In recent news the world witnessed Venezuela’s turmoiled path to hyperinflation. According to a recent report by the International Monetary Fund, Venezuelan citizens have been experiencing price hikes on consumer items of 200% week to week, and that’s just things like coffee and bread.
Behind the cause of Venezuela’s inflation is rumoured to be corrupt politics, price-fixing and social unrest, but much of the capital crisis began with rising prices of raw materials and a large reliance on imports for day to day living. Since 2015, an estimated 1.6 million people have left the country making themselves economic refugees elsewhere.
However, before we can understand how Venezuela, once a country with one of the strongest economies in South America, came to bust a 3-month annualized inflation rate of over 1,200,000%, we should learn about inflation and how it works.
Inflation is often considered the pinnacle of modern economics, but it’s not just a modern phenomenon. It goes way back, and has impacted exchanges, banking and commerce for hundreds of years. Today, inflation primarily influences interest rates, including but not limited to mortgages, pensions, payments, accounts, and all in all, the price of goods and services. On the back of all these, inflation also impacts investors.
In fact, inflation could be described simply put as the rate at which the price of things increases. The opposite is deflation, the rate at which the price of things decreases.
Inflation is usually measured and discussed according to two systems: The Consumer Prices Index (CPI) and the Retail Prices Index (RPI). These change according to data on how much stuff costs, how much people spend and how much something is valued, over time. The percentage figure shown by the measured CPI, i.e. 1.5%, means that goods and services are costing 1.5% more than the previous year. In theory, CPI should fluctuate according to supply and demand and therefore inflation occurs quite naturally in most countries, like the US and the UK, while in countries like Venezuela, the equation is littered with impacting factors that are difficult to even make sense of.
CPI figures in the UK are measured up to at least three decimal places and reported rounded up to a single decimal place. In Venezuela, they are far from reporting CPI in decimal round-ups, and perhaps they may never again. Once the fast-paced acceleration towards hyperinflation occurs, it’s very difficult to come back. Two famous examples of similar hyperinflation that have occurred are 1920s Germany and 2008 Zimbabwe, and in the latter case the solution was a complete overhaul of the African nation’s currency and dollarization of its economy.
The natural turnaround of inflation is that when the prices of items increase, the value of the currency buying the items decreases. For example, if I bought a cup of coffee for £1.50 last year, and this year it cost me £1.55, then for the same cup of coffee, I’ve had to spend more money, which on the flip side means my money is worth less; it’s worth less cups of coffee.
This video explains it well.
If we take a look at the changing prices of a cup of coffee in the UK compared with Venezuela, over the last four or so years, it may look something like this:
Since Venezuela's established position as a leading economy in South America, it has come a long way in doing bad trade. Prices of daily used items and household groceries have been coupling MoM. The main reasons behind this are a, shortages in state manufactured and produced goods, and b, a shortage of imported goods due to poor international relations. Within this equation is oil, which forms a majority stake in Venezuela’s export economy and a greater part of its GDP, given that Venezuela is home to some of the biggest oil reserves in the world. A slowdown in oil production since Maduro’s government came to power, mainly due to a lack of historical investment in the sector compared with the rest of the world’s oil markets, consequently resulted in a 45% reduction in GDP since 2013.
Pre-2013, Chavez was in power, and managed to keep the country’s economy afloat via oil revenues, but when he died of cancer in 2013, Maduro came to power and when global oil prices crashed, he failed to maintain stability. He ordered money to be printed to pay employees and continued to dispense state welfare. He then proceeded to control the price of household groceries, like flour, eggs and cooking oil. As CPI figures increased, the value of the Bolivar decreased, making foreign imports even harder. These events, combined with a collapse of import trade, led to the current hyperinflation that exists today. Further scarcities in food and medicine have also created hostile local environments, with protests and riots taking place across the country.
