What's A Central Alabama Home Depot Employee Have To Do With The Bolivar?

by: Principal Financial Group

By Robin Anderson, Ph.D., Senior Economist, Principal Global Investors

Given the current state of its economy, Venezuela officially became a brand new member of a notorious club: the "hyperinflation club." This is based on a method for identifying hyperinflation by economists Steve H. Hanke and Nicholas Krus, aptly named Hanke-Krus World Hyperinflation Table. The membership requirements are as follows: a country must have an inflation rate of at least 50% per month for 30 days, and that inflation rate must be documented and replicated.1 So, despite its nefarious reputation, hyperinflation is exceedingly rare. In fact, since 1796, there have been only 57 episodes, Venezuela included.

There's an order of magnitude difference between hyperinflation and high inflation. During the height of stagflation in the 1970s and 1980s, U.S. inflation peaked out at 13.6% per year. At that rate, it took five years for prices to double. With Venezuela's inflation rate at 221% per month, prices double every 18 days.2 While that's horrible, Venezuela's hyperinflation is in the middle of the pack. Based on the Hanke-Krus table, post-World War II Hungary was the worst of the worst, with a peak monthly inflation rate of 4.19X10^16%, or 41.9 quadrillion percent. That's right, prices doubled every 15 hours! Zimbabwe's 2007-2008 hyperinflation "episode" was second, with prices doubling about every 24 hours. The Weimar Republic's hyperinflation period in the early 1920s rounded out the top five - prices doubled every 3.7 days.

Why has Venezuela joined this wretched club?

The country has a toxic combination of a wildly mismanaged and corrupt government plus an extreme dependence on oil. The International Monetary Fund (IMF) expects the economy to contract a whopping 10.1% this year. About half of the government's revenue and 96% of exports come from oil. That was great in boom times. Oil revenue helped expand social programs; flush coffers of foreign exchange provided for imported necessities like medicine and food. However, as oil prices collapsed, so did foreign exchange reserves. To make matters worse, a large share of Venezuela's reserves are in gold, which has also fallen sharply in value. With little oil money coming in, the government deficit has ballooned. By the way, the national oil company, PdVSA, has basically defaulted on its debt.

The real driver of hyperinflation may be, as The Economist aptly puts, Venezuela's "Rube Goldberg" currency system.3 There are "three exchange rates" - two official and one black market. The highest official exchange rate is only 10 bolivar per U.S. dollar, but the black market value was 4,600 bolivar per U.S. dollar as of early December.4 This gapping spread between the true and official exchange rates incentivizes corruption. Those in the know can get dollars for cheap and sell them on the black market. In addition, with dollars pouring into the black market, they can't be used for imported necessities like medicine or toilet paper.5 In fact, with so much uncertainty about the true exchange rate, the most reliable purveyor of the prices is a humble Home Depot (NYSE:HD) employee in Alabama. Mr. Gustavo Díaz is a former colonel and security officer of a businessman who attempted a coup against the deceased leader Hugo Chávez in 2002. Diaz now serves as president of the insurgent Venezuelan website DolarToday.com, which offers a benchmark exchange rate used by Venezuelans to trade black market currency, thus bypassing the country's tough currency controls.6

So what has the government done to fight this scourge?

It has taken the largest bill, the 100 bolivar bill, out of circulation and promised to replace those with bills worth up to 20,000 bolivars. According to calculations from the Wall Street Journal, that amounts to removing about half of Venezuela's currency from circulation.7 To make matters worse, the government's logic for the currency's removal makes even the most hardened conspiracy theorist blush. Interior Minister Nestor Reverol claimed that the bills must be removed from circulation to stop the U.S. Treasury and a network of international mafias, which have been hoarding the notes in Central and Eastern Europe until the current government is overthrown.8

The economic crisis in Venezuela has had a terrible toll on its people. Shortages have been disastrous. Families are struggling to get basics like food and toilet paper; infant mortality skyrocketed without proper medical supplies. Now, with prices and the government unhinged, the crisis has entered a more dangerous phase. Stay tuned!

1 Hanke, Steve H. and Bushnell, Charles, "Venezuela enters the Record Book, the 57th Entry in the Hanke-Krus World Hyperinflation Table," Studies in Applied Economics, Number 69: December 2016.

2 The government has stopped measuring inflation. This inflation rate is derived from exchange rates. Hanke, Steve H. and Krus, Nicholas, "World Hyperinflation," The Routledge Handbook of Major Events in Economic History, edited by Robert Whaples and Randall Park, 2013.

3 Data team, "Venezuela: a nation in a state," Economist, February 18, 2016.

4 Toro, Francisco, "The Monetary Meltdown in Venezuela," Washington Post, December 2, 2016. Toro, Francisco, "Declaring War on Common Sense, Venezuela bans its own money," Washington Post, December 15, 2016.

5 Hetland, Gabriel, "Why Is Venezuela in Crisis?" The Nation, August 17, 2016.

6 Kurmanaev, Anatoly, "Venezuela's Nemesis Is a Hardware Salesman at a Home Depot in Alabama," Wall Street Journal, November 20, 2016.

7 Kurmanaev, Anatoly, "Venezuela Yanks Bills from Circulation," Wall Street Journal, December 12, 2016.

8 Toro, Francisco, "Declaring War on Common Sense, Venezuela bans its own money," Washington Post, December 15, 2016.