Venezuela is a Ponzi scheme

Quiet ... con man at work.

Quiet … con man at work.

(Posted on Foreign Policy´s Transitions blog)

A pyramid scheme called Venezuela
By Juan Cristobal Nagel

Hugo Chávez, Venezuela’s embattled president, is living on borrowed time. The real problem for Venezuelans, though, is that their economy is also living on borrowed time, and the day of fiscal reckoning may be near. Venezuela has an enormous fiscal deficit, and it is running out of places to borrow from. Like Ponzi schemes, the Venezuelan government needs ever growing sources of funding in order to keep paying for the generous promises it has made to its people.

The Chávez administration’s record on fiscal issues is, in pure chavista fashion, deeply red. Last year, in order to secure re-election, the fiscal deficit reached 15 percent of GDP, according to The Economist. In spite of record high oil prices that saw state revenues balloon relative to historic levels, the government found that it had to spend billions of dollars it did not have to give people appliances and apartment homes.

But 2012 wasn’t a one-off affair. Even though the deficit was absurdly high, it was only fitting for an administration that has rarely balanced its numbers. In 2003, for example, the fiscal deficit was around 5 percent of GDP. Only in 2005 and 2006 did the numbers look reasonable — but population growth and increased subsidies mean those days are gone for good.

Foreign banks lend to Venezuela at very high rates, reflecting the inherent uncertainty of lending to a country where one person makes all the decisions. The extra yield from Venezuelan bonds demanded by the market in order attractive in comparison wtih U.S. Treasury bills is 722 points — more than double that of countries such as Sri Lanka or Zambia, and much higher than neighboring, slumping Brazil. In spite of this, or because of it, bankers have benefitted mightily during the Chávez years.

That is mostly due to the fact that Chávez never misses a bond payment. In a provocative article, Bloomberg’s Ye Xie and Nathan Crooks report that, over the years, Venezuelan bonds have yielded 14.7 percent annually, a very high figure even for emerging markets.

As it likely faces yet another presidential election, the government is desperate for new funding. In the last few years, it has received fresh money from China (at, presumably, better rates than the market) as part of an obscure loans-for-oil scheme, the details of which have yet to be fully revealed. But recent reports suggest the Chinese are reluctant to continue with the flow of money, citing unhappiness with the uses to which their funding is being put and the quality of the oil being provided.

This spells trouble for Venezuela. The situation — large historical returns to investors, a structural inability to balance the books, complete lack of transparency on how it gets funding and what it spends on, and an increased scrambling for ever higher sources of funding just to stay in business — has all the classic marks of a Ponzi scheme. Substitute “Bernie Madoff” for “Hugo Chávez,” and the situation in Venezuela looks remarkably similar to the famous pyramid built by the notorious American fraudster (except, perhaps, for the fact that Chávez will never go to prison).

After 14 years in which he has expropriated everything from oil companies to jewelry stores, one thing is clear about Hugo Chávez: He loves other people’s money. But as with all Ponzi scams before him, there will come a point when El Comandante will run out of cash. Only high oil prices are preventing this house of cards from collapsing.

Someday, the music will stop, and Venezuelans — and their bondholders — will be left with the bill.

24 thoughts on “Venezuela is a Ponzi scheme

    • The BMI thing also has to do with being an oil exporting economy. The same way China undervalues its currency to stimulate its exports, Venezuela’s only export is already dollarized. So instead Venezuela overvalues its currency to stimulate imports and keep the population from being priced out of the market for basic goods and getting angry — but without having to distribute much of that money from government coffers since they are extensively paying into the subsidy ex ante. It’s ludicrous. But that’s why.

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  1. There is a book by John Galbraith titled “The Affluent Society” where he notes the correlation of debt and consumer demand, persistently increased public spending via a “dependence effect”, and, as as demand goes ever higher with the availability of capital, that individuals must seek more and more creative ways to finance things. It would start slowly with slightly higher rates and longer terms on the debt and changing to other, more exotic financing like extra-market funding as conventional means dried up due to being over-leveraged.

    Who knew that a microeconomic theory on an impending U.S. credit catastrophe would be turned into a macroeconomic policy?

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  2. In a true Ponzi scheme, there are no assets, that is why it amounts to fraud. Further, there is no possible mechanism to insure that the obligations entered into will ever be paid. On the other hand, when states are involved, there are always taxable citizens, so investors can demand changes in governmental behaviour and policy to obtain future repayment. Venezuela may sell bonds offering a Ponzi rate of return, but investors are not being defrauded.

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    • The Ponzi scheme in Venezuela victimizes the population, they are the ones being defrauded and given the impression of having returns on their stake in Venezuelan oil.

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    • Well, to continue the conceptualization of Venezuela as an private entity/Ponzi construct, bear in mind that a corporation or other entity typically has two sources of money: equity and debt. While you are correct that Venezuela can issue bonds and, admittedly not having missed a payment, isn’t defrauding the bondholders, what about the other side of the equation?

