UNITED STATES (VOP TODAY NEWS) — The diagnosis of the economic problems of Venezuela and the financial recipe for solving them are suggested by Sergey Blinov, head of the macroeconomic research group of KAMAZ PJSC.
Immediately, I’ll make a reservation, it’s not about saving the regime in Venezuela, but about how to quickly and effectively solve the economic problems of Venezuela. In the end, ordinary people suffer from these problems. For Russians, the sad Venezuelan story is interesting also because it is very close in its economic story to the Russian history of the early 1990s, above all – to the memorable 1992 year.
It has become commonplace to believe that the main economic problem of present-day Venezuela is hyperinflation. According to the IMF, in 2018 it was measured in Venezuela by millions of percent. But, having considered the situation more attentively, we will see that inflation is only part of a more general problem: the problem of reducing the amount of money in the Venezuelan economy. It sounds paradoxical, considering that the number of zeros on banknotes, and the number of banknotes themselves is rapidly growing there. The network is replete with photos with signatures like “chicken for 14 million bolivars.” However, as will be shown later, the main problem of Venezuela is the rapid reduction in the amount of real money in the economy. And it is precisely this problem that the Venezuelan authorities must (and can) urgently solve.
What is bad fight with inflation
Traditionally offered and often imposed by external creditors (for example, the same IMF) attempts to “overcome” hyperinflation by “clamping down” money supply will only lead to a deterioration of the economic situation of Venezuelan citizens and the complete collapse of its economy. After all, the fight against inflation often leads to a deterioration in the socio-economic situation of people, but unfortunately, to the desired economic growth, no. There are numerous examples confirming that inflation is not a problem for economic growth.
The high price of fighting inflation
Minus one: high social price. Classical (in particular, recommended in such cases by the International Monetary Fund) ways of dealing with inflation suggest extremely serious consequences for the economy and population. They include clamping down on money supply, reducing the budget deficit, and, accordingly, social programs, which dramatically worsens the situation of citizens. Enterprises also suffer, which leads to an increase in overt or covert unemployment. Just look at the consequences of just this way of dealing with inflation in Russia from 1992 to 1996: a complete disaster in the economy and the social sphere.
Fighting inflation does not lead to economic growth
Minus two: the result is not guaranteed. The Russian example of 1992-1996 is clear evidence that measures to combat inflation do not lead to economic growth. To combat inflation in these years, strict rationing (quantitative restriction) of the loan, delayed payments from the budget, reduction of the budget deficit and other measures were used (Polterovich, 1996). As a result, over these five years, Russia’s GDP decreased by 37%, in some years, the fall in GDP exceeded 10% (in 1992 -14%; in 1994 -12%).
And post-Soviet Russia is not an isolated case. In the economic literature it is noted that the fight against inflation is almost always accompanied by crises in the economy: “The fact that anti-inflationary efforts, as a rule, lead to a recession, is generally accepted. That is why the governments are trying to carefully dose these efforts and make the stabilization period as short as possible, ”concluded Academician Viktor Polterovich.
High and even hyperinflation does not hinder economic growth.
However, in the economic history of many countries we can find episodes when high (hundreds and even thousands of percent a year) inflation not only does not lead to economic recession, but even allows the economy to grow. Here are some examples taken from the article by V.Polterovich (1996):
Weimar Germany. Hyperinflation 1920-1924 In 1922, with prices rising by more than 42 times, production increased by 11.7%. The decline (relatively small, by 11%) occurred in 1923, when France occupied the Ruhr and prices for the year increased 860 million times. But already in 1924, production began to grow again, despite the fact that from June 1923 to June 1924 prices increased 60 million times.
Argentina. In 1983, the inflation rate was 344%, GDP growth was 2.8%, in 1984, 627% and 2.6%.
Peru. GDP growth by 2.6% occurred in 1991, with inflation of 410%. There are other examples, they are given in the article “Inflation and economic growth.”
Brazil.In the late 1980s and early 1990s, in some years, prices increased by 20-30 times. From 1985 to 1994, the most “benign” in terms of inflation was 1986, when prices rose “only” 2.5 times (by 147%). But a noticeable drop in GDP in Brazil in 1985-1994 was observed only once: in 1990, but even this year was relatively small (-3.1%). Moreover, with this rampant inflation in some years, GDP growth exceeded 8% (1985, 1986).
