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.

40 COMMENTS

  1. Excellent report. I agree 100%.

    We need to get out of the way of the producing parts of the economy.
    No more controls!
    There will be a temporary adjustment period but, to me, it’s the only solution.

  2. Well, everyone knows that a loon is not a duck, AT ALL. Otherwise, a great post! Canada was in fact an early adopter of the floating interest rate, which has been successful as policy for over fifty years. At the time of adoption, there were many doubters, but today the pudding has been proofed and opposition to the float is nonexistent.

    • A loon is like a duck in the same way that a black bear is like an elk. Same zoological class, same general habitat. But among other things, loons eat fish.

  3. While I agree with the thesis, I’m not sure it would work as “easily” as in Canada. I mean, right now, do you really trust Venezuelan know-how, infrastructure, and industrial capacity?

    Hell, would you even trust you will have electricity to run your company?

    That may take time to solve, and … well, not to beat the bush about it, it may require some different government to actually give investors a bit more confidence.

    • Again, understanding the price mechanism is understanding that anything is viable…at a given price. Of course asking companies to operate in Venezuela right now is asking them to eat huge shovelfuls of shit. But there is a price of labor at which the shit-eating will begin in earnest. At $20/month for minimum wage labor, companies will gladly set up their own generators (to run on state-subsidized diesel!) and produce their own electricity and still come out way ahead.

      That’s what prices do, when you allow them to float to meet their level.

    • Let say I understand that but I’m a very conservative and cautious investor 🙂 And of course, right now, the very best problem Venezuela could have would be companies having doubts about how great would it be to invest there vs how much shit they would have to eat, instead of having the certainty not to invest there at all because it would all be 100% shit.

  4. My company was burned very badly by the chavernment. As someone who has spent more then 10 years and counting trying to undo the damage the chavista bastards did to our company I know we would want to see a stake driven through the heart of chavismo before we ever considered dropping another dime in Bolivarian fantasy land.

  5. Sorry but this doesn’t apply in Venezuela. Just floating the exchange rate doesn’t solve the problem by itself. First, who will invest in a country without a legal system? Second, cost of life will increase significantly in less than a week. How would you feed people? Installing a factory or even only setting a company takes at least 6 month, where are the “capable” people will work? How they will earn money?
    Third, who will bring dollars to Venezuela while the investors make their mind to invest? PDVSA will burn money? Where is that money to burn?
    Everything goes through fixing our legal system, we need to build some trust, then dollars will come. Also, the industrial infrastructure is in such a bad place that will take at least 3-4 years to put it back into pre-chavez era.

    • I have a friend who is an excellent graphic designer in Caracas. He wants to sell designs for ads, t-shirts and other products abroad, but doesn’t have an overseas bank account and doesn’t have the money to travel and go set things up. He can’t put his services onto freelancing platforms and he can’t be paid by Paypal. So he is poor. If you open up the exchange rate, he will be middle class literally overnight.

      That’s just one example. Venezuela could bring in heaps of cash by undercutting the competition in just about any service. Petroleum engineering, coding, even sex chat. These would open up in a week, with no change in other policies. There are also industries that could perk up — people are still making chocolate, for example.

    • This seems to have been eaten by the system… let me post again.

      One possible way to look at it is that currently Venezuela imports food from Brazil and Uruguay. Wages there are around the 220-300 $ month.

      So at those wages, Venezuela should be able to produce much, much cheaper food than what is imported.

      • Eventually, perhaps. The problem is in the short and medium term. Agriculture is complex. People go to college to learn to be modern farmers. Then there are things like tractors, medicine for livestock and so forth. It’s my understanding that right now the majority of Venezuela’s people don’t eat enough, especially high protein food.

      • I’ve no doubt that many “buffers” will be needed to cushion the shock, that the issues are not that easy as just remove controls and voila!

        Thing is, the magnitude of the shock that needs to be cushioned is, precisely, because the usual suspect didnt do it way, way, WAY before, where the shock would have been smaller and more resources available to ease the pain

        It is clear the economy needs to be put into a mode where the adjustments can be as natural as Francisco writes them. The amount of pain needed to get there is what makes it awful to contemplate but just following the same “solutions” as before just mean making it even more painful later.

