U.S. inflation reaches 2%, Venezuela's reaches 46,000%
Inflation represents the year-over-year increase in prices for goods and services. Understandably, people don’t like rising prices. But rising prices aren’t inherently a bad thing. In moderation, it simply represents a robust demand for goods and services that helps propel our economy forward. Again, the key is moderation.
The Federal Reserve serves as America’s central bank and establishes monetary policy to promote the health of our economy. The Fed’s target rate of inflation is 2 percent – a rate it deems, over the long-term, is the ideal healthy balance between price stability and economic growth.
In May, according to the Fed’s preferred measure of tracking inflation, the U.S. rate of inflation finally reached 2 percent – the first time since April 2012. For years, a near-decade long sluggish American economy had kept inflation well below the Fed’s target rate.
As the U.S. economy continues to strengthen, the Fed’s challenge is to keep inflation from surging past 2 percent – to 2.5 percent or even 3 percent. The Fed has been gradually increasing interest rates to keep inflation in check. Raising interest rates increases borrowing costs, which acts as a mild constriction on consumer and business spending.
But the Fed’s concern over rising inflation pales in comparison to the economic disaster of Venezuela. In 2016, Venezuela’s inflation rate was 800 percent. In 2017, it was 2,600 percent. For the 12-month period ending June 30, the inflation rate is an absolute mind-boggling 46,305 percent. In other words, a soft drink that cost you $1 last year in June now costs over $460!
Having the highest inflation in the world, Venezuela has reached hyperinflation, or spiraling out-of-control inflation. As defined by economists, hyperinflation occurs when the inflation rate exceeds 50 percent for a month. Clearly, Venezuela has long passed that threshold.
The roots of Venezuela’s crisis can be traced back to 2012. As part of his ultra-socialist political and economic agenda, then-President Hugo Chavez began massive spending on government funded programs. However, these programs were funded by incurring tremendous amounts of debt and from crude oil revenues. Crude oil accounts for 95 percent of all Venezuelan exports.
Straddled with heavy spending on social programs and debt repayments, Venezuela was sent reeling from the 2015 collapse of crude oil prices. Venezuela is a member of OPEC, or the Organization of the Petroleum Exporting Countries, a 15-nation oil cartel that produces roughly 40 percent of the world’s crude oil.
In October 2014, OPEC began an initiative to increase crude oil production, flooding the global crude oil markets with excess supply to drive down prices. The goal was to cripple its competition, primarily the U.S., as rapidly declining oil prices soon made most oil wells unprofitable. As the world’s surplus of crude oil soared, prices fell from over $100/barrel in 2014 to under $30/barrel in January 2016. But the cost of this endeavor for Venezuela and other OPEC nations was that ultra-low oil prices decimated their oil revenue-dependent economies.
As oil prices collapsed, so did Venezuela’s revenues and ultimately, its entire economy. Unable to fund its social programs, pay its debt obligations or buy imported food and medicine for its citizens, Venezuela has plunged into chaos. The country is plagued with high crime, food and medicine shortages, skyrocketing unemployment and citizens unable to obtain basic necessities. A joint study among three universities estimates as much as 90 percent of the population has been forced into poverty.
In a counter-productive attempt to pay its expenses, Venezuela has resorted to simply printing more money. However, this stokes higher inflation and further devalues its currency, the bolivar, which is now nearly worthless. In Venezuela, cash is not so much counted but weighed on scales in massive stacks. Increasingly, people are using the ancient and primitive barter system – the mutual exchange of goods and services without cash – to acquire food and basic services.
After Chavez’s death in 2013, Nicolas Maduro became the new President of Venezuela. For now, Maduro continues the policies of his predecessor. As this cash-strapped nation struggles on its current path, it risks further economic ruin. For the U.S., a 2 percent inflation rate is a challenge. For Venezuela, managing a 46,000 percent inflation rate is beyond a challenge. Instead, it is simply trying to limit the impending destruction.
Mark M. Grywacheski, Investment Advisor
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Quad Cities Investment Group, LLC is a registered investment advisor with the U.S. Securities Exchange Commission.
