Venezuela Averts Default, But For How Long?

Just like most other socialist countries, Venezuela seems to be facing an imminent collapse. The political system is corrupt, the social system is failing with one of the highest murder rates in the world, citizens are leaving the country at record levels and the economy is hanging on by a thread. It sounds like some of the scenarios we saw in the late 80’s and early 90’s in former Eastern Bloc countries in Europe.

Venezuela managed to meet its debt payments today, but how long can the government hang on? There seems to be very little being written about Venezuela in the financial media as investors seem to be focused on everything but a potential collapse in one of the largest oil producing countries in the Western Hemisphere.

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It seems to be a matter of when does Venezuela collapse, not if. When it does, what impact will it have on the global economy? We should certainly expect a spike in oil prices as Venezuela produces approximately 2.5 million barrels of oil per day. That ranks tenth in the world and third in the Western Hemisphere. Much of the oil production in Venezuela is government controlled, so if the government completely collapses it is reasonable to assume that production will be effected.

The situation reminds of the collapse of the Soviet Union, only on a smaller scale. The Venezuelan economy isn’t as big and it doesn’t produce as much oil, but would still be a significant even the government collapses. According to the CIA World Factbook, Venezuela has over $100 billion in outstanding debt and if it defaults on that debt, it would have an adverse effect on the global economy. Interest rates on the sovereign debt of similarly sized and developed countries would likely rise significantly. Neighboring countries in South America would likely take a hit to their economies. Besides the U.S. and China, the two countries that see the most goods imported to Venezuela are Colombia and Brazil.

To get an idea of how a Venezuelan collapse might impact global markets and the global economy, I looked back at 1992. I view Christmas 1991 as the final day of the Soviet Union as it marked the last time the Soviet flag flew over the Kremlin. It is an easy date to remember and seems symbolic in some way.

What we saw from global stock markets and global economies was a slowdown. The S&P 500 moved sideways for the first ten months of 1992. Initially the market rallied on the news of the Soviet collapse as it marked an end to the Cold War and that induced a little euphoria from U.S. investors. Unfortunately, the chaos that ensued after the collapse had an impact on most countries.

As the government collapsed in the Soviet Union, oil production slowed and that caused a spike in oil prices. In the first half of ’92, oil jumped over 20 percent. Granted it jumped from around $19 a barrel to just under $23 a barrel which is significantly lower than today’s prices. Back in ’92, Russia produced approximately 7 percent of the world’s oil. Venezuela produces approximately half of that today. The bigger issue with Venezuela is the oil reserves. According to OPEC’s website, Venezuela holds approximately 25 percent of the world’s known oil reserves and that is the most of any country.

What happens to the oil production if the government collapses? Who takes control of the oil reserves? How will they use the oil reserves? These are all tough questions to answer. The production has already slowed in Venezuela due to the economic conditions. If there is a change in power, the new administration could use the reserves to flood the market with oil temporarily and that would cause a major disruption in world oil prices. The new regime could see this as a way to help give the economy a boost and help the people while collecting some money for the government coffers.

Most of the world didn’t like former Venezuelan President Hugo Chavez, but at least he was somewhat predictable and investors could take solace in that. Current President Maduro is highly unpredictable and he may not be able to maintain his power for much longer. Now there is a whole new level of uncertainty and that is frightening.

While the situation in Venezuela isn’t garnering as much attention as the Catalonia effort to secede from Spain, it is something investors should be paying attention to. Venezuela’s influence on the global economy is just as important as Spain’s. Spain’s GDP is much higher than that of Venezuela’s, but the importance of oil in the GDP of Venezuela and the reserves the country has makes it just as important to global markets.

About Rick Pendergraft

Rick has been studying, trading, analyzing and writing about the investment markets for over 30 years. He has worked for some of the largest financial publishers in the world and he has been quoted in the Wall Street Journal, USA Today, the New York Times and the Washington Post. In addition, he has been interviewed on Bloomberg, CNBC and Fox Business News. Rick’s analysis process includes fundamental, sentiment and technical analysis. Rick started college as an education major, wanting to teach economics, but eventually changed to majoring in Economics and received a Bachelor of Science in Economics from Wright State University. His desire to inform and educate people is at the heart of his writing.

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