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In Every Nation for Itself: Winners and Losers in a G-Zero World, World Policy Institute Senior Fellow Ian Bremmer illustrates a historic shift in the international system and the world economy—and an unprecedented moment of global uncertainty.
By Paul Sullivan
Since 2008, the Tehran Stock Exchange, TSE, has increased by more than 300 percent from just below 9,000 to over 28,000. This, however, does not reflect the underlying fundamentals of the stocks, but a monetary policy and sanctions-driven synthetic market. Since early 2010 Iran’s currency has dropped by over 80 percent, and in just the last week the currency has lost 40 percent of its value to the dollar. With probable bubbles in stocks and housing, Iran’s financial woes may be only beginning.
Over the last four years, the monetary policy of Iran has been hyper-expansionary. Having the broad money supply grow at the mid 20 percent range as the real GDP grows at 3-5 percent on average since 2010 breaks the cardinal rule of monetary policy: Try to keep your money supply growth at about the same rate as your real GDP growth, or expect inflation and other even worse problems.
Iran has serious levels of inflation and unemployment. Of course getting believable numbers is rather difficult, if not impossible, under present circumstances. Officially, unemployment is around 12 percent. Unofficially, it is likely quite a bit higher. According to more reasonable and conservative estimates, inflation was in the 25 percent range prior to the recent collapse of the rial. The speed of this collapse over the last few months, and especially over the last week, could drive hyperinflation.
I cannot see how it could not, unless the Iranian government imposes price controls. That would be a very bad idea and would likely force black markets even further underground and drive the prices in these black markets even higher than on open markets.
Today, people are not able to afford what were considered basic necessities a short time ago, such as meats and replacements of durable goods like small washing machines and refrigerators. Those who have sons and daughters at school abroad in the midst of this currency collapse may find that they can no longer afford their education. The Iranian government also seems to have a policy to not pay for the education of some they previously promised they would. Sometimes, other children in the family will suffer to keep paying for the students outside. Eggs, bread, and other simple foods have become far more expensive. And Iran needs to import a considerable amount of its food.
In recent months, Iran has imported huge amounts of wheat. It also imports lots of machinery, transport vehicles, parts and spares, and more. Domestically produced goods like medicines have become much more expensive too, like the imported ones, given that they are in the same market. So the upward spikes in prices of imported goods due to the fall in the rial will help drive the upward spikes in the prices of domestically produced goods. This is particularly true for the domestically produced goods that use imported inputs.
The drop in the rial may help Iranian exports of pistachios, propane and butane, rugs, fruits and nuts, engineering and construction services, etc. However, this may be short-lived given that the price to produce these and the prices that the experts and workers exporting the services need to pay will be going up. Hence the internal prices for some of Iran’s major exports will push up its export prices to some extent. Hyperinflation within Iran will hardly help Iranian exports.
Hyperinflation will have a tendency to seize up markets. The bazaaris closed their shops last week because they could not figure out what prices to sell things at. At one moment, something may cost 50,000 rials and in the next it could cost 75,000.
Tehran tried to set up a new group of controls on the foreign exchange market last week. This was for a specific set of imports that would have to be imported at the official exchange rate, which is far lower than the market rate as exchanged in the bazaars and via the money changers throughout the country. This was one of the sparks for the panic drop of the rial last week, and indicated to the money changers on the market that either the government was going to hoard more dollars or was running out of them. The resulting panicked contagion caused the rial to drop massively over a couple of days.
In an attempt to stop the free fall of the rial, the government enacted a trading cap. This is pretty much the same as trying to set a limit on the price of the rial in dollar terms. The inevitable happened: trading seized up. If the real value of the rial is 50,000 to the dollar then who would want to trade it at 25,000? Worse yet, who would want to trade it at the official rate, which at last check was about 12,600? Exchange rate caps can also drive the black markets even deeper. This currency cap drove many Iranians to go to neighboring countries like Afghanistan to get dollars. Hence, the dollar stresses in Iran may spread to its neighbors to some degree. That cannot be good. The amount of spread depends on how many dollars Iran takes out of its neighbors compared to their supply of dollars.
President Mahmoud Ahmadinejad showed his near complete ignorance of his economy when he stated that trade was a tiny percentage of Iranian GDP. In fact, it is about one-third of the Iranian GDP. He also said that there were not that many dollars in Iran. There is surely a significant amount of dollars in Iran, and those amounts are increasing due to his government’s policies. As the rial is crashing, he has stated that there is no crisis. This obvious ineptitude only drives the economy further into the ground.
Ahmadinejad’s hyperactive monetary policy drove the inflation that helped lead to the collapse of the rial. The Central Bank of Iran is far from independent from him or the mullahs. They have used the Central Bank and pretty much the banking system as a whole to try to pump up the economy in nominal terms to fool the Iranian people. They overdid it. They also used monetary policy to inflate the economy to reduce the real debt that they owned to domestic bond holders. They overdid that as well. Those bonds are dropping like a rock in value.
The yields on most bonds and bills in Iran have been hammered by Iran’s monetary policy. This has helped drive people to invest in the Tehran Stock Exchange. The run up of the TSE is driven by the portfolio choice away from bonds and bills and towards stocks but also by the fact that given the increased tightness of sanctions there is little else to invest in. The large increases in the prices of immovable and illiquid assets like land and housing have also been driven by the monetary policy-based inflation and sanctions.
Easy money from monetary policy combined with a lack of other investments has, in part, driven a huge run up in the stock index and the housing and land indices. This sure sounds like a bubble to me. The rial bubble popped. The next bubbles to pop may be the housing and land bubbles. Then the stock bubble may pop. The fundamentals for the assets, both liquid like stock and illiquid like housing and land, do not seem to support these huge run ups. I suppose this may sound familiar to some. The housing bubble is likely the least robust as the potentially increased inflation creeps (or rockets) into the economy and people start to liquefy their assets.
Iran may be heading for a severe liquidity crisis given how much of its wealth went into housing and land in recent years.
Iran may also still have significant reserves, but the question is: What will they do with them? The situation is quite difficult now that their options are so limited. They could start buying up rials with dollars and euros to turn the tide. However, that may restrict future options if sanctions get worse or if there is a war or internal conflict. The leadership seems to want to hold reserves for the really rainy days they fear may come. However, it is raining pretty hard on the Iranian economy right now. With the sanctions on oil and the increasing costs of keeping the country running it may be that its reserves are much less than many think. There is a big question mark out there about whether Iran can turn the collapse of the rial around. At this point it seems doubtful given the counterproductive policies they have used so far.
The big economic elephant in the room has been the nuclear program. It has been a serious drain on the economy for many years. Iran has developed almost the entire nuclear fuel cycle. This is unnecessary for a country whose goals are nuclear power. Iran also has very small reserves of uranium. They waste by flaring off the equivalent of four nuclear power plants in precious natural gas. The structure of the nuclear program makes very little economic sense.
The global nuclear defiance and shadiness of the Iranian nuclear program has also driven the brutal sanctions. These sanctions have significantly cut off Iranians from the world financial system, especially after being kicked out of SWIFT, a global communication network used for massive amounts of global financial transactions. It is the most important global financial clearinghouse. Iran is blocked from the usual international flows of currencies and assets that most other countries enjoy.
It is time that Iran comes in from the cold, gets reasonable with its nuclear stance, stops the self-destructive defiance and starts to think more about its people, rather than the machismo and pride of its leadership. It would also help if they started applying proper economic policies to get the country and its people back on their feet.
Paul Sullivan is a professor at Georgetown University and The National Defense University.
[Photo courtesy of Celie]