Preamble: this is a follow-on piece from yesterday’s post on Venezuela’s stock market. In particular, you should know that Venezuela’s stock market is the best performing one in the world (it has returns that are on par with Bitcoin’s). The reason? Hyperinflation causes all parts of an economy to do strange things. And one of those anomalies is a stock market bull rally. In today’s post, I’m asking a related question: who wins in a hyperinflation?
Hyperinflation means the destruction of the value of a country’s money. By allowing inflation to run rampant in a particular currency, people will start to avoid using it (and accepting it).
Now you might expect this to happen fairly quickly: people see a government printing money, and so they stop using it.
But instead, the process takes a lot longer than that. And this is where it gets interesting – because hyperinflation tends to create classes of people with strong incentives to keep the hyperinflation spiralling.
So let’s start with the massive arbitrage opportunity on the table.
The issue of Venezuela’s official exchange rate AKA the best investment horizon in the world
- The official exchange rate sets the conversion of Venezuelan bolivars to US dollars at 10 bolivars to the US dollar.
- On the parallel market, according to dolartoday.com (on 18 August 2017), the rate sits at something like BsF 15,500 to the US dollar.
Now obviously, if you could buy US dollars at the official exchange rate of BsF 10, and sell those same US dollars on the parallel market at BsF 15,500, then you’d be making a bit of a profit. Specifically, you’d be making a 154,900% instant return on your money.
So the question is: who gets to make that kind of money? And how?
The mechanics of screwing an exporter
Here is how the foreign currency gets accumulated at the official exchange rate:
- Exporters earn foreign currency.
- In terms of Venezuelan exchange controls, exporters are
forcedrequired to repatriate a portion of their earnings through Venezuela’s central bank (the BCV).
- That repatriation means that the BCV gets to take foreign currency from exporters, and exchange it for bolivars at the official exchange rate of 10 BsF.
- From the latest report that I could find, as of March 2014, 40% of export proceeds have to be repatriated through the BCV.
- So that’s how the BCV gets its foreign currency.
The mechanics of getting rich quick during hyperinflation
- At this point, the BCV holds foreign currency.
- And the BCV will have some rules about who gets to access it at the official rate.
- So there would be a general clamour of businesses, private individuals, and import schemes, all trying to persuade the BCV to allocate them foreign currency.
- And with those kinds of returns at stake, people get desperate.
Now clearly, a massive chunk of those proceeds will end up being allocated to the politically-connected.
But it won’t just be them. Individuals will also exploit the loopholes wherever possible.
The mathematics of plane tickets
For example, there was a period of time when Venezuelan citizens could apply for foreign currency (up to USD 3,000 worth), provided that they had an international plane ticket. And given the difference between the official and parallel exchange rates, the cost of an air ticket barely dented the profit you could make.
Here’s the math (assuming today’s exchange rate):
- At the official exchange rate, USD 3,000 would cost you BsF 30,000.
- At the parallel exchange rate, BsF 30,000 would cost you USD 2.
- So you could borrow USD 2 from a friend, exchange it for BsF 30,000, and then re-exchange that BsF 30,000 for USD 3,000.
- You repay your friend.
- You’re left with USD 2,998. For doing nothing other than being eligible to buy forex at the official rate.
- And if that ‘eligibility’ meant spending USD 200 on a plane ticket, then you’d just book a plane ticket.
- And now your profit would be USD 2,798.
- Ah, the sweet treats of socialism.
But that’s just one example where individuals got to exploit a loophole. The real winners here are the politically-connected: being the ones able to secure vast amounts of foreign currency, thanks to their friend in the BCV/government/etc.
All the vested interest
Unfortunately, the politically-connected problem is the part that is missed the most often. That is, the ruling class and their friends tend to discover during a hyperinflation that they really want it to continue.
And it’s the main reason why hyperinflations endure for so much longer than you’d expect.
Post Script: About Those Exporters
Some readers might be wondering why the exporters continue to operate, if 40% of their proceeds are repatriated at the official exchange rate.
The thing is, even the exporters won’t be as upset by the repatriation as you might expect. After all, their ‘costs’ are denominated in bolivars. And even if 40% of their proceeds are repatriated, they will be finding ways to:
- Avoid the repatriation;
- Limit it; and
- Even if they can’t do either of those things, they’ll be settling their local costs at massive discounts – because they can take some of the other 60%, and convert it at the parallel exchange rate.
So it works out for them.
The real losers here are all those people who are the ‘local costs’. They’re being paid at massive discounts. It’s also pensioners (with pension funds) and people who have their life savings in fixed deposits. The ‘gains’ of hyperinflation are effectively the confiscation of their purchasing power.
Rolling Alpha posts opinions on finance, economics, and sometimes things that are only loosely related. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha. Also, check out the RA podcast on iTunes: The Story of Money.