Archive for March 23rd, 2011

Venezuelan Inflation: Structural or Self-Generated?

March 23, 2011

We were told by Minister of Planning and Finance Giordani, who has been in this Government over ten of the last twelve years, that Venezuela’s inflation problem was “structural” and in the never changing strategy of blaming the “previous” Government for everything, he accused the IVth. Republic of this problem. I guess twelve years is not enough in his mind to solve this problem, ignoring the fact that in those twelve years, the most insidious influence on inflation, that of the world, almost magically vanished, with most countries not only having single digit CPI’s, but many in the low single digits.

As a famous true and real economist said, inflation is simply a monetary phenomenon. Such a simple concept that is so poorly understood in inflationary and populism-ruled countries like ours. You see, if this were not true, Governments could just spend and make everyone rich. Life would be as simple as Chavez and Giordani want it to be.

But money does not imply wealth. Money is how we exchange things. We went from barter to money, to create a neutral way of transacting. In the beginning of commerce, you had one good and exchanged it for another or for a service. Too many mangoes on the trees and nobody wanted to give you anything for a mango, too much supply. By the end of mango season, you could probably get a lot for it, not enough supply and probably some demand.

But I digress…

If the Government “creates” too much money, without the underlying productivity or supply of goods and services increasing, the money will lose value, there will be inflation and it will be worth less. So, that is what Central bBank’s are supposed to do, try to fine tune the amount of money to balance it out with the supply of goods and services.

Thus, if you want to see why there is inflation, you have to look first at monetary liquidity, the so called M2, which measures all of the money available out in an economy. This number is supposed to be made public weekly by the Venezuelan Central Bank under “Agregados Monetarios” here. Lately, there is some delay to have this number published, but more ominously we no longer see its components, it has been over a year since we can see what is increasing faster in all the parts of M2. I will not bore you with the technicalities.

When you look at M2 since Hugo Chavez became President, the picture is quite scary at first and at second sight, as seen in the plot below:

As you can see, since Chavez became President and Giordani Minister of Planning (He has been in the Board of the Central Bank ever since he was named the first time in 2001 or 2002) M2 has gone from Bs. 8.9 billion to Bs. 302 billion. That is an increase of a factor of 33! Or there is 3,200% more money floating around in the Venezuelan economy, than there was when Chavez became President. (This is all Bolivares Fuertes BTW)

Clearly, someone has not been doing their fine tuning job and to call it a “structural” problem is cynical at best and as we will see, simply an outright lie.

Because in the graph above you can see that for at least the first three or four years of the Chavez Government, the growth in M2 was slower than it became at around 2003-2004.

But when a number changes so much in time and at such different rates, it is better to change the scale of M2 to a logarithmic scale. Why? Because with a log scale, all changes of say a factor of ten are the same. If a variable goes up from 1 to 10, it will look the same as when it goes from ten to one hundred, a ten fold increase. The changes look the same, not like in the above curve, where the change from Bs. 10 billion to Bs. 100 billion can barely be discerned and it is the largest and fastest in the plot.

In a logarithmic scale, M2 looks like this:

You can see in the above graph that there are three very different periods in this plot. First, there is one slope from 1998 to 2002, then from 2002 to about 2007, M2 grows much faster and then it slows down to something that looks more like the first stage, even if with a higher slope.

Basically, in the first stage M2 increased by about 66% in four years, in the second one, it increased by about 666% in five years and in the latest one, it has increased by 162% in four years.

These are really bad, awful numbers, simply because the Venezuelan economy has not grown at a comparable rate during any of this periods. In fact, the increase in M2 during the first four years is larger than the growth of the economy in all of the twelve years of Hugo Chavez. Certainly this means that inflation is induced by this mismanagement of monetary liquidity, there is simply too much money chasing basically the same goods.

There is nothing structural about this, it is structurally unstable to allow M2 to grow this way, except there are elections, of course.

Even worse, all of this money has almost the same backing in foreign currency than it did in 1998. In 1998, when Chavez came to power, there were almost US$ 18 billion in international reserves, today there are US$ 26 billion, barely a 44% increase when the number of Bolivars has changed by a factor of 3200%. This says that when Chavez got to power, there was a half a Bolivar per US$ in reserves (roughly), while today there are eleven Bs. for each dollar in international reserves. Oh yeah! Modern economists believe in “fiat currencies” . But that concept stops working in the face of such irresponsible economic policies. People stop believing in the “fiat” part, they tell their Governments: “Show me the money!” In Venezuela, there has been little “fiat” since 1982.

And the reason reserves are so low, is that some Chavista economists created the concept of “excess reserves”, allowing Chavez to withdraw every year some billions of dollars so that he can spend this as petty cash and without control. We are talking about US$ 64 billion so far removed from reserves. If they were at the Central Bank, inflation would be lower as that bank would have a cushion to control M2, imports, capital flight, etc. as needed. To date, it has so little room for maneuver, so much that it even carries those US$64 billion in its balance sheet (most of them have been spent!), to avoid showing that it is bankrupt. But that is another story.

Finally, if you look at month to month yearly inflation, you can see why the “structural” argument holds no water:

Between when Chavez took over and Dec. 2001, twelve month inflation was actually going down! This happened for two reasons: M2 was being controlled and extra income from oil was being saved in the Economic Stabilization Fund (FIEM). But then, oil went down, and none other than Jorge Giordani decided it was time to use the FIEM, which was drawn down very fast. So fast, that in February 2002, Chavez had to allow the “devaluation” of the currency, which up to that point was only allowed to trade within some bands set by the Government. It was a “light” form of exchange controls, and as expected, it failed to work.

After that, the one to one correspondence between inflation in time and M2 breaks down because of exchange and price controls. Initially, M2 was allowed to increase like crazy, all those bolivars were chasing dollars and inflation jumped up as the currency and devaluation expectations devalued sharply the currency in a country with so many imports. Then in January 2003, the Government began to totally control the exchange rate, introduced price controls, all of which drove inflation down for a while.


Because at the beginning the Government became very stingy with its dollars, refused to allow price increases and like exchange and price controls everywhere, there is an initial positive effect, but it always breaks down. Markets are like that!

Holding the currency constant delays inflation adjustments. That is why inflation first went down and even as the Government reduced the increase in M2 in 2007, inflation has not gone down, because prices and the exchange rate were held back by artificial controls.

But in 2006, the increase in M2 was so large that all the positive effects of controls disappeared and inflation began to grow. And the Government decided to not allow M2 to increase as fast, but inflation did not go down.


Because it did not allow for devaluations, holding back the currency, subsidizing everything and eventually, even that became unsustainable. Thus, even though M2 has not increased as fast, inflation is at the same levels because the Government has to adjust prices and the currency periodically when things get really tough.

Now, that is really structural!

It is built into the absurd system of controls that Giordani, who is not an economist, has built around this Government. And as long as the controls are in place, inflation will not go down for the simple reason that there will be periodic devaluations, periodic price adjustments (This week it was wheat and bread) and the risk of higher inflation is probably higher than that of lower inflation.

Thus, it is all self-generated and is becoming structural, but by structures that were not in place twelve years ago. This is not a chicken and an egg problem. Giordani laid the egg and Chavez allowed him to do it and out of it came this weird chicken who nobody can control.

And if nothing is done, which will be the case as long as Giordani is where he is, inflation, the worst tax on the poor, as the cartoon shows, will remain as high as it is today, if not worse.