The Venezuelan government announced a multi-pronged economic security plan in August, which entailed four key initiatives:

1)The transfer of $6.3 billion in cash reserves to unnamed Russian, Chinese and Brazilian banks deemed politically friendly to Venezuela. Venezuelan Central Bank chief Nelson Merentes clarified that this transfer of reserves did notmean converting from dollars and euro to yuan and ruble but is simply the physical movement of cash and vouchers to banks in Russia, China and Brazil.

2)The transfer of 211 tons of gold (worth $11 billion) kept abroad to the Venezuelan Central Bank, where Venezuela already has 154 tons of gold stored.

3)The nationalization of the country’s gold sector.

4)The creation of joint ventures between PDVSA subsidiaries and state industries involved in mining. (Venezuela has created a joint venture with CVG for the development of Orinoco and is planning another with steel producer Sidor).

Cash Reserves

The Central Bank of Venezuela lists its current foreign currency reserves at $6.5 billionand its gold reserves at $18 billion. 60 percent of Venezuela’s international reserves are thus distributed in gold, while the rest are distributed in bonds and cash. According to the Central Bank, the liquid reserves are held in Switzerland (59 percent,) UK (17.9 percent,) the United States (11.3 percent,) France (6.48 percent,) and Venezuela (3.79 percent.) Most of Venezuela’s gold (roughly $4.2 billion) is stored abroad in the United Kingdom (Bank of Bengland, Barcklays, HSBC, Standard Chartered), with smaller amounts held in the United States (JP Morgan), Switzerland (A??), Canada (Bank of Nova Scotia,) and France (BNP Paribas).

Many have written off this series of economic policies as an irrational move by Chavez’s economic team that will only enhance investor skittishness over Venezuela. Chavez and his economic team led by Finance Minister Jorge Giordiani and Central Bank Chief Merentes described each of these moves as ways to insulate Venezuela from the decline of the US dollar and the havoc in the U.S. and European financial systems. They contrasted the “Yankee” system with the stability of the BRIC countries, claiming that the emerging economies were more stable and friendly to Venezuelan interests and thus suitable to hold Venezuelan assets as Venezuela would work with these economies to create an alternative basket of currencies to the US dollar. Much of this is political rhetoric however. Even Merentes admitted that actually converting Venezuela’s foreign reserves from dollars and euros to yuan and rubles would invite major risks to the Venezuelan economy.

In our view, these moves make political sense for the Chavez regime but are also extremely revealing of the state’s growing vulnerabilities that are bound to afflict the regime in the longer term.We described in our annual forecast at the start of the year how economic decay, runaway corruption and political uncertainty would define Venezuela this year, nothing that Chavez’s ability to manage threats to his hold on power would become more difficult and more complex, especially considering Venezuela’s growing struggle to maintain steady oil production. Most importantly, we specified that the Venezuelan government would become increasingly reliant on its allies (namely China, Cuba and, to a lesser extent, Iran and Russia) to stave off a major crisis.

Chavez’s dependency on Cuba for his regime security has become particularly evident since it was revealed that he had cancer--the longer Chavez was kept away from Caracas, the more he relied on his Cuban-stacked security apparatus to keep tabs on his inner circle and thwart any attempts to destabilize the regime. Similarly, the move to transfer Venezuelan currency reserves to China and Russia reveals a growing Venezuelan dependency on Beijing and Moscow for maintaining political stability at home.

Both China and Russia are major lenders to Venezuela—Venezuela has a total debt to China of $28 billion, much of which is denominated in yuan with terms that Venezuela would pay the amount back with shipments of oil. The Chinese investment has been crucial, not only for raising oil production, but also for building and making sorely needed upgrades to basic infrastructure throughout the country. Russia has also agreed to lend Venezuela $4 billion, at least half of which is designated to upgrading the Venezuelan Armed Forces with new armaments, from AK-47s to fighter jets, and the other half reportedly devoted to infrastructure development.

Bothcountries have becoming increasingly skittish over the political stability of the Chavez regime as both have deep insight into PDVSA’s state of financial disarray and understand that there is no clear successor to Chavez that would be able to maintain stability within the regime to the degree that he has. In short, at the same time Chavez is dispatching delegations to Beijing and Moscow to ask for larger installments on these loan agreements, Russia and China are demanding greater collateral, hence, Venezuela’s decision to transfer currency reserves to Russia and China. This enables Venezuela to draw more from its loans, but also gives Moscow and Beijing the option of blocking reserves should they have legitimate reasons to insulate themselves against a potential Venezuelan default.

