January 14, 2009

FIEM Fatale

Quico says: The thing that makes chavismo's unreadiness for the looming economic shitstorm (a.k.a. Hurricane Feces) genuinely unforgivable is that Venezuela had the institutional mechanism it needed to manage the kind of fiscal crisis we now face...until Chávez gutted it.

It was called FIEM, acronymese for the "Macroeconomic Stabilization and Investment Fund". Technically, it still exists, but it's been so systematically shortchanged it couldn't cover a single week's worth of public spending anymore.

It's important to grasp this: Chávez didn't need to come up with some fancy new framework to manage the risks inherent in being a commodity monoexporter, he just had to apply the risk management system he inherited. Instead, he moved all the stabilization action over to Fonden, a kind of bureaucratic black hole from which no light can emerge.

All of which got me thinking: what would the outlook for this year be like if Chávez had just followed the original FIEM rules?

First, a bit of background.

The idea behind FIEM was disarmingly simple. It was just a kitty where you could save some of the windfall when oil prices are high to guarantee yourself a fiscal cushion for when prices fall back down again. Simplicity was its strong suit: FIEM had a clear, unambiguous, and transparent set of rules for when you had to put money into the fund and when you could take money out, and those rules were simple enough for a keen fourth grader to grasp.

Here's how it worked: You're the finance minister. Each day, you calculate the average price of oil over the last five years. If, on any given day, the price of oil is higher than the average for the preceding five years, you save the difference in an account labeled FIEM. Alternatively, if the price of oil on the day comes in below the five-year average, you get to make up the shortfall - but no more than the shortfall - with money taken from FIEM.

Simple, no?

So how would the outlook for 2009 look if the government had just followed this common sense rule all along? To get a feel for it, lets look at oil prices alongside their retrospective 5-year rolling averages for the whole of the Chávez era:

Click to enlarge

As you can see, in 1998 and 1999, the price of oil was below the average for the 1993-1998 and 1994-1999 periods, respectively. That means FIEM wouldn't have gotten any deposits during those first two years.

Starting in 2000, however, those blue bars start getting taller than the yellow bars. In fact, current prices have remained above the five year rolling average in each of the last eight years. The culmination of that trend came in 2008, when the price of oil was some $30/barrel higher than the 2003-2008 average.

The original FIEM rule called for the government to save the difference. How much would that have come to, exactly? Well, I did the maths - or, rather, I did a quick-and-dirty approximation of the maths based on yearly rather than daily oil prices - and my answer is: a lot.

As best as I can tell, if we'd stuck to the 1998 law, the balance in FIEM would've behaved like this:

Click to enlarge

This exercise is helpful because it gives us a benchmark for what an "appropriate" stabilization cushion might look like in the face of Hurricane Feces. If the government had just followed the law it inherited, it would be sitting on some $116 billion dollars now, ready for any eventuality.

And those would be hard savings, money the government actually has available to spend, which is fundamentally different from Central Bank foreign currency reserves, which represent dollars the government has already spent and so aren't really rainy-day funds at all, no matter what hard-headed chavistas say.

Unlike Fonden, Chávez's ranchificated replacement for FIEM, the original system would've allowed us to, um, actually know how prepared we were for all this. As it stands, chavismo is treating our fiscal cushion like a state secret. It's missed its legally mandated deadline for publishing Fonden's end-of-2009 balance sheet by two weeks (and counting) and it's looking more and more like they're just going to Tibisay the whole thing.

It's clear that Chávez would never accept the restraints on presidential whim that the original FIEM Law implied. You can feel the rage in his train of thought... ¡Que este papel, este pedazo de papel que yo puedo arrugar y volver trizas, tenga fuerza para obligarme a hacer lo que no me da la gana!

He needn't have worried. Even as FIEM accumulated these huge sums, Chávez would still have been able to increase public spending sharply every year throughout the thick of the oil boom:

Click to enlarge

In fact, applying FIEM would've done more than just shield us from Hurricane Feces. Raising public spending in a gradual, orderly way would've prevented the rampant overheating, inflation, and currency overvaluation that have marked Chávez's fiscal-management-cum-lottery-winner's-spending-spree strategy.

But that's gravy. The real point is that if we'd stuck by the original FIEM rules, we wouldn't even break a sweat in the face of a collapsing oil market: FIEM would've covered nearly all of this year's shortfall. 2009 could've been just another year, rather than the deeply traumatizing crash it could so easily turn into.

Note that even after taking out $25 billion to plug the 2009 spending gap, FIEM would still have held a balance of over $91 billion by the end of 2009, which would be a God-send if the global recession does what all the pundits are fearing and drags on for another several years.

That's the kind of resilience to external shocks a monoexporter desperately needs, but which you can't have in the absence of an appropriate risk-mitigation mechanism like FIEM.

As far as chavista fuck-ups go, having gutted FIEM one is not a particularly flashy one. But, in the long run, I'm convinced that it's the single most damaging decision Hugo Chávez has made in his ten years in power...at least in the economic front.