A Café Con Leche? That will be 2,000,000 Bolivars, please.

According to Bloomberg’s Café Con Leche Index, the price of a cup of coffee in Venezuela is now more than 2,000,000 bolivars, up from 1,400,000 bolívars last week. We have not seen hyperinflation this bad since Germany in the 1920s, and it is only getting worse. The annual inflation rate in Venezuela sits at 1,000,000 percent. The economy shrank by 18 percent last year, and is now half of what it was in 2013. Since 2015, three million people have fled the country. What happened?

The majority of Venezuela’s national income and foreign currency reserve comes from the country’s oil reserves, which are the largest in the world. With petroleum making up the preponderance of economic production, government reserves are highly sensitive to world oil demand. When times are good, they’re good. In 2000, oil prices were on the rise, and late president Hugo Chavez held true to his promise to fund welfare programs targeted at reducing inequality. But, when times are bad, they’re bad. Both Hugo Chavez and his successor, Nicolás Maduro, failed tosave up for a rainy day.” When oil prices began to drop dramatically in 2014, the Venezuelan government had only a few long-term investments, either in foreign assets or in education and capital infrastructure, to fall back on.

The production of oil requires significant capital, but the government under Chavez failed to reinvest enough of their windfalls from good years into Petróleos de Venezuela, Venezuela’s state-owned oil company. Many experts in the petroleum industry left while Chavez was in power. “If you talk to experts who have long worked on and followed the oil sector in Venezuela, they will tell you there [had been] significant technical expertise in the past and those experts are just not there anymore,” says Garcia Tufro, Deputy Director of Adrienne Arsht Latin America Center of the Atlantic Council. Oil production has dropped from 3.5 million barrels during the presidency of Hugo Chavez to under one-third of that figure today.

When Maduro took power, Venezuela’s economy was already in trouble. Maduro chose to run fiscal deficits, instead of gutting the welfare programs that Chavez had put in place. When these fiscal deficits led to inflation, food shortages, and mass protests against Maduro’s government, Maduro responded with violence. The United States responded by imposing sanctions against Venezuela in 2014. In 2017, US President Donald Trump effectively locked Venezuela out of credit markets by increasing sanctions that restrict trade in Venezuelan bonds. In February, sweeping US sanctions were announced against Petróleos de Venezuela. US National Security Advisor John Bolton said that turning up the heat on these sanctions would “help prevent further diversion of Venezuela’s assets by Maduro, and will preserve these assets for the people of Venezuela where they belong.” Yet, some people blame these sanctions for exacerbating food and medicine shortages and causing unnecessary deaths.

With Venezuela’s foreign reserves falling from $30 billion in 2013 to less than $10 billion today, and with foreign direct investment from the United States dropping from $600 billion in 2011 to below zero today, Maduro’s government has turned to issuing local currency debt to raise money. With Trump restricting Venezuela from selling debt in the United States, the government has been forced into printing increasing amounts of money to fund imports. The more money it prints, the more the currency loses value, which ultimately led to the 80,000% annual inflation rate Venezuela saw at the end of 2018 .

Venezuela’s ticket out of Dodge will be productive investment of their oil revenues. Many oil-rich countries, most famously Norway, have created sovereign wealth funds to manage investment of their vast oil-generated wealth. Some experts say that “dollarization” can put an end to Venezuela’s economic spiral, arguing that some data shows that countries that officially adopt the US dollar as their national currency produce lower, less variable inflation rates and have higher, more stable economic growth rates than countries that use domestic currencies. Harvard economist Ricardo Hausmann, on the other hand, denounces dollarization as “magical thinking,” and says that data actually shows higher volatility in countries that dollarize. Of the four historical cases of countries adopting the dollar to escape hyperinflation (Peru, Bolivia, Paraguay, and Brazil), half did not achieve the desired effects. Moreover, when a country adopts a foreign currency to gain stability, they lose the ability to control their own monetary policy.

While the policy debate over dollarization continues, it is certain that international aid is necessary to rebuild Venezuela’s shattered economy in the short term. “As soon as we are asked by the legitimate authorities of that country to come in and help, we will come in,”  says IMF managing director Christine Lagarde. “It is going to require significant financing from all the international community.” Whatever policy course is chosen, it is certain that it must be taken soon. The IMF forecast earlier this year that inflation will top 10 million percent by the end of 2019. The more this economic crisis deepens, the greater the urgency for effective government leadership.


Featured Image Source: BBC News

Disclaimer: The views published in this journal are those of the individual authors or speakers and do not necessarily reflect the position or policy of Berkeley Economic Review staff, the Undergraduate Economics Association, the UC Berkeley Economics Department and faculty,  or the University of California, Berkeley in general.

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