As Hugo Chavez embarked on his latest whirlwind diplomatic tour in September, it appeared as if he did so with the express intention of rattling the United States. From Minsk to Moscow and Tehran to Tripoli, the unpredictable Chavez conducted what amounted to a grand tour of America’s rivals, antagonists and sworn enemies. The trip was more than a series of polite house calls – the President went on a shopping spree, buying $2.2 billion of Russian arms on generously extended Russian credit. But Chavez’s latest globetrotting belies close, mutually dependent economic ties between the U.S. and Venezuela that have proven more durable than either government wants.
Venezuela’s oil fields produce a heavy crude that can only be refined in certain, mostly American, refineries. Oil is now almost 95% percent of Venezuela’s exports, even though oil production has shrunk since the 1990s. The U.S. imports between 10 and 12% of its oil from Venezuela, but provides almost 50% of Venezuela’s foreign income. In short, our appetite for oil is the engine behind Chavez’s socialist revolution and his sweeping expansion of the welfare state and social infrastructure. Small wonder, then, that the stridently anti-American President is so eager to hedge his bets by forging ties with Russia, China, and pretty much anyone that will take his oil in exchange for weapons, doctors, food, or just cold, hard cash.
But Chavez’s economic dilemma is deeper than his dependence on selling oil to the U.S. He faces a trap of a more fundamental nature. The global financial crisis has sharply reduced demand for oil and with it the price, down about 50% from its peak. All of this puts severe pressure on Chavez’s ambitions for a socialist revolution throughout Latin America. Indeed, buffeted by the fall in oil prices and high inflation, there are signs that the Venezuelan economy, and with it Chavez himself, is almost certainly going to implode. He may be able to buy time with various measures to stabilize his currency (the bolivar), such as the sale of dollar-denominated bonds to those willing to risk the investment, but the long-term outlook for the economy is dim.
I have invested in the debt of risky developing world countries for more than three decades, but I would not risk investing in Venezuela today. I have always used several methods for measuring the health of emerging market economies. Some are simple observations about indicators like the state of basic infrastructure, or conversations with cabbies that give me a sense of whether things are looking up or down. But there were three main criteria that guided my decision whether to bet for or against the long-term fortunes of a nation’s economy.
First, is there a black market for dollars and how extensive is it? When people are eager to unload their own currency and pay well above official exchange rates for dollars, it’s not a good sign. Second, is financial and human capital fleeing the country? If people are sending their money overseas, or technically skilled and professional classes are moving abroad in significant numbers, that’s a vote of no confidence. Third, if the government is nationalizing key industries, it’s a safe bet foreign investment is going to dry up. In Venezuela all three key indicators are negative.
First, Venezuela has a huge black market in which dollars are being purchased for well over twice the official exchange rate set by the government. Inflation is the highest in Western hemisphere, officially around 30%, but likely higher. All this drives demand for a more stable currency such as the dollar. The recent issuance of dollar-denominated Venezuelan bonds, purchasable in bolivars, is intended to soak up the demand for dollars and allow the purchaser to obtain a rate somewhere between the official and the parallel market rate. The big question, of course, is whether Venezuela can make good on the promise; a bond, after all, is a promise to pay in the future. I have strong doubts. Venezuela’s foreign exchange reserves have sunk precipitously from $42 billion at the end of 2009 to $33.5 at the end of August 2009, so the likelihood of Venezuela’s long-term ability to meet its hard currency obligations is degrading. In addition, Chavez must sustain the popular, massive public subsidies that give him a broad base of working-class support.
In a series of surprising moves, Chavez’s regime has finally acknowledged the existence of a parallel market and taken several steps towards closing the gap between the official and black market exchange rates. Several billion dollars of government bonds have been issued, the state petroleum company PDVSA has also entered the debt market, and the government is committed to closing the gap. However, these are stop-gap measures; investors tempted by Venezuelan debt would do well to recall the president’s proclivity for nationalizing industries and brushing off capitalists.
Second, according to the Venezuelan Central Bank, $22 billion of private capital fled the country in 2008. It wasn’t just money taking flight; the number of Venezuelans in the United States increased from just over 90,000 about ten years ago to over 200,000 in 2008 and the numbers continue to grow. Many more have gone to other countries. Most of these émigrés are from the middle and upper classes.
Finally, as Chavez has nationalized major utilities including steel and cement factories, and has taken majority stakes in projects owned by major U.S. oil companies, those companies have pulled out of Venezuela. In the first half of 2007, foreign direct investment in Venezuela was negative $881 million.
One of the ironies of U.S.-Venezuelan relations mirrors that of our relations with many other Middle East oil suppliers. We are paying, literally at the gas pump, to fund undemocratic regimes whose interests are often hostile to our own. Clearly, our stubborn dependence on foreign oil is a huge self-inflicted wound. But, there is no need to fear Chavez. He has built a house of cards that will eventually fall.
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