Photo: Rick Santorum
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 centres 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:
Photo: Reza Asadi
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 subsidise 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 specialised items often have to turn elsewhere to exchange their rials for dollars. So they turn to the parallel currency market.
Photo: flickr / kamshots
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 characterised 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:
Photo: 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 a while) – not a rapid, uncontrolled surge in the price level that would justify use of the term “hyperinflation.”
The chart below shows the per cent change from a year ago of Iran’s consumer price index:
Photo: 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 like Twitter and Facebook while the regime tried to crack down:
Photo: flickr / Iran Election 2009
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 behaviour 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 realise how counterproductive its policy against Iran has become?
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