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Iraqi Dinar Buzz Updates|Iraq News

Enorrste Response to Groovgal Rate Post: GET 11/2/10

2010-11-03 02:14:54

I thought that it might be appropriate for me to offer some comments on the economics of Iraq and just how it could afford an RV. I may even venture a few comments on the potential rate of the RV as I proceed.

First, I’d like to clear up some issues about Iraq’s supposed debt situation. The fact is that Iraq is NOT in a serious debt situation. While they were in debt to other countries due to the affects of the cost of the Iraq War, almost all of that debt has been forgiven by the various countries.

Similarly, the annual budget of Iraq only includes about 15% of the budget as “unfunded” or in other words in potential debt. With a budget last year of about $75 billion the debt would have been around $10.5 billion. However, the budgets are based upon a hypothetical value for the price of oil. Last year it was based on around $65 per barrel as I recall. In fact the actual price of oil was over $70 per barrel. Therefore the country did not end up incurring debt through its government financing after all.

Next, the IMF and World Bank have extended some loans to Iraq, in theory. However, the loans only become “active” as Iraq draws upon the funds allocated to them. It is my understanding that Iraq has not activated its loans from the IMF because the conditions were too onerous on them.

I am not aware whether Iraq has activated loans from the World Bank. Similarly, while we read several months ago that Iraq was granted a loan from Japan I believe that this loan also was never “activated.”

The government of Iraq is very concerned that it not be burdened with conditions on loans that it finds unacceptable.

Therefore, I believe I am safe in stating that Iraq has the LOWEST amount of debt of most countries in the world at this time.

The next point I’d like to cover is the economics of opening with a low rate. I will use the example of $1.56 that Groovegal used for consistency. Groovegal made a mistake in her analysis in that she stated that Iraq would be led into bankruptcy by attempting to defend the low rate and that the rate would fall. She used a 50% drop as an example ($.78). However, this is not correct.

Here is what would happen. If Shabibi came out on Forex with a rate of $1.56 the world would immediately buy dinars, knowing that the true value of the currency must be higher. As the open markets put upward pressure (not downward, as Groovegal suggested) on the dinar the CBI would be forced to do one of three things: it could expend its reserves in an attempt to maintain the value at $1.56 (called a “fixed rate”); it could support the rate but allow it to rise (called a “managed float”); or it could allow the market to bring the rate to its own equilibrium (called “free float”).

In the first scenario the CBI would expend its reserves fairly quickly in a vain attempt to maintain the rate at an artificially low level of $1.56. It is clear that Iraq can afford a much higher rate for three reasons. First, from their budget for 2010, in which it is stated in the budget that they can afford $3.22 or more. Second, from their own statements starting in 2007, in which they indicated a plan to return the IQD to the early 1980’s value of $3.33. And third from the underlying wealth of the country (now with the 2nd highest level of oil reserves in the world, the largest in gas reserves, and enormous potential agriculturally due to the fact that the Tigris and Euphrates rivers run through the center of the country).

The IMF uses up to 200 different measurements to determine what rate a country can support, but the main issue for them is that the rate must be commensurate with the “underlying wealth” of the country, whether that be in natural resources (oil, gas, trees, good land, etc.), or in manufacturing, or in historic value (ancient sites, such as the Giza plateau), and so on. Iraq clearly can support a high rate based on the IMF measurements.

Therefore Iraq would suffer from loss of reserves through the Forex if it attempted a fixed rate. Similarly it would be under pressure under a managed float for some time, at least until equilibrium is reached. And finally it would be under pressure under a free float.

Assuming that the equilibrium rate is above $3, Iraq would lose reserves under any scenario until that rate is achieved. This applies to the Forex market only, as I will show later.

For this reason I believe that it is in the best interest of Iraq to open its currency at, or near to, the equilibrium level. I know from Shabibi and Zubaidi’s statements that this rate was in the $3.22 to $3.33 range as far back as 2007. More recently, however, we are hearing of higher rates being considered (although through rumors only). These rates go to $5.72 and possibly even higher.

In any case, and this is a concern for Shabibi, at whatever rate he opens with, to the extent that it is below equilibrium there will be a drain on reserves until equilibrium is reached.

On the other hand, if he opens above equilibrium he suffers reduced risk, since the market will sell dinars back to the CBI until equilibrium is reached. The CBI would have to offer up its reserves to buy the dinars back, however, to the risk grows the farther above equilibrium the rate opens. Still it seems to me that it would be in the best interest of the CBI to open at a higher rather than lower rate, that is if it cannot determine what the equilibrium rate is.

Now the next point has to do with the reserves of Iraq. Published reports from the CBI stated during the summer that the reserves were in the $50 billion range. Since that time a cache of gold was found that Saddam had hidden in a cave. It is a huge pile of gold bars (I saw the photos) and is clearly worth over $1 billion.

Add to this the fact that there is gold being held in other countries that belongs to Iraq but has been sequestered pending release from Chapter 7 of the UN charter. In addition there are other resources being held outside Iraq, including ships loaded with cargo that belong to Iraq, cash in bank accounts, and so on.

In addition to this “wealth” there is evidence that oil production is increasing and that it will grow exponentially once the country is freed from the UN sanctions. Therefore we may reasonably expect the country to increase its reserves substantially once release from Chapter 7 occurs.

In order to answer the question of how much reserves are needed we need to know Shabibi’s plan to stabilize the money supply. Fortunately we have his answer from his own lips. He has stated that 25 trillion dinars were printed in 2003. This includes the large denoms, which have been distributed, and the small “new dinar” denoms, which are still in storage.

