South America

The great currency swindle

Francisco Toro on how Venezuela’s elite cashed in on the oil crisis

Venezuelans dump virtually worthless 100 bolivar bank notes

For Venezuela, 2017 has been a year of political and economic chaos. From April to July, the country witnessed four months of daily street demonstrations, often violent, as thousands of people turned out to protest against a government widely loathed for its toxic combination of economic incompetence and increasing authoritarianism.

As riot police met peaceful protesters with tear gas and water cannon, jailing more than a thousand dissidents and setting the stage for dictatorial rule, commentators soon settled on a consensus explanation.

The narrative goes something like this: under the charismatic Hugo Chávez, who ran the country from his first election in 1999 until his death from cancer in early 2013, Venezuela had achieved real social progress, with poverty and inequality falling sharply. This was achieved on the back of record oil revenues, and when the oil price collapsed, the strategy’s shortcomings were brutally exposed.

This account is simple, tidy and wrong.

The problem is not just the way it places the responsibility on international energy markets, outside the government’s sphere of responsibility. The real problem is that the chronology doesn’t work.

To grasp why, you would have done well to spend the afternoon of June 11, 2014, at Claridge’s Hotel. Its Mayfair splendour made an incongruous backdrop to a major policy announcement for a South American leftist revolutionary regime.

On that day, some 50 institutional investors brought together by Lazard Asset Management filed into a Claridge’s meeting hall to hear Rafael Ramírez, Venezuela’s vice-president for economic affairs, make a speech.

Ramírez was no junior minister. As well as leading the cabinet’s economics team, he moonlighted as the chief executive of Venezuela’s state-owned oil company PDVSA and as oil minister.

In his speech, the Chávez protégé signalled that he was ready to accept the economists’ consensus: Venezuela’s macroeconomy was dangerously off-kilter, and major reforms were needed to bring it to something resembling balance. Brent crude was trading at $110 a barrel that day.

The diagnosis was straightforward: following a decade-long consumption boom that had turned him into a folk hero, Chávez’s regime was spending too much.

Spiralling fiscal deficits had led to a rapid expansion in the money supply, leading to quickly accelerating inflation. By June 2014, inflation had topped 5.7 per month for two months running. Over a year, that would be more than 100 per cent. Meanwhile, strict price controls lagged behind this inflationary dynamic, leading to mounting shortages of food and medicine.

One result was a poisonous foreign exchange system. Even as prices doubled year-on-year, the official dollar exchange rate remained pegged at an increasingly unrealistic 6.30 bolivars to the dollar for more than a year.

At that price the state could not supply all the dollars people needed for imports and investment and a flourishing black market sprang up to fill the gap.

The day Chávez died, on March 5, 2013, the black market exchange rate was already at 21 bolivars to the dollar − three times the official rate. By the time Ramírez delivered his London speech only 15 month later the black market rate had rocketed to an alarming level of 71 bolivars to the dollar: an untenable 11 times the official rate.

Proposing to reduce this differential hardly made Ramírez a visionary. To anyone with a passing acquaintance with macroeconomics, what needed to be done was obvious. The overvalued official rate made Venezuelan producers uncompetitive, leaving the country to depend on imports. At the same time, prices were increasingly decoupled from the official exchange rate, and had started tracking the street rate instead. Unless some semblance of fiscal and monetary order was restored, inflation and disinvestment would get out of hand, which would have dire social and political implications.

Indeed, for most of 2013, the chatter among Venezuelan economists wasn’t whether fiscal adjustment would come, but when.

The assumption was that it would come earlier rather than later: in a snap poll called only 30 days after Chávez’s death, his chosen successor Nicolás Maduro had narrowly been elected. He now had a six-year term to serve out, and political logic suggested he would prefer to absorb the short-term pain of adjustment earlier in his term rather than later, when he would face re-election.

In financial circles, news of Ramírez’s speech reassured bond markets. For all its radical, Marxist rhetoric, the Venezuelan regime had never missed a bond payment. Ramírez’s speech reassured them that this wasn’t about to change. But then, the strangest thing happened: the reforms were not introduced. Ramírez flew back to Caracas, and nothing.

