from Follow the Money

Just because one dollar currently buys something like a million and half Turkish lira …

November 30, 2004

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That does not necessarily mean the Turkish lira is cheap. Right now, given Turkey’s almost US scale current account deficit (close to 5% of GDP), the lira probably is a bit overvalued. Turkey is going to exchange a million old lira for one new lira in January. That will make working on Turkey a bit easier -- no more lira quadrillions -- but lopping a bunch of zeros off both the currency and off local prices is not going to make any one rich (apart from a few scam artists), nor will it change the lira’s external value.

The same is true in Iraq: One dollar currently buys 1460 Iraqi dinar, but that does not necessarily mean the dinar is cheap.

This article is not going to make me popular in some quarters. It seems that there are some folks selling dinar to the US retail market, though there not as many who are also willing to buy. The sales pitch for dinar often goes like "if each dinar were only worth one cent" ... you would make a killing.

That, alas, is not going to happen. End the war, and Iraq’s economy should be bigger than the $20 or $25 billion it is now. So the dinar might (and emphasis should be placed on the might) do something like double in value if (a big if) all goes well in Iraq over some time frame. It also might fall if things go poorly.

But Iraq is going to remain a relatively poor country for some time. The dinar is not going to go up by a factor of ten, let alone the factor of fifteen needed for one dinar to buy one cent. That would be like the euro appreciating so that one euro bought ten dollars, or the yen appreciating so that ten yen bought one dollar. Like Martin Wolf, I think the dollar has further to fall, but even I think that kind of change is just not going to happen.

Make no mistake, the big brokers selling dinar are making a profit no matter what. The central bank was selling dinar this morning for 1460, so a million dinar cost about $685 in Baghdad. A broker is offering a million dinar for $790 over the internet. Getting the dinar out of Iraq probably takes a bit of effort -- the broker is offering a real service -- but that is still a nice markup ...

Buying dinar is one way of diversifying out of the US dollar, but anyone considering making an interest free loan to the Iraqi government (that’s what buying dinars as an investment implies) ought to understand the risks. The dinar is not exactly a candidate to be the world’s next reserve currency.1) If you are buying dinars, you are betting on real appreciation through nominal appreciation of the currency -- that is to say betting that the way the purchasing power of Iraqis will increase is through a rise in the dinar’s value. If the currency appreciates in nominal terms from 1460 dinars to the dollar to say 1000 dinars to the dollar, an Iraqi that makes say 10,000 dinar a day would be able to purchase $10 rather than @$7 of the world’s goods.

2) You lose if the nominal exchange rate goes down, obviously, for whatever reason -- civil war, lower oil prices, etc. You also lose -- or at least don’t win -- if Iraq’s dinar stays stable in nominal terms but the currency appreciates in real terms because of inflation in Iraq. In that case, our Iraqi’s salary would go up to 15,000 dinar a day rather than 10,000 dinar, but the exchange rate would stay around 1,500 dinar per dollar. The Iraqi could then buy $10 of the world’s goods even though the exchange rate stays constant. Iraqi citizens are richer, those holding its currency abroad are not. This is not an entirely unrealistic scenario.

3) Iraq’s government has fairly strong incentives to keep the currency stable -- it is one of the few signs of political and economic stability the government can point to. It also has some incentive to resist letting the Iraqi dinar rise in real terms. A stronger currency makes imports cheaper and any Iraqi production (to the extent there is Iraqi production) relatively more expensive. Not exactly the best way to solve Iraq’s unemployment problem. The Iraqi government, one presumes, does not want Iraqi wheat production, for example, to be uncompetitive with imported wheat.

4) Oil alone does not make betting on Iraq’s currency a slam dunk, to paraphrase George Tenet. With production @ 2.5 mbd (November seems to have been a bit lower) and with oil at $50, Iraq is getting a fairly solid revenue stream -- nearly $2 billion a month -- from its oil right now. Even if the security situation stabilizes and, over time, Iraq can bring more oil production on line, it may do so in a less robust world economy with lower oil prices. So Iraq may make less money from selling a larger amount of oil than it does now ...

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