      The citizenry of Venezuela more or less provides the equity; they are after all, the owners/stakeholders of the res publica. Would you argue that they aren’t being defrauded, except for a handful that much as in a Ponzi scheme, got in the ground floor? The Boligarchs seem to be doing swimmingly, but those down the chain, the average citizen, seems to be getting a diminished return. Moreover, as in a Ponzi schema which you note, there is no mechanism that they will ever see a return on their investment.

      Now, I’ll concede the point you make that the citizen-cum-investors “can demand changes in governmental behaviour” but in Venezuela, you a). are not guaranteed this will happen (see previous 14 years) and b). unlike a bondholder or equity investor, you cannot sell your position to recoup perceived or real losses – particularly if you happen to be in a 49.9% minority position.

      To keep within the metaphorical Ponzi scheme of Venecorp going, its a real agency problem where the agents interests are horribly misrepresented and misaligned from that of the stakeholders. However, as long as they can keep funds rolling in and trickle returns back out, they’ll remain in their jobs. Sadly, the required return for the majority of the “equity investors” is so remarkably low (or the real returns are so obfuscated) that they don’t realize they could receive a much better rate of return elsewhere. This is the curse of living within Venezuela – you either know and are powerless to change it, or you don’t and live in blissful ignorance on potatoes and carrots (or, in this case, perhaps arroz y caraotas is more apropos) when you could dine on steak and caviar.

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      • This is by far one of the best analyses I’ve read about the situation in Venezuela. Good job Pitiyanqui, spot on!

        Just to add something very briefly regarding the required return of the “equity investors”; the standards of the majority of the population in Venezuela are so low that they don’t even realise how much better they could be living. Nevermind that they will never be able to afford a house, a car, etc and that they will have to live from miserable salaries forever. They just seem not to care. This is very easy to prove when one considers the electoral results that come out year after year.

        As I mentioned in a post before which talked about Venny/PDVSA bonds, my logic of owning these securities is based on this same point. The Govt. can cut back on so many things first and devaluate even more before defaulting on its obligations because the required return of equity investors is so low that it could allow for many adjustment measures. I believe this is what most of Venezuelan economists fail to understand.

        There are many things one can look at to have an idea of when things could turn bad, the most important being oil prices. But then again, isn’t this what Venezuela has always been about? Investing in its bonds is just a bet on oil with a premium due to the stupidity of Chavez.

        I don’t see any new information in the market that should lead people to look at the country differently. What is the big fuzz all about then?

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      • The original post identified “investors” and “bondholders” as persons potentially victimized in the Venezuelan Ponzi scheme, given the historically high returns on Venezuelan bonds, the lack of transparency, etc. But in fact, investors know exactly what kind of regime they are investing in; they may be greedy, but they are not, in general, being defrauded.

        Flipping the analogy on its head, and arguing that the Venezuelan people generally, and not investors in particular, are being defrauded, is a better analogy. My impression is that 75% of what is promised to the population by the leaders of the revolution comes to nothing, and that the leadership either knows this, or is willfully blind to it.

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  3. Jeffry House @February 5, 2013 at 12:24 pm
    In a true Ponzi scheme, there are no assets, that is why it amounts to fraud.

    That would be true of a “pure” Ponzi scheme. However, it is fairly common for a loan pyramid to be based initially on some real assets. For instance, the bus company in Newark, NJ, circa 1967. Like most private bus companies, it had ceased to be profitable, but the owner borrowed money to keep going. To pay the interest on the initial loans, he borrowed more. His regular interest payments established a “good credit” rating, and so he was able to borrow even more. The assets of the bus company were worth about $10M; he pyramided the loans up to about $50M before the banks finally caught on.

    On the other hand, when states are involved, there are always taxable citizens, so investors can demand changes in governmental behaviour and policy to obtain future repayment.

    Tell that to holders of Imperial Russian bonds. A sovereign state can refuse to pay, and short of the holders getting their governments to invade the country and seize whatever assets are there, they cannot compel repayment.

    There have been many large sovereign-debt defaults in recent years, and also a number of cases where bondholders were forced to take “haircuts”, losing 20% or 40% of the principal.

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  4. Venezuelan economist Jose Guerra sent me this interesting article.
    Although the idea of equating the whole of Venezuela with a Ponzi scheme seems compelling and is a good metaphor, I sadly do not agree with the ending. Ponzi schemes always are discovered in the midst of a horrible scandal. The scandal is followed by swift trial and prison, and that is the end of that story. We have seen this in the cases of Madoff, Rothstein and Stanford. Unfortunately that will not be the case of the “Venezuelan Ponzi scheme.” I have lost track of the many times that well known economists warned me of the demise of the Chavista regime as a result of financial breakdown. Fourteen years later(!) once more, respected economists are predicting another Venezuelan financial meltdown. Even though I highly respect most Venezuelan economists as good hard working professionals, they seem to always get it it wrong. The demise of the Chavista regime will never be the result of financial problems, much less an ending like that of Ponzi schemes. Just think of this: 1) PDVSA just decided to lower its outlays to Fonden with its corresponding effect on BCV’s monetary reserves, 2)PDVSA also anounced that it will change the conditions of the sales financing of oil exports to the Caribbean, exept Cuba of course. If they decided to stop financing altogether and charge cash for their total exports what would the situation be? If (ok it is a big if), PDVSA were to be succesful in raising production by say 1 million barrels a day, what would the result then be? It is a blessing and a curse at the same time. But again, Venezuela because it has endless amounts of oil, will always find a way to wriggle its way out of a meltdown. Meanwhile, the country will always remain undedeveloped, its democracy always on the verge of becoming a sad joke, and a mecca for “el mas vivo.”

