A Latin American tragedy

In my recent Forbes post about Venezuela, I said that neither the exchange rate policy nor the government's fiscal policy were sustainable, and the Maduro regime would eventually be forced to devalue and enact painful fiscal reforms. In the comments, Alexander Guerrero observed that it is already too late for this, because the economic mismanagement of the last few years has all but destroyed the supply-side of the economy: devaluation now would be likely to result in hyperinflation and default. 

The tragedy is that what is playing out now in Venezuela has happened many times before. Those who do not learn from history are doomed to repeat it.....and nowhere is that more true than in Latin America. In this paper from 1989, Dornbusch & Edwards examine the reasons for the parlous state of Peru's economy at that time in the light of the economic collapse of Chile in the early 1970s. These comments set the scene (my emphasis):
Our purpose in setting out these experiences, those of Chile under Allende and of Peru under Garcia, is not a righteous assertion of conservative economics, but rather a warning that populist policies do ultimately fail; and when they fail it is always at a frightening cost to the very groups who were supposed to be favored......
We are struck by the strong similarities in Chile, Peru,and in other episodes not developed in detail here of the way policy makers viewed the objective conditions of their economy, how they proposed that strongly expansionary policies should and could be carried out, and how they rationalized that constraints could be dealt with. And, of course, we are impressed by the fact that in the end, foreign exchange constraints and extreme inflation forced a program of violent real wage cuts that ended in massive political instability, coups and violence.
 But how does everything go so badly wrong?

Dornbusch & Edwards explain that the problem is a combination of factors:
The combination of external influences (debt crises,economic blockades etc.), domestic policies (socialization of firms, bank nationalization, etc.) and macroeconomic policies bring about an unsustainable economy where inflation is out of control, and the foreign exchange constraints force realism on policy makers.
 And they go on to list the four stages of the unfolding disaster.
Phase I: In the first phase, the policy makers are fully vindicated in their diagnosis and prescription: growth of output, real wages and employment are high, and the macroeconomic policies are nothing short of successful. Controls assure that inflation is not a problem, and shortages are alleviated by imports. The run-down of inventories and the availability of imports (financed by reserve decumulation or suspension of external payments) accommodates the demand expansion with little impact on inflation.

Phase II: The economy runs into bottlenecks, partly as a result of a strong expansion in demand for domestic goods, and partly because of a growing lack of foreign exchange. Whereas inventory decumulation was an essential feature of the first phase, the low levels of inventories and inventory building are now a source of problems. Price realignments and devaluation, exchange control, or protection become necessary. Inflation increases significantly, but wages keep up. The budget deficit worsens tremendously as a result of pervasive subsidies on wage goods and foreign exchange.

Phase III: Pervasive shortages, extreme acceleration of inflation, and an obvious foreign exchange gap lead to capital flight and demonetization of the economy. The budget deficit deteriorates violently because of a steep decline in tax collection and increasing subsidy costs.The government attempts to stabilize by cutting subsidies and by a real depreciation. Real wages fall massively, and politics become unstable. It becomes clear that the government has lost.

Phase IV: Orthodox stabilization takes over under a new government. An IMF program will be enacted; and, when everything is said and done, the real wage will have declined massively, to a level significantly lower than when the whole episode began! Moreover, that decline will be very persistent, because the politics and economics of the experience will have depressed investment and promoted capital flight. The extremity of real wage declines is due to a simple fact: capital is mobile across borders, but labor is not.
 To make their point, Dornbusch & Edwards provide the following charts of real wages for, respectively, Chile under Allende and Peru under Garcia.

Remember that at the time they wrote, Peru's collapse was in progress. The pattern is clear. When the economy collapses under the triple burden of supply-side dysfunction, unsustainable fiscal finances and capital flight, the real wage falls to below its previous level. The inevitable IMF program restores stability, but at the price of stagnation, inequality and poverty for much of the population. And as Dornbusch & Edwards explain, therein lie the seeds of the next crisis:
Initial conditions: The country has experienced slow growth, stagnation or outright depression as a result of previous stabilization attempts. The experience, typically under an IMF program, has reduced growth and living standards. Serious economic inequality provides economic and political appeal for a radically different economic program.The receding stabilization will have improved the budget and the external balance sufficiently to provide the room for, though perhaps not the wisdom of, a highly expansionary program.
Policymakers explicitly reject conservative economic policies and implement highly expansionary policies designed to reduce inequality and eliminate poverty quickly, usually by means of large real wage rises.  I was struck by the beliefs that justify such dramatic reversal in policy, in particular the rejection of conventional economics: Chavez, Allende and their kind simply don't think that the rules of economics apply to them. And when it all goes horribly wrong, they blame external factors while exonerating the domestic policies that have enabled external factors to exert such a destabilising influence on the country. It is hardly surprising if investors do not wish to invest in countries where their investments are at risk of expropriation, or where their profits could be wiped out by large government-mandated wage rises or sudden tax increases, or where rising inflation erodes not only their returns but their capital. The loss of capital investment arising from these policies is probably the most damaging aspect, since it erodes supply-side capacity and directly causes precipitous real wage falls when the collapse eventually comes.

