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.

28 Responses to “Venezuelan Inflation: Structural or Self-Generated?”

  1. Miguel Octavio Says:

    Anyone with the most basic understanding of economic knows you are wrong and my articke is right, “myriad” is too many, you can count with one hand and tyere will be fongers left.

  2. brucecarson2008 Says:

    Looks like you got your talking points directly from Faux news and the corporate anti-Chavez misinformation campaign. I bet your corporate masters pay you well to ignore all the facts of Chavez’s myriad accomplishments The only reason there is inflation is because of corporations and businesses price gouging and thus raising the inflation index. These wreckers try to destroy Venezuela’s economy to undermine the Bolivarian revolution. If all these groups weren’t trying to undermine Chavez none of this inflation would be an issue, people just need to follow the law and stop ignoring price controls!

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  4. Kepler Says:


    I think it is in part because that’s his world and because he is paranoid and because he wants to use those weapons against us. Still, I think there is something else.

    1) Russians promise him “political support”, camaradería, if he gives them several billion dollars for weapons

    2) There are some Venezuelans getting “spasibo” money from the Russians for pushing the deals.

    Tanks are useless against Colombia. US Americans would pulverize tanks, submarines and airplanes in a jiffy. Only those AKs and similar stuff could be used against foreign powers – and Chavez knows it- in an asymetric war.

    Tanks and airplanes can be used against us.

    Why buy so many tanks and airplanes? Some people are probably getting a comission for facilitating the deals.

  5. m_astera Says:


    Can you name one thing that you think Hugo knows anything of substance about except military toys? I have never heard him speak knowledgeably about anything at all, but I think it’s safe to assume that he knows what tanks, airplanes, and guns are.

    I don’t think he knows how a road is built, or a bridge or a house, or a powerplant, or what goes on in a hospital, or how food is grown, or how a factory manufactures goods, or how oil is pumped or refined, or anything about finance or economics. Has he ever had job where he had to produce something of value? Not that I have heard about.

    Of course he spends billions on the only thing he understands even slightly, military toys.

  6. Kepler Says:

    I wrote an article recently where I mention where at least some 400 million dollars from FONDEM went. I suppose that money is what did not go to the purcharse of Chinese nappies and refrigerators to buy votes:

    those 400 million dollars went to set up a Russian-Venezuelan bank in Russia that will manage the ongoing and future weapons purchases. Russian specialists are talking about 7 billion dollars already in loans from the Russian government for the purchase of weapons only BY VENEZUELA. Venezuela is the second purchaser of Russian weapons after India. India has over one billion people. Venezuela has 30 million and they don’t produce anything but beauty queens.

  7. An Interested Observer Says:

    Thanks, moses. I got confused. But I still think when he says “structural,” he hasn’t the faintest clue what that word should mean in that context.

    Javier, nice comment on Hanke. These guys detest rules and restrictions over discretion. Not just in economics.

  8. Right, Venezuela’s inflation is monetary and structural to people that do not understand monetary effects after 12 years or don’t want to understand and change.

    In normal countries governments income represent expenses to the families and businesses, that in the form of taxes reduces their amount of spending, so money passes from the pockets of the consumers to the arcs of the treasury which then the government redistribute as spending so the money in the economy more or less stays the same and governments have monetary and fiscal policies to control it’s growth.

    But in Venezuela, due to the huge income that the government has because of oil and devaluations – which does not come from families and businesses there is a natural tendency to have excessive money circulating that Miguel mentions and it’s how I would define the structural problem.

    But structural problems can only be fixed with structural solutions, and it has to be one that does not allow this excessive money to come in into the economy . In CAP I times ( Carlos Andres first term in 1974 ) when the oil price went up really fast economist at the time knew this could happen and created the Fondo de Inversiones de Venezuela ( FIV ) as a way to keep out the Dollars from coming into the economy. But after 40 years Presidents could not fix it this effect and no one has really tried or wanted to specially this 12 year government. We even had Steve Hanke come to Venezuela, the person behind Currency Boards, and I’d say he was almost kicked out because of his ideas because behind a Currency Board lies the fact that the government can’t spend as it wishes but it’s one way to control excessive money circulating in the economy.

  9. m_astera Says:

    Vitor nails it. Nice to read some solid economic facts instead of Keynesian fantasies of laissez faire counterfeiting.

    If there is a perceived shortage of TVs or automobiles can we fix that by printing fake titles to non-existent cars and televisions?

  10. Vitor Says:

    Any amount of money is suitable for any amount of product and services. Simple as that.

    Prices falling is the main signal of real economic growth.

  11. moses Says:

    Interested Observer:

    Just one comment, Grrodani is not a mathematician (thats Nelson Merentes president of the Central Bank !) he is an Electrical Enginner, with a Masters degree in Urban Planning:

  12. An Interested Observer Says:

    Kepler, I took a look at that a year or so ago. Here’s a summary of what I found (data is through 2008, though I’m quite sure it hasn’t gotten any better).

