Key factor behind Venezuela’s downfall

Without brute commodity extraction, a capitalist market is needed to prop up the economy — something that the South American country has failed to do

According to the International Monetary Fund, by the end of this year, the annual inflation rate in Venezuela will reach 1 million per cent. A number like that is hard to grasp. Simply put, a candy bar that costs $1 (Dh3.67) today would cost $10,000 at the end of a year. Anyone in that position would understandably rush to spend the money right now, on anything that might possibly hold its value. Everyone else would too. The entire economy becomes a giant game of monetary “hot potato”. Saving or planning becomes a sucker’s game.

Venezuela is not exactly a struggling undeveloped country; it has the world’s largest proven oil reserves. So how did this happen?

There are two answers: One technical and one political. The technical answer is that hyperinflations occur because the government wants to spend much more money than it is collecting in taxes — so much more that no one is willing to lend it the money to cover the deficit. Instead, the government uses the central bank to finance the deficit. That puts more money in the economy, but since it’s chasing the same number of goods and services, prices rise to soak up all the extra cash. Unless the government manages to close its budget deficit, it must print even more money.

Rinse and repeat a few times, and the inflation rate starts running into many zeros. The end generally arrives in one of two unpleasant ways: The government decides to stop the madness and implement a strenuous reform programme, or the currency becomes so utterly devalued that churning out more of it is pointless. By the end of its hyperinflation, Zimbabwe was printing banknotes that ran into the trillions.

But it’s not a secret that this is where hyperinflation ends. Why did Venezuela embark on the road to destruction? And why does the government stay on it while the citizenry slowly starves?

In a word, socialism. After his election as president in 1998, Hugo Chavez pursued an increasingly aggressive socialist agenda, one that continued under his 2013 successor, Nicols Maduro. Chavez nationalised foreign oilfields, along with other significant portions of the economy, and diverted investment funds from PDVSA, the state-owned oil company, into vastly expanded social spending.

Falling production, rising prices

Unfortunately, Venezuela’s heavy, sour crude oil was unusually hard to get out of the ground. Continual investment was needed to keep it flowing. So was the expertise of the banished foreign owners and the PDVSA engineers Chavez had purged for opposing this scheme. Production plunged; the only thing that kept Venezuela from disaster was a decade-long oil boom that offset falling production with rising prices.

Then came the 2008 financial crisis that crushed global demand for oil, followed by the onrush of United States shale oil, driving prices down further. And no one would loan money to Venezuela that couldn’t be repaid in oil. Meanwhile, unwilling to admit that socialism had failed, Venezuela made a fateful turn to the central bank.

Now, one could say that this is not an indictment of socialism so much as the particular Venezuelan implementation of it. But it’s striking how the precarious economics of socialism, including hyperinflations, are tied to petroleum. Many of the notable hyperinflations in history were tied to the collapse of the Soviet Union. And the story of the Soviet collapse is also a story about oil.

Central planning had wrecked the Soviets’ grain production by the 1960s, and collectivised industry didn’t produce anything that the rest of the world wanted to buy, leaving the Soviets unable to obtain hard currency to import grain. Oil sales propped up the Soviets until the mid-1980s, when prices crashed as new sources of oil came online (sounds familiar?). The Soviet leadership was forced to liberalise to rescue the economy. USSR’s collapse soon followed.

Socialism, in other words, often seems to end up curiously synonymous with “petrostate”.

Without brute commodity extraction, you need capitalist markets to generate a surplus to distribute, which is why Denmark’s and Sweden’s economies have more in common with the US system than with the platform of the Democratic Socialists of America. And as both Venezuela and the Soviet Union show, even oil may not be enough to save socialism from itself. ■ Megan McArdle is an opinion columnist and blogger who writes mostly about economics and finance.