Wednesday, December 21, 2011

"Iraq Needs the RV"

Have you ever heard anybody say that Iraq needs the RV to do this or that?  Or maybe you've heard them say that the rate has to be at a certain value in order for them to meet their budget or fulfill some other obligation?  Behind such statements lies a complete lack of comprehension for what currency is, and how it is valued.

For example, Iraq has a problem with security.  Bombs still go off far too frequently to put foreign investors at ease about investing in Iraq.  When you mention the lack of adequate security to some people you get a response like "well that's why they need the RV .... to fund better security!"  People who say things like this fail to understand that currency isn't valued according to what a country needs.  Currency is valued according to what the country's condition is.  If you were a million dollars in debt and you had a house to sell with a market value of $200,000 would you put it on the market for $1 million because that's what you need to pay off your debts?  Of course not.  The market is the market, regardless of your needs.  It's the same with currency.  If there's a lack of security the currency will reflect that.  You don't change the value of the currency to fix the problem.  You fix the problem to change the value of the currency.

Continuing with the real estate analogy, if you had a house appraised at $100,000 in need of repair in a neighborhood where comparable houses in good repair were selling for $130,000 would you go ahead and list the house for $130,000 because that's what it will be worth when the repairs are done?  No, you would either do the repairs first and then price it at $130,000 or you would list it at $100,000 and let the new owner take care of the repairs.  Well, Iraq is in need of repair.  Until those improvements are done the value is lowered just like that house, and their currency will reflect that lower value.

Another example is Iraq's budget.  Some people claim that the new value of the IQD needs to be a certain amount in order to meet their budget.  Again, the market is the market folks.  If Iraq can't support $3 it doesn't matter what their budgetary needs are.  Their currency will only be as valuable as current conditions warrant.  The country doesn't reflect the value of the currency.  That's ass backwards.  The currency represents the wealth of the country.

Some people say that Iraq can support a high RV because they have the second largest oil reserves on the planet, but presently Iraq's infrastructure only allows them to deliver about 2.5 million barrels a day.  So it doesn't really matter how much oil they have if they don't have the ability to boost production substantially beyond where it is now.  It's like people who are stranded at sea and die of thirst.  Even though they're surrounded by water they can't drink it because it's not potable.  "Water, water everywhere and not a drop to drink!"  Ever heard that?  It means that sea water does you no good if you don't have the ability to convert it into drinkable water.  It's the same thing with oil reserves.  Iraq's oil reserves could be a trillion barrels and it would still do their currency virtually no good without a better infrastructure.  And developing that infrastructure takes time.  We also have to take into consideration that Iraq is a member of OPEC, and therefore restricted by more than just the limitations of their infrastructure.  And even if Iraq could double their production overnight, it probably wouldn't improve their bottom line too much as the price of oil would certainly drop as a result.  It's called supply and demand.
A final example would be the Iraqi people themselves.  Often people say "the Iraqi people need the RV.  They're suffering!"  Well in the first place, if their currency's exchange rate were to change overnight from 1170 to the dollar to .33 to the dollar ($3 value) there would be little immediate impact on the Iraqi people.  Think about it.  Before the sanctions were imposed during Desert Storm Iraq's currency was worth up to $3, and yet most of their people at that time weren't wealthy.  So restoring it to that value wouldn't make them wealthy now.  The impact would mostly be seen in imports.  After all, that's what an exchange rate is.  It's the rate of exchange between the currencies of two countries, not the rate of exchange between people in the same country using the same currency.  What will help the Iraqi people the most is seeing progress within their government and infrastructure.  Reducing corruption, improving security, developing their infrastructure .... in general transforming their country from the hellhole it is now into one with more tolerable conditions.

Raising the value of their currency will help, but that doesn't have to be done via a straight up 1000+ to 1 RV.  Yes, Iraq has stated their intention to dedollarize the country, and they would need to raise the value to over $1 to accomplish that.  But there are a number of approaches that they could use when they redeonominate.  They could continue to raise the value via incremental revaluations of 50% or more until they reach a penny and then move the decimal over two spaces, they could raise the exchange rate to 1000 to 1 and then lop off three zeros and watch the dinar climb back up toward $3, or they could raise the value to $.00333 and then move the decimal three spaces to the right, giving them a new value of $3.33.  All of those scenarios would give them a more valuable currency without violating most of the known laws of economics (and common sense).

Will Iraq revalue their currency?  My guess is that they probably will sometime in 2012.  Most agree that it is currently undervalued.  The question isn't one of whether or not the value will go up, but of how they will do it and whether or not investors will realize any profits when they do.  If and when they do it will only be to a degree that they can justify with factors such as GDP, money supply, and current conditions in their country.  It will not be driven by any pressing "needs" other than those that have already been laid out, which are controlling inflation, dedollarization, and easing cash transactions.

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