I’ve been getting a lot of emails and questions about Iran’s sudden spiral into hyperinflation. It actually hasn’t been that sudden, but it appears that way. In my opinion, the situation in Iran proves many of Monetary Realism’s core understandings exactly right. I’ll try to keep this brief, but to the point. Monetary Realism offers us a set of principles that help us better understand the economy and the monetary system as a whole. We begin with an institutional understanding of the macro “machine” and then dig down into the pieces of the machine. At the core of these understandings is learning how resources are the lifeblood of an economy. And an economy lives or dies on the way these resources are exchanged and produced. As I’ve previously mentioned, at the end of the day the economy is really nothing more than a system of flows much like the human body. The body either grows and nourishes itself through these flows or it perishes.
One of the keys to understanding this is understanding what Monetary Realism refers to as “acceptance value” and “quantity value” with regards to how a currency regime operates and is sustained. Acceptance value represents the public’s willingness to accept something as the nation’s unit of account and medium of exchange. Quantity Value describes the medium of exchange’s value in terms of purchasing power, inflation, exchange rates, production value, etc. This is the utility of the “money” as a store of value. While acceptance value is generally stable and enforceable by law, quantity value can be quite unstable and result in currency collapse in a worst case scenario.
Understanding these concepts is crucial to understanding the monetary system. While a government can name whatever it wants as its currency it cannot force its citizens to use that currency. That is, the government cannot control quantity value. It can control acceptance value to a large degree. It can even enforce it aggressively and maliciously as Robert Mugabe often did in Zimbabwe when his currency was crashing around him. But a powerful regime cannot give a currency value merely by willing it or by enforcing it. Monetary Realism shows us that resources precede taxation and that capitalism makes socialism possible. Ie, a government cannot moves resources to the public domain if the resources are not in the private domain to begin with. And an increasingly healthy and expansionary private sector allows the citizens of that nation to use this strength to potentially move more resources to the public domain for the (potential) good of the nation as a whole.
So, what does this all have to do with Iran? Well, Iran is a classic case of an economy that is built around a single resource – oil. And their dependence on this one resource makes them a very weak currency issuer. They cannot be considered a fully autonomous currency issuer by virtue of the fact that their economy requires them to be far too dependent on the kindness of strangers. And the strangers in this story don’t like Iran too much. As Professor Steve Hanke notes in this Financial Post article:
“Since the U.S. and E.U. first enacted sanctions against Iran, in 2010, the value of the Iranian rial (IRR) has plummeted, imposing untold misery on the Iranian people. When a currency collapses, you can be certain that other economic metrics are moving in a negative direction, too. Indeed, using new data from Iran’s foreign-exchange black market, I estimate that Iran’s monthly inflation rate has reached 69.6%. With a monthly inflation rate this high (over 50%), Iran is undoubtedly experiencing hyperinflation.
When President Barack Obama signed the Comprehensive Iran Sanctions, Accountability, and Divestment Act, in July 2010, the official Iranian rial-U.S. dollar exchange rate was very close to the black-market rate. But, as the accompanying chart shows, the official and black-market rates have increasingly diverged since July 2010. This decline began to accelerate last month, when Iranians witnessed a dramatic 9.65% drop in the value of the rial, over the course of a single weekend (Sept. 8-10). The free-fall has continued since then. On Oct. 2, the black-market exchange rate reached 35,000 IRR/USD — a rate which reflects a 65% decline in the rial, relative to the U.S. dollar.”
Now the Iranian economy is collapsing around the collapse of its resources. And its government is collapsing as well. It is powerless to control the people trying to escape the Rial into safer currencies. In short, what we have here is a classic collapse in productive output. As I noted in my paper on hyperinflation several years ago, this phenomenon is “more than a monetary phenomenon”. This isn’t just a story about a corrupt government. This is a story about an economy built primarily on the back of one unstable resource. You didn’t need money printing to cause the inflation. You just needed a collapse in output. And once the productive output of an economy is gone there is really no purpose for that monetary system to exist. The result – death of a currency.
For more on hyperinflation please see our understanding hyperinflation section.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.