Caracas Chronicles

It takes a minute or two to fully absorb this Bloomberg chart:

It shows the correlation between oil prices and Venezuelan sovereign bond prices. Venezuela’s ability to pay its debts is tightly bound up with PDVSA’s earning power, so oil prices and Venezuelan bond prices usually move in lockstep. In normal times, the more money oil brings in, the less international investors perceive Venezuela as a default risk, the more Venezuelan bonds they’re willing to buy.

But these are not normal times: the republic and PDVSA have been issuing new debt at such a dizzying rate – $10.8 bn just since last August! – that not even the Oil Boom of 2011 can sustain investors’ faith in Venezuelan paper. And so, as oil jumps to over $100 a barrel again, that longstanding correlation between the price of oil and the price of Venezuelan bonds has broken down.

To my mind, this all comes back to Giordani’s batshit-crazy Forex policy: thanks to his convoluted Sitme mechanism, Venezuelan dollar buyers are forced to keep selling sovereign bonds abroad to gain access to dollars – a steady and “artificial” source of downward pressure on bond prices that, arguably, is not directly related to the country’s capacity to pay. And since the system can only remain “liquid” with a steady supply of fresh paper people can buy for bolivars and sell on for dollars, the only way the government can keep the Forex market supplied is by issuing more and more and more debt.

It really is madness.

So do those tanking bond prices show Venezuela really is the riskiest place to buy sovereign bonds on earth?

Not necessarily. To put it an Austrian spin on it, government intervention always distorts prices and distorted prices always carry faulty information about underlying economic realities involved. Just like the government’s ham-fisted intervention in the market for sanitary towels makes the sticker price on a pack of Kotex convey faulty information about their scarcity, forcing women to scurry all over town trying to find one during their time-of-month, its ham-fisted intervention in the currency market distorts the sovereign bond market, leaving bonds with prices that convey screwy information about their own riskiness.

El librito – the standard macroeconomic textbook – has nothing very specific to say about the twisted nexus of distortions that goes by the name of Sitme: it’s too weird a mechanism to have received a lot of theoretical attention. (I don’t know of any other country that’s ever tried anything quite like it, actually.) So I’m leary of making grand ponouncements on the basis of a mechanism that nobody understands all that well.

My sense is that reading Venezuelan bond prices too literally as an indicator of default risk is not quite right under these circumstances.

Yet it’s also clear that any currency control regime that depends on an endless supply of new bond issues is…let’s say, “suboptimally sustainable”.