Reprinted under creative commons rules - non-commercial educational material.
By Joseph Cafariello
Wednesday, June 26th, 2013
In early 2010, the Iraqi government announced plans to redenominate the dinar, giving rise to one of the most globally anticipated “get-rich-quick” speculations in recent times.
Three and a half years later, investors are still waiting, still hoping, and still buying more dinars. Their hope is that since Iraq has the second largest oil reserves in the world with the prospect of doubling its oil revenues over the next 10 years, any currency redenomination will be accompanied by a revaluation, resulting in a huge increase in the dinar’s value.
In this, there is not one but three misconceptions that may unfortunately shatter the expectations people are placing on the dinar. These misconceptions center on a) the redenomination process, b) debt forgiveness, and c) the central bank policy.
Misconception A: Redenomination Process
In most cases, a country will redenominate its currency when inflation erodes its value to such an extent that it becomes increasingly difficult to process transactions – when there are just too many darned zeros on every bill.
To simplify matters, nations will often chop a few zeros from their currency. For example, Bolivia in 1987 and Peru in 1991 dropped 6 zeros from their currencies, a redenomination of 1 million old money to 1 new money. To avoid confusion, the currencies were renamed. In Bolivia, 1 million pesos became 1 boliviano, while in Peru, 1 million intis became 1 sol.
But no one became a millionaire. In either country, you still had the same value in USD after the conversion as you had before. When you went to a Peruvian bank to exchange 1 million intis for 1 sol, you walked in with 1 USD worth of money and you walked out with 1 USD worth of money. It was a flat exchange.
The same will be the case with the Iraqi dinar, as indicated by XE.com:
“In 2010, the Central Bank of Iraq announced their plans to redenominate the Iraqi Dinar to ease cash transactions. The intention would be to drop three zeros from the nominal value of bank notes; but the actual value of the dinar would remain unchanged.”
Misconception B: Debt Forgiveness
But what about foreign debt forgiveness – as much as 80% in Iraq’s case? Won’t the erasing of so much debt make the new Iraqi currency so much more powerful?
Indeed, Iraq’s debt cancellation is substantial, as a 2006 CRS report for the U.S. Congress explains:
“When fully implemented, the Paris Club’s treatment of Iraq’s debt will reduce the total debt owed to Paris Club countries from $38.9 billion to $7.8 billion. This remainder (20% of the original total), will be rescheduled over a period of 23 years with an initial six-year grace period of repayments.”
However, the report shows that this forgiveness of debt has already taken place – first by the U.S. in December 2004 and then by the remaining Paris Club member countries in December 2005.
The remainder of Iraq’s debt forgiveness has largely been completed as well, as the Central Bank of Iraq notes, “Negotiations with non-Paris Club creditors are ongoing (mainly with Gulf countries), and resolution of the commercial debt is largely complete ... This portion of the external debt has been reduced to $45 billion in 2010.”
The CBI further states that while Iraq’s debt for 2010 was estimated at $92.3 billion, its GDP for that year was $82.2 billion. While the debt is high at 112% of GDP, it is not uncommonly high, and it is manageable. It is highly doubtful that any remaining debt forgiveness will be substantial, nor that it will ever impact the currency all that much.
Misconception C: Central Bank Policy
Another major misconception is that the Iraqi government wants a stronger currency that better reflects the wealth of its substantial oil reserves, which are currently the second largest in the world.
As the following graph of the dinar versus the USD shows, the IQD has remained largely flatlined and stable since the beginning of 2009.
Source: XE.com
(Chart shows dinar per $1 USD. Descending plotlines indicate dinar strength.)
Just by looking at the graph, any trader familiar with currencies will tell you the IQD is being manipulated by the Iraqi government. There is no way any currency could maintain flatlines as steady as this if it were trading freely.
The CBI has been using daily currency auctions to control the amount of USD in circulation. It will allow banks, importers/exporters, and other authorized companies to buy USD at these auctions based on their trade receipts and only for the purpose of paying foreign entities.
The central bank, therefore, allows into the economy only as much USD as is going out through international trade. In so doing, it maintains a steady balance between the amounts of USD and IQD, thereby keeping the value of the dinar stable. You can find a more detailed explanation of this currency manipulation process in my previous article, Iraqi Dinar Stabilization.
