Myths And Realities Of The Distorted Venezuelan Economy Part II

July 7, 2016

In the beginning ,,,

Chavismo tried to expropriate land and agricultural companies. It did not work…

It then tried to get into the production business. It failed…

Then came exchange controls. One lower rate for essentials, another higher rate for non-essentials. A third parallel, and legal rate, the swap rate, sprouted spontaneously.

Except the difference between the first two rates became wider in time, the subsidies became gigantic (including dumb subsidies for travel abroad) and the third rate soared.

Thus, the Government made the third rate illegal. Which did not stop it, it simply became the black market rate, which continued to go up…

Price controls were then introduced…

In parallel, the Government became importer of goods at the lowest rate, expropriated whole industries and began to distribute products without the private sector. Shortages began.

Profit controls were then introduced…even larger shortages became daily events, as inflation soared…

By then, the official rate stood at Bs. 10 per US$, the second rate at Bs. 200 per US$ and the black market rate around US$ 1,000.

Just imagine getting your hands on anything imported at Bs. 10, export to Colombia or sell it to those desperate for acquiring for it. We are talking profits of 10,000%…

If you sell it locally, profits are less, but there is less work, Bachaquerismo became a profession. Arbitrage at its best!

This was the picture three or four months ago when the Maduro Government supposedly decided to do “something” about the distorted Venezuelan economy.

This would be the picture for the exchange rates at the time:

rates

If you want to “get” the size of the distortions, think about this picture: At Bs. 10 per US$ monetary liquidity (M2) is about US$ 500 billion, a large amount for the Venezuelan economy. At Bs. 1,000 per US$ it is barely US$ 5 billion, peanuts for an economy of a couple of hundred billion dollars of GDP.

It does not take a genius to realize that the first rate, Bs. 10 per US$ is simply too low and should be moved first closer to the second rate which is “only” twenty times larger.

Instead the Government, in its ignorance, decided to:

  1. Create a “new” rate called Dicom which would start at the level of the second rate (Bs. 200 per US$) which was called Simadi. New regulations would be issued within thirty days
  2. Keep the lower rate of Bs. 10 per US$
  3. Slide the second rate towards the third rate
  4. Adjust controlled prices on a large number of essential items
  5. Quietly (Very quietly!) forget about profit controls
  6. Restrict excess liquidity in the financial system to lower the black rate

Today we thus have:

rat2                   Mostly Government                             Little Volume                  Limited by liquidity

The result is that today, the Government has moved prices up, fueled inflation, barely affected the black rate and done little about shortages. It “adjusted” the Venezuelan economy, without the benefits of an adjustment.

And the Government, for example, has yet to issue the Dicom regulations. That’s how efficient they are!

Why can’t the Government solve the problem with shortages or just improve supplies?

Easy, at Bs. 10 the main importer and distributor is the Government, some importers of essential goods are given some dollars, but it is a small fraction of the overall amount.

The Government is not only inefficient, but there is wholesale corruption, over-charging and a lot of the stuff imported is taken to Colombia and other bordering countries.

And the private sector can do very little to help, because it has been minimized, it has become for lack of a better word, miniscule. There were over 600,000 employers in Venezuela in 1998, there are around 260,000 now.

That’s how bad it has been decimated…

But to understand why shortages can not be reduced by the private sector let me give you an example: Assume for a second, that you are a private meat importer/distributor. A meat cargo ship carries somewhere around 15,000 Tons of meat. (About a two day supply for the whole country). Depending on the type of meat, this would cost around US$ 25 million to US$ 35 million to import.

Let’s say it costs US$ 30 million, simply as an example.

There is NOT A SINGLE COMPANY IN VENEZUELA that has enough Bolivars in the bank to pay for this ship at the Dicom rate of Bs. 600 per US$., as this would be Bs. 18 billion. (0.36% of M2)

In fact, not a single private or public bank could lend any company this amount, as the largest banks have capital of about Bs. 50 billion and they are not allowed to lend more than 10% of their capital to a single customer (Which mostly don’t do anyway, it is just too risky, suppose the Government nationalizes that company). It would take a syndicated loan of all banks to bring a ship that carries all of two days of meat for the whole country.

Get the picture?: Even if the Government gave a company dollars to import meat at the Dicom rate, no company could pay for a single ship (two days supply). This applies to wheat, corn, rice and many of the basic staples needed for the population. And the Government is not willing to give foreign currency at any other rate to the private sector. It reserves the Bs. 10 rate for itself

This simply shows how hyper-distorted the Venezuelan economy is today.

At Bs. 600, the largest private bank in the country has capital of around US$ 90 million, ridiculous for the size of the economy. No company can receive dollars at the Dicom rate and bring any sizable import that would make a difference.

The economy is simply trapped in the hands of an incompetent, inefficient and corrupt Government that has tried to control everything.

The whole thing is so distorted, you practically have to start from scratch to fix things…Eliminate all the rules, controls, regulations, start over…

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20 Responses to “Myths And Realities Of The Distorted Venezuelan Economy Part II”

  1. wmpg Says:

    Enlightening. Never stopped to think about it this way.

  2. Tom ODonnell Says:

    Really helpful overview. Data-driven & refreshingly devoid of empty ideological rhetoric . Thanks!

  3. Harold Says:

    Hi Miguel
    Great commentary as always. The most sad part, in my non-Venezuelan opinion, is that USA, UK and most of the “west”, is going in the same direction. But, like in Venezuela a few years ago, almost nobody is aware enough. Chavez began as Trump, but ended as a Maoist-Hitler dictator. Very sad for a great country.

