Basic Economics: A Look Into What Happened to Venezuela

Written by: Aaditya Kumar

Inflation is synonymous with increasing prices, but it also means a decrease in a currency’s purchasing power. Typically a country tries to keep inflation under 10%, but when adverse economic shocks hit, the rates can spiral out of control. A more extreme version of inflation, hyperinflation, is marked by inflation exceeding 50% for a fiscal year. Hyperinflation causes a myriad of problems for a country, but the driver of most of these problems is that wages are slow to adjust, while prices are not. This results in workers having substantially less purchasing power under hyperinflation, which can lead to unemployment and poverty. There have been a few episodes of hyperinflation throughout human history, with many ending in a radical change. For example, China was plagued with hyperinflation towards the end of World War II, which ultimately led to the rise of Mao. Similarly, Germany suffered an episode of hyperinflation at the end of World War I, causing a sentiment that put the Nazis in power. Over the past decade, the world has witnessed a new episode of hyperinflation in Venezuela stoking fear about what might happen to Latin America’s biggest oil exporter.

Traditionally Venezuela’s currency, the bolivar, and the Venezuelan economy have depended on oil exports. More than 90% of the country’s export earnings came from oil. But, the global price of oil dropped in the 1980s, causing demand for the bolivar to plummet. As the currency’s value fell, the cost of imported goods rose. This positive feedback loop was the impetus that forced the economy to spiral out of control. Each Venezuelan president developed solutions with mixed results, but the strategy of Venezuela’s most recent president, Nicolas Maduro, was to print more money. Printing money seems like it should not be a viable long-term solution. Nonetheless, it can keep the economy moving during a short recession, and then the government can institute more comprehensive policy later. But, the oil crisis did not get better as prices continued to fall; this caused international investors to look elsewhere, driving the bolivar’s value even lower. Paired with the continued oil shock, printing more currency exacerbated the problem. As prices rose, the government printed more money to pay its bills, inciting hyperinflation.

Naturally, a situation like this makes saving money in the local currency nonsensical. As a result, Venezuelans started to convert their savings into other currencies, like the US dollar. This behavior lowered the value of the bolivar even further. The government responded by issuing a ban on all legal currency exchanges in order to stabilize the money supply. However, these controls did not extend to the black market, meaning that this policy was not as effective as anticipated and people continued to sell bolivars for dollars. In response to his monetary policy not working, Maduro tried to print more money again but under a different name: currency devaluation. Maduro devalued the bolivar by 95% and tied the new currency to oil price to prove that the Venezuelan economy had a firm footing. Maduro’s government hoped this policy would get Venezuelans to believe in their own money and economy, thus paving future stabilization. But soon after the devaluation, it was clear this policy had not worked. At this point, the Venezuelans had no reason to trust the government, given their general authoritarianism, incompetence, and lack of interest in other critical issues, such as poor health outcomes, food shortages, and poverty.

Under Maduro, Venezuela entered a period of rampant hyperinflation. Inflation rose from 69% in 2014 to 4000% in 2017, and to an estimated 10 million percent in 2019. Another way to view inflation is through exchange rates. In 2010, the exchange rate was 2.15 Bolivars to the US dollar, which increased to 10 bolivars per dollar in 2016, and roughly to roughly 250000 bolivars per dollar in 2020. Inflation became so bad that the Venezuelan government stopped producing inflation estimates and many vendors stopped providing price tags on goods because it became too expensive to keep up with the prices. In addition to unpredictable pricing, hyperinflation plummeted Venezuela’s monthly minimum wage, from $360 in 2012 to $2.80 in 2019. Usually a drop in wages means an increase in labor; however, due to hyperinflation sabotaging demand for labor, unemployment increased dramatically from 7.3% in 2016 to 35% in 2019. Such conditions dramatically deteriorated Venezuelans’ well-being, resulting in a mass exodus, where roughly 16% of the population are refugees and migrants. 

President Maduro has insisted several times after his devaluation policy to rebrand the bolivar to cut against inflation, but this would have the same negative outcome of his devaluation policy. Many economists believe that the only way to stop inflation is to tie the currency to a real basket of goods or commodities and then have inflation predicated on that basket. Yet, this might not even solve the problem. The crisis in Venezuela is a salient example of how a system’s strength is contingent on citizens’ shared confidence in it. This means that it matters who leads a system and how that person has come to be in charge. When a system has a leader such as Maduro, who not only has demonstrated incompetence to solve the problem but is also connected to illicit drug activity and election fraud, it is not easy to have faith in the system. This is an argument for a democratic process and a process where leaders are incentivized to perverse the system for the benefit of their people. Looking forward, the only way for the Venezuelan economy to recover is by the removal of Maduro from office in order to help heal the lack of trust Venezuelans have in their system.