How could we curb Venezuela’s hyperinflation?

Think of a note worth 10,000 bolívars. That seems like a lot, right? I’m a nice guy; I’ll give it to you. Go buy yourself a nice TV or something.

What’s that? They said you don’t have enough money?

Precisely.

As of July 27, 2016, this seemingly valuable note is worth just over ten dollars (it’s almost definitely worth less by the time you’ll read this). In the UK, it wouldn’t be enough to buy you a takeaway dinner. This is because of the rapid hyperinflation that’s occurring in the South American country, leaving it in a tumultuous spiral of poverty, with some not even having enough to pay for essentials such as food or heating. A recent Bloomberg report even suggested that the Venezuelan government is running out of money to print money, such is the state of the country. An analyst at Nomura even predicts that a $200 oil price is needed before the Venezuelans can balance their budgets. Estimates for the rate of decrease of prices range from 400% to 720%, meaning that Venezuelans are eager to spend their money before its worth dramatically decreases just a few weeks later. It seems that policymakers are unable to come up with a solution to the problems that Hugo Chávez’s government largely created. Is the country doomed?

Not quite.

The Venezuelan government needs to learn from the lessons of German, Zimbabwean and Brazilian hyperinflation in order to put a stop to the inflationary pressure that has roiled its economy. Fundamentally, the problem is that, due to the pegging of the bolívar against the dollar, there is an “official” exchange rate of bolívars to dollars, and then there is a black market rate, which is a cause of the hyperinflation. Officially, the bolivar trades competitively against the US currency, however on the black market, it is estimated that 10,000 bolívars are worth just over one dollar. The solution? Officially unpeg the Venezuelan currency from the dollar, and allow it to float freely, so that both the government and the people of Venezuela are on the same side: there is now only one exchange rate, and this makes the problem much easier to solve – we need only one bullet, rather than two, so to speak. In addition, this allows Nicolas Máduro and his government to significantly reduce their fiscal deficit, that came about through them getting significantly less bolívars from overseas for every unit currency than the people got through black market transactions using the unofficial exchange rate.

Now that we have a reduced fiscal deficit, the Venezuelans need to stop printing money in order to finance deficit spending. This would stabilise the aggregate money supply in the economy, reducing the potential for a further reduction in the value of money. Logic dictates that the reduced inflation will disincentivise Venezuelans from spending their money in anticipation of a coming decrease in value, which would in turn lead to an increase in savings. Aggregate demand for goods and services would therefore reduce, causing a corresponding decrease in demand-pull inflation (inflation as a result of aggregate demand outmatching aggregate supply). This leads to a continuous cycle whereby more and more people save more and more money rather than investing it, and combined with the stable money supply, inflation will continue to decrease. Years of hyperinflation have battered the Venezuelan people’s expectations, however, so it may take a long time for them to be convinced that their currency will hold its purpose as a store of value, enabling inflation to decrease substantially. While this may allow the national debt of the country to increase, it is a price worth paying for the country to return to a period of long term economic sustainability, during which tight fiscal policy (increasing taxes and cutting government spending) can help bring this debt down.

The final prong of this three-pronged attack on inflation is that when inflation decreases substantially, the likelihood is that it will still be relatively high; inflation ranging from 400% to 720% can’t simply be swatted away. Therefore, the government needs to maintain interest rates at a level such that the nominal interest rate is far higher than inflation, causing the real interest rate to be high and positive. Intuitively, this means people will see it as beneficial to further save their money rather than invest it immediately, curbing the cycle that increases demand-pull inflation. As the rate of inflation continues to decrease, the central bank should gradually decrease nominal interest rates, while keeping them high above inflation, until they have reached a level of inflation that they see as sustainable, at which point real interest rates could potentially come down.

The sad state of Venezuela is a reminder of the dangers that letting inflation go out of control can provide; Hugo Chávez has failed his country immensely. Despite this, the policies outlined above should go a long way to cut out the plague of hyperinflation, and restore peace and prosperity to the Venezuelan people.

What do you think?