      • Agriculture is more than just paying worker wages, medicines, fertilizers, equipment and other supplies are imported, and since chaburrismo invented their monopoly mechanism over the currency to destroy the food production system, there’s little that can be done under today’s circumstances, where producing food is several times more expensive than importing it.

  6. Loud cheers from the peanut gallery!

    I would also point out that Venezuela (with investment) could use its oil wealth to produce electricity cheaply to supply to manufacturing instead of selling it for almost no profit on the world market. But, it all starts with a new and stable government that investors can trust to keep its promises.

  7. I theory this all makes sense. But as Pepe Trueno points out, there will be an important lag from when you float the currency and when investments comes in, factories get built and people get hired. After devaluing, and removing controls, internal prices would shoot up very quickly, but people’s wages won’t increase that fast. In Venezuela, the trick is surviving this period without being overthrown and some other government coming in and undoing everything you just did.

  8. FT, you do know however that your premise of an ’easy correction’ is only true in the Venezuela that we dream of, one that is not.

    Canada with its healthy institutions, e.g. a legal system that works, makes it possible for it to ‘do literally nothing’ as you say. Only that ‘nothing’ has taken a long, sustained, lovingly amount of collective work to build.

  9. To all of the naysayers, it is true that Venezuela could just keep on doing what it has been doing. But, how is that working out for you?

    If you accept that the status quo is a failure, it means trying something else. Continuing to do the same thing and expecting different results is one definition of insanity.

    • So lets drop a bomb and start all over again, is this something different enough for you?
      My point is that floating the exchange rate will not solve the problem it will actually make it worst unless you take some other measurements first. There is nothing more coward than a investor, how would you attract them if there is no rule of law in the country? So food prices goes up, how do you pretend to keep your salaries down? Slavery? People need food.

      It is not socialism or capitalism, it is reality. Floating the currency will be a consequence of clearer games rules for investor. If not, we will get drained.

      We are in a deeper shit hole than people think, not only economically but morally. I think that the biggest problem left by Chavismo

      • There are established mechanisms for doing this:

        -Take the $10 billion/year that are currently stolen via sobrefacturación due to multiple and wouldn’t be stolen if you floated and straight out transfer them to the most vulnerable third of the population. Boom – Bs.83,000/month per person.

      • Pepe,

        I do not underestimate one bit how bad the situation is. Regardless of the decisions taken, Venezuelans will suffer privations unlike any experienced in the Americas in the last century for some time to come. Venezuela may well need international humanitarian aid simply to prevent mass starvation. But, just as any country has done after a devastating war, Venezuela can recover. The questions are how and how fast?

        Obviously, the removing of currency and price controls is only one of the measures needed. Simultaneously, Venezuela needs to address reforms in virtually every area of the public sector. It is a huge job. Macri’s challenge in Argentina is child’s play in comparison. But, if you don’t start, you will never get there.

  10. Guys, don’t underestimate the pull of potentially paying child slave wages to educated people in an industrialized country (we do have infraestructure, you can’t evaporate, rust or export all the machinnery we used to have).

    As i said before, the trick is stop expropiaciones (for real, like not having the guys who support it in power), even personal security can be sorted out (but it would be nice to have it as well).

    Since we are not collectig real Money from taxes, fiscal incentives can also be implemented.

  11. I had the opportunity of visiting a Canadian factory back in early nineties, and saw in a message board a newsletter about a last month negative COLA (Cost of Living Adjustment) which was used to calculate monthly that salaries (indexed to inflation) The issue was that negative COLA (for example -5%) meant that your salary for next month decreased 5% ! I asked someone and he told me many people were not happy because in a case like this the indexed salary was a double edged sword … No somos Canadienses
    .

  12. Just like in Canada. Really? Canada never stopped working during that time. In Ven, you would have to retool the whole country, teach a new generation how to work, preferable decently. A tall order, it can be achieved but there is a long tunnel ahead of the light.

  13. It brings up back to a post nearly two years ago, by Quico on the very same subject.

    http://caracaschronicles.com/2014/05/20/adjustment-or-collapse-the-case-for-collapse/

    What I wrote then still stand, word for word. Verbatim from two years ago :

    Devaluation is not a lifesaver for Venezuela.

    Devaluation is a lifesaver for countries equipped with a somewhat non-competitive yet fairly functional economy and can help readjust impaired trade and payment balances.

