The inevitable is happening. The omnipresent socialism is reaping its fruits. Both developed countries and developing ones are battling with huge debt levels, budget deficits, and an overgrown public sector. The mechanism always looks the same: the government begins the term with low taxes, a small administration and then starts to give away money under the pretence of helping the poor. It doesn’t take long for the number of the poor to increase as authorities cannot make ends meet with ever bigger deficits. To cover them they borrow big sums. Of course, they have to pay for additional liabilities: more bureaucrats are employed to manage an ever bigger system of controls and amount of certificates, while in the fog of blurred legislation the multinational corporations have enough space to flourish and avoid taxes. Before anyone could stop this avalanche, it is too late to intervene. The society lured into a ‘free give away’ policy will vote for those who can outbid the opponent.

It happens everywhere in the world and no region can feel secure from this wrecking ball of central planning. You may know it under a different name: ‘social-democracy’, ‘neoliberalism’, ‘welfare capitalism’, ‘European Union’. As you can see the vocabulary evolved just like reasons to justify huge expenses by politicians.

 

Puerto Rico

Puerto Rico is an island South of Florida. It is a part of the US but it doesn’t function like the rest of the Union. The Island is under the US jurisdiction, its currency is American dollar and citizens of Puerto Rico are also citizens of the US. The difference is that they do not pay federal taxes and have a big autonomy when it comes to legislation. Some parallels can be drawn between a member state of the EU and Puerto Rico being a part of the US.

Financial troubles pushing many Puerto Ricans to leave their home and crush the economy are directly caused by the incompetence of their government. Welfare programs and the burdensome public sector make taxes – from private enterprises and the tourism sector – not sufficient to fund expenses from the public purse. It is no surprise that budget deficit grows each year.

Only last year public debt reached 70 billion USD and ultimately stopped the economy from growing. In those conditions, business-owners cannot sustain their ventures and lose out to foreign competition both in the production and the tourism department.

Another factor working against the small economy is the USD. When the economy experiences problems its currency devalues. The devalued currency can impoverish the nation but it brings a competitive edge over foreign competition. This enables this country to export more successfully not to mention the cheaper cost for any visiting tourists. The influx of capital could buy time for the necessary reforms and settlements with creditors. Unfortunately, the strong dollar is preventing any of this from happening and keeps the Latin economy in the miserable state.

Results: growing emigration and the unemployment rate of 60% causing tax base to shrink. Even a tax haven status with which government tried to lure foreign capital, didn’t help.

Although Puerto Rico is dependent on the US, the Congress refused to bail out the bankrupted economy. This makes Puerto Rico another Detroit. The government to pay social workers and police had to sell national jewels. Politicians are bad students and they haven’t learnt anything. The debt is still on the rise and the only way out of this situation is severing ties with the US, creation of an independent currency and drastic cuts in government spending. This idea is promoted by Governor Alejandro Garcia Padilla.

Venezuela

Venezuela is the poster child of the political and economic consequences of handing over a country to socialists hands. Natural resources of Venezuela and its geographical location giving access to the ocean, warm climate – none of those advantages could stand a chance against the ‘equality and social justice’. Venezuela after Chavez wasn’t in the best shape but Maduro pushed the country off the cliff.

After nationalisation of oil reserves and burdening foreign capital with huge taxes, all international companies left Venezuela. Caracas introducing capital controls and high taxes made sure there can be no growth in the private sector. If this is not enough, the local mafia, armed better than the military is helping the corrupt regime.

To handle public spending and without any outside sources of financing, authorities turned to printing currency. As a consequence, the inflation rate during last 18 months reached over 1000%. Unemployment, lack of goods on the shelves and lynches of a chaotic mob is a regular picture in Caracas.

It is not a crisis – it is a result. The previous president of Venezuela, Chavez, repatriated gold reserves from the Fort Knox. This put Venezuela in the crosshairs of the US and Wall Street especially after the nationalisation of oil fields.

Another factor to contribute to the terrible situation was governmental policy to appease the crowd. High welfare payments and low gasoline prices drained too much money from the budget. The government grew more powerful and corruption was soon to follow – the privileged elite was stealing from their own people. The last nail in the coffin was quantitative easing – or printing the money – which decimated the economy.

The sheer scale of incompetence is best shown in the attempt to print Bolivar. Venezuela doesn’t have enough printing presses to match the demand for fresh currency. The government outsourced printing Bolivar abroad. This causes another problem because they are asked to pay in the USD for the delivery. The US dollar is one of many things scarce in Venezuela. At the end of the day, even hyperinflation may not succeed in this model welfare state of Venezuela.

Vietnam

Vietnam is different from Venezuela. It doesn’t have a problem with hyperinflation but rather with deflation. Vietnamese central bank tried to keep the dong-dollar parity but it resulted in the loss of money. The main reason for this is an amount of debt denominated in the American currency that had been taken by businesses . They had a choice of taking credit with 8% interest rate in VND or 3% in USD.

Vietnam faces strong competition from their neighbours – China, South Korea, Japan and Indonesia. They wanted to use every opportunity to develop their industry. Cheap credit used for financing operating costs was one of the methods they used. This debt additionally received governmental guarantees to ensure that costs of debt were even lower.

Vietnam started to experience problems when the dollar became stronger in the mid-2014. It gained on average 20-30% vis-à-vis emerging markets’ currencies. For highly leveraged Vietnamese businesses it meant widespread insolvency. The cost of debt did not surge by a big margin but the exchange rate was very unfavourable. Since the beginning of 2015 central bank held onto the dollar peg but in August it allowed for rapid VND devaluation. As of today central bank is trying to keep the exchange rate of USD/VND stable but ultimately it is on the losing side.

Vietnamese business owners had to make a choice. Their situation was worsened due to decreasing volume of Vietnamese goods being traded – thanks to the financial crisis and low global demand. Growing liabilities denominated in USD and weakening VND put many companies out of business due to low liquidity. The necessity to pay growing amount of debt drained the economy from local currency and ultimately caused a currency deficit. Vietnamese are also losing their purchasing parity and the central bank trying to push the influence of the USD out of the country is not helping.

 

Summary

All those emerging economies experiencing a variety of problems have one common denominator. Central planning attempted by their regimes failed miserably. It didn’t matter how noble the reason for intervention was. The law of unintended consequences does not discriminate when it comes to who conceives the plan. Unfortunately, plans made by the government tend to affect thousands if not millions of lives. From the perspective of probability, it is clear that when governmental plans are failing (and they do very often) they fail big.

While you were reading this piece you may have noticed some parallels to the policy of your own country. These problems are not exclusive to emerging world. They are indeed advocated by our own governments in our highly developed, rich economies. The only difference will be the height from which the economy (and we as a society) will fall unless politicians change their course.

 

Trader21