Monday, 17 August 2015

Never mind Greece, look at Venezuela

Via Business Insider comes this colourful map and chart of CDS spreads worldwide:

Those who thought Greek bonds would be the most expensive to insure, since everyone knows it can't pay its debts, need to think again. Venezuela is the most expensive, by a long way. 

Related to that is this:

The yield curve has been deeply inverted all year, but yields at all maturities are now rising:

When even the yield on long-dated bonds is heading for 30%, the public finances are completely unsustainable. 

Venezuela, of course, is monetarily sovereign, since it issues its own currency. Well, in theory. In practice it is burning through reserves at a shocking rate to support its absurd managed exchange rate system:

Don't be fooled by the uptick in June. That is because China lent it some dollars. It'll get through those in short order if it continues on its present path. To be sure, Venezuela is still earning FX due to its trade surplus, but its current account is deteriorating. 

Floating the currency is not really an option. The black market exchange rate is approaching 700 VEF to 1 USD. Inflation in Venezuela is officially nearly 70%, but almost certainly much more, since the central bank has provided no updates since December: some estimates put it over 100%. Whatever it is, it is undoubtedly rising fast despite the pegged exchange rate. The bolivar is currently pegged at 6.30 to the USD, though hardly anyone uses that rate: most goods are priced at one of Venezuela's secondary exchange rates. Even those substantially overvalue the bolivar. 

Because of Venezuela's unsustainable public finances, the central bank is monetising the public deficit, which in January was 11.5% of GDP and is probably now much higher. This is the growth in base money in the last year:

Again, don't be fooled by the tapering-off in March. The central bank, like the government, is no longer providing reliable figures. 

Unpegging the bolivar would almost certainly trigger hyperinflation. But unless the bolivar is allowed to float, Venezuela faces a FX crisis despite its trade surplus. Either way, default appears a near-certainty. Hence the astronomically expensive CDS and the wildly inverted yield curve. Dollarising the economy - which would mean surrendering control of monetary policy to the Fed - has been ruled out by President Maduro. 

That's the financial story. But underlying it is a political crisis. It is hard to obtain neutral reports on the political situation: captive media claims that Maduro is set to win the December elections with a landslide are not remotely credible. But reports in American press that Maduro's personal popularity has fallen to 25% and his Socialist party would fail to gain a majority are also suspect, given the Maduro administration's claim that the country's economic problems have been engineered by the US government to bring down the regime - though the fact that Maduro is now ruling by decree with the support of the military does suggest that he doesn't have much in the way of a democratic mandate. Personally, I think it is unlikely that the Maduro government would survive disorderly default, hyperinflation and economic collapse, which seem likely to be Venezuela's fate within the next couple of years. But what would replace it?

There are no good answers. The history of Latin America suggests that a military coup is likely, though not inevitable. Years of political chaos is a second possibility. And a third is the election of a much more radical government, right or left, which opts for near-autarky and a highly authoritarian command economy. All of these have been experienced by countries in Latin America over the last half century. All have proved disastrous. US hegemony, Colombia-style, is a fourth option which might prove more successful, though opponents of course claim that this is the US's plan, driven by desire to gain effective control of Venezuela's rich natural resources. 

Whatever. The real issue here is the human tragedy. Venezuela faces a humanitarian disaster. Even under a new regime, it would need aid as well as restructuring and reform. And without a viable government, it would not qualify for the IMF programme it will almost certainly need. Not that the IMF is exactly up to speed on Venezuela, given that the Article IV consultation has been delayed by 110 months. Only Somalia is further adrift. 

But I warned in my previous CC piece about Venezuela that the genesis of disastrous populist governments lies in the wrenching fiscal adjustments typically imposed on defaulting countries by the IMF under the Washington Consensus. People facing the ruin not only of their own lives, but those of their children and grandchildren, do not long tolerate unyielding fiscal austerity. Too many mistakes have been made by the Bretton Woods institutions, both in Latin America and elsewhere. Most recently, the IMF is significantly to blame for the situation in Greece. 

There must be no more mistakes. The IMF's primary concern must in future be the wellbeing of people and the restoration of social and economic prosperity, not the repayment of creditors. 

Related reading:
The IMF's Big Greek Mistake - Ashoka Mody, Bloomberg View


  1. This good news for the enemies of communism. If Venezuela runs out of dollars, it will be bad for the criminal Castro Dynasty.