Shrey Srivastava, 16

Why central banks should target 4% inflation

Photo by Remy Steinegger

It is October 29, 1929 , also known as Black Tuesday. The Great Depression, one of the largest economic downturns in history, has just begun. Unbeknownst to the everyday man and woman, this will last a backbreaking decade, during which these everyday people will see their dreams slashed in the face of lower wages. That is, if they even find a job in the first place; unemployment will reach almost 25% in America at the height of the depression in 1933. During this time, it’s obvious that we will start looking to policymakers for solutions to this problem, however, even they have been silenced by the lunacy of the gold standard: there are no solutions in the pipeline.

Time for a voyage into the future. 1990, specifically – New Zealand. The Reserve Bank of New Zealand has just introduced a pioneering measure that will shake up monetary policy: the inflation target. They say they target a rate of price increase of 0 to 2%. Fast forward 22 years, and on the 25 January 2012, Ben Bernanke, the chairman of the most famous central bank in the world, the Federal Reserve, has introduced a 2% inflation target. Nowadays, the magic “2” is the norm, with central banks from the Bank of England to the Bank of Japan adopting the target. The problem? Well, there’s more than one, but the most arresting drawback is that we’re veering into very dangerous territory should we be even slightly amiss in meeting these targets.

Say we undershoot from our inflation target. That can happen, right? People make mistakes – even big, bad central bankers. If prices, therefore, appreciate by only 1% a year, that’s not too bad. But say we adjust the degree of error even more, and then we’re veering dangerously into deflationary territory – a nightmarish decrease in prices. In both my opinion and the opinion of many others, deflation is far worse than even high levels of inflation. This is because a deflationary slump in an economy causes people to think twice about purchasing goods and services, reducing demand for these goods and services, decreasing their prices to levels lower than they already are. Intuitively, this causes job layoffs as the reduction in demand causes a corresponding reduction in corporate revenue, and so the freshly unemployed aren’t very likely to buy non-essentials like a bottle of Coke or a packet of gum, let alone a new house. The ensuing vicious downward price spiral amidst a plethora of redundancies has historically been extremely difficult to get out of; deflation can batter an economy like nothing else. Where do we look for an example of this? Back to the past, that’s right – the Great Depression, where prices plummeted and redundancies soared due to a collapsing banking sector.

Moreover, recessions happen. We can’t prevent all of them, and it’s a fact of life that the average person is overwhelmingly likely to experience at least one or two in their lifetimes, if not many more. It’s how a central bank deals with the recession that defines how strong and robust their monetary policy is, and when you can only decrease interest rates by a small amount, then you’ve got a problem. Take the Bank of England. Interest rates currently sit at staggeringly low levels: 0.5%, to be precise. Let’s assume they meet their inflation target of 2%, and so the nominal interest rate (the interest rate when we don’t take into account inflation) will be 2.5%. Now, let’s hypothesise that they increase their inflation target to 4% and meet it (I know, I’m optimistic about their abilities). Now we have a wiggle room of a whole 4.5% should we face a recession, so we have a greater chance of stimulating the economy and getting it back on track. Even taking into account that central banks may not meet these targets, it’s logical to believe that they’ll at least achieve a higher inflation rate than before, and so regardless of the scenario, the overwhelming likelihood is that we’ll have more chance of beating back a recession than before.

Finally, we need to lend the companies that are the backbone of our economy a hand in being able to dish out nominal wage increases. Again, let’s take a scenario whereby we have higher inflation, say 3% (due to central banks undershooting the 4% inflation target) and the nominal wages of not very productive employees operating in, for example, McDonalds rise by 2%. In reality, they’ve still got 1% less purchasing power than they did before, however McDonalds’ 2% rise in wages keeps them happy and satiated; they won’t go on strike or resign or do all the things that corporations fear so much. Say we had a much lower inflation rate, perhaps 1%. Now, McDonalds is in hot water because they can only increase wages by a small, small amount, risking the ire of its employees. If the inflation rate went even lower, then we have even more of a problem; McDonalds cannot hand out relatively large nominal wage increases, as if they were to do so, their costs would increase, therefore enabling a reduction in profits. So now we have annoyed corporations, annoyed employees and perhaps an economy on the verge of recession, with very little room to alter interest rates when we enter one. All because of those dastardly low inflation rates.

Since 1990, the inflation target has become one of the key symbols of monetary policy and central banking. We need to increase it; I think it’s time to change this symbol for the better.