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. Rinse, repeat. This has been the story of Latin America for a very long time.

Venezuela is currently in Phase III. There are pervasive shortages, inflation is over 65% and rising, and foreign reserves are declining sharply despite Venezuela's trade surplus. The budget deficit is currently at 17% and rising. The economy is demonetizing rapidly as more and more transactions are done on the black market. To make matters worse, the US government has imposed sanctions on Venezuela for suppressing dissent. So far, the government has resisted devaluation and subsidy cuts, but it cannot do so for much longer. Maduro - never as popular as his predecessor - is resorting to bribing the population with unsustainable fiscal expenditures, but this will only hasten the economic collapse that now appears inevitable. Venezuela is headed for default, hyperinflation, disorderly regime change and a wrenching fiscal adjustment. And the people who will suffer - indeed are already suffering - are the poor that Chavez and Maduro set out to help, just as the poor in Chile and Peru suffered.

Alexander Guerrero's warning about Venezuela seems all too prescient:
To put it in few words, our fiscal situation is similar with the Russian one in 1989 at the fall of communism in Europe. It means we have to go for a unlimited privatization process, I know that politically there is no way to get it, but we are driving to that point, I just beg God, that everything happens in peace, I doubt it any way!.
Poor Venezuela.

But this is not wholly a Latin American story. Much of what is described here also applies to Greece. The only difference is that Greece is in the Euro, so hyperinflation is impossible and all the adjustment must come from brutal fiscal retrenchment and sharp falls in real incomes. But if it were to leave the Euro, or worse, be thrown out for non-compliance with Troika demands.....

Be careful what you ask for, Mr. Tsipras.

Related reading:

Who pulled the switch?

Image from the Wall St. Journal


  1. You make a good argument for getting rid of the IMF, rather the actions of the IMF make a good argument for getting rid of itself.

    All these countries need to look for less conventional, more sustainable development models, something other than fashionable auto-centric American-style industrialization. Pursuing inappropriate development is the root cause of the problem. Overseas-produced manufactured goods require overseas-produced manufactured credit to obtain them: no Latin American country is a credit provider, they all depend on dollar loans from Wall Street. As such, none of these countries is fertile ground for industrial development ... in fact, America itself is not suitable: this is a wicked trick we have played on ourselves.

    A connected problem is dependence upon one-time asset sales: extraction and export of capital/natural resources. Any country w/ a commodity export/forex dependence is in real trouble right now. It will be harder going forward: 'use' of the capital is mostly waste and non-remunerative, the credit needed to support such use has become more costly than can be afforded by borrowing ... not just that of Venezuelans.

  2. What do you mean by "unsustainable fiscal finances" ? Sovereign currency issuers do not have problems like this and "capital flight"" is a misnomer because deposits always stay where they are only the price adjusts.

    Problems you are describing come from the lack of monetry sovereignty and western "educated" policy makers/puppets in particular from foreign debt or fixed exhchange rates .

    Borrow in local currency only , pay for imports in the same way , adjust output and employment increasing "G" are the simple remedies to these false IMF sponsored "current account crises" or above mentioned "capital flight". CPI move upwards aka inflation should be dealt with via taxation. There is nothing magical about this stuff.

    Why fearmongering about GREXIT ? Greece must leave EZ or face further social deecay and degradation. There will be a shock that's for sure but the transition can be asily smoothened via programs like Argentine JEFES ( I wonder why didn't you mention this in your post ... ) only much broader and better financed .

    Michał Kalecki said that persistent ignorance is a manifestation of the political reasons behind it.

    1. Sovereign currency issuers cannot technically run out of money (since they can always print more), but their currencies can become worthless. Capital flight is not a misnomer - deposits really can leave the country: exchange local currency for hard currency then deposit it in an account outside the country. Only capital controls prevent this.

      You can't pay for imports in a local currency that is depreciating at a rate of knots. Exporters do not have to accept it.

      A defining feature of hyperinflations is that the government loses the power to tax. This is consequent upon demonetisation and the growth of the black market. Government can only tax things it controls. It does not control foreign currencies used for under-the-counter transactions. The more of the economy that migrates to the black market, the less taxation power the Government has.

      As I have been a long-standing proponent of GREXIT, accusing me of "fearmongering" is a bit rich. We should not underestimate the pain that exit and redenomination would cause, though I think it would be short-lived. Your assumption that Greece would obtain international finance to support its exit is unjustified.

      Your Kalecki quote is a personal attack on me. My rules (on the About page) clearly state that I do not permit personal attacks on me or on others on this site. Refrain from such attacks in future or be banned from commenting here.

    2. Frances,

      My Kalecki's semi quote wasn't directed at you. I am sorry if you felt this way.

      "...Sovereign currency issuers cannot technically run out of money (since they can always print more), but their currencies can become worthless..."

      Sure they can but it's always a policy choice ( corruption, bank loans to insiders ). Japan's "printing" and "printing" and Yen only goes up.

      "..Capital flight is not a misnomer - deposits really can leave the country: exchange local currency for hard currency then deposit it in an account outside the country. Only capital controls prevent this..."