    • bobthebuilder Says:

      Totally agree. Personality driven politics is reaching a new zenith, especially the UK. In the recent Brexit campaign, Michael Gove received rapturous applause after saying “people have had enough of experts”. Worse was that neither he nor Boris Johnson actually believed in the cause they espoused. Venezuela for years, and now the UK, are devoid of enough effective politicians or a plan to deliver anything meaningful.


  4. The cuban approach will be to outlaw beef sales to Venezuelans. Very soon they will roll out a ration card, which will allow the masses to feed on a starvation diet. I hear things in Cuba are really tough, they can’t steal as much from Venezuela. The Cuban dictatorship has increased repression in both countries, but seems unable to deviate from imbecility and Marxist dogma. Meanwhile Obama is rewarding Raúl Castro with permits to have American tourists fly to Cuba from 10 USA cities.

    • TV Says:

      American tourists could be the catalyst that destroys the Castro regime. The regime will be very hard pressed to control the significantly increased inflow of forex into the country, creating a middle class that will have both the motive and the means to counter the regime eventually.

      That’s why North Korea keeps such a watchful eye over tourists.

      • Ira Says:

        If Canadian, South American and European tourism money hasn’t changed Castrofascism, can you explain your logic where you think American dollars will?


        • American dollars are coated with a secret freedom film that turns docile people into political activists. Just look at China and Vietnam where people are protesting their regimes by the 10’s of thousands. Well, not yet, but soon, when the magic dollars activate them.

        • Boluco Tejano Says:

          If Canadian, South American and European tourism money hasn’t changed Castrofascism, can you explain your logic where you think American dollars will?
          There is a magical quality about the US dollar which the the Canadian dollar or the Euro lack. 🙂

        • TV Says:

          The fact it’s the Americans the Cubans are supposed to fear and hate, plus the significantly increased scale of tourism. Both Castro brothers will have to die before we see much effect though.


  5. The Tale of two Countries: Zimbabwe and Venezuela
    That’s the rationale behind the hyperinflation, once starts it should be allowed to evolve as a (auto)corrective process. During hyperinflation, governments must eliminate controls on prices, including exchange rates, and allow contracts to be indexed, prices should run without controls, exchange controls eliminated, so scarcity will disappears asap, markets will work and most importantly, they will signal the end of hyperinflation, which as we know it is politically induced, so it will require a political agreement between all parties, without it would be not easy to get out of it, living with the worst of two worlds.
    Government should print as much money the market “requests”. So, hyperinflation will evolve hyperbolic, -like the dogs behind the fox, a game with happy end- , that it is normal. In months, or weeks, we arrive to the solution, as everybody is interested stopping hyperinflation, this fact is very important, as the political solution come as a collective action, it is its logic.
    The political solution arrives immediately, it will bring institutional reforms, a monetary reform with the creation of new money, and new rules, no matter which, the rules will guide everyone behavior to converge. A fiscal reform is carried pout immediately, since hyperinflation is generated by monetization of fiscal deficit well above it ¾ parts.
    Maduro and his government did other way round, they do not believe in markets, unfortunately, this caused a lot of pain, we are in the middle of it, they did not allow indexation process, but they could not do it anything to stop dollar’s arbitrage in the parallel market. Even thought it was the main signal that something g was wrong in the system of controls, we got the worst of both worlds, fixing prices and penalize its process, lots of distortions where in play immediately.
    One thing to remember: markets will work either way, even if decrees that markets will not work any longer does not work neither, since distortions are arriving by tons, so it does not matter if you allow or no markets to work, if you do allow them to free for prices, you will see immediately where you go, otherwise, if you do not allow they to exists you will never observe the horizon.
    The net results in Venezuela was the impoverishment of 75% of population, it was just a crime of “lesa humanidad”. However, apart of non-intended consequences, I think Maduro and his governments new what they were doing, they needed to impoverish people, that way would l be easier to establish the Road to Serfdom (Hayek), we are on the way, this does not mean that the trolley would not jump off the rails.
    Mugabe in Zimbabwe finally accepted, the accord happens the decided to dollarize its economy, using as rule, a money basket from dollar (USA), GBP (UK), Euro, Rand (RSD) and Yuan (China). We have to hurry up, we are late, everything starts should evolves and end, life lives as a cycle.

  6. IslandCanuck Says:

    Interesting to note that the “official” International Reserves this morning are at $11.956 billion. Below $12 billion for the first time.

    That is if you believe the “official” numbers. Why would you?
    They’ve lied about everything else – inflation, oil production, the amount of food & medicine in the country, etc., etc.

    Most of this, of course, is supposed to be in gold.
    I also have huge doubts about that based on all the rumours since Chavez repatriated great quantities years ago.

    One day we’ll know the truth. Not soon – but one day.

  7. Salesman Says:

    Hyper distorted is a kind word; a Hayekian word.

    Others would call the Venezuelan economy tyranny; or grand theft; or a grotesque without modern equivalent.

    I hope that the kindness of economics prevails. But in this special case the obstacle sits on a spigot of devil’s excrement. Why would they adjust?

  8. gordo Says:

    Actually, importing vs domestic production is not just a forex issue. It is even more stupid, because they are paying foreign producers reasonable prices while forcing domestic producers out of business with unreasonable price controls. That is sooooo stupid!


  9. The ship of meat analogy really brings it home. Of course even if they wanted to import a ship of meat, they need government permission and then they need to exchange bolivars at some rate (why so many rates) because no foreign entity is gonna accept bolivars which are useless outside Venezuela (and almost useless within it).

    Those kinds of analogies and examples are important for educating people of what is happening there.

  10. IslandCanuck Says:

    Here’s your Monday morning smile:

    MADURO: ESTAMOS PREPARADOS PARA GANAR LA PAZ CON NUESTRO PODER MILITAR

    Maduro: We are prepared to win the peace with our military power.

    What???


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