Time and again the chart will show how the dinar returns back to a pre-determined line, which the central bank controls simply by controlling the amount of
USD in circulation. It is as close as you can get to a currency peg.
As the CBI explains, “The primary objectives of the Central Bank of Iraq is to ensure domestic price stability and foster a stable competitive market based financial system. The CBI shall also promote sustainable growth, employment and prosperity in Iraq.” This includes to “implement the monetary policy and the exchange rate policy of Iraq.”
Price stability involves ensuring the IQD remains weak. Even the wealthiest of nations are opting to devalue their currencies, such as Japan (to a greater extent), the U.S. (to a lesser extent), and a whole host of European countries in between.
A weaker currency allows a nation to earn more from its exports. As the country exchanges its goods for a higher priced foreign currency, that export income is converted into more of the local currency. And the weaker the local currency is, the more income is earned from those exports.
With extra money on its balance sheet, a government has more money to spend internally. It can hire more workers, putting the unemployed to work. It can upgrade infrastructure, expand industry, stimulate the economy, and support social services such as education and health care.
Think, too, about all that Iraqi oil still locked underground. The country needs to develop new oil fields, extend railways and pipelines, increase refining capacity, and improve its export facilities.
Iraq is in rebuilding mode. The more it puts into its oil industry now, the more it will get out later. Only by keeping its currency cheap can it maximize its oil revenues and pay for more expansion.
If even the wealthiest of countries do not want a powerful currency, why in the world would Iraq want one, given the sorrowful state it is in?
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Beware of Lofty Promises
Sellers of the Iraqi dinar are making a killing on all this talk of a currency revaluation. DinarTrade, for one, is selling 1 million dinar for $980 USD but buys the same amount for just $810 USD. According to XE.com, the trading value for 1 million dinar is $860 USD.
According to a Salt Lake City, Utah news report, financial attorney and Forbes contributor Jay Adkisson believes there is “a proliferation of websites and social media created by scam artists pushing the dinar as an amazing investment opportunity. They tout a thousand-percent-plus return just as soon as the Iraqi Central Bank revalues the currency by resetting its exchange rate to a more favorable one.”
“There's no realistic possibility of the revaluation of the dinar anytime soon,” Adkisson dispels. “And anytime soon is within the next 10 years.”
Even the U.S. state of Washington has become alarmed enough to issue the following alert:
“The Washington State Department of Financial Institutions is warning consumers about potential scams regarding Iraqi Dinar currency exchange services … asking the consumers to send a check, wire, money order, or pay cash upon delivery of the Dinars.
“What consumers are not told is that the Dinars can be redeemed only in Iraq, as most of the established currency exchange houses and banking institutions cannot convert the Dinar to US dollars. Since no exchange exists for the Iraqi Dinar, dealers can charge whatever they want to sell and buy back the Dinars.
”In addition, most of these websites are operating illegally in Washington State, without a currency exchange or money transmission license issued by the Washington State Department of Financial Institutions. Make sure you only deal with licensed, legitimate companies when making financial decisions.”
The alert was last updated December 2012.
Time Frame
Yet some investors feel purchasing dinars is a great way to participate in the expansion of Iraq’s economy, which is set to boom over the next 10 years. As the International Energy Agency summarized in the Wall Street Journal:
“Iraq's oil output is on track to more than double in the next decade, supplying almost half the growth in world oil supply” and eventually “taking the place of Russia as the world's second-largest oil exporter.”
But there are more secure ways of benefiting from oil than the risky trading of a speculative foreign currency. Knowing how much Iraq’s central bank is involved in keeping the dinar at a steady exchange rate would make any currency trader nervous. You just don’t know what the bank will do or when.
It could be years or even a decade before the Iraqi government allows its currency to trade as freely as most other currencies do – according to the laws of supply and demand, interest rates, and economic activity. And remember, too, that a flat “redenomination” is not to be confused with an increased “revaluation”.
Better returns could be found in one’s own country or in economies where continuing stimulus will keep stocks strong for years to come. And if oil is your thing, there is no shortage of global petroleum giants that offer more tangible returns on your investments than the pie-in-the-sky promises made by dinar vendors.
Joseph Cafariello
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