Oil, Uncertainty, and Inflation: Why Venezuela’s Economy Unravels During Political Shocks
Venezuela is extremely dependent on earning foreign money, mostly by exporting oil to the rest of the world. Foreign money can be thought of as the gasoline that allows a country to reach out to the rest of the world. It pays for the things that Venezuela cannot produce by itself: medicines, food, machines, spare parts for power stations, even some consumer goods. As long as enough dollars or euros are coming in, imports can keep coming, and supermarkets, hospitals, and factories can just about keep their heads above water. But when that slows down, the pinch will spread throughout almost every part of the economy.
A sudden political shock, like the arrest of a country’s sitting president by a foreign power, will usually affect that. Oil can still be exported from Venezuelan soil, but everyone in the chain will be nervous. Buyers will wonder if new sanctions aren’t just around the corner. They’ll wonder if a deal made today will be against the law tomorrow. Some will decide not to buy anything new or will insist on enormous discounts to cover themselves. Banks will put up new obstacles, delay payments, or simply decide not to make some payments. Companies that transport and insure oil will, now realizing that Venezuela is a riskier proposition, charge more. The oil itself is the same, but the money that goes along with it will take longer, will cost more, and will be less.
As soon as there are fewer dollars in the economy, the foreign exchange market reacts quickly. The demand for foreign money is still high because Venezuela is still importing necessary goods. The supply goes down because there are fewer dollars from oil sales and other goods. This leads to a shortage, causing the “price” of dollars to be higher in terms of bolívars. In other words, the value of the bolívar falls. More bolívars are required to buy each dollar. Since imported goods and products are priced in dollars, their prices in bolívars also rise.
This is where inflation affects the lives of Venezuelans. Importers pay higher prices and, in turn, charge higher prices to consumers. Food, medicine, gasoline, and transportation costs rise in local currency. Wages do not keep pace. A teacher or nurse earns about the same amount of bolívars, but the bolívars are worth less. They can buy less rice, less cooking oil, less bus rides. Families cut back. They delay doctor visits, eat cheaper calories instead of nutritious meals, and forgo any kind of spending that seems non-essential. Businesses, struggling between high prices and low sales, cut back their inventory or stop producing certain products that seem too risky.
The cycle can turn into a vicious cycle that you might recall from class. People notice prices going up and anticipate that prices will keep going up. This anticipation alters their actions even before new information is out. Households start to build up stocks of goods as soon as they can, especially the essentials like flour, sugar, and medicines. Panic buying leads to the depletion of stocks faster than normal. Shortages become actual, not just perceived. Once goods are scarce, the remaining ones become more valuable, and prices go up again.
Production falls too. Many Venezuelan businesses need imported goods: chemicals for agriculture, parts for industry, medical equipment for clinics. When these imports become expensive or unreliable, businesses cut production or shut down production lines. Workers lose their jobs or hours of work. Unemployment rises. People threatened with job loss cut spending even further, reducing demand. The economy may enter a period of high inflation and low production, a situation explained in textbooks as stagflation but felt by families as “everything costs more and work is harder to find.”
Uncertainty also works through confidence, which is what economists mean by what people think about the future. Expectations explain almost all big decisions. If people who save money think the bolívar will fall apart, they want out. They convert savings into dollars, products, or assets that seem more solid. This extra demand for foreign money pushes the exchange rate even lower. In this way, fear of a weaker currency leads the economy to a weaker currency.
Businesses behave the same way. Starting a big project, opening a factory, or hiring lots of workers requires confidence in the future. Without knowing who will be in charge of economic policy in a month, there is no confidence. It is better to wait and see. They hold back from buying equipment, forgo expansions, and make no long-term commitments. Less investment means less productive capacity in the future.
Banks also employ the same logical reasoning. If they feel that people might lose their jobs or that prices might rise, they will reduce lending. They will make loans less accessible or raise interest rates. This will mean that even relatively stable businesses will have trouble staying afloat during difficult times or expanding their business. The whole economy will be more risk-averse and less lively.
Confidence is especially fragile in a country like Venezuela, which has a very recent history. People have already lived through several instances of devaluation, reversal of policies, different types of control, and protracted periods of scarcity. Many already doubt the government’s promises and official figures. They have already seen their savings evaporate due to inflation before. In such a scenario, an event such as an arrest does not occur on a clean slate. It occurs in a population that is already preparing itself for a shock and often for the worst.
Some individuals believe that the absence of a leader who has been accused of overseeing an economic meltdown may, in the long run, help to catalyze an economic recovery. In the long run, a more competent and honest government may be able to handle oil resources more prudently, reduce corruption, and provide basic services. This may encourage foreign investors and give local businesses more confidence. Economists often agree that good institutions and stable policies are necessary for economic development.
The problem is in the transition. A sudden arrest is likely to create a power vacuum or at least a struggle for control of the most important institutions. Different groups are likely to claim control of the central bank, the state oil company, and finances. Until then, no one knows whose signature will matter on a contract or whose policy will win out. This is when investors are least likely to appear, and when the average citizen scrambles to protect himself. The bolívar will be under further pressure, and inflation may begin to rise once more.
Economists look at many crises and see the same thing. Political shocks that increase uncertainty hit foreign currency revenues, lowering the exchange rate and confidence. In an economy as import-dependent as Venezuela’s, this can happen quickly to affect food prices, access to medicines, and jobs. In Venezuela, it means the difference between bread on the shelves, antibiotics in the hospitals, and a future for young people.
Article written by Biegelan Redeli | Proofread by Zhangir Zhangaskin
