For
a nation that has only recently come out of decades of dictatorship,
war, and mismanagement, Iraq’s currency—the dinar—has been remarkably
stable. Perhaps too stable. Something is going on with the Iraqi dinar.
After
a gradual strengthening from 2007 to 2009, the Iraqi government decided
it wanted a weaker dinar in early 2010, and the currency has remained
remarkably stable ever since.
CHART IQD per 1 USD
A
couple of months ago, however, the currency abruptly strengthened
against the USD, as can be seen by the sharp drop at the far right.
Immediately, the Central Bank of Iraq scrambled to weaken the dinar back
to 2012 target levels.
Why?
Isn’t it supposed to keep strengthening? After all, Iraq has the
world’s second largest oil reserves. What ever happened to that highly
anticipated revaluation? Is the CBI deliberately weakening its own
money?
CBI Control
One
short sentence answers all these questions: the Central Bank of Iraq
regulates the flow of money through controlled auctions.
Needless
to say, this is not normal. In most other countries, money can be
easily exchanged into a number of currencies at the will and whim of any
citizen. The exchange rates are allowed to move freely according to the
forces of supply and demand, interest rates, etc.
According to Middle East e-paper Al-Monitor:
“Every
day since 2004, the CBI has held an auction through which hard currency
is sold to banks, companies and traders in exchange for evidence of
import and transaction receipts. The auctions aim to prevent market
speculation and stabilize the exchange rate of Iraqi dinars to the US
dollar.”
The
purpose of these auctions is to control the IQD:USD exchange rate by
controlling the amount of USD circulating in Iraq. At these auctions,
USD is issued exclusively to banks, companies and traders for the
purpose of conducting business transactions with foreign entities (ie:
importers, securities traders, banks, etc).
By
controlling the amount of USD available in Iraq, the Iraqi government
controls the value of the USD relative to its own currency, thereby
stabilizing the dinar. It is as close as you can get to an outright
currency peg.
Cracking Down on Auction Abuses
Things
were going really great for years, until evidence turned up that some
buyers at these auctions were falsifying their transaction receipts,
enabling them to purchase more USD than their business activity
legitimately entitled them to have.
The
government believes much of the excess dollars purchased were smuggled
across the border into Iran, which has a shortage of hard international
currency due to sanctions. Money laundering and black market demand
account for the remainder of auction abuses.
When
it came to light earlier this year that more USD had made it into
circulation than was officially thought, the value of the USD relative
to the dinar abruptly dropped and the dinar rose. The supply/demand
ratio dictates that the more supply you have of something, the cheaper
its value. More USD in circulation than previously thought meant a
cheaper USD, which meant a stronger dinar. Hence the sudden inverted
spike at the right of the chart.
Following
the recent arrest of the CBI’s former governor, Sinan al-Shabibi, the
CBI has introduced additional auction controls, as Al-Monitor explains:
“The
CBI prohibited any bank or company with capital of less than $400,000
from taking part in the currency auction. Additionally, all participants
had to submit their [transaction receipts] to the criminal division in
the Ministry of Interior, the economic crime unit and the
money-laundering division of the CBI for approval.”
Reducing
the number of buyers at the auctions meant reducing the amount of USD
making it into circulation, strengthening the USD relative to the Iraqi dinar, and weakening the dinar back to that desired 2012 target level.
Anger Over Weakening Dinar
Iraqi
citizens and businesses who do not have dealings with foreign entities
are understandably angered by CBI controls aimed at keeping the dinar
weak. A weak currency means citizens and businesses need to pay more for
goods and services, especially since so many goods are still being
imported from abroad.
Iraqi parliament’s Amin Abbas stressed to Al-Monitor that
the CBI must take “full responsibility for the fall of the … Iraqi
dinar … because of its restrictive measures in granting permits to
exchange companies.” And Mohammed Khalil, an official on Iraq’s Economic
and Investment Committee, accused the CBI of deliberately “hinder[ing]
the flow of US dollars into the market.”
Others are pinning the blame on Iraqi banks, as Al-Monitor informs:
“Hussein
al-Yasiri said some banks have stopped selling dollars to regular
customers and instead have been selling them to exchange companies. This
has prompted Iraqis to buy dollars from the exchange companies at
prices favorable to the companies. The exchanges are not subject to
government monitoring.”