As investors waited for implementation details to emerge, Ramírez’s clammed up. Days stretched into weeks, weeks into months.

President Maduro never specifically disavowed Ramírez’s speech, but neither did he embrace it. As nervous bondholders waited, speculation mounted of a serious schism at the top of the Venezuelan regime.

Then, on Boxing Day 2014, Maduro relieved Ramírez of all cabinet duties and appointed him as Venezuela’s ambassador to the United Nations. Ramírez was out and there would be no reform. By now Brent prices had collapsed to $55 a barrel.

How could a set of reforms that economists of all stripes agreed on fail like this? Who or what stopped it, and why? Those are the questions that need answering if Venezuela’s fearsome social crisis of 2016-2017 is to be explained.

The London speech had centered on narrowing the gap between Venezuela’s official and unofficial currency values. Even with oil at $110 a barrel, Venezuela didn’t take in enough dollars to sell them at the overvalued official rate.

To ration them, the government had created a byzantine regime of foreign currency controls. You needed a series of official authorizations to get the Central Bank to sell you cut-rate dollars. As the gap between the official rate and the street rate widened, it became obvious that only regime cronies were able to get these authorizations.

To regime-connected figures, arbitraging between the exchange rates became an obsession. The spread between them meant that you could take 6.30 bolivars, use them to buy one official-rate dollar, turn around and sell that dollar on the black market for 71 bolivars, use those 71 bolivars to buy $11.27 at the official rate, then sell those $11.27 cents for 800 bolivars on the other market, which would turn into $127 on the other market … and so on.

Fortunes were made overnight through this arbitrage trade. Relatively junior officials suddenly found themselves piloting yachts, while second-tier businessmen were riding around in private jets thanks to their regime connections.

Exchange controls impoverished the country as a whole, but they were also the lynchpin of a predatory elite’s strategy for looting the country’s oil revenues.

The winners from this system were few, but by definition they were well-connected and ideally placed to veto any policy proposal that threatened their interests. I like to think of these people − in the military, in the state oil company, in the upper reaches of the bureaucracy − as the Arbitrageur Kleptolobby, the people whose interests Ramírez was threatening that distant afternoon in London.

Back in 2014, Venezuelan economists assumed reform would come early simply because the political costs of failing to reform would be so exorbitant.

Fast forward to 2017. The official dollar exchange rate was allowed to slip, cautiously, in February 2016 from 6.30 bolivars to the dollar to 10. The black market exchange rate, for its part, exploded from 71 to the dollar in June 2014 to 23,786 bolivars at the time of writing. The 10-to-1 arbitrage margin that horrified economists back then has turned into a 2,379-to-1 margin now.

It is huge distortions like these − and not anything that happened to the price of oil − that have seen Venezuela slide into the social and economic crisis it is now in. The real story of Venezuela’s collapse is the story of its Arbitrage Kleptolobby, because the exchange-rate-aided looting of the Venezuelan state continues unabated.

The days of 100 per cent annual inflation look like the good old days now: the country may be on track for 2,000 per cent inflation this year; it is hard to say for sure, as official figures are no longer published. The country’s GDP and living standards are in free fall: 93 per cent of Venezuelans say that they can’t afford to buy food to meet their family needs, and three out of four say they are actually losing weight because they cannot afford enough food. Infant mortality rates are back to 1950s levels and the precarious social gains of the Chávez-era oil boom are a distant memory.

The collapse of the oil market hit all petro-states hard but it set off a social and political cataclysm in only one of them. Elsewhere − from Norway to Ecuador, from Canada to Iran − pragmatic reforms turned the 2014 blow into a temporary setback economies could bounce back from.

But Venezuela’s economy was already dangerously off-kilter before the oil shock, and the government knew it. Venezuela’s problems were already well understood long before the oil crisis, and not just in academic circles: the country’s top economic policy-maker saw it all clearly, and tried to do something about it.

What Ramírez grasped only too late was that in Venezuela policy-making had been taken over by a kleptolobby determined to protect its rents come what may.

He paid for his tardiness with his job. Millions of other Venezuelans have paid for it with their livelihoods, their dignity, their freedom and even their lives.