Hyperinflation in Venezuela: oil prices and political factors

Hyperinflation in Venezuela

The Roots of Hyperinflation in Venezuela

Currently, the country of Venezuela is experiencing is experiencing an estimated 720% inflation rates, while prices spiral out of control, and the country is on the verge of defaulting. However, it is difficult to even know what the actual financial situation is because the country basically gave up on keeping records in 2015. There has been a mass exodus of Venezuelans from the country. While many blame the current hyperinflation that Venezuela is currently experiencing is based upon poor political leadership, which certainly could be a contributing factor, this analysis has identified that the crisis has been almost certainly have been caused by the prices in the international oil markets, caused by a strategy that was initiated by Saudi Arabia, a fellow OPEC country.

Literature Review

Inflation has been defined as a sustained upward trend in the general level of prices in the economy (Tucker, 2016). It is important to note that it is not just higher prices, but persistently increasing price levels that constitute inflation in the economy. For example, when general prices rise, a one-dollar bill buys less each subsequent year, which translates in effect that with inflation there is a fall in the monetary unit\'s overall purchasing power for goods and services. Inflation is calculated by considering whether there is a rise in the level of prices of goods and services in an economy over any given period of time. By contrast, the opposite trend is relatively rare, but possible, and when the price levels decrease over time this is referred to as deflation.

When the aggregate price levels rise, this reduces the effective purchasing power of money. For example, if you had one hundred dollars this year it would buy so much and this could be associated with a certain level of buying power to make purchases. However, if inflation occurs, then the purchasing power would be reduced relative to the level of inflation and you could not purchase as many goods or services as you could have in the previous year. This phenomenon can have both positive and negative effects on the health of the overall economy and these effects are largely a result of the other factors and the broader set of circumstances.

To understand the influence of inflation on the economy, it is first vital to understand how it is measured. Inflation deals with the value of money and what it is able to purchase based on what is considered a \"basket\" of goods. For example, in some previous time periods a dollar might have bought a whole grocery list worth of items, but in today\'s market, it doesn\'t go far. Inflation is measured by the percentage rise in the consumer price index (CPI), which is reported annually by the Bureau of Labor Statistics (Hall & Lieberman, 2009). The goods that are included in this calculation include a range of items such as (Bureau of Labor Statistics, 2017):

• FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, full service meals, snacks)

• HOUSING (rent of primary residence, owners\' equivalent rent, fuel oil, bedroom furniture)

• APPAREL (men\'s shirts and sweaters, women\'s dresses, jewelry)

• TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance)

• MEDICAL CARE (prescription drugs and medical supplies, physicians\' services, eyeglasses and eye care, hospital services)

• RECREATION (televisions, toys, pets and pet products, sports equipment, admissions);

• EDUCATION AND COMMUNICATION (college tuition, postage, telephone services, computer software and accessories);

• OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and other personal services, funeral expenses).

Venezuela has a similar regulatory body that also tracks the price levels relative to a basket of goods that represents normal purchase for the average citizen. The CPI is thus calculated for Venezuela, and as the following graph indicates, has risen steadily over the years.

Figure 1 - Banco Central de Venezuela (Trading Economics, 2017)

Hyperinflation occurs when inflation starts to spiral out of control and the CPI rises quickly. Hyperinflation is defined more specifically as when the prices of goods and services rise more than 50% a month (Amadea, 2016). For example, if milk cost a dollar at the beginning of the month, by the end of the month it would have to cost at least a dollar and a half to qualify as the hyperinflation rate. This has the effect to eventually render the currency worthless and this is a rather extreme level of pricing increase and occurs relatively rarely. Although hyperinflation is considered a rare event, it occurred as many as 55 times in the 20th century in countries such as China, Germany, Russia, Hungary and Argentina (Investopedia, N.d.).

The situation in Venezuela and the causes of the countries hyperinflation result from a complex set of many different factors. Price inflation at the Venezuelan national level can occur from a variety of forces including central bank actions, (increases in the money supply or interest rate policies) government actions (higher taxes, excessive regulation, minimum wage laws, tariffs or mandates) or for economic reasons, that may or may not be caused by central bank or government actions (decline in the value of a nation\'s currency vs. the currencies of its trading partners, shortages, or an increase or decrease in the price(s) of key commodities such as oil) (Metals, 2016). Each of these factors have worked to influence inflation in Venezuela in the current circumstances.

