THERE IS NO HYPERINFLATION IN IRAN–The Real Story Is Much More Interesting
Matthew
Boesler
6
October, 2012
Contrary
to reports, there is no hyperinflation in Iran right now at all.
In
fact, the Western sanctions imposed on Iran's oil trade are failing
miserably to meet their objectives.
And
a regime collapse – or even, coming short of that, another popular
uprising reminiscent of June 2009 – seems further away from Iran
than ever.
Meanwhile,
the Iranian regime is using the current sanctions imposed against it
by the West as a weapon to weaken its own fiercest domestic threat –
the educated, relatively pro-Western Iranian constituency that
comprises the middle class.
In
this way, the economic warfare the West has waged against Iran to
weaken the regime is actually amplifying the regime's control.
Before
we get to that, though, we need to take a look at why there is no
hyperinflation in Iran – because what is being confused as
hyperinflation by outside observers and the press right now is
actually the mechanism through which Iranian leaders are tightening
their grip on Iranian society.
The
Iranian rial plunges
The
Iranian rial has been in absolute freefall against the U.S. dollar in
the open market this week. Below is a chart of the currency up
through Wednesday or so, when
protests broke out in the money-changing centers and
quotes were blacked out on currency trading websites because the
plunge in the currency was so bad.
Just
weeks ago, less than 25,000 rials could be exchanged for a U.S.
dollar. At last check, that number is now close to 35,000:
This
chart has led many observers to confuse Iran's current situation with
hyperinflation. The fact is, though, that U.S. dollars aren't really
an essential medium of exchange in the Iranian economy, and Iran
still maintains control over the official exchange rate – closer to
12,000 rials per dollar – which dictates most day-to-day
transactions.
The
Iranian regime is thus able to channel the most pain of the sanctions
in whatever direction it chooses, while avoiding any of the
ramifications of the sanctions itself.
Dr. Djavad
Salehi-Isfahani, a Virginia Tech economist and Brookings
Institution fellow
whose expertise is the Middle East, told Business
Insider that
"what the [Iranian] government is trying to do is make sure the
targeting of sanctions goes to the rich, so that Iran's middle class
– not the lower class – becomes the victim of Western
sanctions."
The
politically-important lower classes – which represent a significant
amount of voters – are shielded from devaluation of the dollar
because their day to day lives don't even involve dollars.
Salehi-Isfahani
told Business
Insider, "The
Iranian currency is very worthwhile for poor people. They go to work,
they get their daily wage, they go buy their chicken and bread, and
they get the same that they got the day before."
University
of Michigan social historian and Middle Eastern affairs expert Dr.
Juan Cole agreed, telling Business
Insider,
"It's just that you don't pay for your eggs in Iran in dollars."
To
understand why and how the regime is using this dynamic to target and
weaken the Iranian middle class, then, we need to review some basics
about the Iranian economy.
How
Iran's currency system actually works
The
Iranian government, up until the sanctions from the West came into
forceful effect in July, was bringing in billions of U.S. dollars by
selling oil to Western nations.
The
sanctions, which have quashed Iranian oil exports to the West and
have effectively frozen Iran out of the international financial
system, have stemmed the flow of dollars into the country, but the
central bank has whatever reserves it has accumulated from prior oil
sales that it hasn't already pumped into the economy (there is
limited visibility on this sort of thing, so the exact amount of
dollars the Iranian central bank currently possesses are a bit of an
unknown).
Dr.
Salehi-Isfahani explained that in other countries, foreign exchange
is transacted among traders in open currency markets. In Iran,
however, the dollars are supplied to the economy from the
government's oil purse.
What
this means is that Iran can effectively value the rial at whatever it
wants against the dollar – at least, as long as it still has
dollars.
And
this is exactly what the regime does. It has the rial on what is
called a "multiple exchange rate" system.
This
system allows the government to subsidize the prices on certain
critical items, like food, keeping them relatively affordable for the
politically-important lower classes.
Salehi-Isfahani explained
how this works in an article on Thursday:
Iran’s
Central Bank has classified a long list of goods into categories with
priorities 1 through 10, leaving it to the parallel market to take of
all other needs. Priorities 1 and 2 are food and medicine, receiving
foreign exchange at the official rate of 12,260 rials per dollar,
followed by other categories with lower priorities, which are mostly
intermediate goods used in industrial production.
That
brings us to the parallel market, where dollars are freely traded
based on market rates – this is where the rial has seen its plunge
against the dollar in recent weeks.
The
parallel currency market destroying Iran's middle
class
As
Dr. Salehi-Isfahani described in his article, certain goods are
considered "lower priorities" to the government, which
means the government may be less willing to dole out dollars from its
oil purse to an importer who wants to bring in industrial goods than
it would be to give those dollars to an importer bringing in food.
This
means that importers looking for dollars to bring in more specialized
items often have to turn elsewhere to exchange their rials for
dollars. So they turn to the parallel currency market.
Pictured
above is the Grand Bazaar in Iran's capital city of Tehran. This is
the type of place where the Bazaari
set up their currency exchange shops that
comprise the parallel market.
Massive
anti-regime protests erupted at the Grand Bazaar earlier this week as
middle class Iranians, including the Bazaari, protested the plunge in
value of the rial, which forced currency exchange shops to close
down:
Dr.
Cole explained to Business
Insider why
the Bazaari and the Iranian middle class are so angry:
The
fall of the rial against the dollar would mainly have the effect of
making dollar-denominated imports more expensive. It is doing
that, but dollar-denominated imports are not everything in the
economy, so it would be sectoral, the impact.