    1. Actually it's pretty bad news for the Caribbean generally. If Venezuela is forced to pull the plug on Petrocaribe, it's not just Cuba that will suffer.

    2. In long run, it's best for all of world. America cowboy capitalism wins. Everybody else bends.

  2. Interesting. I have no real comment being ignorant about the issues. Maybe sometime you might post about the reasons for/benefits of/problems with weird artificial exchange rates. Years ago I went to Egypt when there was an official exchange rate, an official black market rate, and a real blackmarket rate.

  3. I was trying to work out how a government deficit of just 11.5% of gdp could give 100% inflation.

    So I looked on the internet and saw this:

    It is interesting - there is like a carousel fraud where importers exchange Bolivars for USD at the government rate so that they can import vital supplies. They then sell these in eg. Colombiaand receive USD which they can then exchange back into Bolivars at the black market rate making a huge profit. And apparently 30-40% of all imports are exported in this fraud/loophole.

    So not surprisingly there is a shortage of goods, hence leading to inflation. And since the government pegs all wages and pensions to inflation, next year the whole thing stats again just with more Bolivars in circulation and even lower black market currency rate so more incentive to smuggle the goods out of the country.

    In my opinion, it looks like they should just let the currency free float.

    As an aside, I do hate it when people use Venezuela/Weimar/Zimbabwe as examples of what happens when the government can print money (see Jack Straw recently). There is always another (real) reason for inflation.

    1. The government deficit is much higher than that. That's the figure reported in January when inflation was 65%. No reliable figures for either the deficit or inflation have been reported since.

      Having said that, I agree with you that there is a carry trade going on. It's reminiscent of the tourist carry trades that went on in the Soviet Union, of which I have personal experience. You could fund your entire trip to the USSR by importing small amounts of jewellery, watches and jeans for sale at black market rates. Customs officials used to search tourist suitcases for that reason, but it was always hard to prove that the contents were intended for sale.

      Because of Venezuela's import dependence, though, unpegging the bolivar would make inflation far worse. Wilpert does say that in the interview. The combination of Dutch disease with a massively overvalued currency peg is deadly. I used to think floating the currency was the best thing to do (see link to my first Forbes post, the one about Russia & Venezuela) but I've changed my mind now. I think things have gone far beyond that.

      The Venezuelan central bank is monetising the deficit because of Venezuela's very high borrowing costs. That is not the cause of the inflation. But it is another reason why unpegging the currency is likely to make inflation far worse.

    2. It's a really interesting and sad situation and a very thought provoking post as ever. As a study in how not to run an economy there are so many lessons.

      I can see the one off inflationary impact of removing the peg. But after that, the terrible destructive impact of the peg would stop.

      If it's true that 30 to 40 % of all imports are smuggled out then literally 30 to 40 % of all export revenues are just given away to profiteers. That is so huge that no economy could cope.

      I am not sure what other alternatives they have here. How long can this go on for?

    3. PDVSA generates 90% of FX so they will be able to keep paying the debt which is very low so I don't think they will default.

      They have Citgo and other foreign holdings that can be seized by the creditors.

      Doesn't make sense to default.

    4. Unpegging would mean hyperinflationary default as Venezuela tried to service US-dollar denominated debt in an increasingly devalued currency. That is classically how hyperinflation happens - see Weimar.

      The alternative is to default and unpeg. That would be much better, and actually that is what markets expect - hence the very high short-term bond yields and expensive CDS. If unpegging were combined with default on foreign-denominated debt, then I agree the inflationary shock would be short-term. If Maduro would swallow his pride and ask for help, the IMF would probably support this approach as it's currently pushing for something pretty similar in Ukraine. If so, Venezuela would be lent the money to restore its economy, though there would of course be tough conditions - hence my warning in the post. But pigs don't grow wings, do they? And I'm not sure leopards change their spots, either. So it's understandable that Maduro would not want to seek help from the IMF.

      But the longer Maduro sticks his head in the sand, the worse it will be. Russia is not going to help him, and neither is China. I suspect he will end up relying on the backing of the military to stay in power - indeed he is already a long way down this road. And that means that eventually the military will take over. My money would be on a military junta fairly soon. Military juntas do usually sort the books out. But they also murder and starve a lot of people. Poor Venezuela.

