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Blog Archive -February 2014

 

25th February 2014

Venezuela’s Troubles

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.  

 

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