Outside Economics

Last week we looked at our inflation, now we will take a looks at what hyper inflation looks like  for one of our neighbors to the south. The price of oil has affected many economies around the world. It has hurt our economy in many ways, and helped in many other ways. But our economy is we diversified which is why the low price of oil has had such a balancing effect in our economy - other countries are not so blessed. 

One major oil exporter, Venezuela, is particularly hurting because of the low oil prices. As oil became the main income source, the country began to ignore other industries, like agriculture, and thus requires most of their food to be imported from Columbia and the United States. 

Before the 1950s agriculture was greater than 50 percent of Venezuela’s GDP, now it accounts for approximately five percent of GDP. This is a serious problem for the country’s leadership. As oil prices drop they are truly hurting. Its like still needing to feed the family on half the income; some things you can no longer afford and you don't have the economic base to find the income from other sources.

With oil exports accounting for over 95% of Venezuela’s revenue, the 50% collapse of oil prices in the past two years has thrown the country into fiscal and political turmoil. In order to raise critical cash to keep the government operational, officials have started to sell the country’s gold reserves. 

Even though the country is a major exporter of oil, it is also a major importer of essential goods for its citizens. The country’s currency, the bolivar, has collapsed to the value of one U.S. cent, creating hyperinflation which led to prices soaring over 121% in 2015, and expected to rise nearly 500% in 2016, as estimated by the IMF.

Inflation of this magnitude is similar to having a massive heart attack after twenty years of high blood pressure! It can really kill an economy!

In addition to its fiscal woes, the country is also suffering from little rain, which has brought about severe electricity shortages due to its main source of power generation, a dam whose water levels have dropped to historical lows. In late April, the country’s president ordered a two-day work week for government employees, in order to stem the consumption of electricity. The government workweek now is down to Mondays and Tuesdays, affecting roughly 2.6 million employees, representing 20% of the nation’s workforce.

Economic conditions have worsened, as the economy shrank 5.7% in 2015 and is projected to shrink another 8% in 2016, as estimated by the IMF. Such dire circumstances have created concern among U.S. officials, which are increasingly worried about an unraveling socialist economy and a political meltdown. Such an occurrence could lead to social unrest, chaos and political instability, causing tensions to rise with neighboring countries in South America.

So why is this important? Well hopefully two reasons: 1. perhaps it will bring about a political change, which will move the country back to a democracy and a free market economy and away from its current socialist/communist government. 2. hopefully they will begin to expand their industrial base and grow into other industries besides oil. Any time an economy is based on a single product the risk goes way up for future economic troubles.  

Additionally, it would be great for our two countries to get along better - geographically we are very close to Venezuela (less than 1400 miles) and the several people I know from Venezuela are wonderful people!

Sources: IMF

Remember:

There are plenty of good five cent cigars in the country. The trouble is they cost a quarter.
Franklin Pierce Adams

The Federal Reserve operates under a dual mandate, with three key objectives for monetary policy (which the Fed sets) to accomplish: Maximum employment, moderate long-term interest rates, and stable prices. Two of these three have been validated for the most part, with unemployment at 5%, and long term bond yields above short term bond yields. Stable prices (also known as inflation control) is monitored and released by the Consumer Price Index (CPI) each month and has been fairly subdued for sometime, until now. The Bureau of Labor Statistics which tracks the CPI reported that prices, as measured by the CPI, increased at the highest rate in three years as of April 2016. This latest report showed prices increasing at annual rate of 1.1%. 

A 1.1% inflation rate may not sound like much, but the data hidden within this number reveals something that the Fed may be concerned with. When broken down, the categories with the largest price increases nationwide were medical care services, transportation, and rent. What’s amazing is that the CPI increase would have been much higher if it wasn’t for the dramatic drop in energy and oil prices. 

The Fed considers various aspects of the economy and the country’s demographics when drafting its monetary policy. The fact that American’s are aging and are requiring more medical attention is an inflationary threat for retirees. In addition, many younger American’s are still having a very difficult time in securing mortgage loans, thus forcing young families to rent rather than buy. Such a dynamic has increased demand for rentals nationwide, forcing rents to rise until more supply is made available.

One cause of the medical inflation is the fact that Medicare, in an effort to control costs, continues to reduce payments to hospitals and doctors. The reduction in payments causes these businesses to look for other more profitable lines of business - meaning they stop seeing medicare patients altogether. This lowers the supply of services, thus raising the costs - it is simple economics. The additional problem is the enrollment in medical schools are down since the passing of Obamacare - meaning we are producing fewer doctors. 

While demand for rentals is high, so are sales of new homes. Housing is always challenging because of the time it takes to bring new home developments on line. The housing standards and regulations are so difficult, that it leaves fewer opportunities for low income housing. Gone are the days when a 1 bath, 3 bedrooms, 1000 square foot house is considered adequate. And yet for many first time home buyers maybe this is what the market needs (except I would opt for at least two bathrooms!).  

I think the next CPI report will have inflation at a much higher level, due to the recent large price increases in the energy sector. It is certainly affecting many people on the expense side, while at the same time it is good for the oil companies, who are starting to see a future in their business and maybe an opportunity to employ more people. 

It has been said that high blood pressure is a "silent killer"; Inflation is the silent killer of personal finances. Many may be asking how this will affect their investment portfolios and plans for retirement or issues with their own businesses. As inflation heats up, people need to be prepared. Helping people get prepared for these events are what I do - so if you want to be more prepared or you want a second opion on your current level of preparation call me for a no obligation free consultation. Click here for .

Sources: Bureau of Labor Statistics, Federal Reserve

Remember:

Inflation is one form of taxation that can be imposed without legislation.
Milton Friedman