Hyperinflation finally arrives… in Iran

The Washington Post - It’s worth taking a closer peek at what’s been happening lately in Iran, where U.S. sanctions are biting down and inflicting a vicious bout of hyperinflation on the country. This is obviously a foreign policy story—and, for those who live in Iran, an absolutely miserable situation. But it’s an economic policy story as well.

Since 2010, the United States has been steadily tightening sanctions on Iran. All told, these moves have reduced the supply of dollars and other foreign currency reaching Iran. A good chunk of the country’s $110 billion foreign exchange reserves is now locked up in offshore accounts that are frozen. Foreign banks are barred from doing business with Iran’s central bank. And Iran is having trouble selling its oil overseas.

All this has made it extremely difficult for Iran’s central bank to maintain its currency peg of 12,260 rials to the dollar. Individuals and businesses are instead buying up scarce dollars on the black market, often to pay for imports. As more Iranians try to trade their rials for (increasingly rare) foreign currency, dollars get pricier and the value of the rial drops.

That problem exploded last month. In the black markets, the value of Iran’s rial has now dropped 65 percent in the past few weeks. The dotted line on this chart from Steve Hanke at the Cato Institute shows the free-fall:

The fact that the rial has become less valuable means that imported goods in Iran—such as food or construction equipment—are becoming vastly more expensive. As more people chase a limited supply of dollars, hyperinflation sets in. The country’s monthly inflation rate, Hanke estimates, is now 69.6 percent.

What triggered last month’s sudden collapse? That’s not yet clear. One explanation is that the Iranian government set up official “currency centers” to sell dollars at a discount to businesses that import, say, meat or grain or medicine. The idea was to ration out dollars to those who need it most. But the move may have stoked widespread panic that the government was running out of dollars, triggering a run on the rial.

Iran’s hyperinflation hasn’t yet reached the level of the most out-of-control episodes in history—such as Hungary in 1945 or Zimbabwe in 2007. But it’s a reminder that hyperinflation is usually a problem that plagues countries hit by a severe external shock, rather than a result of, say, quantitative easing.

The Christian Science Monitor has more on how Iran found itself in this situation, noting that the country’s atrophied private sector and the government’s failure to build up sufficient foreign reserves has made the country extremely vulnerable to currency speculation. Over at FT Alphaville, Izabella Kaminska also delves into Iran’s woes, noting: “At this point, Iran is running out of options. Indeed, historically speaking, the only options left on the table may be brute force or taking control of the remaining dollar supply.” And my colleague James Ball has reported on the street protests in Tehran that have erupted in response. An ugly scene.

Source: http://www.washingtonpost.com/blogs/ezra-klein/wp/2012/10/04/hyperinflation-finally-arrives-in-iran/