      How much money can you transfer this way? Yes , exchanging X currency for eg. USD at bureau de change, putting the bills into the suitcase and driving them abroad is a closest thing to "capital flight" but given ratio of cash to the overall monetary base we can dismiss this kind of behaviour as irrelevat.

      "...You can't pay for imports in a local currency that is depreciating at a rate of knots. Exporters do not have to accept it..."

      Again , why is the currency losing its value in a first place? Corruption, misguided policy etc. Even Zimbabwe managed to import oil..

      "...A defining feature of hyperinflations is that the government loses the power to tax..."

      Hyperinflations' core reason is always foreign debt, selling local currency to obtain eg. USD , driving import costs up and causing cost push "inflation. Another , secondary reason is persistent devotion to "honor" contracts that caused given situation. Weimar, Zimbabwe, Volcker created wave of hyperinflations around the world , in my native Poland among others .

      "...Your assumption that Greece would obtain international finance to support its exit is unjustified..."

      What does Greece need international finace to "support" its exit for? They will drop EURO , go back to Drahma see some adjustment in their purchasing power in relation to imports . NIKEs will become expensive for a while but imagine the crowds in Athens :) What are the creditors going to do? Invade? Impose sanctions? Close the borders? There will be some stuff confiscated abroad on orders of some American corporate sponsored judges but this is all. Government will get rid of the criminal Maastricht rules and unemployment will drop being always a fiscal phenomenon. Pain? Isn't current unemployment there painful enough?

      ".. I do not permit personal attacks on me..."

      Fair enough , I hope I managed to explain myself with m y first paragraph.

      Best regards


    3. Mariusz

      Thank you for explaining the Kalecki quotation. I'm sorry I misunderstood.

      I disagree with you on a number of points, I'm afraid.

      - Hyperinflation is political in origin, yes, but rejection of the currency is not specifically due to corruption or bank loans to insiders. Nor is it necessarily to do with foreign debt, though I agree this is often involved. It is always, without exception, due to breakdown of trust in the government. And it is a domestic, not a foreign, phenomenon. Hyperinflation occurs when the domestic population rejects the currency en masse.

      - Capital flight can take place via currency exchange without any physical cash being involved. Central banks will facilitate this transfer by providing reserves if necessary, in both currencies. It's worth reading Izzy Kaminska's latest piece on the relationship of hyperinflation with online shopping: http://ftalphaville.ft.com/2014/12/24/2078381/what-does-online-shopping-have-to-do-with-hyperinflation/

      - The reasons for depreciation are complex. In Venezuela's case, a lot of it is because of the falling oil price. However, regardless of the reasons for the devaluation, it is reasonable for importers to refuse to accept payment in a devaluing currency.

      - If Greece returns to the drachma hyperinflation is extremely likely. Hyperinflation is common after the collapse of a fixed exchange rate system, especially if the supply side is damaged (as it is in Greece), because it takes time to establish trust in the new currency and replace the nominal anchor. When I looked at the possibility of Greek exit in 2011, I concluded that it would temporarily need to peg the new drachma to another currency, probably the dollar. But with the rising dollar, that strategy now would cause a monetary tightening even worse than the present one, so a Euro crawling peg with sufficient flexibility to permit reflation of the Greek economy would be better. The best approach would be to do an Iceland - drastic devaluation, redenomination of Euro debts into drachma (lex monetae) and capital controls. This may be sufficient to prevent catastrophic capital flight and runaway inflation. I am personally of the opinion that leaving is still the best strategy, but they should not be blind to the short-term pain it would cause - which in my view would be much worse than you seem to think.

    4. BTO, you are sort of right that the local currency does not leave the country, so capital flight sounds like it can not happen. But if an individual takes his wealth to exchange for a foreign currency and leaves the country, he and his capital have taken flight. What really happens is the price of the local currency goes down. Governments try to stop capital flight, but there are so many tricky ways to move wealth around that they straight jacket an economy in the attempt and still don't stop it. With Bitcoin it is harder than ever to stop capital flight. Any individual can be a black market currency trader exchanging Bitcoin for the local currency. There is always a big black market for currency trading. And with Bitcoin, getting out of the country is impossible to stop. Capital controls have no real chance, but they will hurt the economy in their attempt.

  3. I have no sympathy for the Venezuelan people, because they voted for Chavism, more than once.

  4. Has population got anything to do with LA problems? arg/chile/ven/Peru have relatvively small populations. So does NL/ Belgium, but they are v closely tied to bigger economies. No idea, just asking.

    1. I don't think so. Brazil has had its share of problems as well, and that's a much bigger country.

    2. Good point.

      Still vaguely wondering though. See Brazil vs USA. Or Germany vs Greece. Combination of size and commodity reliance (or lack of commodity reliance)?

  5. Ultimately, I think the world really needs a bancor, and the lack of a non-national currency helps create international currency crisis. I think that attempting to blame corruption or misguided policy as the main cause is simply pandering to conservatives who hate the provision of social services and the taxation/tax structure it implies.

    Because frankly, I think that focusing on Venezuela is a distraction. The crouching tiger per se. China is the hidden dragon.

