Sunday, August 30, 2015

Printing Your Way Out of Economic Troubles...

from Bloomberg
Venezuela seems to be hovering on the edge of tipping into hyperinflation. Or perhaps it has already fallen into the abyss. Given the paucity of official data -- the none-too-believable official figures were last published in February -- it's a little hard to tell. The best guess we have at the value of a Venezuelan bolivar comes from the Colombian village of Cucuta, where people go to buy currency so they can smuggle subsidized fuel and other price-controlled goods out of Venezuela. As The Economist notes: "Transactions are few; the dollar rate is calculated indirectly, from the value of the Colombian peso. The result is erratic, but more realistic than the three official rates."

Using those rates, economist Steve Hanke recently told Bloomberg that annual cost-of-living increases are running at about 722 percent. To put that in some perspective, it means that a $400 monthly grocery bill would climb to $2,888 in a year. That may not approach the legendary status of Hungary's postwar inflation, which reached 41.9 quadrillion percent in a single month, but it's devastating for savers, or for people like pensioners whose incomes consist of fixed payments. It's also pretty bad for the economy.

It's a bit of a mystery why this is happening. No, right, don't tell me: The government is printing too much money! Indeed. As Milton Friedman famously said, "Inflation is always and everywhere a monetary phenomenon." When too much money is chasing too few goods, prices rise. And the most common source of "too much money" is government printing presses.

But I'm not asking for the mechanism; I'm asking for the reason. Why is the Venezuelan government resorting to the printing press?

I know you've got an answer to that, too. Seigniorage! That's the fancy name for the profit a government makes by printing bills and minting coins. If you can buy more goods and services with the cash you made than it cost you to make it, you have essentially collected a stealthy sort of tax on the people who take the money from you and give you valuable stuff in exchange.

In general, seigniorage revenue is trivial -- indeed, it costs the U.S. government more to make nickels and pennies than the coins themselves are worth. But even with higher-value bills, the revenues pale in comparison to, say, the income tax. Estimates are hard to come by, but a 1992 analysis by the Federal Reserve put the value of seigniorage to the Treasury at about 1.6 percent of real federal on-budget expenditure. It's not nothing, but it's not going to keep civil servants in pensions, either. And the U.S. enjoys an unusual amount of seigniorage revenue because dollars are in heavy demand among citizens of unstable countries and people who want to conduct illegal transactions in cash.

Governments can try to jack up the amount of seigniorage revenue by stealthily inflating the currency. Basically, they exploit an information asymmetry between them and the people they trade the money to: The government knows how much money there is, and its citizens don't. So they'll probably accept fewer units of currency than they would if they knew the government was going to print extra money and thus cause prices to rise again.

But this is a terrible way to make money, which is why governments normally don't resort to this one clever trick for raising government spending without raising taxes. The problem is that inflation expectations rise pretty rapidly to compensate, and then the government needs to print even more money to outrace its newly suspicious trading partners.

The core thing to understand about inflation as a policy tool is that in general, steady-state inflation doesn't do you any good; what you need is accelerating inflation. A little bit of inflation is actually OK -- it allows the economy to naturally cushion economic shocks that would otherwise lead to unemployment. In the dark ages of economics, some people got the idea that if a little bit of inflation was good, more must be even better: Set the printing presses to "full stun" and enjoy perpetually higher economic growth. (You still see this folk economics circulating on the Internet from time to time.) But this doesn't work. People start to expect the inflation, and the economy returns to its natural level of output, except that everyone's savings are now worth less. To get more growth, you have to inflate even faster than you did before.

Unfortunately, once inflation starts to accelerate, it's kind of hard to stop because people also start pricing the acceleration into their expectations. Hyperinflation has all sorts of bad knock-on effects: It hurts your capital base and makes people unwilling to plan for the future because they have no idea what their money will be worth. But the supreme irony is that after a certain point, the government actually starts losing money. You've probably heard of the much-maligned Laffer Curve, which was used to support unrealistically optimistic estimates of the revenue-generating effects of Reagan-era tax cuts. But it actually does a pretty good job describing what happens to government revenues during hyperinflation: First they go up, but then they go down, down, down, and the government stops being able to buy goods and services because people don't have any use for the money, except maybe to economize on the Kleenex they can no longer afford to buy.

These are not arcane secrets, known only to a select few in the economics community. I guarantee that there are sober analysts in the Venezuelan government who know exactly where this is headed. Why, then, have they let things get to a point where they are preparing to issue bigger bills so that people won't have to carry around a sack of money every time they want to run out for a quart of milk?

Part of the answer is that in the early days, inflating does make the government a little more money, and the point at which it starts to lose money is also the point at which the freight train is traveling 120 miles an hour, and it has a choice between slamming on the brakes and killing everyone instantly or waiting to hurtle over the cliff. Embezzlers and accounting frauds often start this way -- they fudge things just a little to cover a temporary shortfall. Only the underlying problem doesn't go away, and they need to fudge even more the next quarter to cover up both the gap they have now and the gap they covered up last quarter. They tend to be uncovered when the gap is so big that it can no longer be fudged. This is what happened to Bernie Madoff when the market collapsed.

The larger answer is that this is the end game of Chavismo. For about a decade, some sectors of the left hoped that Hugo Chavez represented an alternative to the neoliberal consensus on economic policy. Every time I wrote that Chavez was in fact direly mismanaging the economy, diverting investment funds that were needed to maintain oil output into social spending, I knew that I could look forward to receiving angry e-mails and comments accusing me of trying to sabotage his achievements for the benefit of my corporatist paymaster. And in fairness (though without minimizing his appalling authoritarianism), those policies undoubtedly did improve the lives of some incredibly poor people.

The problem was that the money he was using was, essentially, the nation's seed corn. Venezuelan crude oil is relatively expensive to extract and refine and required a high level of investment just to keep production level. As long as oil prices were booming, this policy wasn't too costly because the increase offset production losses. But this suffered from the same acceleration problem that we discussed earlier: The more production fell, the more the country needed prices to rise to offset it. Between 1996 and 2001, Venezuela was producing more than 3 million barrels a day. It is now producing about 2.7 million barrels a day. In real terms, the price of a barrel of oil is barely higher than it was in August 2000, but Venezuela is producing something like 700,000 fewer barrels each day. Policies that looked great on the way up -- more revenue and more social spending -- became disastrous on the way down as the population was hit with the double whammy of lower production and lower prices.

This was predictable. Indeed, many people predicted it, including me, though I was just channeling smarter and better-informed people, not displaying any particular sagacity. But the Venezuelan government either didn't listen to the predictions or didn't believe them. Now falling oil prices are crushing government revenues at exactly the time the country most needs money to help the people who are suffering great misery as the oil cash drains out of their economy. In the beginning, printing money may have looked like the best of a lot of bad options. By the time it became clear that the country was not fudging its way out of a temporary hole, but making a bad situation worse, it was committed to a course that is extremely painful to reverse.

Venezuela may be able to pull back from the edge, though it can only do so with great pain. Or it may end up in a hyperinflationary spiral, which will ultimately mean even greater pain. I don't envy the decisions it will have to make. Or the millions of Venezuelan people who will have to live with them.

No comments:

Post a Comment