Meanwhile, the Venezuelan government claims a deal has been made with Brazil for a $4 billion loan but the Brazilian government has not yet confirmed this claim. Given the trouble Brazil has experienced in getting PDVSA to pay its share of major projects, such as the $4.8 billion it owes to Petrobras for the stalled Abreu Lima joint refinery project, along with a stack of debts in the areas of food production, dam construction and other projects, we expect Brazil (already facing major budgetary battles at home) to be more cautious in extending sizable loans to Venezuela.

Since 2005, Chavez has spoken of reducing the exposure of the country’s currency reserves. The freezing of assets held by Chavez’s close ally, Muammar Ghadafi, has also likely panicked the Venezuelan leader, motivating him and his team to move their reserves to more politically friendly countries and out of the United States and Europe. The anti-Chavez and anti-Iran sanctions lobby in Washington, DC has been extremely active in trying to get the United States and European governments to sanction PDVSA for its growing business relationship with IRGC-linked companies (a planned trip in September by Iranian President Mahmoud Ahmadinejad to Caracas should be monitored closely in this regard.) Another key reason likely motivating Venezuela’s move to transfer its currency reserves to countries deemed as politically safer harbors likely has to do with pending arbitration on nationalization suits filed by Conoco Phillips and Exxon and others, which are estimated to exceed $30 billion.

Chavez’s Gold Strategy

The Venezuelan government moves to nationalize the gold industry and transfer more of its gold assets back home are likely indicative of PDVSA’s increasing cash flow problems. In addition to PDVSA’s heavy tax burden (roughly 47 percent of the company’s revenues goes to paying taxes) and ever-growing debt, the company’s financial overextension be seen in its wide-ranging portfolio, which now includes building affordable housing, paving roads in the countryside, running farms, importing, distributing and selling food, among other tasks. PDVSA has at least nine different parallel funds that are fed with oil revenues to fund state’s social development projects. As the need for these projects is growing, Chavez will find it increasingly difficult to maintain popular support when his health and successor line is in doubt. Further undermining the state company’s health are the corruption schemes taking place under its roof that remain unchecked and are having a debilitating effect on nearly every state sector in Venezuela.

In trying to improve the efficiency of PDVSA and key mining industries, the Venezuelan government announced a new policy in August in which PDVSA would enter joint ventures with state mining firms wit the logic that PDVSA could provide the financial muscle to revive companies like steel producer Sidor and state miner Coroporacion Venezolana de Guayana (CVG.) In theory, this move would have real potential to raise the efficiency of these key industries. However, since 2008, PDVSA has bought at least 15 companies in farming, agribusiness, shipbuilding and metallurgical areas, among others, and has reported losses in these areas since the takeovers. Recent history shows that PDVSA’s expanded portfolio has led to greater inefficiency, not less. Instead, PDVSA is growing into a state within a state without the tools it needs to clean out the inefficiencies already plaguing its growth. The more doubts grow over Chavez’s physical health, the more difficulty the president will face in reining in a corrupt “boli-bourgeoisie.”

The management of PDVSA’s money is becoming a critical issue for the Chavez regime. A clear illustration of this is the recent nearly half a billion dollars of pension fund money that was lost after it was invested in what turned out to be a Ponzi scheme run by a US-Venezuelan financial advisor who worked closely with members of the PDVSA board and Chavez regime. This partly explains the reshuffling of PDVSA’s board in May, when the managers of the pension fund were fired and when Venezuela’s foreign and finance ministers, both trusted by Chavez, were installed on the board to keep the company in check. PDVSA President Rafael Ramirez is believed to be linked to this scandal and has become increasingly problematic for the Venezuelan president, though Chavez so far is holding off on removing him altogether. The rumors persist that Ramirez is on his last legs but he appears to have built up enough leverage over the years to give him some staying power in this regime. (The loss of pension funds is likely to increase the level of labor unrest in PDVSA as the company does not seem to have a clear solution or the will to come up with the funds to satisfy its workers.)

