Iraqi Currency

My comment that I thought Amir Taheri was wrong to praise the stability of the Iraqi dinar, because the dinar is a managed currency and does not float freely, brought a rebuke from someone more knowledgeable about currency issues than I. Collier Lounsbury maintained that the stability was genuine and owing in some part to Iraq's petroleum. (Exporting a pricey primary commodity does wonders to harden your currency). Now I have another reaction from someone who knows something serious about financial matters. Me, I know about ayatollahs. So I'm posting this interesting response for those to whom it may mean something. And also because it supports my deep-seated suspicion that the argument for "good news" on the Iraqi currency front is problematic.

'[The] statement that “The peg (properly a dirty peg, or trading range) is being run with reference to the market, maintained with regular Dinar and Dollar auctions.” is wrong and misleading, see below. Like many others, your correspondent has a “picture” in mind and assumes that it represents the facts. Would the currency have collapsed if there were no peg? Probably in theory, yes. But there would have been and would be under the circumstances no way to implement a “free market” for the Dinar, see below.

There has certainly been a de facto peg, contrary to Bremer’s original intention and applicable laws he “enacted” (although they are superficial and incomplete). The IMF in its recent report acknowledged the fact. The permitted “trading range” has been 1475-1483, with the target 1475. On Sunday, as a greeting to the new government, for the first time in months, the Central Bank bought a significant amount of Dinars to achieve the target rate of 1475 for one day. The exchange rate has been held firm at 1477 since then. Each day, between 15 and 22 banks participate in the Central Bank auctions. At least fifteen of them are state-owned and one, Rashid, when I last saw figures (six or so months ago) held more than 90% of all bank deposits in Iraq. Needless to say, the Embassy is beavering “fanatically” to privatize the banking system, but there is a long way to go even if the new Government were to decide that it should be privatized, which I doubt that they will.

The peg system can be (and is) maintained because its principal function is to convert the accounts of the Government’s Ministries from Dollars to Dinars. The Government receives 90% or more of its revenues from oil exports, priced and paid for in Dollars. The Central Bank accounts and the transition accounts in the Ministry of Finance are maintained in Dollars. The Ministries, for salaries and much else, make expenditures in Dinars. While I cannot prove it with a documentary citation, my belief and assumption (based upon a knowledgeable reading of the text of the KPMG audit reports) is that Dollar deposits are made on a Ministry-by-Ministry basis in the commercial banks and the banks then buy Dinars for the US Dollars deposited on a daily basis (plus or minus $50 million) to provide the Dinars for next day’s government expenditures. The “purchased” Dinars are used to fund the Ministries’ expenses. If the daily amounts are totaled, the annual total is on the order of the size of the Government’s budget, which you and I have been estimating (recall our earlier exchanges on that subject; at his last press conference, Prime Minister Jafari said that, at the end, his budget was $14 billion). As you can see, it is a closed system (although the banks probably also convert some non-government Dollars). They could maintain the peg, within limits, at any level they liked. The banks cooperate because most of them are state-owned.

In administering the peg, “market conditions” may be taken into account, but the data collection and analysis systems are still far from complete. In any event, “market conditions” are only “taken into account” in respect of the insignificant variations within 1475-1483, which has been the range for nearly three years, during which a lot has happened. Is there a black market? I do not know. If it were substantial, one would have thought that at least one reporter would have noted the fact.

The inflation rate provides an indication as to what the level of a “freely-floating Dinar” might be, although care must be taken because there are surely supply problems in parts of Iraq, including Baghdad, resulting from the security conditions. The most recent report (yesterday; reported in VOI) from the Ministry of Planning shows inflation at 48% (down from 53%), but the data are probably not complete and conditions presumably vary among different parts of Iraq.

The system is “good” (stable) because the money supply is calibrated in effect to oil exports, ie. Gross Domestic “Production” (not “Consumption”). The aggregate money supply is firm, because the Central Bank can count (an audit by Ernst & Young is overdue) the physical Dinars it has issued. There are none of the sophisticated money market equivalents that we and most other advanced nations have. The entire system is “primitive.”

The main point is that, so long as the preponderance of aggregate national macroeconomic income is from oil exports, and so long as the oil industry is state-owned (which it will be for some time longer than the four-year term of the current Government), the system in place is the only and best thing that can be done, which is why the IMF has “endorsed it.” The Central Bank cannot “print money” arbitrarily, because the money supply is calibrated to oil export revenues. That eliminates one source of a currency’s collapse. The system is “artificial” (“conservative”) to an extent, because oil export revenues, and the money supply derived there-from, do not represent all productive economic activity. Pax to your correspondent, the system has little (or nothing) to do with currency market supply and demand. I do not know what determines the insignificant variations within the “trading range.” I have attempted to rationalize specific movements, but they make no theoretical sense. It could be a game played by the handful of people who participate in the Central Bank auctions. (As a footnote, at the time the peg target was established, I recommended that they pick a low number so that the situation in Japan with trillions would be avoided. They did not do that, we the 000,000 will abound for a long time.)

While a “currency board peg” is expressly disallowed by the Central Bank Law, the Bank has been holding substantial amounts in US Dollars, $8 billion the last report I saw, which was months ago. See process above which involves receiving Dollars for oil, selling Dinars to the Ministries for Dollars and then holding the Dollars. The amount should be substantially more than that by now and it is being recommended to some that Dollars in excess of the amounts required to maintain the peg (relatively small, given the closed system) be used for major infrastructure projects such as refineries and electric power plants. It would seem to be a better use for Iraq’s “national savings.” We shall see.

Both the Central Bank and the IAMB-supervised Government audits as of 31 December are long overdue. Among other things, that is because no one knows exactly how much oil is being exported in the south (none has been exported from the north for months) and how much of the proceeds actually arrive at the Central Bank DFI account, which was and probably still is held at the New York Fed. They will have to come out with something soon which will give a more current picture. The picture will not be pretty. Iraq, tragically, is a relatively poor country and will continue to be such for some time.'

Collier Lounsbury replies here.