Now,
there is a group of people who are import-export merchants, or money
changers, or their livelihood depends on dealing in dollars. So they
are getting hit badly if they were holding rials.
Cole
warned that as a result, the destruction of the middle class is
"a process which may well have begun with the events of this
week."
However,
Iranian president Mahmoud Ahmadinejad has arguably been laying the
groundwork for this for quite some time.
The
real cause of high inflation in Iran
Mahmoud
Ahmadinejad has served as president of Iran since 2005. His
easy-money policies characterized by distributing too much of the
state's oil wealth into the economy have led to rampant inflation.
The
supply of money in the Iranian economy has skyrocketed during
Ahmadinejad's tenure in office:
Bloomberg,
Business Insider
Unsurprisingly,
inflation has also been quite high, save for the period in the wake
of the global financial crisis in 2009.
It's
important to note that this is high inflation (as it has been for
awhile) – not a rapid, uncontrolled surge in the price level that
would justify use of the term "hyperinflation."
The
chart below shows the percent change from a year ago of Iran's
consumer price index:
Bloomberg,
Business Insider
Dr.
Cole told Business
Insider that
the problem created by Ahmadinejad's policies is one of simple
economics:
The
increased money supply will cause prices to go up, which will eat
away the value of the subsidies, and so forth. So, how you get that
extra money that the government has to the people without causing
hyperinflation is a really tough problem, because the healthy way for
an economy to have more money in it would be an increase in
productivity.
But
there isn't any increase in productivity, it's just an increase in
money coming in from the outside. So, that subsidy policy that
Ahmadinejad kind of buying people's votes, and so forth, by giving
out money, that has caused this inflation.
And
this is where the truth about the devaluation of the rial is
revealed.
Cole
explained that "now you've got all that liquidity in the
economy, and what would you do with it? The sanctions may make
dollars really attractive. So, if you had a lot of the extra
rial money supply chasing the dollars, then that would help to
explain the fall in the value of the rial."
So,
again, the contributions of the sanctions to inflation in Iran are
limited in scope, but it's the middle class – being more active in
dollar-denominated trade – that is getting slammed by them.
Meanwhile,
the regime's control over the population is increasing.
The
Iranian regime's ultimate power play
While
the middle class suffers as a result of high (not hyper) inflation
and the effects of Western sanctions, the position of the government
is getting stronger.
Recall
that in 2009, following Ahmadinejad's re-election to the presidency
for a second four-year term, massive demonstrations by angry
middle-class Iranian voters who felt the election was rigged captured
the world's attention for weeks.
Images
like this were broadcast around the world as demonstrators took to
their mobile phones to spread the word on social networks
Memories
of 2009 have led some to speculate that the plunge in the rial –
which is understood to be misunderstood – could lead to a similar
moment in Iran again.
Unfortunately
for Iran, this does not appear to be the case. Dr. Cole told Business
Insider that
the Western sanctions, far from destabilizing the Iranian government,
are aiding the regime.
The
drop in dollar-denominated trade falls hardest on the middle class,
reflected in events this past week.
And
the lower classes are bought out with easy money policies.
In
a damning analysis of the current course of Western policy, Cole
told Business
Insider:
Personally,
I think the sanctions in and of themselves are rather unlikely –
not impossible, but rather unlikely – to change either regime
behavior or cause regime change. It's relatively seldom that
sanctions alone can change those goals.
More
especially on an oil state – because oil is fungible – even
if you could prevent people from buying Iranian petroleum on the face
of it, petroleum is really easy to smuggle.
We
saw this with the sanctions on Iraq in the 1990s. People were
putting gasoline on trucks and just driving them over to Turkey or to
Jordan. The Baath party squirreled away billions and billions of
dollars from the oil smuggling, all the time that the severe
sanctions were going on. So,
the sanctions did destroy the Iraqi middle class and reduced Iraq in
some ways to a 4th-world society. But,
the government was held harmless because it owned the petroleum, and
it could smuggle, and so forth.
The
same thing likely is true in Iran. I think the sanctions could well
substantially reduce the standard of living of the average Iranian
over time, but that it could so harm government receipts as to weaken
the government seems unlikely.
The
other problem is that if you destroy the Iranian middle class – a
process which may well have begun with the events of this week – what
you're doing is depriving the most active people in the society of
the resources with which to challenge the government.
So,
if the government is still getting billions in oil revenue, and the
middle class is being devastated, the middle class doesn't have
resources, and the government becomes even more powerful as an actor
in society.
Again,
this is what happened in Iraq. So, I think the sanctions are probably
counter-revolutionary.
Cole
concluded by saying:
I
think that the people who used to have the money to play politics and
impact candidates and maybe get up demonstrations are increasingly
going to be poverty-stricken, and not have those resources.
I'm
afraid I think that the sanctions probably forestall, rather than
encourage, an "Iranian Spring."
Dr.
Salehi-Isfahani told Business Insider, "Since 2009, it's become
quite obvious that Iran's middle class is not with this government,"
and that, "when the sanctions come, the government uses its
power of allocation of foreign exchange to make sure its base is
taken care of, and the people who suffer are the people who are kind
of ideologically, in some sense, allied with the West."
"They
are Western oriented – they want government to compromise, so that
they could have travel abroad and have all sorts of things."
Does
the West realize how counterproductive its policy against Iran has
become?
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