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  5. I agree that “Ponzi scheme” works as a kind of suggestive simile, but if you push it too far it soon breaks down as a description of the underlying dynamic.

    Venezuela sits on almost 300,000,000,000 barrels of oil – worth $3 TRILLION dollars ($3,000,000,000,000 – count those zeroes!) at today’s prices.

    The whole point of a ponzi scheme is that there aren’t any actual underlying assets to back the impossible promises made.

    The Venezuelan tragedy is that there are…

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    • I am guessing 3 trillion is the discounted Chinese price? That would be a fair statement giving that the current direction is them owning it anyway.

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    • Exactly Sr. Francisco Toro!!!
      The Venezuelan story is indeed a tragedy. The country (and I mean everyone that lives and works there) seems not to be able to disentangle itself from the curse of having relatively endless reserves of the “devil’s excrement.” I truly wish Venezuelan economists started thinking outside the box. They cannot keep making predictions based on their conventional academic and professional experience . If those oil reserves numbers are not enough to make them think differently then I don’t know what can. If fourteen years of failed economic predictions can not change them then I don’t know what can. What is amazing is that Venezuela does have very good economists.I personally know some of them. So, what is the answer to that?

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      • The problem with the predictions has been that the price of oil has been unpredictable. Chavez has had to make three significant adjustments to the economy, one in 2002, another one in 2003 and he last one in 2008. In each case, the price of oil prevented the dire predictions from becoming true, but some effects were felt. If the price of oil jumps to 200 today, then the current crisis will be avoided. But in the end it is not thinking outside the box. Having so much oil underground is useless unless you begin to exploit it. During the last 14 years there has been little new production of oil, meanwhile, the country has been incurring new debt to amounts that severely limit the range of action based on current production. If Chavismo had thought outside the box, they would have rushed to double oil production to guarantee endless financing of their revolution. Curiously, they seem to have done exactly the opposite, creating new rules that limit what they can do, destroying the know how and increasing debt, before they could see that they could increase it beyond a certain limit. The devils excrement is that precisely because it is so easy to improvise and push the problems to the future. But when one sees what is happening in North Dakota, Angola and Iraq with oil production is scary, because in two or three years, we could see a temporary sharp drop in oil prices which could make the worst predictions optimistic.

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        • “…because in two or three years, we could see a temporary sharp drop in oil prices which could make the worst predictions optimistic.”

          I very much agree with Moctavio’s statement above. One of the reasons why oil prices have shot up over the last few weeks is as a direct result of QE (insert number here: …..) money flooding the market.. The US Federal Reserve is pumping all kinds of liquidity into the market, which is finding its way toward oil futures. Low interest rate money is used for oil speculation. Simple. The returns are huge. Here’s the kicker though: oil inventories have never been higher! As Moctavio stated above, there is all kinds of ‘new’ oil coming into the market over the next 5 years, especially from countries like Iraq. So, yes, oil prices could indeed tank,…big time!,…. over the next 2 to 3 years. Then what?

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    • Not so fast. Your argument is like saying that Greece is not really bankrupt because it has the Parthenon and hundreds of little islands it could sell and pay off its debt. There is a reason the correct indicator is Debt as percentage of GDP, not as a percentage of a country´s “assets.”

      Furthermore, it´s not just the debt, but the unfunded liabilities this government has created. We have promised people that we won´t devalue, that we will give away gas for free, that everyone gets a pension, that the government will provide housing for everyone, etc etc.

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    • Depends on your definition of getting “out”.

      A couple of examples that spring to mind and will be near and dear to everyone’s heart: Rafael Baduel, Eduardo Manuitt, Didalco Bolivar, and of course, Aponte². Given her long relationship within the government as a judge, you might also want to include Afiuni, although all things being considered equal, that seems almost cruel.

      Much like a Ponzi getting in is a lot easier than getting out.

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  6. Juan: Good article. It’s 722 basis points (could be 722 points some time in the future with current policies-lol). As for the excellent comments, no one has mentioned possible future extreme worldwide financial distress, with current policies of buying your way out of a debt crisis by issuing still more debt not being either sound or sustainable in the long run; this, in turn, would sink oil prices, as well as Venezuela.

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