Venezuela is the latest country to spin into hyperinflation, showing the same signs as the meltdown in Zimbabwe that created the 100 trillion dollar note. Hyperinflation, as defined by economist Philip Cagan in the 1950s, is when a country sees inflation rates rise by more than 50% per month. Wow! Luckily, I’ve never been exposed to that. In the UK, I can remember inflation rates nearing 20% a long time ago, and we thought that was bad, but 50% or more per month is terrible. In Venezuela’s case, it’s forecast that inflation will hit over 1,000,000% this year. In July alone, it hit 87,000%.
This means that Venezuela’s currency, the bolivar, has lost nearly all of its value in the past year, resulting in a chicken costing 14.6 million bolivars.
I only know this because the BBC covered the story this week and showed how much it costs to buy various day-to-day items in a country that is in meltdown.
- Toilet roll costs 2.6 million bolivars.
- Some carrots cost over 3 million.
- A kilo of tomatoes is 5 million.
- A kilo of cheese over 7.5 million.
The result is that, like Zimbabwe, the country issued a new national currency last Monday in lower denomination notes. The sovereign bolivar takes five zeros off the old notes, so that cheese is now just 75 bolivars. It sounds better, but it meant the country pretty much shut down this week, and hyperinflation is still rife.
Related: The Petro that can’t be found
What caused it?
In Venezuela’s case, it was an over-reliance on a single commodity – oil – and a policy under its former President Hugo Chavez to spend all that money. This meant that when oil prices were surging, instead of holding back some money in the bank, it disappeared; then oil prices tanked in 2014 and there was no money in the bank. Combine this with price capping, which forced many companies to close business, and foreign exchange controls, and the ground was laid for a disaster in waiting.
Though each episode of hyperinflation has its unique miseries, there are common patterns. Often the economy concerned will already have a chronic weakness. Usually it is an underlying fiscal problem. There might be pressure on the budget from, say, the cost of prosecuting a war, or from welfare spending or from looting by officials. Tax revenue may rely heavily on a single commodity. Frequently the local currency is pegged at an over-valued rate, which keeps inflation hidden for a while, only for it to show up suddenly. The problems begin with a “shock” to the economy. It might be a slump in oil prices, as in the case of Venezuela, or a slump in farming output, as in the case of Zimbabwe. The shock sets off a chain of events. Tax revenues evaporate, leaving a hole in public finances. The government fills it by printing money. The increase in the supply of money pushes up inflation. That is bad enough. But what accelerates this process, turning a jump in prices into hyperinflation, is the impact of inflation on government revenue. Because taxes on income or sales are typically paid after they accrue, a period of high inflation leads to a fall in their real value. So the government resorts again to financing its budget deficit by printing more money. That produces yet more inflation, a still-weaker tax take and further rounds of money creation. At some point, the exchange rate collapses. The ascent of inflation quickly becomes explosive, especially in countries where wages and price rises are indexed.
Hyperinflations do not last long. They end in one of two ways. With the first, the paper currency becomes so utterly worthless that it is supplanted by a hard currency. This is what happened in Zimbabwe at the end of 2008, when the American dollar took over, in effect. Prices will stabilise, but other problems emerge. The country loses control of its banking system and its industry may lose competitiveness. With the second, hyperinflation ends through a reform programme. This typically involves a commitment to control the budget, a new issue of banknotes and a stabilisation of the exchange rate—ideally all backed with confidence-inspiring foreign loans.
Venezuela is betting on the second reform, and it will be worth watching to see how it plays out. Meantime, most Venezuelans are leaving the country in droves. Over 500,000 so far this year. By comparison, the total influx of migrants into Europe has been about a tenth of that number this year. In fact, from the London School of Economics blog, a worthwhile note:
While the situation in Venezuela is anatomically distinct from Syria, analysts have not shied away from comparing the Venezuelan displacement drama to the forced migration resulting from the Syrian Civil War. At the time of writing, the Syrian diaspora has reached almost 7 million, of which an estimated 1 million are living in Europe.
Estimates of the Venezuelan diaspora, which has not been quantified with as much rigour are diverse, ranging from 1.6 million to 4 million people as of early 2018. With almost one million counted in Colombia alone (June 2018), the overall numbers at mid 2018 are likely to be even higher. Some experts predict that the Venezuelan displacement will soon surpass the number of Syrian migrants and refugees.
The bottom-line is that a country can become a basket case when its money and banking systems fail. No wonder Venezuelans have been highly active in the cryptocurrency world.