Caracas Chronicles

Last time, I explained it like this: it’s as if you had a small abasto that spent more money than it takes in in sales each month. The abasto can hardly come up with its monthly loan payments, and so it sure feels like it’s broke. But there happens to be an unfeasibly huge amount of wealth in the form of morocotas — old Colonial gold coins — buried in its backyard.

In what sense can we say that abasto is broke? 

If you’re in Washington today, you can pop down to Brookings this afternoon and hear Francisco Rodríguez and Ricardo Hausmann hash this out live. If you’re not, you can read the for-dummies version right here.

How to be rich and broke

One possibility is that the abasto isn’t really broke, but rather circumstantially broke because the encargado, the guy who runs it, has gone stark-raving mad. In this interpretation, the wealth the abasto needs to right its finances is right there for the taking. A skilled caterpillar operator could start digging it up tomorrow, but it just so happens that every time the encargado goes out and hires a caterpillar driver to dig it up he loses it and shoots him in the head.

This interpretation leaves critics like Hausmann, who’ve argued strongly that the abasto needs to declare bankruptcy, in a strange kind of Catch-22.

In this interpretation, the abasto is bankrupt, but only in a highly peculiar sense. That its wealth is inaccessible is not a characteristic of its wealth, but of its leadership. If you could pry the keys to the store away from the encargado you would very quickly find that the store isn’t really bankrupt at all. It’s just criminally mismanaged.

This interpretation leaves critics like Hausmann, who’ve argued strongly that the abasto needs to declare bankruptcy, in a strange kind of Catch-22. The store is bankrupt because its managers are crazy. The managers are so crazy, in fact, that they refuse to see reason and declare bankruptcy, even though they run it in a way that’s plainly incompatible with servicing its debts.

What the store needs most right now is new leaders with the clarity of mind to see that. But if the store had leaders with the clarity of mind to see that, it wouldn’t be bankrupt at all, because a minimally sane leader would just hire a caterpillar operator, get him to dig up the gold, and refrain from shooting him!

I think this is a powerful argument. At the very least, it has an intuitive plausibility that you can’t dismiss. But I don’t think it’s the end of the story. It relies on a bit of rhetorical sleight-of-hand that doesn’t really fly in the real world: it confuses a flow problem for a stocks problem, it confuses the balance sheet and the income statement.

It’s about Flows, not Stocks

If you look at the total stock of Venezuela’s public debt ($150 billion, give or take) and compare it to the total stock of its oil reserves (300 billion barrels) then the problem seems childishly simple. There ain’t nobody between here and Timbuktu who would value a barrel of oil at less than 50 cents. By any conceivable stretch of the imagination, 300 billion barrels are worth more than $150 billion. Case closed. Right?

Well, maybe. If you had 300 billion barrels of oil already produced and delivered to port and ready to ship, they would obviously be worth much more than $150 billion. But the reality is you don’t: you have 300 billion of oil stuck in bumfuck nowhere Guarico, under a few kilometers of dirt, and there’s no technologically feasible way to get them all out at once. (And, environmentally speaking, a very good thing that is, too.)

Even if you quintupled Venezuelan production to 12 million barrels a day you’d only pump out about 27% of our reserves out of the ground in the next 25 years.

The 300 billion figure is actually a bit of a red herring. You can spreadsheet it any which way you want, but even if you make genuinely heroic (read=crazy) assumptions about how much you’re going to increase production, you come back to the conclusion that the vast bulk of those barrels will never see the light of day. With technological advances closing in on the oil industry from every direction, it’s hard to imagine oil making it more than another quarter century as a leading transport fuel. And even if you quintupled Venezuelan production to 12 million barrels a day (which nobody remotely sane thinks is feasible) you’d only pump out about 27% of our reserves out of the ground in the next 25 years.

The other three-quarters? Never coming out.

For all intents and purposes, then, Venezuela’s oil reserves aren’t large, they’re infinite. Within the period of time when you can reasonably figure oil will have any value at all, there’s no feasible way to get at them all. They are like 433 Eros, the far off asteroid made of solid gold: the wealth they contain is as theoretically limitless as it is practically irrelevant.

What markets are really concerned about isn’t the stock of reserves but the financial flows they can sustain. The question isn’t how much oil there is, but how much of it you can turn into money and at what rate and how much debt you can finance out of that flow. And this…this is where things get dicey.

Borrowing against decomposed zooplankton (a.k.a., oil)

If you have wealth that’s virtually limitless, why wouldn’t you continue to borrow against it in perpetuity? Offer investors semi-reasonable conditions and they’ll be lining up around the block precisely because — did we mention? — your resources are basically infinite. Isn’t this is the exact type of problem credit markets were invented to address?

Credit, of course, comes from the latin credere, to believe. Aye, there’s the rub. Investors have to believe that future you is going to honor the promise present you is making. And what calculus will go into making that decision?

If your borrowers are smart too they’ll price your next expropriation into your cost of credit today.

Well, let’s see. First they’ll look at your track record. They’ll realize that you have this nasty habit of reneging on your promises to investors every few decades…sweeping new oil laws in 1943, 1975, 2004 fundamentally changed the rules of the game, each time against investors’ interests.

If they’re smart, they’ll realize that the reason you do this is not that you’re nasty, but that you’re smart: a sovereign has a permanent built-in motivation to expropriate concessions that produce outsized rents. If your borrowers are smart too they’ll price your next expropriation into your cost of credit today.

If they do that, they’ll implicitly underbid for the resource stream, charging you today the cost of the expropriation they figure they face tomorrow. But if they do that, they won’t offer all the credit you need to develop the stream!

This kind of situation can reliably lead credit markets to fail, and not because the encargado is crazy but because he is sane.

In a situation like this, borrowers have no good incentive to make promises they can keep and, as a result, lenders have no good reason to believe the promises made to them. Market failure of this kind can create a situation where it’s impossible to raise the capital you need today to develop financial flows out of a stock of wealth that is, in some sense, unlimited.

In the economist’s jargon the provision of credit will be sub-optimal: less than would be efficient in a market where the promises made were worth keeping, and therefore worth believing. This doesn’t mean there’ll be no credit, just that it will be costly.

Too costly to be worth contracting? Too costly to service?

Conceivably. And if you add in the cost of servicing pre-existing debts taken out by the old, psychopathic encargado too…well, then it’s more and more conceivable.

It’s a deeply thorny question…and one to which, for sure, we’ll keep coming back.