robert looney teaches economics at the Naval Postgraduate School in California.
Published February 28, 2018
Venezuela’s economy – not so long ago one of the most prosperous in Latin America – is imploding. With mass demonstrations increasing and strongman/president Nicolas Maduro clinging to power, Venezuelans with the resources to leave are heading for the exits. The government’s latest fix for a problem that has no apparent solution other than a change in government: a new cryptocurrency called the Petro.
As a cure-all for Venezuela’s woes, the Petro faces daunting – make that insuperable –challenges. That conclusion puts the cart before the horse, though. First one needs to understand the depth and breadth of Venezuela’s economic problems.
According to the IMF, Venezuela’s inflation rate topped 800 percent (at an annualized rate) through October 2017 and is projected to soar as high as 2,300 percent in 2018. This hyperinflation is hardly surprising, given that the free (but illegal) market exchange rate of the bolivar is less than one-tenth the legal rate, making foreign staples astonishingly expensive or simply unavailable to those without an uncle in the finance ministry. And the government has fed the flames, increasing the money supply 120-fold since Maduro became president following populist icon Hugo Chavez’s death in April 2013.
Venezuela’s oil reserves, controlled by the PDVSA, the government monopoly, are the largest in the world – that’s right, larger than Saudi Arabia’s. Which is a good and bad thing from Venezuela’s perspective, since the country produces very little else and now generates 95 percent of its hard currency earnings by selling the stuff. This exceptional dependence has made the country unusually vulnerable to volatile oil prices. Making matters worse – much worse – after a decade of underinvestment, myopic maintenance and crony-dominated management, the oil monopoly is barely functioning. Production fell by 10 percent in both 2016 and 2017. And with output heading south this year, too, the firming of global oil prices won’t be nearly enough to offset production shortfalls.
Not surprisingly, the economy has contracted each year since 2014; output fell by 12 percent in 2017 alone. Indeed, Venezuela's economic contraction from peak to present is the largest in the region's recorded history – and in Latin America, that’s saying a lot.
Venezuela, which owed $9.0 billion in international debt payments in 2018, ended 2017 with just $9.6 billion in international reserves and is currently in technical default – making payments, but highly in arrears. A successful restructuring by the Maduro regime appears impossible, in part because of the government’s unwillingness to adopt anything resembling economic reforms that would satisfy creditors. And unlike, say, Argentina a decade ago, Venezuela cannot run the risk defaulting for fear international bondholders will file claims to its extensive and valuable overseas energy-related assets, including the Citgo refining and marketing company.
As if things weren’t bad enough, many of Venezuela’s high-ranking officials, including President Maduro, are under U.S. “smart sanctions” for offenses ranging from drug trafficking to human rights violations. The U.S. assets of these individuals have been frozen, and Americans are forbidden from doing business with them.
With the head of the state-run oil company under sanctions, U.S. banks and investment funds are understandably reluctant to provide letters of credit to potential buyers of the country’s dwindling oil products. Likewise, U.S. financial institutions are precluded from buying Venezuelan debt issued after mid-2017, which makes not only debt restructuring but even dollar-denominated debt servicing through U.S. financial institutions extremely difficult.
Which is where the “Petro” comes in. Maduro touts the new digital currency as offering investors who have made millions in Bitcoin an opportunity to “diversify part of their risk” by “acquiring natural resources, real assets, without leaving the digital world.” In other words, unlike Bitcoin and other digital currencies, the Petro will be convertible not into hard currencies in unregulated markets but into specified amounts of Venezuela’s oil, natural gas, gold and diamonds. In this way, Maduro hopes the Petro will circumvent U.S. financial sanctions and ease ongoing dollar shortages, while providing Venezuela with a mechanism for insulating itself against hyperinflation.
If this plan sounds too good to be true, you’ve got a good ear. To explain what’s wrong with the Petro, start by examining Bitcoin. Bitcoin is a cryptocurrency platform on which units can be acquired by random users, who “mine” them by investing vast amounts of computer power to solve an increasingly difficult cryptography-like puzzle, or purchased from someone else at a price dictated by the free market. Market transactions are verified by an exceptionally clever publicly available software-based system that at the same time guarantees anonymity.
The Petro is not a cryptocurrency at all. It is a government IOU that essentially functions as a digital alternative to a conventional bond contract backed by collateral.
In contrast, the Petro involves no self-regulating mechanism for limiting the quantity in circulation and certainly no public transparency. In fact, it is not a cryptocurrency at all. It is a government IOU that essentially functions as a digital alternative to a conventional bond contract backed by collateral. Indeed, control of Petros would be entirely in the hands of the Maduro government.
To assure their value, the total supply of true cryptocurrencies is pre-defined. For example, the total number of bitcoins to be mined was fixed at 21 million. Maduro initially intends to raise up to $6 billion by issuing 100 million Petros – many to be sold at a substantial discount. But there is nothing to stop the government from creating another $6 billion worth, other than the word of a government with a track record of changing its mind.
Then, too, Maduro's government has not specified how one would exercise the right to cash in Petros for oil. Even if the logistics could be worked out, investors are sure to wonder whether this government or the one that follows will honor its obligations. Would anyone really be willing to hold large numbers of an expanding pool of Petros? And with the PDVSA’s production falling, Russia’s and China’s existing claims to much of Venezuela's current petroleum output as collateral on loans make the backing even more problematic.
As for Maduro’s assertion that the Petro will help fight Venezuela’s hyperinflation, there is no plan to tie Venezuela’s conventional currency (the bolivar) to the Petro. As such, there is no apparent way to use the digital currency to bring down hyperinflation, which ultimately stems from widespread distrust of the government's ability to manage the economy.
Nor is the Petro likely to help Venezuela avoid U.S. sanctions. The U.S. Treasury has already declared that purchases of Petros “would appear to be an extension of credit to the Venezuelan government … [and] could, therefore, expose U.S. persons to legal risk.” Given that warning, any firms that depend on U.S. banks as financial intermediaries would have to bet that the sanctions on buying and selling would be lifted sooner rather than later.
Maduro lauds the Petro as a digitized barter platform that sidesteps the global financial system in order to dismantle the “tyranny of the dollar.” But if that is its real purpose, why not just use an existing cryptocurrency such as Monero that claims to be better camouflaged from prying eyes than Bitcoin for international transactions? More likely, the Petro’s primary function would be to secretly move cash out of a collapsing economy and convert it into foreign currency, making the Petro a digital money laundering tool for government insiders and their cronies.
Venezuela’s opposition-run parliament also seems to have arrived at this conclusion. Arguing that the scheme only opens up more opportunities for corruption, it has officially barred the government from issuing Petros – though Maduro has never paid much attention to the lawmakers.
If, or rather when, the Petro scheme is discarded, the government has a Plan B. The new tourism minister sees a rosy future fueled by tourism, “the oil that never runs out.” This in a country experiencing out-of-control inflation, widespread street crime and food shortages.
Venezuelans are already apprehensively awaiting Maduro’s Plan C.