    1. This comment has been removed by the author.

    2. Japan is the big hyperinflation about to happen. Hyperinflation comes from high debt and deficit when people stop buying bonds and the government is forced to print money. Japan has debt of 240% of GNP, China is about 30%. Japan should shock all the advocates of money printing but somehow it won't. They will blame it on the Tsunami or something.

    3. By all accounts hyperinflation in Japan has been imminent for 20 years or so.

    4. It is only very recently that the base money supply has been going up like 1% every 10 days.

      It is only over the last year that private ownership of JGBs has been dropping and the central bank monetizing for the full deficit and the reduction in private ownership.

      The action is really heating up in Japan. It won't be another year.

    5. Somehow I don't see queues of Japanese trying to withdraw their savings.

    6. Vincent,

      have you ever heard of the "widowmaker" trade? It is shorting JGBs, or yen. I wouldn't bet against Japan, personally.

      Expansion of base money due to central bank purchases tells us absolutely nothing at all about the future path of inflation.

    7. If the central bank is like Switzerland and buying Euros there is no extra risk of inflation. The quantity theory of money is just not true. If the central bank is buying 30 year bonds from their own government, in their own currency, in huge amounts, the odds of inflation do go way up.

      Yes, I am familiar with the widowmaker trade. But it is not the rates on bonds that changes. It is the value of the Yen.

      Frances, why do you think what Japan is doing is any different than the countries in this paper? Sounds very much the same to me.

    8. gastro, Japanese total savings has gone down for the first time ever.

    9. Because Abe weakened the YEN to make life easier for the exporters , hitting hard the real wages. This is what exporters do , rely on foreign demand and long for better "competitivness" what actually is an euphemism for shafting labor. Check YEN's performance recently it imitated RUBLE almost.

    10. Vincent. Link please?

    11. gastro, here is a link:

    12. Vincent,

      There is very little evidence that in an economy like Japan's with an ageing population and rising per capita GDP central bank purchases make much difference. The savings of the Japanese are virtually entirely held in yen and yen-denominated assets. They aren't going to dump their currency in favour of someone else's. It's not in their interests to do so.

      You really do need to take more notice of domestic conditions. What international investors think of the yen is unimportant. Hyperinflation is a domestic phenomenon.

    13. Hyperinflation was never in the interest of any country, yet it happens again and again. For each individual they would be better off investing outside Japan than holding 5 year bond denominated in Yen and paying 0.02% interest per year. The people in Japan see the prices on Amazon going up about 1% each week and it is in their interest to spend and not save. For the first time ever they are drawing down on their savings. You need to look at it from the actions of each individual and not what would be good if they all did a certain way.

      We will see who is right in the next year.

    14. Vincent - that is a report, not the stats themselves. If you look at, for example http://www.tradingeconomics.com/japan/personal-savings, there is no sign of the savings rate falling dramatically.

    15. gastro, I don't know. Mine says "Japanese household savings is negative for first time ever" and yours shows "Japanese worker savings" is about the same. I would guess these are different things. Not sure what is what. But it is normal as you go into hyperinflation for money to start moving faster and not sit around in savings so much, so mine makes sense to me. :-)

    16. Frances, you say, "What international investors think of the yen is unimportant. Hyperinflation is a domestic phenomenon. " The Yen has gone from 75 to the dollar to 120 to the dollar. If it makes it to 150 that is a factor of 2 and 225 would be a factor of 3. If Japanese stuff can be bought for 1/2 or 1/3 what it used to, there would be a huge increase in demand and it would drive up prices in Yen. If Japanese have to pay a factor of 2 or 3 for all imports then those costs will drive up other costs and the expenses ripple out through the economy. Tourists are already flocking to Japan in record numbers to take advantage of what to them seem like really low prices. This is also more demand. At some point people will be buying anything that can move easily and taking it out of Japan. So cars, trucks, boats, new and used seem really cheap to foreigners unless the prices go up. But if those prices go up, their increased cost has to ripple out. It will take some time for the ripples, but it seems to me that eventually this will drag up local prices. If not, everything will be boxed up and shipped out of Japan at some point. This is part of hyperinflation to really. Lots of tourists and all sorts of things being exported, even that did not used to be.

    17. I would say local prices are more sticky than exchange rates, but they can not stay fixed forever unless the economy is totally cut off from the rest of the world. North Korea might not care about their exchange rate, but Japan will feel the difference.

    18. Vincent: "so mine makes sense to me" Well it would, wouldn't it, not to quote Mandy Rice Davies.

      Just give us one set of real stats (not a report) that shows that Japanese households have started meaningfully dissaving.

    19. Ok gastro, I did the Google search for you:


    20. OK, so it seems that household savings have been falling steadily for some time - but I did a bit more digging and it also seems that private corporate savings have been rising. So overall there is no great fall in the savings of the Japanese private domestic sector.

  6. Frances,

    Thank you for the time invested in replying to me. Thank you for pointing mi to Mrs. Kaminska's piece as well but to make the long story short it doesn't convince me nor do your other arguments. Please do not find my remarks agressive or ad hominem attacks.

