Dispatch from a Normal Petrostate

When oil prices collapsed, the Canadian dollar took a tumble. Consumers took a hit, but for businesses, it was a big boost. Walk with me on a tour of macroeconomic adjustment in a petrostate run by sane people.

As many of you know, a few years ago, I traded one petrostate for another, moving to the snowy wasteland/socialist utopia that is Canada.

Like every petrostate, Canada’s been struggling to cope with the effect of the collapsing oil market. It sucks. The Budget Deficit is expected to soar to $18 billion (Canadian) – or about 0.74% of GDP. (Don’t laugh, that’s considered a lot around here.) Alberta, the most oil dependent province, has a serious hole in its budget. GDP is growing slower – though still growing – and, most noticeably, the Canadian dollar is down.

Way down.

Canadian Dollar

At the height of the oil boom, five years ago, a Canadian dollar was briefly worth more than a US dollar. But when oil prices tanked, the loonie – our affectionate nickname for the Canadian dollar, after the cute duck duck-like aquatic bird no real Canadian would ever mistake for a duck (happy now?) on the one dollar coin – did what you’d expect it to: it tanked right along with it.

In Canada, in winter, everything you eat that’s not in a can was probably imported from somewhere.

That’s logical – with oil exports bringing in fewer and fewer gringo dollars, there was less and less demand for loonies. And absent price controls on the currency – since, thankfully, we’re governed by sane people – that meant a weakening Canadian dollar.

Let’s be clear, nobody around here is happy about the weaker dollar. Last month the loonie slipped to just 68 US cents – a traumatizing experience for the snowbird set.

The loonie has since rallied a bit. It’s up to 74 US cents now. That’s still quite weak, though. So the price for imported goods has shot up, and in Canada, in winter, everything you eat that’s not in a can was probably imported from somewhere. Last month the New York Times rebranded us the Land of the $8 Cauliflower. Yikes!

So there’s plenty of grumbling about, yes, but that’s not the end of the story. There’s also opportunity.

Canada’s gone through one helluva macroeconomic adjustment, alright, but nobody had to sit around waiting for a minister to announce it.

The weaker loonie is rocket fuel to Canadian companies that do business abroad. Suddenly, they can offer much better prices to foreign customers.  Why? Because for one thing, hiring Canadians has gotten a lot cheaper. Five years ago, that Ontario minimum wage of $11.25/hour cost companies, well, 11 US dollars and 25 US cents an hour . Now, that same minimum wage costs just $8.35 in US money. When you’re competing in manufacturing markets with paper-thin margins, that makes a big difference.

Long story short, in Canada the Oil Bust doubles as a Manufacturing Boom.

And it’s not just manufacturing; the service sector’s doing better too. Here in Montreal we have gringo tourists pa’pegar pal techo these days: it’s no wonder, visiting here’s gotten ridiculously cheap for them.

And equipment that’s no longer being used to dig up the Albertan tar-sand that’s no longer profitable to sell as oil is being auctioned off at what – to international buyers – are amazingly low prices: of course they’re amazing, everything is 25% off just from the fall of the dollar!

Notice how crazy life is when you have a floating exchange rate. Canada’s gone through one helluva macroeconomic adjustment, alright, but nobody had to sit around waiting for a minister to announce it. There was no #GalloPeloning, no waiting for announcements of announcements of announcements.

Oil prices fell, less hard currency came into the country, the loonie fell, imports became more expensive, exports became cheaper, oil producing provinces got poorer, manufacturing provinces richer and equipment that used to be devoted to oil got redeployed to more profitable uses in other industries.

No one person consciously designed any of it. It just sort of…happened.

That’s the magic of the price mechanism. It coordinates economic activity without any need for a Gaceta Oficial. After 13 years of currency controls, Venezuelans have just forgotten this kind of adjustment is even possible, much less desirable.

But walk with me on a little thought experiment. Follow along as we ask what would happen if Nelson Merentes went insane and floated the bolivar tomorrow.

The exchange rate would obviously shoot up. How high? No one can tell. The only reference point we have is for the Cucuta Market, a market where the Venezuelan state is not a net seller of foreign currency.

As it turns out, now that the oil crunch has destroyed the profitability of the oil industry, the Venezuelan government might not be in any position to be a net seller of dollars in a floated market either. So let’s go all out, let’s say that after a float the bolivar collapses to Bs.1,000 to the dollar. A catastrophe, right?

So what happens when you float the bolivar? The exact same thing that’s happened in Canada – only more abruptly.

Well yes…and no. Many prices would jerk up, for sure. But it’s also true that at Bs.1,000 to the dollar, the cost of employing a minimum wage worker in Venezuela is…kind of crazy. $12 a month? $20 once you’re through paying non-wage costs?

That’s about a third below the minimum wage in Burundi.

OK, say the exchange doesn’t shoot up to 1,000. Let’s say it goes to 500. At that level, the minimum wage would still be 16 times lower than in China, where the typical production worker earns $650 a month. What if it goes to Bs.250/$? You’re still eight times cheaper than China.

So what happens when you float the bolivar? The exact same thing that’s happened in Canada – only more abruptly. As the bolivar weakens, Venezuela could zoom from having one of the world’s least competitive economies to one of the most competitive, helped along by a relatively well educated workforce and in-the-grand-scheme-of-things, not-so-bad infrastructure.

The day after a float, then, the Investment Rush would start. You’d see Chinese companies outsourcing production operations to Venezuela, and not just Chinese: any big industrial company anywhere in the world would lap up $20-$80/month wages in an instant. It’s too good to miss.

Of course, if you accompanied the exchange rate adjustment with sensible reforms to make labour markets less rigid and property rights more stable, you’d get still more investment dollars.

Venezuelans have forgotten all about these dynamics.

But even if you don’t reform, even if you keep all the inefficiencies and all the craziness involved in producing in Venezuela today, there is some price of the bolivar at which capital would say “y’know what, that’s too good a deal: let’s go down there and set up a factory”. If you let the exchange rate float, the market will find that rate.

Of course, as the investment dollars pour in, the exchange rate would tend to strengthen and wages would rise until dollar-equivalent wages came to something that more reasonably reflects the underlying productivity of Venezuelan workers. Oil’s loss would become manufacturing’s gain. Just like in Canada. Some of the export revenues lost due to lower oil prices would be made up by higher exports from industry, from agriculture, and from tourism.  Just like in Canada.

What’s ironic is that even as the government goes on and on about “overcoming the rentier state” and moving towards a “productive model”, it fights tooth and nail against the one policy move that actually would help overcome the rentier state and shift productive resources from natural resource extraction to tradable manufactures and services.

But it’s not just the government. Venezuela’s entire political class has forgotten all about the way Exchange Rate dynamics can shift the balance from rent extraction to production. The official bolivar rate has been so overvalued for so long we’ve somehow internalized lack of competitiveness as a feature of the National Soul rather than seeing it for what it is: the aberrant outcome of a catastrophically ill-conceived set of policies, and a relatively easy one to correct at that.

How easy to correct? So easy that, to correct it, all you have to do is what Canada did: nothing. Literally nothing. Just get out of the way and let the currency float. It’s only when you do something, by setting the exchange rate por decreto, that you shortcircuit this adjustment process. It’s stupid, but to a Canadian, it’s even worse than stupid. It’s impolite.