At this point, having depleted the state’s foreign exchange reserves, nation’s like Russia and China are no longer willing to help. Venezuela also cut off ties with the IMF in 2007, and the chances of a current bailout are slim. Although reports indicate Venezuela is on route to hit the 1 million percent inflation mark this year, according to the BBC, Venezuelan officials plan to resolve the country’s current economic anguish with very unorthodox methods. Nicolas Maduro’s government introduced a new digital currency, launching an Initial Coin Offering (ICO) for Petro this year. Serious doubt surround this move, as it is widely agreed the Petro is simply smoke and mirrors, with no real value. On the other hand, the government claims it raised $735m with the ICO, mostly backed by oil. The aim is to circumvent US and other countries’ economic sanctions, originally put in place due to political squabbles, and open the country up to international investment. They also intend to turn things around by introducing urban chicken and rabbit farming…
Sources: https://nationalpost.com/news/world/an-estimated-1-6-million-people-have-fled-venezuela-since-2015-thats-five-per-cent-of-its-population https://www.finance-monthly.com/2018/03/the-pound-vs-inflation-and-how-this-impacts-investors-today/ https://www.forbes.com/sites/garthfriesen/2018/08/07/the-path-to-hyperinflation-what-happened-to-venezuela/#6b96ff9915e4 https://www.bbc.co.uk/news/uk-45652921 https://www.bbc.co.uk/news/business-12196322 https://en.wikipedia.org/wiki/Hyperinflation_in_the_Weimar_Republic https://www.forbes.com/sites/stevehanke/2017/10/28/zimbabwe-hyperinflates-again-entering-the-record-books-for-a-second-time-in-less-than-a-decade/#776634f03eed https://www.livemint.com/Opinion/7gNrvecy9QlyFrJYmZfiiL/The-how-and-why-of-the-Venezuelan-crisis.html
Annual consumer price inflation across the Eurozone climbed up to zero in April 2015 after four months of consecutive declines, Eurostat has announced. However, there is still much to do. Even at zero, the rate of inflation remains well below the European Central Bank's (ECB) target of at or below 2%, with the weak performance owing largely to declining energy prices. Meanwhile, the unemployment rate stayed steady at 11.3% in March.
According to the Centre for Economics and Business Research (Cebr), this should give the ECB a chance to catch its breath after a bumpy start to the year. Its quantitative easing programme (QE), launched to address the currency union's poor economic performance, is showing results. Much has happened through the currency channel, with the euro depreciating sharply against major currencies since the policy was announced. Consumers are also starting to feel the benefits: confidence across the Eurozone is up and retail sales are growing at their fastest pace since 2005. This has caused some to think that the ECB may terminate QE earlier than the currently suggested timeframe of end 2016.
The last two years suggest that trying to gauge the economic climate a year ahead can be tricky. Cebr remains on the cautious side. “The Eurozone job is definitely not done yet, let alone well done. Germany is carrying on a decent path to recovery but the union's second-largest economy, France, is still far from finding its way there. Much-needed labour market reforms have been absent from the picture, and, with the presidential election season approaching fast, appetite for pressing on with unpopular measures is bound to decline,” Cebr said in a statement.
The independent economics consultancy continued: “Conditions seem brighter in the South, especially in Iberia. Looking ahead to the rest of the year, the Eurozone's southern periphery will most certainly enjoy an uptick in the summer as tourist season kicks in. Receipts from tourism should be especially strong this season given the weakness of the euro and geopolitical tensions in regional competitors such as North Africa. But the fundamentals remain weak.”
Greece, while closer to a deal now after a new reforms package emerged from the new negotiating team in Athens earlier this week, is still at a very fragile state. Its banking sector is heavily dependent on the ECB's willingness to continue providing funds through the Emergency Liquidity Assistance mechanism. In 2015 thus far, around €30 billion of deposits have been withdrawn from Greece's banks. And non-performing loans are at 35%, much higher than 2012 levels of 25%. The banks remain systemically sound: capital adequacy ratios at above 12% are exceptionally high. But any “accident” in the negotiation process would quickly make banks lose deposits. It will then be up to the ECB to decide the country's fate.
The UK’s Office for National Statistics (ONS) today announced that UK consumer price inflation has hit its lowest point since the early 1960's. After a 0.3% reading in January, annual inflation fell further to 0.0% in February.
According to the Centre for Economics and Business Research (Cebr), the greatest contributors to the inflationary slowdown were falling motor fuels and food prices. Taken together food and motor fuel prices have reduced the CPI rate by some 0.9 percentage points in the year to February.
Cebr said it continues to anticipate a brief bout of deflation in the coming months with inflation at -0.3% and -0.1% in March and April respectively. Despite a pickup towards the end of the year, for 2015 as a whole Cebr expects inflation to stand at just 0.4%.
Adam Chester, Head of Economic Research & Market Strategy at Lloyds Bank Commercial Banking, agrees that falling fuel and food prices are having an impact. He said: “The latest drop in inflation to 0.0% leaves the UK on the cusp of deflation for the first time in nearly 50 years. Notably, the drop has not been driven by weakness in the economy but by aggressive supermarket discounting, and the feed-through from lower oil prices to forecourt fuel prices. With sterling’s exchange rate pressing down on import costs and retail energy prices set to fall further, inflation looks set to dip briefly into negative territory over the coming months.
“The drop in inflation is good news for consumers and businesses. Falling food and energy prices are easing the pressure on household finances, whilst businesses will benefit from lower fuel prices and strengthen their ability to invest for future growth. For householders and businesses with debt low inflation strengthens the case for the Bank of England to keep interest rates at a record low.”
