Business

So far, Goldman Sachs’ Venezuela bet doesn’t look good

For decades, Latin America has been America’s back yard… perhaps similar to how some countries in Asia are increasingly viewing the Pacific as their stomping ground.

Though it’s been a bit more careful in recent years, the United States has a long history of meddling in the affairs of its southern hemisphere neighbours.

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But on August 11, U.S. President Donald Trump seemingly threatened to roll back the years, when he said the U.S. was considering a military intervention in Venezuela: “We have many options for Venezuela, including a possible military option, if necessary.”

The comment came after months of protests and widespread food shortages in the country… as President Nicolas Maduro looks to shore up his power.

In financial terms, Venezuela is a deeply discounted asset. But it’s cheap for good reasons. And it’s a very broken toy that Trump – and investors, for that matter – should stay away from.

Venezuela should be rich

As recently as 1970, Venezuela was the richest country in Latin America.

Its gross domestic product (GDP) – or economic output – was higher than Spain, Greece and Israel.

The country’s wealth came from its large oil reserves – which are twice as large as Iraq’s and almost seven times as much as those in the U.S. The country also has lots of natural gas, iron ore, bauxite (the world’s main source of aluminium) and gold.

But then things went horribly wrong…

Venezuela has the world’s largest oil reserves. But during the country’s oil boom in the 1970s, Venezuela’s politicians decided to keep all of the country’s oil revenues instead of sharing them with the foreign oil companies helping operate Venezuela’s oilfields.

So in 1976, Venezuela’s oil industry was nationalised. And because governments are never as efficient as private enterprises, productivity and efficiency in the sector fell sharply.

In the early 1980s, Venezuela’s politicians – concerned that the country might run out of its greatest resource – decided to limit oil production growth. Around the same time, a global oil glut pushed down oil prices.

The combination of lower oil production and lower oil prices hammered the country’s economy. From 1980 to 1990, Venezuela’s GDP per capita collapsed by 46 percent.

Things got worse in the 1990s. Although oil production picked up again, low oil prices meant that the economy deteriorated further.

The Chavez era

Then, in 1998, a charismatic strongman named Hugo Chavez was elected president. Chavez appealed to Venezuela’s poor by promising to rescue them from poverty and to restore the country’s pride.

Chavez had the good fortune to take office in early 1999, within days of the price of oil hitting a bottom at US$10 per barrel. The 1999-2008 commodities boom helped send oil to US$140 per barrel… and gave Chavez’s socialist government the cash it needed to create one of the world’s most subsidised economies.

Subsidies are a powerful tool for politicians. Few people, especially in poor countries, will vote out someone who gives them free stuff. And as things got worse, subsidies became the glue that kept the entire Venezuelan economy together. Chavez died of cancer in March 2013, but his handpicked successor, Nicolas Maduro, won the presidential election after Chavez’s death and has carried on his policies.

But subsidies distort economic incentives. And over the long term, providing subsidies to everyone can destroy an economy. That’s what has happened in Venezuela.

Today, because of its bad government policies, basic goods in Venezuela are often in short supply. That means many basic items are rationed, only available occasionally or sold at sky-high prices.

A nation on the brink

For example, shortages of toilet paper have sparked riots in the past. When I visited the country a few years ago, I saw hundreds of people waiting outside state-run supermarkets that hadn’t opened for the day yet. Things since then have gotten far worse. In March, for example, a basket of basic grocery items – including eggs, milk and fruit – cost 772,614 bolivars. That’s close to four times the monthly minimum wage.

And if you need critical medicines – or even just plain aspirin – you’re out of luck. There’s none to be had at any price. News reports say that the country’s hospitals have less than 5 percent of the medicines they need.

Venezuela also has the world’s second-highest inflation rate (just behind South Sudan). It reached an all-time high of 800 percent in December 2016. For comparison, the all-time high rate for the U.S. was just 23.7 percent in 1920. And this year, inflation could go as high as 2,200 percent.

The International Monetary Fund also expects Venezuela’s economy to shrink by 7.4 percent this year. That will bring the total decline to 30 percent since 2013.

The dire economic situation in Venezuela has also resulted in a crime epidemic.

Venezuela has one of the highest kidnapping rates in the world – ahead of Afghanistan and Iraq. It’s practically a national sport.

And the country’s capital, Caracas, has the highest murder rate of any large city (a city with more than 1 million inhabitants) in the world. You’re more than twice as likely to be murdered in Venezuela’s capi­tal, Caracas, than in Detroit – the most dangerous city in America.

The danger of Venezuela isn’t just media hype. Pretty much everyone I spoke with there had been robbed, or knew someone who had been robbed, within the previous few weeks.

Corruption is also a way of life in Venezuela. The country scores a dismal 166 out of 176 in Transparency International’s Corruption Perception Index.

And lately, the country has been in the headlines for its numerous protests and food shortages. The New York Times has called it a country “on the brink of a collapse.”

You see, in March, Venezuela’s Supreme Court, which is closely aligned with Maduro, announced it was taking over the powers of the opposition-controlled National Assembly. Essentially, this would have undermined the country’s separation of powers and given Maduro more power.

The Supreme Court ended up scrapping this plan, but it was too late. Widespread protests over Maduro’s grab for power (and the continued shortages of food and medicine) broke out in the following months… leading to more than 120 deaths.

And in July, the Maduro government held a “vote” (which was anything but fair) to elect members to a new, all-powerful National Constituent Assembly made up entirely of government supporters. This assembly basically gives Maduro dictator-like powers.

In response to the vote, the U.S. announced new economic sanctions against Venezuela and Maduro himself. Meanwhile, 40 countries including the U.S. and EU have said they will not recognise any decisions from the assembly. To try to ease tensions, Maduro asked for a meeting with Trump… saying he wants a strong relationship with the U.S. But just one day later, Trump said the U.S. is considering military options.

In short, this story is far from over.

Investors should be wary

I warned readers about investing in the country back in March. I said, “even if Venezuela’s pressing political and macroeconomic problems were somehow solved tomorrow, the country still faces more structural challenges than most countries will experience over the course of a few generations.”

But despite the signs, many investors poured into the country’s sovereign bonds. As I told you in June, some investors – most notably, global bank Goldman Sachs – were betting that the Venezuela government would pay bondholders back instead of importing food and medicine for its people.

So far, Goldman Sachs’ Venezuela bet doesn’t look good. The Venezuela sovereign bond index has steadily fallen since early June, as shown below.

Usually, the best time to get into a market is when things seem like they can’t get any worse. If things can’t get any worse, they can only get better. And that improvement can lead to massive returns for investors.

But things can stay bad for a long time. Venezuela’s troubles don’t seem to have an end in sight. So until there’s positive news, the county remains a contrarian investor’s black hole.