    VZ inflation was 30% of the average for the rest of the Western Hemisphere pre-Chavez, and 277% post-Chavez.

    VZ inflation was 234% of world average pre-Chavez, and 550% post-Chavez.

    The numbers are very different, and it’s because the rest of the WH has figured out a great deal about how to tame inflation (probably by listening to Friedman, in part), while Venezuela pretends.

  13. Gringo Says:

    Miguel Octavio, as a physicist and as an economist, you might be interested in this article: Physics Envy May Be Hazardous To Your Health– And Economy.

  14. geronl Says:

    In other words: Governments create inflation.

    A good dream to have is one in which Hugo and his henchmen never figured out how to turn on the printing presses.

  15. I am grateful for this post. very didactic. It has helped me to understand the mechanics of inflation and the role liquidity plays in its promotion. I hope Mr. Giordani reads it.

  16. Gordo Says:

    And if Venezuela paid off all its debts, including paying off nationalized assets including foreign petroleum contractors, etc. What would happen to the M1 and the international reserves?

  17. LT Says:

    the index of demcratic freedom ranks venezuela as follows (5th from the bottom, that is, N.Korea):

    175 Venezuela, 176 Eritrea, 177 Cuba, 178 Zimbabwe, 178 N.Korea

    Compare: 171 Iran, 172 Congo, 173 Lybia, 174 Burma

    great company, no? Here’s the link:

  18. Alek Boyd Says:

    Compare with this and cry…

  19. m_astera Says:

    Somewhat on topic, here’s the Ebay page that lists Zimbabwean currency for sale. One can buy a 100 Trillion Zimbabwe dollars banknote for less than $5.

  20. A_Antonio Says:

    Let me see if I understand: some Gordany economist theory applied with some mix kind of “personalitystic”, egomaniac, self “mitomaniac” of some kin of socialism to the way to a communism is a soundly failure and do not get idea what is the inflation origins means. Get it right?.

  21. Bloody Mary Says:

    As their Mars theory, all the policies that have been implemented are based on suppositions, even when real world has showed that those suppositions have failed in other places….. But what is even worse is that Giordani has learned nothing… all is going wrong, and he still go further….. He is waiting that reality changes because they also suppose that is going to happen, without any ground (of course, the real Devil’s Excrement gives them oxygen). One year ago they supposed that solutions would come from Bolivar’s crypt. Now he suppouses solutions will come from…… Yes!!! you guess, more controls…….. look the list of the Congress’s agenda for 2011: nothing there has to do with progress: Only more restrictions for the economy:

  22. Kepler Says:


    Great post.

    Now, about Caldera time: it would be nice to plot the inflation rate next to that of other L.A. countries.
    I was collecting the information from CIA stats, but got tired about it.
    Venezuela was not the only horrible case back then. Now it is the only one.


    Great post! The only thing is, I would argue that its mostly a tax on the rich and middle class. The poor tend to spend all of their disposable income while the rich and middle class tend to save more of it. At the same time wages in the long-run adjust to inflation. Perhaps the fact that it doesn’t affect the masses is the main reason inflation hasn’t been addressed in the past 12 years. I’m really not sure, just food for thought i guess.

  24. An Interested Observer Says:

    Remember, Giordani is a mathemetician. Terms that are standard to economists can have different meanings to him. Since M2 and inflation are linked, to him, that’s just the “structure” of the equation.

    This is one hell of a post, though. I would only dispute that Chavez laid the egg. Giordani did what he did because there was no other way to accomplish many of the things Chavez wanted. (And truly, Chavez could also be described as “this weird chicken who nobody can control.”)

  25. There is a technical problem in doing that in that the inflation base was changed. Also, I think half of Caldera’s Government was a disaster too. Imagine, Caldera changed his mind about controls when inflation hit 100% annualized in December 1994. The only difference? Oil was low. I was writing similarly critical articles about Caldera’s policies at the time.

  26. Mikael Says:

    Great post Miguel! I have a suggestion though. When you make graphs it would be even more convincing if you put in the last ten years prior to Chavez. That would make the post look more objective. I try (even though it is a hard job) to find a balanced view of the venezuelan government and as I read yur post, I really miss the comparison to before Chavez.

    Otherwise, it’s a great post!

  27. moctavio Says:

    Funny, I have an iPadband had never used it to see my blog other than the worpress application to create posts, I have no idea if it can be turnrd off, I see the problem

  28. Mike E. Says:

    is there a way to disable “onswipe”? Iread you most of the time on an iPad on it is a major pain in the ass. As I type this comment, I notice that I can’t make corrections by finger insertion touch, e.g. I,d have to delete everything after “iPad” to change “on” to “and”, same with a few other typos / mistakes.
    But the main issue is that I see no advantage (quite the contrary) to reading your posts using “on swipe” (won’t let me write on swipe as one word – another example. This is a case of “if it works, .don’t fix it.”

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