Vietnam. Against the background of high inflation (in 1988 it was more than 400%), in 1989, during the “shock therapy”, instead of the traditional for “shock therapy” fall in Vietnam there was a growth of GDP by 7.4%.
Russia. After the “default” and the devaluation of 1998, inflation rose sharply. As of January 1, 1999, the annual price increase was 86%, and by April of the same year it exceeded 120%. Despite this, in 1999, GDP growth was 6.4% (an unprecedented rate since the late 1980s). And then followed the growth of GDP in 2000 – 10% (higher than in China).
Brief summary: fighting inflation is a false goal.
In other words, the price (social and economic) of anti-inflationary measures is very high, and the growth of the economy as a result of these measures is not guaranteed. Conversely, numerous examples confirm that economic growth is quite possible with high and even ultra-high inflation. Therefore, to recognize the main problem of the Venezuelan economy is hyperinflation and throw all the forces at its suppression – a false diagnosis and a false course of action.
As we shall see, the main harm of such a diagnosis is that as a tool to fight inflation, a reduction in the money supply is used. A seemingly logical chain of reasoning is false:
• the main problem is hyperinflation, a fall in the value of money,
• the value of money falls because there are too many of them,
• it means that you need to reduce the amount of money.
To reason like this is to fall into a trap leading to the collapse of the economy. And, alas, a huge number of countries fell into this trap.
The correct recipe: defeat hyperinflation so that the amount of real money grows in the economic turnover
Why are the economies of some countries growing in the midst of rampant inflation, while other countries, struggling with inflation, are suffering from an economic recession? The answer from the elementary truths of the economy: the amount of goods that can be bought for a certain amount of money depends on the size of this amount and on the price of the goods.
We write this ratio in the form of the formula (1) Q = M / P, where Q is the number of product units that the buyer can buy (or, which is the same, the seller can sell to this buyer); M – the amount of money from the buyer; P – unit price. (Connoisseurs probably recognized in this formula the well-known Fisher exchange equation in a simplified form, for a single transaction. Simplification does not affect further conclusions).
Imagine that a student has 40 rubles for the purchase of notebooks. With a price of 2 rubles per notebook, he will be able to buy 20 notebooks. But, if prices rise (important for our further reasoning!), Say, up to 4 rubles, he will be able to buy only 10 notebooks for the same amount.
Now imagine that the formula describes the economy of an entire country. Q is the quantity of all goods that the inhabitants of this country can buy with the money M they have, and P is the price level for these goods. What happens with the growth of P, that is, prices? If the amount of money M does not change, then the people of the country buy less goods. Accordingly, manufacturers produce less of these goods (or fly into the pipe with excessive inventories). And this means a fall in production or, in another way, a fall in GDP.
Let’s look at the formula (1). What should happen so that sales of goods (and therefore their production) continuously grow and not decrease? The answer is obvious: the amount of money must grow faster than prices rise. And that’s it! Brazil, Vietnam and other countries in the examples above used this “magic” formula, managing to grow with high inflation.
But Russia used the same formula in the decade of rapid economic growth in 1999–2008. And the countries in which they tried to fight inflation by reducing the amount of money went the wrong way, wittingly or unwittingly reducing the demand for goods (and therefore their production), thereby plunging their own economies into crisis.
Both approaches — correct and erroneous — are shown in diagram 1.
Scheme 1. The biggest mistake – the fight against price increases by the contraction of the money supply. The fraction M / R in our formula reflects nothing more than the real money supply, or the money supply in real terms.
Increasing the amount of money
Increasing the amount of money is the first of two correct actions in hyperinflation. And it can be effective even if prices continue to rise. The secret of economic growth with high inflation in Weimar’s economy after World War I, Brazil in the 1980s, Vietnam after price liberalization, and Russia in 1999 is simple. In all these cases, despite the rise in prices (P), the amount of money (M) grew even faster! Simply put – the money supply in these examples grew in real terms.
For example, in Vietnam in 1989, the money supply M2 increased by 213% in real terms (more than 5 times in nominal terms). It was this super-soft monetary policy that allowed the country to grow by 7% per year in conditions of high inflation and “shock therapy”.
The same method of accelerating the growth of the money supply after inflationary or devaluation shocks was successfully and repeatedly used in our neighboring Belarus. That is why in the previous two decades, the economy of this country grew faster than other CIS countries, despite the sometimes high inflation and the periodic devaluation of the Belarusian ruble.
