At the end of August, the Trump administration imposed harsh sanctions on Venezuela that prevent the country from borrowing or selling assets in the US financial system. The new embargo will exacerbate shortages of food, medicine, and other essential goods, while severely limiting the policy options available to pull the country out of a deep depression.
Prior to these sanctions, it was possible for the Venezuelan government to launch an economic-recovery program that could have restarted economic growth. Unlike most countries suffering from a balance-of-payments crisis, Venezuela would not necessarily have to go through a period of “structural adjustment,” as it used to be called before IMF programs gave this term a bad reputation. In this kind of adjustment, living standards typically fall, at least temporarily, because the country has to cut imports in order to balance its external accounts. Venezuela has already cut imports by about 75 percent since 2012. This is an astounding number; Greece, for comparison, has reduced imports by about 31 percent after suffering through a depression for most of the past seven years, which is twice as long as Venezuela’s current crisis.
This means that Venezuela’s economy could begin to recover fairly quickly in response to the appropriate reforms, without having to endure further declines in output or employment. Or at least that was true until Trump’s August 25 executive order.
The adjustment that Venezuela needs is primarily of relative prices, most importantly its exchange rate. We can see this by looking at what has happened over the past five years. In October of 2012, inflation was running at an 18 percent annual rate, and the black-market price of $1 was 13 BF (the domestic currency). Over the past year, inflation has been more than 600 percent, and $1 costs more than 17,000 BF.
These two trends reinforce each other in an “inflation-depreciation” spiral. As inflation increases, more people want to hold dollars; as they buy dollars, the black-market price of the dollar rises. This increases the cost of imports, which drives up inflation, and the cycle continues.
If we look at the data from the past five years, this process has been more or less constant. Today the government still gives away more than 90 percent of its dollars at a rate of 10 BF per dollar. This is supposed to be used for the import of food, medicine, and other essential items. But you can imagine the incentives for corruption when a dollar that costs 10 BF can be sold for more than a thousand times that on the black market.
Of course, the collapse of oil prices made everything much more difficult for Venezuela, since oil accounted for 95 percent of its exports and the majority of government revenue. Yet Venezuela went into recession in 2014, when oil was still more than $100 a barrel. Policy failures, not an oil shock, precipitated the country’s financial decline. But the response to the oil-price collapse, especially maintaining the economically deadly exchange-rate system, ensured prolonged catastrophe.