    1. please show me at least one example when the hyperinflation wasn't connected to foreign debt/fixed FX rate.( Poland even in 1939 after NAZI invasion didn't experience this phenomenon , it did in the 1980ies when Volcker jacked the rates up and installments on our USD denominated debt killed the economy)
    2. What Mrs. Kaminska described is still a policy choice eg. persistence on fixing the exchange rate and being "export led" economy , neglect of internal demand and relying on foreign banks for "financing needs". I would call it a colonial character of the economy. Plus what she described as "capital flight" is still a misnomer , deposits stay where they are some guys sell RUBBLES/PESOS and someone else buys USD/EUROS .

    3. Venezuela stubbornly upholds its status as a colony just like Russia or Belarus against their national interests. They extract resources and sell them for so called hard currencies no wonder they are held hostage to Anglo-American controlled markets. Again the root cause is fixed rate and a bad policy.

    4. Greece. Supply side is always damaged with deflationary measures employed by the governemnt restricting internal demand sticking to bad policy choice in this case Masstricht related madness. Euro additionaly makes it impossible for them to follow the export led way to prosperity ( bad choice but it's an another topic ) , again fixed exchange rate is to blame. Argentina droped its currency board, defaulted on 120 billion USD debts and still didn't experience hyperinflation.

    The answer is sovereignty not fixing anything and relying on foreign "financing" , we know what the currency is and how it's created.

    Best regards


  7. That is a very good paper.

    Abe in Japan is trying the same populist economics that has failed so many times in the past. The IMF is not big enough to save Japan from the total destruction that will come. Greece will seem like such a tiny problem when Japan falls apart.


    1. Japan's problem is their government deficit being too small not too big, IMF is not in the business of saving but destroying economies. What this total destruction is going to look like? Japan is a sovereign currency issuer with no foreign debt, real problems they are facing might be demographic in nature ( not enough working people to keep the things going someday in the future ) but for sure they are not financial. Have you heard of "widow trade" ?

    2. Japan is spending twice what they get in taxes. Half of spending is deficit spending. The Bank of Japan is buying government bonds at a monthly rate equal to twice taxes. The currency over the last 4 months has been dropping at an average of almost 1% per week while 5 year bonds pay 0.02% interest. Nobody is buying their bonds except the central bank and they are just printing money like crazy to buy the bonds. The total destruction will look like hyperinflation without and IMF to stabilize things.

    3. Foreign debt is just one way to get a government's finances in trouble. If defaulting on foreign debt could avoid hyperinflation then people would gladly default on foreign debt (foreigners don't vote after all). There are many ways governments get to where they spend much more than their taxes. And many ways to explain the positive feedback loops that kick in to destroy the currency.


    4. As long as Greece was still running a deficit it needed more and more loans from foreigners and so needed to go along with what the IMF etc told them to do. Once they have balanced their primary budget, then they can default on foreign debt and be fine. Long ago Mish predicted that at some point someone will get elected in Greece on a platform of defaulting on foreign debt. I think he is right. Does not mean they will leave Euro though.

    5. Hi Mariusz,

      Ah, I see where you're coming from now. Broadly, I agree with you.

      Yes, in capital flight the currency stays where it is, but the price falls - rapidly. Capital flight causes fast depreciation of the currency. Except in the Eurozone, of course, where it bankrupts banks and sovereigns because the currency can't depreciate. I don't think this is in improvement, personally. Now you've added fixed exchange rate to your "foreign debt" reason for hyperinflation, I agree. Collapse of a fixed exchange rate regime IS a predictor of hyperinflation - as you may recall from the hyperinflations after the collapse of the rouble zone.

      I'm with you on exchange rate policy. Fixed rates are almost always a bad idea. The exception is oil exporters when the oil price is rising fast, where a fixed exchange rate can help defend against Dutch disease, and countries experiencing rapid capital inflows due to capital flight from troubled areas (Switzerland, for example) where a fixed exchange rate can help limit the inflationary effect of inflows. Neither of these is the real reason for Venezuela's insane exchange rate policy. It has a bad case of Dutch disease despite its fixed exchange rate, and stupid fiscal policies have done considerable damage to the supply side - including its essential oil production. It's a basket case.

      I completely agree about the damage to Greece's economy caused by the Maastricht insanity - and other appalling Eurocrat decisions, too.

    6. Frances,

      Again thanks for your reply. I want to make myself clear about what I think cause hyperinflations. Fixed exchange rate may lead to currency depreciation after policy change but it would only lead to runaway inflation if a given country insists of honoring its foreign debts. The same applies to Greece , leaving EZ but still trying to balance the budget and honoring its EURO debt wouldn't do them anything good.

      We are coming to a very important conclusion here. The root cause is foreign debt but fixed FX regime is a further devastating factor , especially when it comes to social issues.

      Let's look at Argentina. After the default and dropping 1:1 PESO/USD peg , local currency went from 1 to 4 pesos for USD in a short period of time but finally it stabilized at level of around 3.5, please forgive me if am not precise but I am just shooting numbers out of my head now. What happened? Taxation of the state put the natural demand floor under PESO it didn't go to zero.

