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Hyperinflation for Venezueala; Deflation for the U.S.

Editor's Note: This article originally appeared in Jason Farkas' January 22 Weekly Insight column of EWI's intensive Currency and Interest Rate Specialty Service

Hyperinflation for Venezuela; Deflation for U.S.
Venezuela is firmly on the road to hyperinflation, particularly since President Hugo Chavez recently announced that he would devalue the currency. Many people are worried that the United States is headed down that same road. But that's not how we see it, mainly because the U.S. government still has access to cheap capital. Let’s review Venezuela’s past economic and currency problems, because they show the difference between an economy headed for hyperinflation and one headed for deflation.

Oil has been of paramount importance to the Venezuelan economy since its discovery in 1922. Oil sales account for about 80% of exports, and they generate half of the government’s revenue. In 1998 Hugo Chavez was elected President on a socialist platform. Socionomics, the study of social prediction based on the Wave Principle, could have predicted this change in leadership, because it happened as oil was completing an 18-year bear market in which it fell almost 75%. In an oil-dependent economy, a bear market of that magnitude had voters looking for change – even a bad one.
Here are key events of the last decade:
1.    2002 Workers Strike - As oil fell in a wave 2 correction, the economy of Venezuela came to a standstill when workers went on strike in a political protest of Chavez’s policies. 
2.    2003 Currency Intervention - In an attempt to support its currency, Venezuela suspended currency trading in the bolivar, and installed a US dollar peg at 1.6-to-1 (redenomination adjusted).
3.    De Facto Devaluation - By 2007, black-market prices for the renamed bolivar fuerte, or strong bolivar, had fallen to 4.75-to-1. The name change didn’t prevent this weakness.
4.    De Jure Devaluation – On January 1, 2008, the government devalued the currency from 1.6-to-1 to 2.15-to-1. Its 2010 devaluation puts it as low as 4.3-to-1. Even after the 2010 devaluation, the black-market rate has fallen even further to 6.15-to-1.
A currency peg is an attempt to impose one’s will on a market, but as the January 2010 Elliott Wave Financial Forecast points out, “When government tries to drive a market in a given direction, prices rarely cooperate." Look at this chart of the Venezuelan bolivar in relation to the Brazilian real, a regional market with no artificial peg. The “five-down, three-up” pattern in the VNE/BRL indicated that the larger trend was down. In addition, if the black-market price had been charted, the bolivar would have shown even more weakness than was apparent in the official rate. In fact, the recent devaluation simply recognizes what citizens have understood for some time, given the “unofficial” black-market rate. Many other currency pegs will likely be victims of the coming depression, which is a topic we’ll cover in a future Weekly Insight.
Rampant inflation (see table) has already destroyed any idea of savings in Venezuela, but it is only likely to turn into hyperinflation now because of three conditions: (1) Inflation was already systemic, (2) the money supply has increased substantially, and most importantly (3) with Venezuelan government bonds at 8.56% over U.S. Treasuries, it is impossible to access to cheap capital. In contrast, the U.S. has abundant access to cheap capital with 2-year notes yielding less than 1%.
As we have shown before in June’s Global Market Perspective with respect to Latin America, and in the Weekly Insight on Zimbabwe, hyperinflation happens when access to cheap capital vanishes. Hyperinflation has never

taken place with such minuscule interest rates as are available to the US government today. As we see it, the access to cheap capital is a dividing line between deflation and hyperinflation. That makes deflation the most likely path for the US over the near term with hyperinflation, or its cousin, stagflation, remaining long- term concerns over the next 7-10 years.

Jason S. Farkas, CMT

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