And
Iranian involvement is still suspected by Ahmed al-Alwani, head of the
Iraqi parliament’s economic committee, who believes Iran is supplying
Iraqi partners with false trade receipts in order to obtain USD from the
auctions.
But
Ahmed Bureihi, a former senior official at the CBI, denied such
accusations. “Iran has nothing to do with the increased exchange rate,”
he told Al-Monitor.
“The CBI sells foreign currency to Iraqi customers to be used in
funding trade transactions outside the country.” “There are Iraqi
traders who defraud the CBI and provide counterfeit documents of virtual
imports to Iraq. However … this has nothing to do with political
issues.”
Oil Revenues Spent
For
its part, the government has a simple explanation for the dinar’s
weaker value back to 2012 levels: the country spent it down.
“A
former senior official at the CBI [Bureihi] said the rise is linked to
increased government revenue from oil sales, leading to an increase in
government spending,” Al-Monitor explains.
Bureihi
then describes a very logical chain reaction that stems from these
increasing oil revenues, which really is a bona fide explanation. “Oil
revenue increased, which in turn increased government spending.” “The
increase in government spending means higher per-capita income. [When]
spending increases, there is an increased need for importing goods.
Providing these goods requires an increased demand for foreign currency,
which led to the increased exchange rate [for USD].”
On
the dinar’s side of that equation, as more oil is exported, more
revenue is generated, and the nation becomes wealthier “per capita”.
Enabled by this increased wealth, the government starts funding sorely
needed rebuilding and expansion projects on infrastructure, energy,
education, health care, and industry. In so doing, it pumps more of its
local currency into circulation, which in turn weakens it.
This
is a valid explanation for the stronger USD and weaker IQD. However,
what the CBI is reluctant to admit is that apart from these increased
oil revenues, the government is controlling the dinar’s exchange rate by
controlling the amount of USD in circulation via its daily auctions.
It
will only let into the economy the same amount of USD that is leaving
the country. “X-amount” pumped in equals “X-amount” wired out. The
balance of USD in circulation stays unchanged, and thus the exchange
rate stays the same.
(Actually,
the CBI does have to pump in very slightly more USD than is going out
of the country in order to apply upward lift to the dinar as a counter
to the downward push on the dinar exerted by the increased spending
described earlier. Spending pushes the dinar down, USD auctions lift the
dinar up, cancelling each other out to keep the exchange rate flat and
steady.)
What About the Revaluation?
But what ever happened to that dinar revaluation everyone has been expecting? Even I wrote about it a couple months back (Dinar Speculation).
All
over the web you will find plenty of investors who expect the Iraqi
government will be forced to revalue its currency upward. Iraq has the
world’s second largest oil reserves, and it is rapidly increasing its
production and exports. The International Energy Agency recently
projected Iraq’s oil output to more than double in the next decade.
So
the revenue is there. Unfortunately, so is the spending. Remember, Iraq
is still rebuilding from decades of dictatorship, war, and
mismanagement. The economy is in shambles, and social services are
appalling. Any money coming in through oil exports is quickly being
spent on reconstruction and industry, not to mention its debt burden.
This
is why the CBI is going to such great lengths to control the amount of
USD in circulation through auctions. It wants to keep the dinar cheap.
Not too cheap so as to introduce hyper inflation. But cheap enough to
maximize the value of its import income and get as much construction and
labor for its money as it can.
What
if it takes another 5 or 10 years for that revaluation to come? Might
there be better returns elsewhere? Investors have to weigh the pros and
cons and make their own investment choices.
If
one still believes the global economy will once again run full steam
ahead, then metals such as copper, iron, and steel will be in great
demand, as will lumber.
If
one still believes the global credit crises are not over, then precious
metals will also be in demand, such as gold and silver. Who knows,
perhaps this recent pull-back is a good entry point; no one knows for
sure.
And there is always the stock market, which is remarkably resilient given the Federal Reserve’s easy money policy. Wealth Daily provides valuable trading information to help you make the right choices for you.
Perhaps
the most crucial variable in any investment formula is time. You can
have a sure-fire bet in a stock, gold, or even the Iraqi dinar. But how
much time will you be waiting for it to pay off? Could you score better
returns elsewhere over that same period of time?+
Source: Wealth Daily