      Why fixed regime only made the matters worse? Some people were promised one dollar for each peso, economy lost its competitivness which in turn led to 22 % unemployment rate, some big speculators and rentiers lost their shirts etc. Argentine government made an only possible decision , terminate the peg and default. If it didn't manage to curb the riots and keep the ability to tax we would have seen some wild inflation. This is what happened in former USSR when some states almost desintegrated, with rampant corruption, banditry and whatnot. Again, the problem lies in a quality of the government rule not in economic science.

      So Greece will only face the threat of hyperinflation if it doesn't manage to put in place/enforce TAX obligations extinguishable only in DRACHMA. They may even leave EURO deposits in place and just wait for people to exchange them for the new/old currency to pay their dues. After GREXIT I wouldn't put much hope in EURO anyways because when it happens it's game over for this failed experiment.

      I agree with you that fixed regime kind of works for some countries that made producing stuff for somebody else to consume in exchange for net financial assets their national policy . If I were Saudi king I would have tried to develop my own economy , import resourcescfrom abroad for my CB tokens and leave my in the ground for the future generations when nobody has any but maybe it's only me :)

      Best regards



      I am glad that you called Maastricht related legislature insanity - Eurocrats so eagerly focused on imposing them belong in the Hague with other criminals.

    7. Aren't we a bit quick at drawing conclusions in the absence of counterfactuals here?

      Greece without the euro crisis (or some equivalent shock) would have likely plodded along as a poor country with dysfunctional governance and ever lagging (median) real incomes and standard of living compared to better run countries. The shock therapy could have been smoothed with better European institutions, but it's not obvious the end game will be worse for the average Greek, especially if Tsipras gets the mandate to finish some of the necessary reforms (e.g. reducing church privileges and getting rich people to actually pay due taxes) that the incumbent parties have not dared doing, and that no electable party would ever had a mandate to do under a perpetual devaluation model.

      Without parallel universes to conduct controlled trials, we'll never know for sure, but reasonable people should be at least open minded to the possibility that their hypothesis on such a complex matter is not a certitude.

  8. Politicians do not engage with the rules of economics because they cannot.

    You see they must first deal with the rules of capitalism as it seems there is no other canvas for their work.
    So as to distribute the industrial surplus wage rises become the key method rather then capital redistribution.
    This of course leads to failure.

    As for Greece a return to village life is the only option whether the state provides a viable means of exchange or not.
    However nothing stopping Russia engaging in a fordist experiment for 100 years or so.
    Perhaps this is the main cause of global tension at the moment.
    If the European roboten return to village life the centre of European usury ( London and its greenbelt)will also implode in a spectacular fashion.
    Which is why the modern version of the RAF is more then willing and capable of straffing the Greeks on their streets if needs be.

  9. Thanks for bringing the Dornbusch & Edwards work to our attention.

    When government decides to embark on a long term pattern of borrowing, government must be planning to borrow from someone .

    The someone government is planning to borrow from, must have acquired something and must have something under their control that is worth borrowing. If the something is money, then something government has done has allowed the accumulation of money, because, fiat money is a government creation.

    Long term borrowing by one entity is a form of 'free ride'. It can go on as long as the lender is willing to lend. That can be a long time when government decides to borrow from itself. Think here Japan and maybe Venezuela.

    When an economy borrows from itself, it is allowing one group to enjoy the results of work done by the lender group. If this pattern is allowed to expand without check, the result is the not-working group growing and working group shrinking.

    When the money supply expands, the economy is borrowing from itself. Each new money unit is a new share of any item for sale in the economy. Foreign workers, looking for markets, find it easy to under- price the few remaining workers who are in a position to command top wages. New money then tends to flow out of the country to purchase less expensive foreign products.

    At some point, Phase III is reached. and then Phase IV. Eventually, the remaining workers are too small in number to supply the needs of the borrowing majority. The whole system must collapse into an evolved system of more workers and better sharing of economic responsibility.

  10. "When the money supply expands, the economy is borrowing from itself. Each new money unit is a new share of any item for sale in the economy."

    And if the total number of goods increases?

    An increase in the "total national value", achieved for example through investment (maybe education?) should be reflected in an increase in base money, otherwise the value of existing money increases. The latter is what the rich would like, of course.

  11. The main reasons why there is still a large group of Greek people who want the country to remain in the EMU are two: a) they don't like austerity but they know what to expect. So one reason is the fear of the unknown and, b) their money don't lose it's value, at least literally. It becomes lesser but it doesn't depreciate. The above reasons apply to all those who still have any money left, no matter how much. Those who don't have anything just don't care. As far as I am concerned, I can't blame any of the two groups.

    Would a grexit cause hyperinflation? I can't tell. What would surely happen would be: the government would have to print money in order to recapitalise, mainly pension funds and the banks. Now, the group of people I mentioned above, those who still have any money left, would go bananas and try to get rid of the new national currency. In the end the government would have to apply capital controls but (so many of them really) there is always the black market. The people would keep drawing their money from the bank accounts to exchange it at the black market, even in smaller amounts.