Given current political uncertainties, Chavez cannot afford to have his social development projects held back by PDVSA’s cash flow problems and thus risk a loss in popular support. This explains why the government is so eager to move the bulk of its gold assets back home to have quick and easy access to reserves. The Chavez government strategically made the move when gold prices are at an all-time high. Nationalizing the gold industry makes it easier for them to add more gold to their existing reserves while reducing exposure to the dollar. Venezuela can sell oil abroad in dollars and transfer its currency reserves to gold, which will now be more accessible. Venezuela can then issue bonds at much lower rates, offering its own gold as collateral, to increase borrowing for its social development projects.

Notably, Venezuela has taken great care not to threaten Russia’s gold stake in the country in proceeding with the nationalization plan. Rusoro President and CEO Andre Agapov made clear that there would be no changes to the company’s operations while supporting the Venezuelan government’s line on the need to combat illegal miners. Chavez does not appear to have any intention to anger the Kremlin and thus risk a loss of much needed political and economic support.

Chavez Health Status

The Venezuelan government is not only looking to Russia for arms sales, oil production and infrastructure investment, but Russia is also the source of the medical aid Chavez needs to improve his prognosis. Chavez is reportedly undergoing histhird phase of chemotherapy, this time in Caracas. Though he claims he is already cured and the chemotherapy is preventative, his condition appears to be more serious than he is letting on. One source claims Chavez has stage 4 prostatic cancer that has spread anus, which is where the claims of colon cancer originated.The prognosis his Cuban medical team has allegedly given Chavez is 50 percent chance of surviving another 2 years if he is limited to the medical team in Cuba and Cuban facilities while his survival expectancy could be 4 years with Western technology and medical care and Russia has offered its medical team and services to Chavez.There have been some hints in the open source as well of Russian doctors joining Chavez’s medical team.

Lastly, we are closely following rumors in the Venezuelan press of Cuban leader Fidel Castro falling into a coma. A Cuban political crisis could exacerbate instability within Venezuela should Chavez lose his ability to rely on the Cuban leadership for his own regime security.

Security Developments The Minister of Interior and Justice, Tareck El Aissami, stated when? that only the National Forces and members of the public security forces would be allowed to carry arms on public transportation or in transport terminals. It is noteworthy that a 2011 amendment to the 2008 Law of the National Bolivarian Armed Forces (LOFANB)established a separate officer corps for the militias, which could be defined as “public security forces.” The amendment was already raising eyebrows because it could be interpreted to mean access to “war weapons” for the militia officer corps and also be used by the government as an end around the transport law and other laws or amendments meant to control weapons in Venezuela. The transport law and amendment taken together could be interpreted as means to potentially disarm political opponents while at the same time guarantee at least some of the militias have immediate access to weapons. This makes the degree of difficulty much higher in securing weapons for anyone attempting a coup.If there was a coup and move to secure the weapons meant for the militias, members of the militia loyal to Chavez could potentially resist long enough to provide at least some access to the armory for the rest of the militia.

Also, PDVSA employees took part in a non-violent protest Aug. 29 at a PDVSA oil refinery in Puerto la Cruz, Anzoategui state with the goal to bring attention to alleged violations of their labor contract by the oil company and what they termed to be the deteriorating security situation inside the facility.The employees claimed that they had been the targets of multiple threats, including shootings, stabbings and robberies by people who did not work at the facility, although no further specifics were given, including what type or nationality of employees were targeted. Although we do not have any hard data regarding these incidents yet, if true, it marks an increase in the threat level related to criminal acts perpetrated against PDVSA employees, and potentially partners andexpatriate employees that may be visiting the site, which warrants reviewing security protocols to make sure Chevron employees are not included within this reported target set.

Lastly, according to reports in August, 500 prisoners have been released from a prison in Uribana, located in Lara statesince April 2011, citing either humanitarian reasons or that inmates had met conditions for parole. This could signal that the Venezuelan government may be serious about releasing 40% of the prison population or potentially 20,000 current inmates. As we noted in last month’s report, even those prisoners who were incarcerated for minor crimes have been living in a violent environment, immersed with hardened criminals. Therefore, there is the potential that general crime could increase in the areas that those prisoners settle should they not be able to find legitimate work and a means for income after their release.