    But, if there isn’t a functional economy ready to answer the devaluation, devaluation has no tangible effect. And that’s the situation of Venezuela, a country that no longer has a productive economy to speak of, save PDVSA (and barely so).

    For a lack of local producers ready to fill the gap of now unaffordable imports, the only effect of devaluation will be to make imported basic staple and consumer goods merely unaffordable rather than unavailable. The shops will be full and many won’t be have the money to buy. It’s actually better than not having anything to buy but barely.

    At least, it will make it clear to all Venezuelans how poor they have become, readjusting perception to reality. So devaluation won’t be a complete failure in that respect. Knowing you’re neck high in of pool of shit is always the first step of dragging yourself out of the cesspit. It may also have some beneficial side-effects like putting a dent in smuggling and black-market by reducing the scope of subsidized ‘price-controlled’ goods, hence reducing the opportunities for arbitrage. But that’s that.

    Beyond that, knowing you have a problem, namely that Venezuela is now a third-world country left without a productive economy after 15 years of Chavismo, is only a first step. It will not bring any solution of its own. At best, it will make a solution possible.

    And

    Quico makes implicit assumptions which are only valid in somewhat functional economies. Those assumptions are generally correct and carry very good predictive power.

    But what Quico fails to see is that those assumptions are no longer applicable to Venezuela. The country has now become far too dysfunctional to respond efficiently to economic signals.

    There’s no economy left in Venezuela to respond to economic signals.

    And still verbatim:

    There is no shark. There is no lifesaver. Just water. And Venezuela is going to drown.

    Well, there we are.

    • As long as chaburros (ANY chaburro, not just maburro or chapodado) retain power, no investor will bring its money here.

      Any procedure to attempt to fix anything in Venezuela has the necessary number one step “Remove chaburrismo from power for good”, because nothing can be done as long as there’s an imbecile who thinks that anything that isn’t his own whims is inmediately dismissed as “privatizing the country and thus exploitation of the working class”

      The sole fact that there’s a person that has nothing to do with chaburrismo sitting on chimpanflores will boost Venezuela’s trust factor for foreign investors in several digits, because they’ll at least assume there won’t be a megalomaniac that will seize their assets on a butt itch.

      Will venezuelan working class get exploited as cheap-ass slaves like in China in the post-chaburrismo? Well, post-chaburro government must dedicate some resources to pin the responsibility and guilt of that on chaburrismo, who came and sucked the country dry while destroying everything to enslave the people.

  14. Its simple. But people prefer grudges and utopias.

    Keep subsidizing energy, lift all other controls and make barrio adentro and mercal actual functioning and effective institutions.

    The rest, as they say, is all straw.

    • The one difficult thing would be barrio adentro without the slavery. It seems simple enough to have a mandatory 3 year barruo adentro service for all doctors while inviting foreign doctors to also help in exchange for the experience, the feeling of good deed, and cheap beer or something. Playita… Get some of that adventure doctor market share or something.

  15. Quico, I don’t quite disagree with your analysis, but I think it lacks an important element that cannot be found in Venezuela. Canada is really a federation with Provinces with very different economic profiles.

    When Alberta was increasing its revenues due to high oil prices, Quebec and Ontario economies were losing because those high oil prices increased the canadian dollar, and they live on their manufacture and technology exports. We Quebecers had to fill up the tank up to 1.4 $/liter, despite Canada being considered an oil producing country. Now that oil prices are low, sure we pay more for imported goods but we pay much much less at the pump (0.9$/liter) and (we hope) the low canadian dollar can help the sluggish Québec economy. So we Canadians profit or suffer from the economic standing of the particular Province we live in. Afterwords, the rules of the federation (federal taxes, transferts, etc.) help in rough times.

    So Canada federation acts as a natural diversification strategy for the economy.

    This is not the case of Venezuela.

    Venezuela is a centralized country with a mono-production economy. When oil prices go down,
    if no pre-planning was done, the effect is catastrophic, there is no natural diversification strategy like in Canada.

    In my view, a more interesting comparison, and I hope that you do write a post about it, would be that of the situation in Alberta and in Venezuela, despite the difference in their population.

