One of the stories I’ve been watching is the dramatic decline in value of the Iranian currency, the Rial. The Rial has lost about 75% of its value over the past year, with a decline of approximately 40% coming over the past week.
When a currency declines, it is often idiosyncratic, as seems to be the case with Iran. The initial driver of currency weakness was economic sanctions. Iran has not been allowed to sell its oil overseas.
One way to think about currency is as follows: the value a foreign currency is the ability to be able to buy goods from that foreign region. Stated even more simply, if there is nothing local worth buying, currency will not have value. Since Iran cannot sell its oil, markets are increasingly questioning the value of the Rial. As a corollary, the resultant economic unrest (in this case intentionally intensified by sanctions) means that foreign currency does not flow into Iran, so there are very few dollars/euros (etc) with which to either invest or buy goods from outside Iran, most notably food.
The drop in the value of the Rial was exacerbated this past week when the government tried to fix exchange rates for importers of products such as food and medicines. Governments cannot simply issue a directive about how much value a currency can have. Imagine if the US government decreed that certain importers would have a preferential exchange rate such that one dollar was enough Yen to buy a car. Would you want to be the bank to be forced to take that dollar and provide Yen? In the case of Iran, the government is providing the excess foreign currency to achieve the designated exchange rate. Still, would you have confidence in the currency’s value, especially if you were not one of these select few beneficiaries?
To appreciate the social implications of the currency collapse, several stories provide striking glimpses into the real life effects:
A Huffington post story writes: “The owner of a furniture showroom said he hasn’t made a sale in 10 days while his workshop rent has been increased by 30 percent. He said one of his workers bought a can of tuna for lunch Saturday for 35,000 rials, or about 98 cents at the current exchange rate. The next day it was 45,000 rials, or $1.26, said Hamid, who gave only his first name because of warnings by Iranian officials not to discuss the economic situation with the media.”
A New York Times article describes a man encountering inflation as he prepares to buy a year’s supply of rice: “Better buy now,” one rice seller advised Abbas Sharabi, a retired factory guard, who had decided to buy 900 pounds of Iran’s most basic staple in order to feed his extended family for a year. “As I was gathering my money, the man received a phone call,” said Mr. Sharabi, smoking cigarette after cigarette on Thursday while waiting for a bus. “When he hung up he told me prices had just gone up by 10 percent. Of course I paid. God knows how much it will cost tomorrow.”
The article goes on to highlight the plight of some immigrants who had come to earn wages in Iran, now only to find their earnings have lost most of their value. Specifically, the article writes: “Among the country’s Afghan community, a mix of refugees and guest laborers, some were debating whether to leave Iran. Their currency, the afghani, had gained considerably against the rial, effectively slashing their already meager wages. After risking his life to get to Iran from Afghanistan, Amin, 18, had thought he was lucky to find a job sweeping the floors of an expensive Tehran apartment building. Now, he said he felt as if he were working for free. “I can make more money working in Afghanistan,” he said shyly, turning his face away. “The people are good to me here, but I have to think of my family back home.””
I don’t think that this inflation and currency crisis in Iran heralds similar problems elsewhere. However, there are a couple of significant implications. The first is that, in a region already plagued by instability, this massive social unrest adds a new and concerning wildcard. History is replete with periods of social unrest wherein governments protect their regimes by finding a scapegoat against which to direct hostility. Any votes for either Israel or the US as likely candidates?
Additionally, I take note of how suddenly economic stress can arise when confidence erodes. The situation in Iran did not arise overnight. Currency markets, like most financial markets, are underpinned by confidence in their validity. When there is a collective recognition that the underlying market structure is illusory and artificial, the market collapses. While I do expect this to be isolated to Iran, it is none-the-less scary stuff.
Sources: NY Times: As Iran’s Currency Keeps Tumbling, Anxiety Is Rising; Huffington Post: Iran Rial Crisis: Currency Fall Leads To Tightened Measures; NY Times: A New Sign of Distress as Iran’s Currency Falls; BBC News: Iran’s rial hits an all-time-low against the US dollar