Do you?

Shrey Srivastava, 16

Scandinavia is not a socialist triumph

Sorry, socialists; Scandinavian success isn’t your trump card.

While Scandinavia has emerged as one of the world’s leaders in terms of how to run an economy, many advocates of socialism claim that its success is down to large numbers of socialist economic principles. This fanciful perception could not be any more untrue; in fact, the Scandinavian countries extol the virtues of the capitalist economic ideology more than anything else. The fact that even figures such as Senator Bernie Sanders, who claimed that America should look to countries “like Denmark, like Sweden and Norway” for their purported socialist beliefs, believe this woeful and misguided claim, comes as a shocking challenge to the belief that socialism in itself cannot bring about economic prosperity. In theory, this is all well and good: differing ideas are needed to promote healthy, beneficial economic debate which allows countries to further develop. Despite this, when one side of the argument persists with making claims that are inherently flawed and against basic facts and statistics, the debate becomes much less healthy than toxic and useless, and this intuitively benefits no one. Hence, while it could be argued that Scandinavia has some socialist principles that have helped it grow economically, it is completely asinine to brand the whole region with the “socialist” moniker. Frankly, it’s akin to saying that socialism alone works in the first place.

Free market capitalism is perhaps most strongly enforced in the countries which Sanders seems to so idolise. While it is disputed whether laissez-faire economics works in the long term or not, it is a testament to these countries’ resilience and principles that they do not intervene and let large companies go bankrupt if they are not performing or have mismanaged their finances. For example, Sweden allowed Saab, an automobile manufacturer, to go bankrupt, even when there was considerable pressure to bail the company out. Many similar occurrences have taken place with the other Scandinavian nations, affirming the ethos of economic competition that these nations hold so dear. This competition, that is so prevalent in these societies, allows companies to make more and more efforts to innovate and gain a comparative advantage over their rivals, thus increasing the prosperity of these companies, which gives the state more income through taxation with which to fund social services such as healthcare and education. This also results in a reduction in unemployment, again increasing the wellbeing and happiness of the country’s citizens. It stands to reason, therefore, that Denmark is the world’s happiest country. And a large proportion of this has nothing to do with socialism.

The reason why countries such as Sweden have evolved into such developed and financially stable economies is also due to capitalist ethos, and most definitively not socialist ones. In the latter half of the 1800s and the early 1900s, Sweden was floundering financially, with it being very poor and economically destitute (1.3 million Swedes left Sweden for America during this time). The capitalist reforms which were then instituted by the Swedish government spurred economic development and growth, incentivising creativity and encouraging investment into small and medium sized enterprises (SMEs). At this point, the country’s taxes were far lower than the majority of Europe’s, raising serious questions to socialists who propose higher levels of taxation. Therefore, despite the fact that the welfare system in Sweden is amongst the best applications of socialism in the modern world, this is only a small cog in the wheel; and to a large degree, has only been made possible through the wonders of capitalist reform that swept the country. After all, the system could have only been financed through money, money which would have been in high relative scarcity had Sweden continued the way it was going.

Scandinavia has also been made into a pseudo-utopia by some socialists, a place where everything is perfect and nothing has ever gone wrong. However, while the region is a massive success story, it is not as prosperous as some would claim it to be. For example, the United States has a higher economic output per person than Sweden, Denmark and Finland, calling into doubt those who claim that the few socialist policies have resulted in an increase in productivity in the Scandinavian region. Moreover, the Organisation for Economic Co-Operation and Development (OECD) also states that the average Dane has an average household debt equal to 310% of his or her disposable income, again making the claim that Scandinavians are more financially prosperous than others seem highly dubious. According to Credit Suisse’s Global Wealth Report of 2014, the wealthiest 10% of people in Norway, Sweden and Denmark possess between 65 and 69% of the wealth of those countries, displaying staggering levels of wealth inequality. While low inequality is frequently espoused by proponents of the socialist economic system as a virtue of Scandinavia, these figures prove that that is not the case, and that, like much of the Western world, Scandinavia also has serious problems regarding wealth inequality.

