The Venezuela economy is in trouble, high inflation rates and shortages. Most commentators
are pointing to a currency crisis associated with government mismanagement but the
root cause appears to be an imbalance between wealth creation and wealth destruction;
over the years oil production has fallen but internal consumption has remained the
same. Traditional economists have laid the blame at Chavez's redistribution policies
but this is a problem that would have fallen on any government regardless of its
political hue. This difficulty is one that effect many resource rich economies that
of raised exchange rate resulting from the great wealth generated. This is a double
edged sword of higher living standards but a reduction in the competitiveness of
any industry not associated with the resources exploitation. Eventually any unrelated
industries will be squeezed out; in Venezuela's case oil has come to represent almost
50% of GDP and up to 95% of exports. This is all very well until production falls
and without any other indigenous industries to take up the slack real wealth creation
will also decline. As the oil wealth is exchanged for dollars which are used to by
imports this real wealth imbalance manifests itself as inflation and a dollar crisis.
However Venezuela's inflation problems are not all related to a wealth imbalance
they also relate to the interest rate. If one for one moment we ignore the last few
months and looks at the longer picture the familiar pattern of inflation rates mirroring
interest rates appears (see here and here and extend the time span to the maximum).
For traditional economist Venezuela's problems can be solved by cutting the subsidies
to the poor and invest it within the debt laden oil industry. The intention would
be to expand production but at best this is only postponing a longer term problem.
At worst it could lead to a much greater collapse in the domestic economy as the
real money supply is reduced. A more creative solution would be to use the investment
made in the poor's health and education to start indigenous industries for those
product where there are shortages. The fact that goods like dairy products have become
expensive suggests that a local industry could easily compete with imports. And just
to break the inflation pattern drop the interest rate; 6% may do it.