    So where does that get us? Austerity is not doing any good. However grexit won't do any good either, at least for Greece. Instead of printing money, the government should convince the citizens to pay their taxes in advance, while still inside the EMU, by issuing some kind of national state bills which will offer tax discounts instead of interests. Prof Varoufakis can explain this better than me. Anyway what matters is that, in a very short time, these bills would become a covered up parallel currency, providing liquidity and at the same time a safety pillow, in case Greece was to be pushed out of the EMU, in order to set an example for all those in Europe who don't like hard money.

    Always keep in mind: tragedy and drama are Greek words...
    Yours truly, Evaggelos

    1. Evaggelos,

      A trick was played on small deposit owners that convinced them they are rentiers hence cementing their support for "hard currency". This way little people bark in defense of the big fish , this happens all the time look at TEA PARTY fanatics in the US working for the oligarchs against their own interest.

      GREXIT won't do any good either? Why are you so sure dear Evagellos ? Maybe 5 more years of double digit unemployment will incite you to reconsider? Is 40 per cent enough for you or you need 50 ?

      I will tell how GREXIT can be managed. Your governemnt says bye bye to EZ , pays all its employees in Drachma , settles tenders and decides on new investements in Drachma , all taxes must be paid in Drachma. It must default too. Than it starts Job Guarantee program for anybody able and willing to work , it can pay on weekly basis in the beginning.

      People have jobs , economy starts working again and after an adjustment period things settle down.

      Magic? Again study Argentina and its exit from 1:1 USD peg.


      "...Instead of printing money, the government should convince the citizens to pay their taxes in advance, while still inside the EMU, by issuing some kind of national state bills which will offer tax discounts instead of interests..."

      Why????? Please explain , because no matter how hard I try I don't get it. Sovereign governemnt doesn't need taxes to spend , it's econ 101.

    2. ctd.

      taxes regulate aggregate demand and make currency "desired" . This is a primary reason Greece is in such a mess right now. It became a local fiefdom dependent on markets, ECB, and taxes to spend.

  12. at typically causes the collapse of the supply chain in this modern banked universe.

    A extraction of purchasing power via the mechanism of usury.

    Noble efforts such as this attempt to supply the local town of dingle with low input dexter beef live a precarious existence.
    Your mission should you choose to accept it is first bypass the various euro health and safety ( cartel ) laws.
    Then you must attempt to sell your product to local people whose purchasing power has been extracted in gross manner.
    You are forced to rely on a precarious income from the long distance tourist consumer trade and not local fishermen and farmers who have long gone the way of the dodo.
    Obviously the amount of inputs required to transport consumer tourist roboten dwarfs even industrial farming input requiriments.
    However everybody on the island is forced to pay for this weird scarce money trade via this artificial balance of payments crisis.


  13. Current world trade dynamics can trace their origins in the north of Europe during the Tudor phase of exploitation .
    Towns such as Dingle in the early 1500s were engaged in balanced trade most probably exchanging the miniature cattle of the west for spanish wine.
    London's aim via the use of crown forces was to concentrate rather then create wealth.
    It labelled Dingle among others the Hussy Dingle .
    No less then one of the infamous Greys was dispatched to extract the towns wealth.
    All of Ireland's wealth was thus concentrated in England which most probably enabled the beginnings of proto industrialisation during the Elizabethan era.
    We have been living with the horrid ramifications of this corporate takeover of the world ever since.
    So as to maintain its control Anglo american power is now engaged in a total war of destruction with the implosion of ancient Syrian cultures having a similar dynamic to previous gael destruction.

  14. Since my original point got derailed, I decided I'll make an extension here:

    1) It is often not politically possible to maintain a sensible fiscal/trade/currency posture, at least without the aid of a friendly hegemon, and countries generally don't. The basic reason why is that most such poor countries simply do not have the human resources necessary to fill out the bureaucratic muscle necessary to do any redistribution on political imperatives efficiently. If one is a reader on urban politics or state/province politics, like, say, the Strong Towns blog, one can easily understand how difficult it is to maintain expenditure or design infrastructure appropriately--in the face of local political imperatives. More than that, if you read regularly about state politics, say Kansas or New Jersey politics, you can get a feel for how strong that imperative to loot the taxpayer base is, even to utter insanity. These politics tend to do what they have to do, say what they have to say, to pretend that productive bureaucratic infrastructure like teachers and road repair guys aren't worthy. That pension plans should not be honored, or that the idea of adequately funding IT programs to keep the electronic side of the government working is utter tomfoolery.

    That's why I think that talking about "mistakes" should always be handled with a level of political astuteness. There are reasons why Venezuela or Cuba tries to do the games it does, and not accounting for them ensures that bad policy will always follow, because there will be no political support for what economists think are "sensible". Ireland made no real "mistake", and nor did Spain, fiscally--although, I strongly suspect that the tight (prudent) fiscal policy did a LOT of preliminary damage, not that either supported particularly sensible initiatives (build lots of malls, housing far from jobs, and unneeded airports for the win!). Tight fiscal policies diminish human talents, allow insider business entities to starve entrepreneurs, and silently lay infrastructure bottlenecks. They make austerity policies at the downcycle procyclic as people can't be rotated into more efficient or more profitable activities for lack of all the things that should have been done during good times. This is all really big, such that overly simplistic rhetoric only favors conservatives, no matter how much you don't favor idiot initiatives.