    • Bruni, the difference is starkly simple.
      Venezuela has Venezuelans and Alberta has Albertans! (*)

      La viveza criolla has squander 15 yrls + of commodity price bonanza with no investments to show for.
      Alberta has not stopped investing in people, in services, in infrastructure etc.

      Now that the times are though, we are hurting, but confident we will get through it, if anything despite new provincial and federal governments that have proven to be ideologically not aligned to our industry and open market values (Alberta could be described as the most “right wing” province of the confederacy).

      In reality, it is the prairie values that run deep here. 100 years plus of immigration fighting for a survival working the land in the hardest weather conditions, just later followed by a innovative energy and mineral industries. If anything we are resilient and will come through.

      It is also discouraging to feel the effect of the said confederacy transfers you mention.

      We fell unappreciated and scammed.

      Good while they lasted, but now that is our turn to hurt, The east seems to be too silent and enjoying they turn at more prosperity in manufacturing (ontario) and tourism (quebec). It will be interesting to see how politics play out and waht evolves form this cycle.

      Quico has edited out my last two comments on this blog. One for being radical and negative about venezuela I guess, I call it as I see it IMO, and the other for raising the same insight you did so well.

      Hopefully this one remains and we can drive some discussion on this.

      (*)mind you, tens of thousands of modern Venezuelans have made Alberta their new home and are an important part of our social and economic drive. It has to do with values and work ethics, world views etc that where you were born.

      • LuisF, exactly my point. As a Quebecer, I never felt I lived in a Petrostate, even if I lived in Canada. So I am encouraging Quico to write a post about Alberta and how they are doing things differently than Venezuela.

        • Bruni, just to interject. I spent most of the oil boom years in Ontario. What I saw was plant shut down after plant shut down.

          It did not feel like we were in a petrostate because we could not see the oil. But we were experiencing, to a significant degree, the effects of being in a petrostate. My understanding is that Quebec was similar. People who made things were taking a real beating. Leaders were content to see a migration of skilled workers to Alberta, leaving behind closed plants. Policies to encourage the investment and upgrading of technology, to make our manufacturing more “German”, were not developed the way they should have been. Building pipelines was the vision for the future.

          I have a feeling a lot of that manufacturing will never come back, and our economic profile has become less diverse and more precarious for the longer term. The situation is by no means as extreme as in Venezuela, but it is not great. But we have “sunny ways” and a new leader and a new Parliament not steeped in an Alberta/oil patch mentality, and that is not a small relief…

          • The opportunity lies in complementing each others strengths, energy from the West fueling a demand for manufacturing from the east, fueling a demand for energy from the west. …

            Surplus capacity of energy and manufacturing to be exported elsewhere.
            Tourism and agriculture etc. supporting this virtuous cycle.
            Continue funding a transition to cleaner energy mix, yes. Ostracize the oil sands no!

            I can infer from your comment Canucklehead you are more biased in favor to the false dilemma of us against them. If its good for Alberta it must be bad for us. (Ontario et al)

            “The oil patch mentality”, which i would describe as t the natural resource extraction mentality of Canadian all along (timber, gold, diamonds, potash, O&G, etc.) is nothing new.
            It’s what has allowed economic profits in the “true north” to support this thriving society of ours.

            IMO the attitudes of many of downplaying the importance and the necessity of a healthy oil and gas industry specially form the east, serves no one. and in due time will hurt all- add the deficit policies of the new liberal government will take Canada’s prosperity down with it.

            I know the political and economical debate is being affected by the world view on sustainability and climate frameworks of nowadays, but one thing we all need to understand is that the only alternative forward is to be efficient in our use of energy, renewable and unconventional will not support our needs and fossil fuels will remain the larger share in the energy mix for the mid term (50 yrs.).

            The green and the east need to embrace Alberta’s energy as a driver for national development and enforce responsible management of it, rather than curtail its development on dogmatic grounds.
            ( …or put your money where your mouth is and move to Lasqueti island, BC)

            Many are just been played as pawns to tidewater oil producers’s incumbents commercial interests.
            Fools hurting their own national interests in defense of less responsible fossil producers.

            A ruined down Canada will have less influence and less impact on the world.

  16. With the current prices of oil we are having a hard time, I hope that OPEC coutries can agree on price cuts because it is really a harsh reallity for many of us right now.

    good analysis from the chronicles.

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