    5. I should add that default would have horrible consequences elsewhere, though. If Venezuela does default, Petrocaribe is bound to collapse. And that would be a major supply-side shock rippling through the northern Latin American countries, Central America and the Caribbean, including the politically-sensitive Cuba. Petrocaribe is already in trouble because defaults by various members has left it seriously short of funds, and Venezuela is not honouring reciprocal purchase agreements. It's a mess, frankly. I probably should write about this in another post.

    6. Anonymous, look at the FX reserve position. Because of falling oil prices, PDVSA is not generating enough FX to support the currency. Consequently Venezuela's FX reserves are plummeting. I didn't invent that graph. Devaluation is certain and I think default is too, unless oil prices rise well above $100 a barrel, which seems unlikely.

  4. The worst governed country of the Western hemisphere. Venezuela was already running huge deficits when its oil basked traded above USD 100. Chavismo has destroyed the non-oil economy by countless distortions and restrictions. Even the oil economy is in bad shape (output < 1990s levels when PDVSA was one of the best managed state oil companies) and lots of exportable barrels go to China for debt service. There is no easy way out of this mess. Venezuela needs to start from scratch. Politics is even worse. Maduro is an incompetent clown that is currently doing his best to provoke a border conflict with Guayana. Even worse, the country has become one of the most dangerous to live in.

    1. Interesting since debt to GDP actually decreased and the country grew faster since Chavez came to power.

      The problem is the private sector that simply wants petrodollars instead of producing something.

      And you should look at the CA balance that it's in surplus.

      All the other countries in Lat Am rely on foreign borrowing to grow. Not Venezuela.

    2. Unfortunately this is not true.

      1) The big fall in debt/gdp actually happened before Chavez came to power. Since 2008 it has been rising steeply.

      2) Country did not grow faster under Chavez either. Venezuela was in deep recession from 2002-4. It did grow fast from 2004-2009, but then dipped back into recession. Growth after that was much slower. It's currently in recession again.

      3). I mentioned the CA balance in the post. It is still in surplus - just - but it's deteriorating. I don't think it will remain in surplus much longer.

      4) Venezuela's official external debt has risen considerably since 2013:

      Also you should bear in mind that official debt figures do not include bonds issued by PDVSA. If these were included - as they should be, since they are liabilities of the state - Venezuela's dollar-denominated debt would be far higher.

      5) I agree with you that the private sector is milking the oil reserves. Venezuela has a bad case of Dutch disease, namely the crowding-out of productive industries by a dominant extractive industry. But I have to say that I have seldom seen such appalling economic mismanagement. The Maduro government should be held to account by the people for the damage it has done to their lives. I'm very sad that you defend it.

  5. Substantially agree with this post.

    Some points of emphasis:

    1) The political crisis is effectively the absence of a viable right wing. The dominant faction of wingers are ex-Copei folks that have collapsed into an irrelevant body of narcissistic parasites that are a bunch of cats Capriles has to herd. They take in spy money but refuse to campaign outside of the capital, refuse to have inside/outside voices, and refuse to have policy platform other than narrow, pet issues, leaving ordinary people with too-good ideas about what would happen if wingers were in charge and why they wouldn't like it. That means Chavismo mostly makes space for their own members in Venezuela's patchwork of corruption, especially post Chavez, rather than put political capital in reducing corruption so as to not lose elections to anyone with appeal and a plan.

    2) Don't be shocked if Venezuela manages to muddle along, even under the great stress it's under. CDS for Venezuelan debt has always been too high relative to structural position that Venezuela occupies. It's only been since about the Saudi oil flooding that actual default possibilities have started to match the CDS. This has made an awful lot of money for certain traders to this date.

    3) I've realized in the time since arguing with Noel Mauer about the Venezuela elections that the situation is utterly intractable b/c Venezuela can't keep this up, and that floating the currency wouldn't work. More critically, Venezuela is really too large an economy to be running on dollars and that it *must* have its own currency. My guess has been that part of the refusal to become more rational is because of the lack of viable options, and a passive determination that capitalist enemies will have to find their own dollars to import the goods needed for production, sucking away political power that might change status quo. The carry trade is basically destroying the country--the refusal to hold anything but hard currency means that every single internationally tradeable thing not nailed down is exported for dollars--likely held in offshore banks. Subsidized gas, illegally mined minerals, rationed toilet paper, the works. One way or another, this basically means that a seriously illiberal government is in the future.

