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The Power of the Wave Principle

Panic in Persia as Hyperinflation Hits Iran

Economics / HyperInflation Nov 04, 2012 - 02:45 PM GMT

By: Steve_H_Hanke

Economics

For decades, the Iranian economy has been cobbled together by religious-bureaucratic regimes that have employed mandates, regulations, price controls, subsidies and a wide variety of other interventionist devices, in an attempt to achieve their goals. It's all been kept afloat – barely afloat – by oil revenues.


Shortly after Mahmoud Ahmadinejad took power as president, Iran began to draw the ire of the United States, Europe and their allies over a number of issues related to Iran's nuclear ambitions. Of late, this loose coalition of ‘allies' has ratcheted up economic sanctions against Iran.

Has the cascade of sanctions had an effect? The Iranian rial's exchange rate tells the tale. When US President Barack Obama signed the Comprehensive Iran Sanctions, Accountability, and Divestment Act in July 2010, the official exchange rate for the rial to the US dollar was very close to the black market rate. Since these sanctions took effect, however, the official and black market rates have increasingly diverged.

collapses in the demand for the Iranian currency. With each collapse, there has been something akin to a ‘bank run' on the rial – with a sharp rise in the black market (read: free market) exchange rate to the greenback. Ironically, Iranians are clamoring for US dollars.

On September 8, 2012, the black market exchange rate was 23,040. In the course of just under a month, after the two big sell-offs, the rate settled at 35,000 on October 2, 2012. This represents a 34.2% depreciation of the rial relative to the greenback. It was at this 35,000 exchange rate that I first calculated the monthly inflation rate implied by the rial's depreciation using the principle of purchasing power parity. The implied monthly inflation rate for September was 69.6%. Since the hurdle rate to qualify for hyperinflation – as defined by US economist Philip Cagan – is 50% per month, Iran registered what appears to be the start of the world's 58th hyperinflation episode.

To estimate Iran's hyperinflation, we must derive it from changes in the rial/US dollar exchange rate. In Iran, the demand for rials is inversely related to the rial/US dollar rate. It confirms a conjecture first made by Nobel laureate Robert Mundell. In 1963, Mundell posited that the demand for money was a function of, among other things, the exchange rate (RA Mundell, ‘Capital Mobility and Stabilization Policy Under Fixed and Flexible Exchange Rates', Canadian Journal of Economics and Political Science).

When the rial loses value against the dollar, Iranians expect further losses and want to unload rials for US dollars (or gold). After all, if you expect the purchasing power of your currency to be halved in 40 days (as it would be at the current inflation rate), you're not going to wait around to convert your wealth to a stable store of value.

In short, it is this process – a sort of Persian panic – that is feeding the hyperinflation.

By Steve H. Hanke

www.cato.org/people/hanke.html

Steve H. Hanke is a Professor of Applied Economics and Co-Director of the Institute for Applied Economics, Global Health, and the Study of Business Enterprise at The Johns Hopkins University in Baltimore. Prof. Hanke is also a Senior Fellow at the Cato Institute in Washington, D.C.; a Distinguished Professor at the Universitas Pelita Harapan in Jakarta, Indonesia; a Senior Advisor at the Renmin University of China’s International Monetary Research Institute in Beijing; a Special Counselor to the Center for Financial Stability in New York; a member of the National Bank of Kuwait’s International Advisory Board (chaired by Sir John Major); a member of the Financial Advisory Council of the United Arab Emirates; and a contributing editor at Globe Asia Magazine.

Copyright © 2012 Steve H. Hanke - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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