Hugo Chavez's economy is starting to unravel in the currency market.

Alex Kennedy and Matthew Walter, Bloomberg
While Venezuela earns record proceeds from oil exports, consumers face shortages of meat, flour and cooking oil. Annual inflation has risen to 16 percent, the highest in Latin America, as President Chavez tripled government spending in four years. Exxon Mobil Corp. and ConocoPhillips are pulling out after Chavez demanded they cede control of joint venture projects.

The currency, the bolivar, has tumbled 28 percent this year to 4,750 per dollar on the black market, the only place it trades freely because of government controls on foreign exchange. That's less than half the official rate of 2,150 set in 2005. Chavez may have to devalue the bolivar to reduce the gap and increase oil proceeds that make up half the state's revenue.

``This has been the worst managed oil boom in Venezuela's history,'' said Ricardo Hausmann, a former government planning minister who now teaches economics at Harvard University in Cambridge, Massachusetts. ``A devaluation is a foregone conclusion. The only question is when.''

Chavez will devalue the bolivar 14 percent in the first quarter of 2008 after he introduces a new currency on Jan. 1 that will lop three zeros off all denominations, according to JPMorgan Chase & Co., the third-largest U.S. bank, and Merrill Lynch & Co., the biggest brokerage firm.

The new currency, to be called the strong bolivar, will have an exchange rate of 2.15 per dollar, the equivalent of today's rate, Finance Minister Rodrigo Cabezas said last week. Analysts forecast the official rate will decline 13 percent by the end of 2008, according to the median of nine estimates in a Bloomberg survey.

Healthcare, Housing

``We're not going to devalue no matter how much they pressure us,'' Cabezas told reporters in Caracas on Aug. 31. ``The so-called parallel market doesn't dictate our fiscal, exchange or monetary policies.''

Chavez, an ally of Cuban President Fidel Castro who calls capitalism ``evil,'' weakened the currency 11 percent in 2005. He imposed restrictions on foreign exchange in 2003 to halt capital flight that has driven down the bolivar more than 70 percent since he took office in 1999.

A devaluation would give the government more bolivars from its oil export tax receipts, helping fund Chavez's policies to provide free healthcare, housing and discounted food to millions of Venezuelans. The government says social programs helped cut the poverty rate to 34 percent in the first half of 2006 from 49 percent eight years earlier.

Oil, which has risen 155 percent in the past five years, accounts for about 90 percent of Venezuela's exports. The country is the fifth-biggest member in the Organization of Petroleum Exporting Countries.

Trips to Curacao

As the gap between the official exchange rate and the black market rate has increased, so has the incentive to exploit rules, such as a regulation that allows people to spend $5,000 a year on their credit cards while traveling abroad.

Some Venezuelans travel to nearby Curacao, where they buy $5,000 of casino poker chips with their credit cards, exchange the chips for cash and then sell the dollars in the black market back in Caracas.

``People are invoking their right to circumvent what are very, very stiff controls,'' said Alberto Ramos, senior Latin America economist at Goldman Sachs Group Inc. in New York.

The foreign exchange regulations are part of the controls that Chavez, 53, has created in his ``march to socialism.'' The government sets retail prices on hundreds of consumer products and fixes both the maximum rate at which banks can lend and the minimum interest they can pay depositors.

Chavez, who is seeking to end presidential term limits, has taken $17 billion of foreign reserves from the central bank and expropriated dozens of farms that he deemed underutilized.

Exxon, ConocoPhillips

He nationalized Venezuela's biggest private electric and telephone utilities and took majority stakes in oil projects owned by Exxon, the world's largest producer, and ConocoPhillips, the third-biggest in the U.S. Foreign direct investment was a negative $881 million in the first half as foreign companies pulled out money.

Chavez terminated the broadcast license of the country's most-watched television network in May, sparking weeks of student protests. He has threatened to take over cement makers, hospitals, banks, supermarkets and butcher shops, saying they weren't obeying price controls.

``It's like our director of marketing, our director of sales, our director of manufacturing is President Chavez,'' said Edgar Contreras, who runs international operations at Molinos Nacionales CA, a Caracas-based food manufacturer that employs 1,500 people. ``We can't go on like this.''

`Fantasy Prices'

Contreras called the government-set prices on many products ``fantasy prices'' that are below production costs. Items including milk, chicken, coffee and flour have disappeared from store shelves in Caracas at times this year because companies refused to sell at a loss.

The government has responded by giving importers more dollars at the official exchange rate. Imports soared 43 percent in the first half to a record $20 billion after tripling in the previous three years.

The country's current account surplus fell almost in half to $8.8 billion in the first half even as near-record high oil prices buoyed exports. Crude oil for October delivery rose 4.2 percent last week to $74.04 a barrel on the New York Mercantile Exchange.

``The growth in imports is so out of whack that it's choking off the local sector,'' said Teodoro Petkoff, a former government planning minister who now publishes opposition tabloid Tal Cual in Caracas. ``The engine of growth isn't the real economy. It's the government.''

`House of Cards'

While the rise in government spending fueled economic growth of 9 percent in the first half, output in five of 16 manufacturing industries shrank from January to May, according to the central bank.

Harvard's Hausmann said the growth in public spending has been so rapid that the government needs oil prices to keep rising to hold its deficit in check. He estimates the public sector deficit will equal about 5 percent of gross domestic product this year. The Finance Ministry forecasts the public sector will post a balanced budget this year, Public Credit Director Luis Davila said last month.

``For the macroeconomic house of cards not to come crashing down, the price of oil has to go up at double digit growth rates,'' Hausmann said. ``If oil stays at $70, they're going to hit the wall.''