Venezuela circumstances have put it on the verge of default and it will be difficult for the country to find a path back to some form of financial stability. The country\'s oil production, which is one of its primary economic drivers of the economy, has been affected by low international oil prices. The country has reduced its imports and has been using its reserves, which have declined by roughly half in the last couple years, and only has a little about ten billion in assets, in contrast to debts that likely exceed the one hundred-billion-dollar mark (Krauss, 2017). Some analyst believe that oil prices will have to rise from $15 a barrel, to at least $70, for the country to return to a solvent path (Krauss, 2017).

Methodology

The literature review has revealed that economic situation in Venezuela is complex and difficult to dissect and understand in regards to any one particular factor independently. That being stated, given that international oil prices has been one of the key drivers, for the purposes of this analysis, it will focus on the manner in which the international oil markets has influenced the current levels of hyperinflation in Venezuela by limiting the country\'s revenue streams through its nationalized oil company. While this approach will not consider the effects that have been caused by internal factors such as the country\'s political instability, it does explain one of the primary factors in which the economy is impact by this market which also exacerbates the other factors involved.

The global environment for oil and gas has rapidly evolved in just the last few years and as a result, a new set of macroeconomic market conditions have developed in the international market. One of the factors that has been responsible for this trend is that there has been an oil surplus of oil created by the increase in the global supply of oil relative to previous years. Some of the fluctuations in supply can be contributed to different factors such as the technological developments that have allowed for new forms of oil. For example, new technologies and drilling methods have effectively unlocked new reserves and allowed the extraction of the oil from more sources in the US. Furthermore, offshore drilling and oil reserves that have recently become accessible by hydraulic fracking represent the two best examples of how extraction methods have added to a new level of oil reserves. This has revitalized the US oil production which has in turn reduced the dependence on the cartels and Middle Eastern oil which has had the effect on the international market (Doshi & Corrigan, 2015).

There are many other factors that are present in the international market as well. For example, Saudi Arabia has been subject to a significant amount of attention regarding its decisions relative to the production levels that the OPEC cartel have instated in November 2014; by defying the international pressure to reduce production, OPEC has consistently exceeded its official production target of 30 million barrels per day since May 2014 (Agnihotri, 2015). In previous market strategies, the OPEC countries typically will try to balance and adjust the production levels to achieve an equilibrium to maximize their revenues relative to the demand. In this manner, the OPEC countries can control their revenues that they generate from oil which also fuels their economy. Furthermore, this has allowed many of the OPEC countries to fund the high level of social programs that they have in their countries. These social programs are necessary given the fact that these economies are almost solely run on the revenues generated from oil revenues.

However, the strategy was significantly altered when OPEC made the decision to maintain production levels in November 2014, despite the fact that this was certainly a decision that was understood to throw off the market equilibrium given that the decision was made with weak demand in the market. The previous strategies in such situations, the OPEC countries will curtail production under such conditions to attempt to maximize profits under an equilibrium condition. Saudi Arabia, which is the biggest producer in the OPEC group, produced 10.3 million barrels per day. It also offers discounts to protect its market share in key strategic regions to countries in Asia and India. It is likely that the Saudis produced this strategy to hurt the US shale oil producers since the lower prices in the market by the production levels could have put pressure on these operations by reducing their margins (Agnihotri, 2015).

Thus, instead of OPEC\'s production levels have been put in place to influence world oil prices and artificially subvert the new forms of competition in the global market. However, at the same time, this also has exposed many of the OPEC to a substantial amount of risk. Venezuela is an extreme example, given it is on the brink of insolvency, but even Saudi Arabia\'s domestic revenues have significantly fallen and the country has been forced to use its reserves. Saudi Arabia, by comparison to Venezuela, had more reserves than everyone else in OPEC as well as more access to capital in general. Therefore, the Saudis may be destroying other OPEC member nations, like Venezuela, with it plans to continue with its long-term plan to suppress market prices (Raval & Kerr, 2015).

The OPEC production levels have produced some mixed results and did not hurt the US industry as much as originally expected. According to the data from Baker Hughes Inc. dated 20th February, the number of rigs for drilling oil is the smallest in the United States since July 2011; the figure fell by 37 last week to 1,019 as well as 556 were withdrawn from service since 5th December (Taneja, 2015).