Unless you’ve had your head in the sand, you’re probably aware that Venezuela’s socialist paradise is quickly collapsing. Shortages, rationing, blackouts and hyperinflation have all contributed to social unrest in the country and will likely result in a complete collapse of the government and currency in short order. A small example of the collapse of the currency can be found in the price of a hamburger, which as of a few days ago, was reported to be $170! While the official currency exchange rate is 10 bolivares per dollar, the rate in the black market is purported to be 1000 to 1! According to this FT.com report, the Venezuelan government sold an estimated $1.7 billion of its gold reserves during the first quarter of 2016 to repay its debts. Is this an exercise in futility or will the sale of the country’s gold reserves ultimately result in a stabilization of the economy and subdue civil unrest? We’ll discuss our thoughts in further detail below.
The Venezuelan government’s gold holdings were estimated to be the 16th largest in the world prior to the substantial sell off in gold during the first quarter of 2016. Per this report from the World Gold Council, the government’s holdings as of May of this year are 272.9 tonnes, which has a market value of approximately $10.6 billion. While this still sounds like a substantial amount of holdings on the surface, it’s not likely to last long with the country’s current woes. If the Venezuelan government proceeds to sell off the rest of the country’s holdings, will this be sufficient to allow the government to work through its current debt and currency issues or is this merely delaying the inevitable? Let’s take a look at some other countries who have recently experienced similar situations to determine the likely fate of Venezuela.
Argentina & Zimbabwe
In recent years, Argentina and Zimbabwe succumbed to hyperinflation causing the currencies to collapse. In Zimbabwe, a basket of currencies, including the U.S. dollar, replaced the Zimbabwe currency and in Argentina, the government devalued its currency and defaulted on a portion of its debt. At the height of the Zimbabwe currency crisis, the government issued a $100 trillion bill in an effort to save the currency. Unfortunately, it was short lived, as the government effectively abandoned the Zimbabwe dollar in June of 2009. Today, most people are surprised to learn that the $100 trillion bill was an actual bill. While worthless in Zimbabwe, a $100 trillion bill today will cost you around $25 as a novelty item, as it’s the largest bill ever produced. We have seen the horrendous effects of hyperinflation on Argentina and Zimbabwe, but is it possible that the Venezuelan bolivar will rebound in the months to come? Let’s take a look at a recent forecast from the IMF to get a glimpse into the future of the currency.
Predications on the Venezuelan Bolivar
The International Monetary Fund (IMF) predicts that the currency exchange rate of the bolivar to the dollar in the black market will increase from its current level of 1000 to 1 to 6,699 to 1 by the end of the year. In other words, the bolivar is estimated to shed 83% of its value versus the dollar by the beginning of 2017. This is clearly unsustainable and would put the value of a hamburger by year end at over $1,100! Even in an environment where the government is enforcing price controls and rationing, there’s little hope that Venezuela will survive with its current administration and currency through the end of the year. Hyperinflation often causes leaders to be ousted from government, either by a vote from the citizens or via a military coup. One or the other is likely to happen over the next six months.
Should Venezuela Sell its Gold Reserves?
Based on the not-so-rosy picture we’ve painted, it’s unlikely that the sale of Venezuela’s gold reserves will sustain the economy in the long term. In fact, as we’ve seen countless times in the past, this is merely kicking the can in hopes that the future will improve. The sad reality is that the current administration will be replaced, one way or the other, and the government will default on most, if not all of its debt. If Maduro were truly concerned about the future of Venezuela and its citizens, he would do the honorable thing and default on their debt. Iceland did exactly that in 2008, and has been one of the most stable economies in recent years. Getting back to Venezuela, wiping the slate clean would help the government rebuild from a solid foundation. Additionally, gold reserves could be used to back a new currency, which would instantly make Venezuela’s currency the envy of the world. Of course, fewer gold holdings only increases the challenge of implementing a gold backed currency. We’ll now discuss the fiscal situation in the U.S. and the likelihood of a Venezuela-type scenario.
U.S. Fiscal Situation
Many of our customers are viewing what is happening in Venezuela and preparing for a similar event in the United States. We regularly tell our customers that the dollar (in isolation) is a terribly flawed currency; however, it’s one of the cleanest dirty shirts, when viewed relative to other major currencies. A quick check reveals that the U.S. has north of $19 trillion of debt, which is ever increasing, and is routinely running annual deficits of $500 billion to $1 trillion. If you ever want to view our current debt situation in real time, we recommend that you view the U.S. debt clock, which can be found here. Unfortunately, the current official debt level of $19 trillion is just the tip of the iceberg, as Dr. Kotlikoff from Boston University has estimated that the present value of our current unfunded liabilities is north of $210 trillion! It’s clear that there will be a default in some form or fashion, as this is an oppressive debt load that can never be repaid. Not to mention, just a slight increase in our current interest rates will make our debt servicing costs nearly impossible to meet.
Hyperinflation in the U.S.?
While we don’t know if hyperinflation will ever reach our shores, we know that the value of the dollar has been eroded since the Federal Reserve was established in 1913 and that the Federal Reserve believes that a reasonable level of inflation is good for the economy. According to the U.S. inflation calculator, an item purchased for $1 in 1913 would cost $24.16 today. This is a cumulative rate of inflation of 2,316%, which means that the dollar has lost roughly 99% of its value over the past 103 years. Additionally, the Federal Reserve isn’t hesitant to increase its monetary base, which it did from $800 billion in 2007 to nearly $4 trillion today. Many would refer to this as hyperinflation of our currency (at least mass inflation). However, it hasn’t translated into price inflation, as banks would prefer to keep their excess reserves at the Federal Reserve as opposed to loaning out the money. If we enter into another recession in 2016 or 2017, which could happen considering that earnings are falling at their fastest rate since the Great Recession, look for the Federal Reserve to further bloat its asset base; thereby debasing the currency. While a Zimbabwe, Argentina, or Venezuela-type scenario is impossible to predict, an allocation in precious metals, such as gold or silver, appears to be a prudent hedge against a currency collapse. After all, gold and silver have been used as money for thousands of years, and are the only currencies that have withstood the test of time.
In summary, the Venezuela bolivar is not the first currency to experience hyperinflation, nor will it be the last. Based on predictions from the IMF, the inflation rate is likely to increase 6 to 7 fold by the end of the year, which will all but assure the collapse of the bolivar, resulting in regime change, and the establishment of a new currency. Our opinion is that the Venezuelan government should outright default on their debt; similar to Iceland, and maintain their current gold reserves, which may be needed to establish a new currency. As to if a hyperinflationary event will affect the dollar, it’s impossible to know. However, allocating a portion of your personal holdings in gold and similar seems to be a prudent strategy.