Venezuela is not the first developed country to put itself on track to fall into a catastrophic economic crisis. But it is in the relatively unusual situation of having done so while in possession of enormous oil assets. There aren’t many precedents to help understand how this could have happened and what is likely to happen next.
There is, however, at least one — the Soviet Union’s similar devastation in the late 1980s. Its fate may be instructive for Venezuela — which is not to suggest Venezuelans, least of all the regime of Nicolás Maduro, will like what it portends.
Venezuela has been ailing ever since the decline in oil prices that started in June 2014, and there is no reason to think this trend will shift anytime soon. Energy prices move in long quarter-century circles of one decade of high prices and one decade of low prices, so another decade of low prices is likely. Similarly, the biggest economic blow to the Soviet Union was the fall in oil prices that started in 1981 and got worse from there.
But the deeper problem for the Soviet Union wasn’t the oil price collapse; it’s what came before. In his book Collapse of an Empire, Russia’s great post-Soviet reformer Yegor Gaidar pointed out that during the long preceding oil boom, Soviet policymakers thought that they could walk on water and that the usual laws of economic gravity did not apply to them. Soviet policymakers didn’t bother developing a theory to make sense of their spending. They didn’t even bother paying attention to their results. The math seemed to work out, so they just assumed there was a good reason.
This is as true of the current Venezuelan leaders as it was of the Soviet leaders. The Venezuelan government, though it doesn’t claim to be full-fledged in its devotion to Marxism-Leninism, has been pursuing as absurd an economic policy mix as its Soviet predecessor. It has insisted for years on maintaining drastic price controls on a wide range of basic goods, including food staples such as meat and bread, for which it pays enormous subsidies. Nonetheless the Venezuelan government, like the Soviet Union’s, has always felt it could afford these subsidies because of its oil revenues.
But as the oil price has fallen by slightly more than half since mid-2014, oil incomes have fallen accordingly. And rather than increase oil production, the Venezuelan government has been forced to watch it decline because of its mismanagement of the dominant state-owned oil company, PDVSA.
And now Venezuela seems intent on repeating the Soviet folly of the late 1980s by refusing to change course. This is allowing the budget deficit to swell and putting the country on track toward ultimate devastation.
The Soviet Union in its latter years had a skyrocketing budget deficit, too. In 1986 it exceeded 6 percent of GDP, and by 1991 it reached an extraordinary one-third of GDP. Venezuela is now following suit. The Soviet Union used its currency reserves to pay for imports, but when those reserves shrank, the government financed the budget deficit by printing money. The inevitable result was skyrocketing inflation.
It seems as if President Nicolás Maduro has adopted this tried-and-failed combination of fiscal and monetary policy. Venezuela already is dealing with massive shortages as a result of its controlled prices, because the government can no longer afford its own subsidies. But it will get worse from here.
Maduro seems intent on printing money like crazy, so the next step will be hyperinflation. Inflation is already believed to have reached 700 percent a year, and it is heading toward official hyperinflation, that is, an inflation rate of at least 50 percent a month.
Hyperinflation is as frightful as it is rare. According to Johns Hopkins University professor Steve Hanke, the world has experienced only 56 hyperinflations, and half of them occurred when communism collapsed. (All of the Soviet Union’s 15 union republics suffered it during the country’s disintegration.) Hyperinflation is profoundly demoralizing. Suddenly, it makes no sense to work any longer. Instead of standing in queues to buy food with the money they’ve earned, people stop working entirely, because they cannot spend the money they would have earned. Smart profiteers indulge in speculation, buying safe assets such as commodities or real estate.
As a result, output plummets and enters a downward spiral until financial stability is restored. In 1991, Soviet production probably fell by 10 percent, and oil production plunged by half from 1988 to 1995. Something similar seems to be going on in Venezuela.
The Soviet Union had insisted on an unrealistically high official exchange rate of the ruble, usually five times higher than the black market exchange rate. The government did so to make people feel richer than they really were, but this meant that the government subsidized purchases of foreign currency just as it subsidized purchases of food. As the Soviet government spent more money, allowing the budget deficit to balloon, the black market exchange rate plummeted, humiliating its citizens. Gradually, people accepted the black market exchange rate as the real rate. When the Soviet Union fell apart in December 1991, the average Russian monthly salary was a miserable $6. This is where Venezuela is heading.
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