In January of this year Shabibi announced that he would begin withdrawing the large denoms from the money supply. In July he stated that the process had reduced the overall money supply by 70%. Using that number 17.5 trillion dinars had been removed by July, leaving 7.5 trillion dinars in circulation.

Let’s assume that the uncirculated small denominated notes total 25 billion dinars. We may safely do this since Shabibi has stated his intention to reduce the money supply to 25 billion dinars by the end of this year or early next year. In other words, once the large denoms are removed the remainder is 25 billion dinars, and that must be the small denominated notes.

This means that almost all of the remaining 7.5 trillion dinars will have to be drawn in within his stated time frame, or at least “accounted for.” I will explain this in a moment.

We know that Iraq “uses” the large denom notes for its own in-country commerce. We may safely assume that the in-country economy of Iraq has about 2 trillion of the outstanding large notes. Shabibi will have the locals bring those to the banks for deposit and the locals will receive smaller denoms for local commerce. The large notes will then be destroyed by the CBI. Of course the Iraqis will have the “value” of the large notes in their bank accounts, making them all wealthy, relatively speaking.

This leaves about 5 trillion dinars outside of Iraq. We have no firm numbers as to who holds these dinars but we can estimate the numbers as follows: about 3.5 trillion dinars are held by countries around the world, predominantly the US, China, Britain, and France. The remaining 1.5 trillion dinars are held by speculators, including ourselves.

Now we know that the big four countries have made formal agreements with the CBI and country of Iraq to hold their dinars after the RV for 6 months minimum, after which they will surrender them over time for oil credits. The US has signed contracts for the dinar-to-oil trade at $32 per barrel. Therefore the US government will make out well on this exchange. Unfortunately, the US government may well take over the American oil industry, or at least control it, after the RV because of its contracts made with Iraq.

This leaves the CBI with 1.5 trillion dinars to account for. At $3 per dinar that is $4.5 trillion dollars worth that have to be recovered. The question is, “Can they afford this?”

This was a question that was brought up in commentary after Groovegal’s post. It is a serious question that needs a serious answer. Put another way the question is this: “How will the CBI pay us all off?”

The answer to this question is that Iraq needs to increase its reserves to start with. I believe that it is doing this now and have shown that it will increase its overall wealth substantially after release from Chapter 7.

Incidentally, this is a very good argument for having the release from Chapter 7 come either before or simultaneous with the RV. If it doesn’t it seems to me that Iraq will be hard pressed to pay for the RV.

So I will assume that the release is simultaneous with the RV and that therefore the reserves of Iraq will increase shortly after the release from Chapter 7.

I will assume that their reserves will double to $100 billion. In a “fractional reserve” system such as we have in the US, we have 10% coverage of our money supply. Assuming that Iraq had the same 10% coverage then, their $100 billion in reserves would allow for a money supply of $1 trillion.

We can now see the problem that confronts Iraq. They are going to have to increase reserves substantially in addition to increasing their “income” from oil substantially in order to pay us off. If they don’t have a plan to do that then the dinar would not be likely to come out above $1, and even then that assumes a 10% fractional backing for the currency.

So how can we be talking about $3.33 or so then?

Before you all panic let me state that I have the answer.

We need to understand this simple statement: we do not cash in to the CBI directly!

Instead, we cash in to a bank, or to Ali, or to DinarBanker. This is important, because if we follow the money trail we will see that the CBI has no concerns about us at all.

When we cash in the money eventually ends up in a bank, either directly or through a broker. The bank transfers the notes to the regional banks, which transfer the notes to the Federal Reserve.

We now come back to what the Federal Reserve will do with the notes. We have that answer: they will hold them for a minimum of 6 months and then trade them in for oil credits!

Therefore we now know that the CBI does NOT have to cover our notes at all with their reserves. They will pay for them in time with oil credits.

So who does pay us, then? The answer is that the US government will pay us directly with dollar credits to our accounts (unless you take gold, which will have NO affect on our money supply). But if the US government is crediting our accounts with these billions of new dollars, what does that mean? It means that our country’s money supply will increase, possibly dramatically. The short, mid-term, and longer term affect of this I have discussed before. Let’s just talk about the short term for now, since this is already a long post.

In the short term we see that the US Government will have dinars in the federal reserve to “back” the issuance of billions of new dollars into the money supply. In this sense only we can say that the US government can “afford” this.

On the other hand, the money in our accounts will shortly be used to buy homes, planes, cars, RVs, and other durable goods. The initial impact will be that the glut of homes on the market will begin to dry up. As we buy these homes and rent them out there will be an overall short-term benefit to the economy. The guy who sells his distressed property to us will recover money and either downsize or rent. In any case his “equity”, whatever that amount is, will be freed to go back into the market.

Similarly for car dealers, who have been struggling for 4 years now. They will see real profits again, which will mean more hiring and ordering of more cars. In short, our durable goods purchases will “kickstart” the economy, leading to more employment and more money flowing through the system. The flood of new money will enable banks to loosen up on their lending practices. We may reasonably expect interest rates to FALL initially due to the glut of money in the system.

Therefore the short term prospects for the American economy are very positive. When I use the term short-term I am talking less than one year.

Now, to conclude, let’s go back to Iraq. What happens there?

With $100 billion in reserves and a money supply of 25 billion dinars (remember that is what Shabibi himself projected), we can see that the dinar could go to $4 per dinar. Even at $4 per dinar the reserves would cover the money supply 100%. If they wanted only 50% reserve coverage, what could the rate for the dinar go to? You guessed it: $8.00.

I think I have given you all enough to chew on for a while. I hope it is helpful.