones they already have
within ninety days.

Say what? You may be thinking…

You see, Venezuelan banks are only allowed to have foreign currency up
to 30% of their capital or equity. But Wall Street institutions are
very clever and creative, recall the subprime crisis. So, they invented
a “Structured Note” issued by them, say Bear Stearns, since they almost
don’t exist by now, which is denominated in Bolivars, but has under it
US dollars. Thus, a bank will tell bear Stearns: Have these US$ 100
million I just bought in the swap market, issue me a note in Bolivars
for what I paid for it and I have not violated the law, because I only
have the 30% allowed by law in US$. Oh, by the way, with the US$ 100
million buy me some Venezuelan bonds so that the note can earn some
interest in dollars while you hold it.

Thus, presto! The bank has Bolivars not dollars and it can circumvent the local regulations.

Thus, the resolution was meant to forbid this, but they forgot to put
in a few commas or it was written badly and instead it forbids
financial institutions from having ANY securities, whether in Bolivars
or Dollars.  But that should be fixed before the ninety days are over.

So, the purpose of the resolution, is to have banks and financial
institutions sell these notes and be forced to sell the corresponding
dollars behind them in the parallel swap market, helping to lower it
and making it unnecessary (and cheap!) to have the Government intervene.

How large are these notes? Estimates range from US$ 2 billion to US$ 7
billion, but from the balance sheets of the banks, it appears that it
is at least US$ 5 billion.

So, in a world where things work, US$ 5 billion should be headed to the swap market…

Except that…

–I am sure the same creativity that came up with these structured
notes, will come up with an alternative. Banks may have to simulate
they are selling and the like, but they will not sell it all and may
even buy it all back.

–If you force some banks to sell the dollars now, they will lose all
their capital and more, maybe even creating a banking crisis. Some even
suggest that this is the Government’s plan to have an excuse to
nationalize the banking system.

What this all shows is how complex and distorted the economy has
become. Rules are piled upon rules in order to correct effects of the
original rules. But then, any decision, like the fact that the
Government needs to increase spending fast because there are elections
coming up, forces them to invent new rules.

There is no question in my mind that banks have abused these notes, but
they would not exist if there were not so many controls that make no

In the end, not all structures will be sold, they will be disguised,
the Government will increase spending, the swap market will go up again
and a new clever guy (This one certainly is) will be hired to help with
the next crisis.

Because in the end, the main problem is that the official rate of
exchange has been held constant at Bs. 2.15 per dollar for four years
with inflation hovering around 20% and that my friends is simply

Imagine you made something here four years ago and sold it for Bs.
2.15, your profit margin was 25%. Your current cost is Bs. 3.38, but
your foreign competitor has had 3% inflation.

Which is destroying Venezuela’s production little by little… But Chief Economist Chavez knows better…