According to Cebr, the benign inflationary environment is almost certainly going to prolong the Bank of England’s (BoE) period of inaction. Given the lack of inflation and the pound’s sharp rise against the Euro, the pressure on the BoE to maintain low interest rates for longer has intensified. Cebr expects the first rate rise in February 2016.
The UK economy edged closer to deflation as annual growth of the consumer price index (CPI) fell from 1% in November to just 0.5% in December, according to data released by the Office for National Statistics yesterday. This is the joint lowest rate of CPI inflation on record, equal with 0.5% seen in May 2000.
“The main contributions to the fall came from the December 2013 gas and electricity price rises falling out of the calculation and the continuing drop in motor fuel prices (reflecting the collapse in global oil prices). Falling food prices – a result of intense competition among UK supermarkets – have also played a major role in the low inflation figures,” the Centre for Economics and Business Research (Cebr) said in a statement.
According to Cebr, disinflationary pressures look set to continue in the first half of 2015. Retailers are still in a phase of intense competition, petrol prices should fall back further in the first half of the year and utility companies are likely to cut prices given developments in wholesale markets. Already, E.ON has announced a 3.5% cut to its standard gas prices, and other utility providers will almost certainly follow suit. Cebr said that, with prices for a number of essentials lower now than a year ago, the prospect of inflation on the CPI measure dipping into negative territory - i.e. deflation - is now very real.
However, Cebr claims that a bout of ‘good deflation’ could be just what is needed by the UK economy. Cebr says that, when the main driver of deflation is falling essentials prices – such as food and petrol - this could result in freeing up household spending power for more discretionary goods.
“While even this kind of deflation may have negative consequences if persistent – falling prices mean that the inflation-adjusted value of household and government debt rises – a brief bout should prove virtuous. With weak economic growth in the Eurozone and no hope of an export-led recovery anytime soon, the boost to household spending power from falling food, transport and utility prices could be the shot in the arm that the UK economy needs to maintain momentum in 2015 – especially when combined with the pick-up in earnings growth which Cebr expects to emerge this year,” Cebr stated.
The Eurozone has slipped into deflation for the first time since October 2009 as the annual change in the Consumer Price Index fell below zero to -0.2% in December, Eurostat reported on January 7, 2015. The unemployment rate across the currency area was reported to have remained steady at 11.5%.
Beneath the headlines, the data continues to mask the mixed realities faced by the currency union's members, especially those to the south of the Frankfurt-based European Central Bank (ECB) who is responsible for maintaining price stability across the bloc, according to Danae Kyriakopoulou, Economist with the Centre for Economics and Business Research (Cebr).
Greece and Spain have already been in deflation for months now (in the case of Greece for almost two years) and have been suffering from unemployment rates more than twice as high as the Eurozone average since mid-2011. In Germany, by contrast, unemployment has been on a downward trend and is now at a modest 6.5%, while annual inflation is still positive at 0.2%.
“This picture may seem puzzling to the eyes of the German taxpayers, who as the largest creditor to the European institutions are becoming increasingly fatigued by the Greek bailout saga. With so many funds sent to Greece and managed under the direction of the combined economic expertise of the troika lenders (ECB, EU and IMF), why are economic indicators in Greece still doing so badly five years on?” asked Ms Kyriakopoulou.
Recent research by the Athens-based economic analysts Macropolis shows that out of the total €226.7 billion that has been supplied to Greece since May 2010 by the troika, only 11% was used to sustain the needs of the Greek state, such as maintaining the provision of basic public goods and services. More than half of the funds have gone back to the creditors in the form of repaying the debt and the interest associated with it, the think-tank reports.
“As recovery remains elusive not only in Greece, but in many other debt-ridden periphery economies and even the currency bloc as a whole, the key question now is what kind of fiscal and monetary policies will be designed in response? Due to their dire economic situation, most periphery countries have little fiscal room to boost their economies through spending, and Germany has pledged to deliver a balanced budget this year,” said Ms Kyriakopoulou.
“The ECB retains a potential silver bullet in the form of quantitative easing (QE) still up its sleeve and ready to be launched. The central bank has a central target for consumer price inflation of 2%. In this light, [Eurostat’s report] undoubtedly raises the pressure on the ECB to act. On the other hand (Liposuction in Dubai), it is worth keeping in mind that the decline in prices was chiefly driven by a 6.3% year-on-year fall in energy prices. This is a ‘good type’ of deflation as it directly translates into a boost for consumers' pockets.
“Given that the ECB has for so long resisted QE even while some countries were in ‘bad’ deflation, there may be little hope in expecting action now that deflation has spread to the rest of the bloc due to factors beyond its control. Overall, Cebr would welcome a move to QE but maintains its view that it would be insufficient to kick-start the recovery. A softer take on austerity and the setting of both fiscal and monetary policies in expansionary mode are imperative to avoid another crisis,” Ms Kyriakopoulou concluded.
