Adjustment or collapse? The case for collapse

2013-12-19T102108Z_2_CBRE9BI0E7400_RTROPTP_3_NOMURA-EARNINGS_originalAs the debate about whether Venezuela is facing macroeconomic adjustment or macroeconomic collapse rages on, some traders* at giant Japanese investment bank Nomura make the case for collapse about as succinctly as is possible:

“Let us start with the one-liner of our trip last week: we came back more concerned about Venezuela. It is becoming clear that Sicad II will not be used as a vehicle for a fiscal and external adjustment any time soon. Senior government officials understand the need for a more coherent FX regime, but they themselves recognize that the political and social context to make it happen is not there. The timing and size of the latest PDVSA issue is just a manifestation of this – by allowing PDVSA to sell just a few weeks of exports through Sicad II, the company would have collected the same amount of resources without further deteriorating its creditworthiness.”

Here’s the context: When Sicad II came into existence, most people (myself very much included) assumed it was a fig-leaf for devaluation. Sicad II would allow a dollar seller to turn a given number of dollars into many more bolivars, and in Venezuela the overwhelmingly dominant seller of dollars is PDVSA, which then turns the resulting bolivars over to the government.

Everyone’s assumption was that Sicad II was  just a “polite” way of devaluing – i.e., allowing PDVSA to turn the same number of dollars into a greater number of bolivars. If that’s not the point, it’s sort of hard to see why they went to all the trouble.

Devaluing to the Sicad II rate would end most of the government’s fiscal problems instantaneously.

What Nomura’s traders point out is that Sicad II is not (yet) being used as a vehicle for devaluation. PDVSA is still not selling its petrodollars for Bs.50 each. So the government remains deep in the fiscal hole: spending many, many more bolivars than it takes in. Which is why PDVSA has been having to borrow the shortfall instead, by issuing fresh bonds at very high cost.

Is the decision to let PDVSA keep piling up debt rather than let it “jump” to the Sicad II rate with both feet a sign of a pre-meditated belief in gradualism? Is it evidence of a power struggle over key policy levers? Is the willingness to keep issuing very high cost debt when a low-cost alternative solution is close at hand a matter of just sheer stupidity? Or does it show someone working extra-hours protecting their arbitrage margins?

We don’t know. We do know it’s awful policy-making. It is, by any reckoning, remarkable that the government would keep flirting with hyperinflationary conditions and default this long after it’s created the institutional mechanisms for an exit.

Ultimately, though, the “collapse” narrative is not persuasive to me. Here’s why:

Venezuela’s state finances are like a weak swimmer who’s gotten way out of his depth. Everyone can see he’s flailing. His arms are tired. He’s struggling. His head bobs under the water now and again.

And yet…there’s a lifesaver right there, within easy reach, for the taking. That lifesaver is called devaluation.

The spectacle of the struggle is frankly discomfiting, because it’s so obvious to everyone what the swimmer needs to do. It’s hard to make sense of his resistance to grab onto it. Everyone can see he needs it.

To me, the very fact that the swimmer isn’t frantically reaching for that lifesaver suggests that he isn’t in quite as much trouble as horrified observers figure he must be.

To argue Venezuela is edging toward hyperinflationary/default collapse is to argue that that swimmer’s going to end up drowning, even though a lifesaver is right at hand.

It’s not impossible, of course: maybe he’ll judge his strength wrong. Maybe by the time he panics and reaches out for the lifesaver, it’ll be too late. But, ultimately, the smart money must still be on the idea that, when push comes to shove, the government is going to maxi-devalue.

Countries don’t collapse if they have a choice. Venezuela has a choice.

*Ojo: The paper comes from Nomura’s trading desk, not its research and analysis department. People misunderstand the Chinese wall involved all the time, but there’s a thicket of rules and regulations at play here and Nomura does not (and cannot) claim the material its traders produce is investment advice, in part because incentives are plainly different between traders and analysts. So there’s that.