Causes of Venezuela’s Hyper-Inflation

BGASC Metals
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Posted: Jun 07, 2016 12:01 AM
Causes of Venezuela’s Hyper-Inflation

Shopping in Venezuela: $150 for a dozen eggs, toilet paper, soap, beer, diaper, aspirin, car parts, milk, sugar, flour and other essential items are in short supply or unavailable.

Venezuela’s price inflation is and has been the highest in the world for three years. Price inflation was about 150% during the fiscal year ending September 2015. The cost of goods and service in Venezuela increased to nearly 500% in 2016 and is projected by the International Monetary Fund to increase to 1,600% next year.

Why is Venezuela Experiencing Massive Price Inflation?

Price inflation at the national level can occur from a variety of sources including central bank actions, (increases in the money supply or interest rate policies) government actions (higher taxes, excessive regulation, minimum wage laws, tariffs or mandates) or for economic reasons, that may or may not be caused by central bank or government actions (decline in the value of a nation’s currency vs. the currencies of its trading partners, shortages, or an increase or decrease in the price(s) of key commodities such as oil).

Venezuela currently has a potent mix of nearly all of the above factors.

Decline in the value of Venezuela’s currency vs. the currencies of its trading partners

The Venezuelan Bolivar Collapse

Venezuela has a government set two tier exchange rate system for its national currency, the Bolivar. The Bolivar has one exchange rate for what the government determines to be ‘essential goods’ and another for ‘non-essential’ goods. Essential imported goods (food, health, education) get a a better rate of Bolivares to the U.S. Dollar than non-essential goods. While no official statistics are kept, the black market (free market) values the Bolivar at near worthless, irrespective of where the Venezuelan government sets the Bolivar exchange rate.

The Venezuelan Bolivar is at its state of near worthlessness because the government is broke and has been talking about explicitly defaulting on its estimated $185 billion in external debt. Venezuela no longer has the option of just printing more Bolivares to pay off its debt as their currency is already near worthless. Defaulting might eliminate a source of financial stress, but would result in a further loss in confidence in the Bolivar and ensure that the Bolivar remains near worthless.

Venezuela’s foreign reserves which consist of U.S. Treasury Bonds and gold are valued at around $12 billion, down from about $42 billion in 2008. Since current government revenues, mostly derived from its oil exports are not sufficient to meet its debt obligations, Venezuela has been forced to sell most of its reserves, including its gold reserves.

The decline in the value of the Bolivar has made it prohibitively expensive or impossible for the government to pay for products, causing shortages and consumer prices to skyrocket.

Economic Reasons

World-wide economic conditions have exacerbated the state of Venezuela’s already deteriorating economy.

Lower Oil Prices

Rising oil prices are generally associated with price inflation. In Venezuela’s case, however, lower oil prices are causing price inflation. Venezuela is the fifth largest oil exporter and member of the Organization of the Petroleum Exporting Countries (OPEC). The bulk of the Venezuelan budget is derived from oil revenues. Lower oil prices over the past year have significantly reduced revenues associated with Venezuela’s oil exports. With lower oil prices, and lower revenues Venezuela has great difficulty servicing its foreign debt obligations, running its bureaucracy and paying for goods.

Shortages

Lack of ability to pay for imports with Bolivares and declining oil revenues has led to shortage of goods and government rationing of the limited amount of products available. Venezuelans have grown used to standing in long lines waiting for the opportunity to buy daily essentials. The black market has managed to provide some goods to Venezuelans but at an even higher price than the government set prices. Black market purchases are illegal and participating in the market provides the risk of government arrest or perhaps worse, kidnapping and robbery by market participants.

Ironically, Venezuela is so broke, that according to a Bloomberg report, the government is short of money to print money so a cash shortage is also developing.

Government Action

Government Intervention

Officious government meddling has made a bad situation worse. The desire of the Venezuelan government to control all aspects of economic life (under the ostensible guise of creating equality) doesn’t allow a private economy to develop in Venezuela that might be able to better provide goods and services to the people.

A Cautionary Tale

What is happening in Venezuela should serve as a cautionary tale regarding government action and its ability to cause price inflation. Gold acts as insurance against bad monetary and fiscal policies that operate to destroy a currency’s value. If the people of Venezuela held their savings in gold instead of the Bolivar their purchasing power would have been retained. Having purchasing power, however, isn’t worth much if, as is the case in Venezuela, there isn’t anything to buy.

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This article by BGASC is not, and should not be regarded as, investment advice or as a recommendation regarding any particular course of action.

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