Iran’s death spi­ral

The Pak Banker - - Front Page - Steve H. Hanke

IN light of the re­cent events that have tran­spired in Iran, I think I might have been onto some­thing back in 2009. Since early Septem­ber, there has been an ac­cel­er­ated slide in the value of the Ira­nian rial. This slide has been punc­tu­ated by dra­matic col­lapses in the de­mand for the rial. With each col­lapse, there has been some­thing akin to a “bank run” on ri­als with a sharp rise in the black mar­ket (read: free mar­ket) rial-US dol­lar ex­change rate (see the ac­com­pa­ny­ing chart). Iron­i­cally, Ira­ni­ans are clam­our­ing for US Dol­lars.

It is worth men­tion­ing that the black-mar­ket rate is an un­bi­ased met­ric. In a land where the sig­nal-tonoise ra­tio is very low, the black­mar­ket rate rep­re­sents an im­por­tant piece of ob­jec­tive in­for­ma­tion. It says a great deal about the state of the Ira­nian econ­omy and the pop­u­lace’s ex­pec­ta­tions.

On 8 Septem­ber 2012, the black-mar­ket rial-US dol­lar ex­change rate was 23,040. In the course of just un­der a month, af­ter two big sell offs, the rate set­tled at 35,000 on 2 Oc­to­ber 2012. That is a 34.2 per cent de­pre­ci­a­tion in the rial, rel­a­tive to the green­back. It was at this 35,000 rial-US dol­lar rate that I first cal­cu­lated the monthly in­fla­tion rate im­plied by the rial’s de­pre­ci­a­tion. The im­plied monthly in­fla­tion rate was 69.6 per cent. Since the hur­dle rate to qual­ify for hy­per­in­fla­tion is 50 per cent per month, Iran reg­is­tered what ap­pears to be the start of the world’s 58th hy­per­in­fla­tion episode.

With that, the Ira­nian au­thor­i­ties swung into ac­tion and in­tro­duced a new mul­ti­ple-ex­change-rate regime. There is an of­fi­cial ex­change rate of 12,260 ri­als to the US dol­lar, which is avail­able for Ira­ni­ans who are im­port­ing es­sen­tial goods, such as grain, su­gar, and medicine. In ad­di­tion, there is a “non-ref­er­ence” rate, which is avail­able at li­censed deal­ers and can be used by im­porters of nonessen­tial goods, such as livestock, met­als and min­er­als. This rate is pur­port­edly 2 per cent lower than the black-mar­ket rate, though it cur­rently (as of 10 Oc­to­ber 2012) sits at 25,480 ri­als to the US dol­lar rep­re­sent­ing a sig­nif­i­cant dis­count rel­a­tive to the black-mar­ket rate. And then, there is the free-mar­ket (black­mar­ket) rate that is avail­able to any- one will­ing and able to avoid the ever-watch­ful eyes of the po­lice.

Among other things, the mul­ti­ple-ex­change-rate regime gen­er­ates noise in the Ira­nian econ­omy. In­deed, more than one price for the same thing cre­ates prices that lie, and ly­ing prices make it dif­fi­cult for Ira­ni­ans to de­ter­mine the true cost of what they are pro­duc­ing and ul­ti­mately sell­ing. The mul­ti­ple­ex­change-rate regime, there­fore, is just one more mon­key wrench that is be­ing thrown in the wheels of the econ­omy.

The an­nounce­ment of Iran’s hy­per­in­fla­tion aroused the priest­hood. In ad­di­tion to im­ple­ment­ing the new mul­ti­ple-ex­change-rate regime, the Ira­nian au­thor­i­ties have boosted the po­lice pres­ence in the bazaars of Tehran and cracked down on cur­rency traders.

As the ac­com­pa­ny­ing chart shows, Iran’s hy­per­in­fla­tion has, of course, sent the Ira­nian mis­ery in­dex to the moon. Talk about a death spi­ral.

Be­fore leav­ing the Ira­nian mis­ery in­dex, it mer­its men­tion­ing that the in­dex was el­e­vated prior to the 1979 Rev­o­lu­tion. Re­call that, be­fore the last Shah was pushed off the Peacock Throne, his vi­sions of gran­deur had led him to em­brace Soviet-type schemes, such as fiveyear plans, mega-projects, ru­ral col­lec­tivi­sa­tion, model towns (shahraks), and cen­tral plan­ners. In short, the “Soviet” Shah, who was propped up by the United States, made a mess of the econ­omy and kept the mis­ery in­dex el­e­vated.

With the com­mence­ment of hy­per­in­fla­tion, we are left with an ob­vi­ous ques­tion: “How long will Iran’s hy­per­in­fla­tion last?” The ac­com­pa­ny­ing ta­ble ranks the 57 known hy­per­in­fla­tions by the length of each episode. The av­er­age du­ra­tion is roughly 12 months, with the long­est hy­per­in­fla­tion be­ing that which oc­curred in Nicaragua. It lasted four years and 10 months. At the other ex­treme, there are 13 episodes that fiz­zled out af­ter one month.

So, how does one stop a hy­per­in­fla­tion? In my ex­pe­ri­ence, as some­one who has been in­volved in stop­ping 10 of the 57 known hy­per­in­fla­tions, there are two sure-fire ways: in­sti­tut­ing a cur­rency board or adopt­ing a for­eign cur­rency (dol- lar­i­sa­tion). In Bul­garia, where I was Pres­i­dent Stoy­anov’s ad­viser, hy­per­in­fla­tion peaked at a monthly rate of 242 per cent in Fe­bru­ary 1997. On 1 July 1997, Bul­garia in­stalled a cur­rency board, un­der which the Bul­gar­ian lev was is­sued. It was backed 100 per cent by Ger­man mark re­serves and fully con­vert­ible at a fixed rate with the mark. As the ac­com­pa­ny­ing chart shows, hy­per­in­fla­tion stopped im­me­di­ately and Bul­garia’s mis­ery in­dex fell like a stone.

In Zim­babwe, Pres­i­dent Mu­gabe sim­ply looked the other way as the hy­per­in­fla­tion roared ahead. It peaked in mid-Novem­ber 2008, reach­ing the sec­ond-high­est level ever recorded in the world. At that point, the daily in­fla­tion rate was 98 per cent, and it took only 24.7 hours for prices to dou­ble.

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