What is happening in Venezuela now? Judging by the publicly available information, the authorities of the country are intensively increasing the money supply, apparently instinctively realizing that they try to stop this process – the collapse is inevitable. When the number of zeros on the bills became off scale, the president of Venezuela, Nicolas Maduro, announced a decisive denomination, having immediately gotten rid of five zeros on the bills in August 2018. Are the Venezuelan authorities doing the right thing by increasing the money supply? Yes, right. Do they have time to increase the amount of money faster than rising prices? And here there are doubts. According to tradingeconomics, prices in Venezuela in 2018 increased by 1.7 million per cent or 17,000 times. Have the authorities been able to “print” money at the same or faster pace? I doubt it. In any case, to get out of the hyperinflationary spiral,
Stabilizing prices is important not only to maintain aggregate demand within the country. High inflation leads to such a paradoxical effect as the real strengthening of the local currency with its nominal weakening! This makes it extremely uncompetitive and therefore unprofitable production within the country. That is why in Russia in the 1990s, even oil production began to balance on the verge of profitability and therefore did not grow.
But to stabilize prices by reducing the amount of money (or even by slowing down the pace of increasing their quantity) is a sure way to collapse. What can the Venezuelan authorities do to stabilize the rise in prices?
What they can really do quickly is to return local currency to attractiveness in the eyes of the public. After all, the main flaw in the Venezuelan currency (as well as any currency during the hyperinflation period) is the inability to use it for savings. Just imagine a person who kept his savings in bolivars for a whole year. These savings, if you believe the available data on inflation, would have depreciated 178 times over 2018! It is not surprising that Venezuelans, in the best Soviet traditions, sweep away any goods from the shelves of the stores.
To solve this problem, the Venezuelan authorities need to fulfill two prerequisites:
1. Provide a free Bolivar rate to the US dollar or any other stable currency (for example, Euro). This free course of power of Venezuela must themselves actually recognize.
2. Provide official and accurate data on inflation.
In other words, anyone should be able to find out the dollar rate daily and weekly and / or monthly from the newspapers or the Internet — official inflation data. If these two conditions are met, then the authorities will be able to resort to issuing special savings instruments — government bonds — that are protected from depreciation. I would suggest at the first stage to get by with only two types of bonds.
The first bond should be an analogue of the dollar, interest-free, with several different maturities (six months, a year, two, three years). Buy such a bond for the bolivars should be able to anyone. And it should also be repaid by bolivars, but already at the dollar rate at the time of redemption. If the dollar rate rises, then the bond holder will not lose anything – he will receive as many bolivars as the dollar will cost at the time of redemption.
Figuratively speaking, the value of the bond will be “indexed” in accordance with the change in the dollar exchange rate. The second bond is also a protective tool, but already against inflation (a close analogue of American inflation protected – TIPS-protected inflationary securities). The cost of this – also interest-free – bonds should be indexed in accordance with the rising prices. For example, if the prices for the year increased by 27 thousand times, then the person who bought such a bond with redemption in a year at the beginning of the year will receive at the end of the year an amount of 27 thousand times greater than he spent on the purchase. In fact, the sale of such a bond to a person will be equivalent to the promise of such a percentage of the deposit, which will fully compensate for the increase in prices.
An important point: both types of bonds should be freely circulated, that is, their owners should be able to sell them at market prices. And the authorities of Venezuela, in order to avoid the depreciation of their government bonds, should be able to conduct a kind of monetary intervention in the purchase of these bonds.
Central Bank Rates
With very high inflation, one of the problems of stabilization is negative real interest rates. For example, this was the case in Russia in 1992-1995. Given that nominally the rates were very high, more than 200% per annum, they were actually negative (sometimes below minus 80%) due to high inflation (chart 1).
Chart 1. Negative rates of the central bank – one of the reasons for high inflation The
Central Bank of Venezuela should raise the refinancing rate, gradually bringing it to the area of positive real rates.
There are still some nuances that the Venezuelan authorities need to take into account as they stabilize financially. I will cite just one of them: if we stabilize the financial system according to the scheme proposed above, the tendency of the bolivar to strengthen in relation to foreign currencies, the same dollar and euro, will soon and manifest itself sharply. And it will be a blunder to make this fortification. But the very trend of strengthening the local currency of the Central Bank of Venezuela can and should be used to sharply increase the real money supply in the country and, accordingly, stimulate economic growth. As for the deadlines, when implementing the above conditions and measures, price stabilization will occur in a matter of two or three months.
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