A few days ago, Venezuelan president Hugo Chavez devalued the bolivar. This comes as no surprise. As I wrote in this space in November,

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…

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…

This weekend, Chavez devalued the bolivar right on cue, sending the people of Venezuela scrambling to buy goods which will spike in price once the measures take effect. The country actually has two exchange rates now – one of 4.3 bolivars/dollar, close to current black market rates, and the other subsidized at 2.6/dollar. The second rate applies to a few classes of goods deemed necessary for the country, including heavy industrial equipment, food and medicine, reported Reuters.

As usual, this will create privileged class of well-connected cronies who snag contracts to buy at 2.6 and sell at 4.3. This has been a recurring problem with the current CADIVI (the government office which controls foreign exchange policy in Venezuela) regime, and it remains a serious criticism of Venezuela’s tightly managed currency regime. Dual exchange rates have a long and ignominious history in Latin America, from Mexico to Argentina. Indeed, Venezuela used to have a body called RECADI in the 1990′s, which established preferential exchange rates to strengthen certain sectors of the economy. As the black market adjusts to the new system and people strive to take advantage of the difference in rates, Chavez will find that the dual rate is not a sustainable system.

The move will benefit certain politically and economically vital industries, said several Venezuelan officials. State oil company PDVSA will get relief from stagnant oil prices, as each barrel of oil sold in dollars yields more local currency with which to pay many of its outstanding debts. Export industries like coffee will find their competitiveness increasing as Venezuelan exports become cheaper.

Chavez’s popularity may take a hit as prices rise. Indeed, the president has threatened to deploy the army in order to shut down and seize the stocks of speculators seeking to take advantage of price differences and shortages, according to the Financial Times. “Go ahead and speculate if you want, but we will take your business away and give it to the workers, to the people,” the British financial paper quoted him as saying.

At this time last year, Chavez did not even acknowledge the existence of a parallel market in the bolivar. For him to now create a dual-rate exchange scheme set near the level of that same black market deals a serious blow to the regime’s credibility and confidence.

Control of his planned economy is slipping through Chavez’s fingers. Eventually, he may realize that trying to strangle private enterprise and market forces will simply delay the inevitable. Hopefully, that realization comes before the country suffers too much more, as Venezuela faces a long and painful road back to economic health no matter what it does.

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.

Venezuelan Coffee Industry Suffering – Financial Times 

“But analysts say many of the problems confronting coffee production – and the private sector in general – are caused by precisely this kind of government intervention. Such expropriations, as well as an aggressive land reform campaign, have generated a climate of uncertainty that has damped investment.

Price controls have made matters worse. Increasing amounts of coffee – and many other goods – are smuggled abroad to be sold at international prices. “Of course there’s contraband. What does Chávez expect when you can sell coffee in Colombia for double or triple the price?” said one coffee producer, who requested anonymity.” (Financial Times)

Venezuela used to export coffee all over the world, and there was a time when they were on par with Colombia. Now, it’s actually importing coffee from Brasil! In fact, domestic farms barely manage to produce half of the nation’s domestic consumption.

“Food imports have quadrupled in the past 10 years, from about $60 to more than $250 per person per year, says Hiram Gaviria, former agriculture minister. Imports cover about two thirds of food consumption in a country that boasts vast areas of unused, fertile land.

While production of some foodstuffs such as maize and rice has increased in this period, the production of beef and sugar, in which Venezuela used to be self-sufficient, is today barely half national consumption.” (Financial Times)

The market is there, globally – but it’s been badly distorted. In trying to fix domestic coffee production, the Venezuelan leader has exacerbated the very problem he set out to cure. Shame on Mr. Chavez.

http://www.reuters.com/article/usDollarRpt/idUSN3139619020090831

Consumers are likely to continue to spend entire paychecks and shun savings in a country where interest rates are kept below inflation to encourage consumption. “

‘Why save? It will be worthless in a few months. It’s better to just spend the money and enjoy yourself while you can,’ said Maria Elena Blanco.”

As Nicaragua, survivor of a brutal Cold War-era proxy-war, contends with the global downturn, we wonder which of two popular political fashions it is adopting. Is it following the populist-socialist route of Venezuela or the populist-capitalist route of Brazil?
 
Venezuelan President Hugo Chávez’s brand of crony-socialism, and populist anti-US rhethoric goes by the name of “Chavismo”. Chávez has squandered Venezuela’s oil wealth to get geopolitical influence. Venezuela’s economy has also suffered from the nationalization of important sectors, now run by Chávez’s toadies . Uncertainty has caused human and financial capital to flee and made Venezuela more reliant on volatile oil earnings. Inflation has soared and the bolivar has been devalued de-facto, if not de-jure. The IIF (Institute of International Finance), estimates that Brent crude prices below $70 per barrel during much of the next two years could put into doubt Venezuela’s servicing of its foreign debt. The miseries of Chavismo are not purely economic, it has intimidated political opponents and critics, some of which are in exile.
 
Brazil’s President Luiz Inácio Lula da Silva, widely known as “Lula”, has created his own political fashion. “Lulismo” entails populist posturing that rivals Chavismo’s in ridiculousness, if not in intensity, but is tempered by economic orthodoxy. Under Lulismo, Brazil has benefited from the recent commodity boom. It amassed foreign reserves of $200 billion while paying for Lula’s Bolsa Familia subsidy to poor families. The World Bank puts Bolsa Familia among the world’s best targeted poverty relief programs. Lulismo’s support of sound monetary policies, under Central Bank President Henrique Meirelles, has helped create the opposite of Chavismo’s capital flight; Brazil battles an influx of foreign money seeking high interest rates and a currency appreciating against the dollar. While payment on Venezuela’s foreign obligations are threatened, Brazil has investment-grade bond ratings. Lulismo’s merits cannot overshadow its inanities that range from Lula’s racial theories (he blamed the Sub-prime Crisis on “white men with blue eyes”) to political corruption that reached into the President’s family. Unlike Chavismo, Lulismo has no economic or political refugees.
 
Daniel Ortega, former guerilla leader and President of Nicaragua, has nationalized no private asset in his second presidency.  Conflicts have arisen with international companies, but these have been resolved through negotiations. Ortega’s Nicaragua claims to be open to foreign investments. It is implementing an economic program agreed with the IMF. New incentives are in place to attract investments in tourism and energy. Labor arrangements that are more business-friendly are being negotiated to respond to the global downturn. However, inconvenient alliances with Chavez, Iran and even Russia, has investors worried and uncertain, particularly Nicaraguans. Furthermore, accusations of fraudulent municipal elections have led the US and European countries to cut off aid. In the opinion of a former government official, Ortega is not adopting the economic aspects of Chavismo, though he seems willing to borrow some of its political tactics. Ortega seeks to chart a course between Lulismo and Chavismo; a difficult task given the long-run incompatibility of political intimidation and economic freedom.