Investment Contrarians

Venezuela Cracks under Pressure, Currency Plummets by 32%

By for Investment Contrarians |

Venezuela Cracks under PressureIn their attempts to stimulate economic growth, more countries are looking at the possibility of devaluing their currencies. The latest to fall into this pattern is Venezuela, which has just devalued its currency, the bolivar, by 32%.

No one should be surprised by the latest move from the Venezuelan government, since this is the fifth currency devaluation in nine years. The net result has been stagnant economic growth and a very high inflation rate.

The annual inflation rate in Venezuela was approximately 22% in January, and it’s certainly set to move above 30% following this latest devaluation. (Source: Devereux, C. and Pons, C., “Chavez Devaluation Puts Venezuelans to Queue on Price Raise,” Bloomberg BusinessWeek, February 11, 2013.)

Considering 70% of the goods consumed in Venezuela are imported, this will have a huge negative impact on its citizens.

Unless the government is willing to tighten monetary policy to prevent a runaway inflation rate, which is unlikely, look for a significant decrease in consumption of foreign goods within the country.

While the official exchange rate has now moved from 4.3 bolivars per U.S. dollar to 6.3 bolivars per U.S. dollar, the unofficial exchange rate is even weaker at more than 20 bolivars per U.S. dollar.

Venezuela’s repeated attempts at trying to stimulate economic growth while increasing the amount of U.S. dollars available for foreign purchases has led to a decline in purchasing power by the average citizen and a pathetic economic growth rate.

Foreign companies selling into that market will be hurt by the higher inflation rate, since the government imposes some price controls. Venezuela’s President, Hugo Chavez, previously seized retail stores and threatened to nationalize other businesses that raised prices in an effort to combat the inflation rate.

Frankly, Venezuela is a nation that is imposing such ridiculous business practices that no company should really consider expanding in that nation.

With the inflation rate soon to hit 30% per year, the government is preventing businesses from raising prices; this creates an impossible situation that will only thwart economic growth.

Economic growth is only viable if new businesses are able to innovate and grow. With the constant instability that the Chavez regime has instituted, I would be leery of investing in foreign companies that have a significant amount of business stemming from Venezuela.

Other markets do offer a different story. Japan has been vocal regarding its goal of increasing its essentially nonexistent inflation rate. In an attempt to generate economic growth, the nation is entering a period of extreme monetary policy expansion.

Toyota Motor Corporation Chart

Chart courtesy of www.StockCharts.com

As I’ve outlined in previous articles, one group that benefits from this new policy shift consists of export companies, such as Toyota Motor Corporation (NYSE/TM). Because Toyota is a large exporter, any devaluation in the Japanese yen is a positive for business. In addition, Japan has almost no inflation rate, as opposed to Venezuela’s inflation rate of over 22% and growing.

It is important to distinguish between countries. Not all countries’ monetary and fiscal policies result in the same investment possibilities. Looking at an economic growth rate is important, but the inflation rate must also be considered in addition to government intervention possibilities.

Toyota recently broke out of a long-standing downtrend resistance line. While the currency devaluation of the Japanese yen is positive, as is that nation’s low inflation rate, when it is combined with strong automobile sales in America, one will need to be careful about buying the stock after a large move.

Since 2009, Toyota has almost doubled in price. This is a huge move for a company of this size. After such a move, I would expect some pullback and consolidation.

Investors need to be able to differentiate between companies and nations. An economy such as Venezuela’s, with its high inflation rate and stagnant economic growth, will continue to grasp at straws and enact ridiculous policies, such as nationalizing companies and enforcing price controls.

Japan certainly has its share of problems, which will continue to grow over the next couple of decades. However, some companies within that nation are quite strong, and the government does not impose price controls or threaten to nationalize businesses. That is an important distinction.

One important lesson that we can take from Venezuela’s situation is that since Chavez has taken over, the Venezuelan currency has tanked compared to the U.S. dollar (or almost any other major currency), economic growth has stagnated, the inflation rate continues to soar, and the average Venezuelan citizen has suffered from massive shortages and instability.

This is yet another lesson that these socialist policies simply do not work when it comes to generating economic growth. Spending freely to gain votes works only in the short term. Ultimately, economic growth stems from businesses, not from government spending.

It is obvious to everyone that if a government hinders business development, innovation, and expansion, it also hinders the long-term economic growth potential of its nation.

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  • David

    Great article!!

  • jerrycollie

    Carry Trade: Sell Japanese Yen and use the money to buy Australian Dollars; and collect the interest.