    4) Collapse of Venezuela==collapse of Colombia at a minimum. Colombia is not better run than Venezuela--it just doesn't suffer from geopolitical conflicts and has some subsidies against changes in geopolitical currents. However, what is governed is really small compared to the political borders and population. Better urban conditions disguise a worse situation outside of the cities and a fermenting deep dislike of the central government. FARC et al aren't that popular, but gov't is really not popular. However, successfully so far able to ignore. Weakened central government is BAD NEWS, though. A lot of things are going on in S. America that would be seriously aggravated w/a Venezuela collapse.

  6. Your post is illuminating but I really don't understand the logic of your blaming of the IMF and the Washington consensus at the end.

    As you previously said, Chile, Peru and Venezuela are classic examples of expansionary politicy gone wrong. You admit that Venezuela has been horribly mismanaged. Most likely, the crash to come will wipe out any improvement since Chavez's rise and leave Venezuela poorer (and much more violent). The logical conclusion is that the people of Venezuela should have stayed the course by learning from the results of previous populist experiments.

    But you're suggesting that the IMF is somehow responsible. Is it because you would favor a lighter but still un-orthodox expansionary policy (unrealistic) or do you think that IMF is responsible no matter what, even when the impoverished people have expectations well beyond what sensible policies can deliver?

    1. You've evidently read my previous post, but you've slightly missed the point. Dornbusch correctly identifies the rise of populist politicians preaching basket case economics as rooted in over-harsh measures imposed by under previous IMF programmes. In Latin America as a bloc this has happened repeatedly and Venezuela is only the latest example. That does not mean I exonerate Maduro or his predecessor. Far from it. But the IMF can't be exonerated either.

    2. Yes, Venezuela had been mismanaged, IMF prescribed a harsh medicine, then the people revolted and have got someplace even worse. You're saying that the IMF could have prescribed something milder, but first, the IMF favors theoretically-sound policies (that is, orthodox) and second, no matter how mild the program of adjustment, it will be unpopular nevertheless and internal politicians will seek independence from it.

  7. Really great article and mostly intelligent informative comments. Thank you Ms. Coppola and I'm glad I follow you on twitter. Very sad for Venezuela.

  8. "But I warned in my previous CC piece about Venezuela that the genesis of disastrous populist governments lies in the wrenching fiscal adjustments typically imposed on defaulting countries by the IMF under the Washington Consensus. People facing the ruin not only of their own lives, but those of their children and grandchildren, do not long tolerate unyielding fiscal austerity. Too many mistakes have been made by the Bretton Woods institutions, both in Latin America and elsewhere. Most recently, the IMF is significantly to blame for the situation in Greece."
    That is a big mistake, taking account of the horrendous previous history of Venezuela in the last a 4 decades. I suppose that there is some scope for internal responsibility, since the times of Carlos Andres Perez, impossible to erase from the global picture. Yu have a trend to a certain manikeism, where only the foreign institution are the villian. It is ridiculous.

    1. What a pity you did not bother to read my previous post, to which I linked, before making this comment. I do not regard "only the foreign institution as the villain". Far from it. My point is that we should not be blind to the considerable mistakes the Bretton Woods organisations have made.

  9. That's true, I don't read it. Sorry. But I see a "penchant" through put the culprit on wveey others. I'll read it immediately

  10. Finally, I read it. You say:
    "Having said that, it is not reasonable to blame expansionary "populist" policies for economic collapses without taking account of the role of the preceding harshness in setting them up. IMF programmes may stabilise the economy, but too often at the cost of real suffering among the population: the desire to improve their lot is entirely understandable. Austerity breeds profligacy, which in its turn is forced to give way to even more austerity."
    I don't understand "Austerity breeds profligacy". And I don't see the fault of IMF (& others) of some restructuring of debt practisized in Latam. On the contrary, I see that the main cause of retuning to "profligacy has been only the culprit of local government.
    There is a crucial difference between Latam problem and Eurozone. It's the free exchange rate, that, time to time, reestablishes external equilibrium. That is impossible in "Zerozone".

    1. Hmmm...Think of it as binge dieting, or perhaps bulimia.

  11. Frances, usually in MMT literature if a country is sovereign in its currency it has to float it.

    1. I know. That is why I said that Venezuela is only monetarily sovereign "in theory" (and by that I don't mean MMT theory). The bolivar should really be a petrocurrency like Russia's ruble , but because Venezuela is trying to maintain this absurd peg to the dollar it necessarily imports much of its monetary policy from the Fed. The strong dollar coupled with falling oil and commodity prices is absolutely crippling for it.