    2) About China, my feeling was, and I really should have said this more clearly, is that I think that there is a crisis pending with a dollar shortage with all of China's trade partners, and that this undermines any sense of comfort regarding China's control over its currency--the RMB becomes more of a proxy for getting US issue than for Chinese trade needs.

  15. Hello,
    BTO seems to be advocating a wholesale withdrawal from the world monetary / trade system for Venezuela. This is simply not an option for the country. I am deeply curious how he (or she) believes the Venezuelan people will obtain luxuries such as toilet paper, since there is no domestic production? The domestic economy was completely destroyed by the Chavistas, so they have no means of feeding their people other than imports.


  16. Alex,

    You seem to be stuck in "current account crisis" false paradigm.

    "... I am deeply curious how he (or she) believes the Venezuelan people will obtain luxuries such as toilet paper, since there is no domestic production..."

    They will pay toilet paper producers with their own currency. If producer X won't accept it than producer Y will or no deal. With all this oil Venezuela has there is plenty of demand for their currency.

    Let's play a little thought experiment:

    What if the whole world disappeared tomorrow and only Venezuela was left? Would they kill themselves , or worse eg.stop wiping their bottoms ? :)

    World monetary system will not allow Venezuela to "withdraw" , to much money to be made there.

    By the way I introduced myslef to Frances in my previous comments. My name is Mariusz and this is a boy's name. Keep attention and you won't have to waste your brain energy asking unnecessary questions.



  17. Hello Mariusz.

    I am Venezuelan. I live in Venezuela.

    I have the answer to your thought experiment. If the world disappeared tomorrow we would have to wipe out bottoms with plaintain leaves or just keep a a pot with water nearby. The last remaining paper manufacturer called PAVENCA shut down a few months ago. Right now we are running on govenrment imports.

    Oh and if I could help it, I would not want a single Bolivart (our currency) for any service or product I sell. I hate the Bolivar. I don't trust this regime. No one does. Every time you go to market you can afford less and less. Plus the bolivar can't buy the books for university, or the laptop I require for my work, or (dare I wish to live with at least one of the comforts you dismiss) a pair of Nike's. Those things aren't produced here. I buy dollars in the black market as a means of safeguarding my income. If I want food I sell back and go to make. If I want anything else I buy it online and then retrieve it once a year when I travel to the US. Those trips are becoming increaaingly difficult because the airlines have also shut down, seeing as to how they cannot repatriate their income from operations in Venezuela.

    Economists and theorizers dig themselves in so many levels of abstraction that they forget that money can only have value if it can buy you stuff that you want, and that stuff has to get produced and taken to market. When you speak of an economy without industrialization, then it's just people moving paper around.

    Venezuelan laborers have become lazy. The brain drain has left us with no professionals. Investors have closed shop or are unwilling to enterprise because they fear one of three things: that the government could seize their property as a "strategic resource of the nation"; that price control and wage increase regulations will eat up their investment; that the need to import or repatriate will make them dependent on a government that has the sole control over foreign currency and does not like to pay its debts, so that you give them all your bolivares and have to wait for years before you get a single dollar... If ever.

    Don't you see Mariusz? We aren't a victim of the IMF of the international banking consortiums, or the US or the dollar. We, the people, are the victims of our government. We are the victims of regimes that manipulate the ignorance of the great mayority of us and promise to give us everything for free, but end up stealing and back dealing their way into lavishness at the expense of our lives.

    BTW I publish anonymously because I fear being identified by someone in the government and loosing my livelihood for saying bad things about them. They own nearly everything and pursue dissenters ruthlessly.

    I want to.live a human life. I'm tired of mere subsistence. And my brothers, the Venezuelans who live in the slums, they aren't tired. They don't know of a better life. They don't expect proper clothing or food. They don't want a better car or a asfer home. They have been taught to conform, to wait and to keep quiet. They celebrate when they find toilet paper. They celebrate when there is running water. They are happy to find flour, even if they have to wait in line for 12 hours. They are scared though and they are dying in roves to violence and starvation.

    I live in a quaint little appartment with my parents. I cannot afford one of my own and rent is 10 times my income. I have an engineering degree and life is hell. Last year I was mugged three times. I've been held hostage and hit with the butt of a gun. I can't afford marriage or children and I am afraid to go out at night. And I'm angry. If you want culprits dear Mariusz, then I offer the irresponsible bottom dwellers who sell the world on stupid pipe dreams instead of simply acknowledging that people should work. Conveniently they are the same ones who steal everything from those they claim to defend.


  18. J,

    I had no idea that things are that dire in your country. Sounds a bit like Poland in the 80s besides crime. I have never been mugged in my life and do not personally know anyone who was and I live in Warsaw.

    Again, your arguments only support my claim. Venezuela's problems come from corruption, cronyism, lending to insiders, foreign debt etc. I agree that at this stage of social decay things seem impossible to turn around. Corrupt oligarchies/vested interest leaching on your national wealth took the nation hostage and won't budge.

    Honoring ODIOUS foreign obligations will only lead to further inflationary spiral.

    I'm afraid that our discussion is really about culture not economics.


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