We do have our share of problems, I admit. Scandinavia is a great place to live, I admit. What I don’t admit, however, is that they’re perfect or that socialist policies have got them to where they are thus far; it’s, in fact, capitalism that has again, saved the day.

Shrey Srivastava, 15

Could the FTSE 100 see new highs post-referendum?

Photo by Raimond Spekking

When the bombshell arrived last week that 51.9% of our country voted to leave the European Union, the prognosis for the FTSE 100 looked bleak. Indeed, on Friday itself, the index initially fell by as much as 8.7%, wiping off almost a tenth of its total value. The financial sector was among the hardest hit, with shares of banks such as Lloyds Banking Group dropping by as much as 19.93%. All the cards were in place for a further drop in the index, so in characteristic stock market fashion, the FTSE surged and reached 6577.83 on Friday, reversing completely the drop made last Friday. This unexpected rise isn’t just due to investor irrationality, however; there are some solid fundamentals behind why the FTSE 100 rose this much, and these fundamentals also mean that there is reason to believe that the index could rise even higher. Another sustained gain such as that seen this week could, indeed, see it push beyond the 7122.74 intra-day high made at the end of 27 April last year; it’s definitely within the realm of possibility, especially given the recent actions of the Bank of England.

On Thursday, the governor of the UK central bank, Mark Carney, suggested that the Bank of England may cut interest rates to levels below the 0.5% of today, given Brexit concerns and uncertainty. Intuitively, this decreases the rate at which banks can borrow money, making borrowing cheaper for these financial institutions. Coupled with the £3.1 billion cash injection into the UK’s banking system, the future for banks operating within the UK became a little brighter, causing shares of banks such as Barclays to rise. Given that financial institutions constitute a major proportion of the FTSE 100 companies, this boost to their immediate and future prospects caused their share prices to appreciate not just on Thursday but also on Friday, in turn causing the FTSE to rise by a considerable amount. Whilst there remains considerable doubt over the long term prospects of banking given the worldwide recession which some reputable economists are forecasting, the Canadian’s actions will go a considerable way to ensuring their short-term prosperity in the event when a Brexit finally materialises later down the line. Thus, there is solid reason to believe that banking shares could rise in value, hence causing the FTSE to upswing in the same vein.

After our country sensationally voted for Brexit, many were sure that Cameron would immediately trigger Article 50, beginning our withdrawal from the juggernaut trade bloc. Instead, he announced that he was to resign as Prime Minister in October, plunging both his party and the future of our country as a member state of the EU into a multitude of uncertainty. The subsequent race for the next leader of the Conservatives is overwhelmingly likely to be won by the Home Secretary Theresa May, who has a reputation for prioritising safety and stability above radical change. Her comments in her recent speech that if she were to become Prime Minister, Article 50 would not be triggered by the end of the year also meant that, at least for some months, companies who would be drastically affected by a Brexit (ergo, most of them) have some degree of certainty regarding their short-term future prospects. In addition to this, the fact that once Article 50 is triggered a Brexit would likely take up to 2 years to materialise, ensures that these companies have some time in which to decide on their future prospects, and to formulate a plan for when the inevitable exit from the EU finally happens. This means that they will be ready for the short-term economic consequences of the event, and with knowledge of this, investor sentiment towards these companies could heighten, causing both their individual share prices and the FTSE 100 to rise.

Given that the constituents of the FTSE 100 are almost exclusively large-cap transnational corporations, a large amount of their revenue is earned from abroad. Carney’s aforementioned comments and the short-term economic pounding that would ensue following our European exit have caused the British pound to decline and to be projected to decline in future; our credit rating downgrade from S&P has done nothing to alleviate this. On Friday, after a staggering initial drop following the EU referendum and Carney’s comments Thursday, the pound was worth $1.33, a far cry from the $1.48 it was worth last Thursday. This sudden and large drop in the value of the pound means that the value of the revenue of the multinationals comprising the FTSE suddenly increases, in terms of the pounds. For companies that display revenue on balance sheets in terms of the pound, this increased revenue could be seen as a strong sign of potential future success by investors, thus perhaps causing the share prices of these companies and the FTSE 100 as a whole to appreciate. In a world where no one really knows what’s going to happen next, at least big business can do well, right?

Shrey Srivastava, 15