Venezuela's unpleasant monetarist arithmetic

Venezuela's unpleasant monetarist arithmetic

By Lars Christensen, CEO and founder, LC@mamoadvisory.com

It wasn’t that long ago that socialists all over the world were celebrating Venezuela as an economic success story. Now according to the IMF’s latest forecast is heading for 1 million percent and according to other assessments inflation might already be much higher than that. Steve Hanke estimates Venezuelan inflation to at 3 million percent. 

The semblance of success was supplied by dumb luck, in the form of a sharp and continuous rise in oil prices during the 2000’s. That created a windfall for Venezuela, which has the biggest proven oil reserves in the world.

By now it should be blatantly obvious to even the most diehard socialist that Venezuela’s “Bolivarian revolution” has been an economic and social disaster.

Since 2013, the country’s real gross domestic product has dropped nearly 20 percent. Inflation has spiked and could very well explode into hyperinflation if President Nicolas Maduro’s regime does not change course. The Venezuelan bolivar has plummeted and ordinary citizens are above all anxious to get their hands on some good old U.S. dollars.

‘Unpleasant arithmetic’

European fellow travelers have echoed President Maduro’s explanations for the economic disaster. “Greedy capitalists” are raising prices and stoking inflation, while the U.S. government is “sabotaging” the economy.

Any economics student, however, would not need to consider the Venezuelan collapse long to conclude that this is the famous case described by American economists Thomas Sargent and Neil Wallace in an oft-cited 1981 article, “Some Unpleasant Monetarist Arithmetic.”


Sargent and Wallace argue that even though inflation is fundamentally a monetary phenomenon, it can also be triggered by unsustainable public finances, which create expectations that the central bank will sooner or later be forced by the government to finance the budget deficit. These expectations by themselves will cause inflation to spike.

Of course, this is exactly what has happened in Venezuela. Even before oil prices started plunging, the country’s public finances were looking shaky after massive increases in government spending. As oil prices started to come down in mid-2014, it soon became evident that Venezuela’s fiscal condition was catastrophic.

Once Venezuela’s central bank began to print money to finance the deficit, it didn’t take a genius to predict a sharp rise in inflation.

Shoot the messenger

Instead of acknowledging the fundamental problem – wildly unsound public finances – the Venezuelan regime decided to blame the country’s misery on “evil speculators.” Consequently, it introduced draconian price controls.

As any first-year economics student would tell you, introducing price controls and forcing retailers to sell below what would have been the market rate will cause goods to disappear from the shops. And sure enough, the shelves are empty today in Caracas.

It all goes to show that not even socialists can defy gravity. Sooner or later, economic reality sets in. Venezuela’s epic collapse is yet more proof that socialism always ends in disaster.

 



WORLD LEADING ADVISORY SPECIALISING IN THIS TOPIC

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