Sunday, September 04, 2005

The Benefits of the New Iraqi Dinar

Dear Friends,

This is an article written in 2003 but still very nice!
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The Benefits of the New Iraqi Dinar
Author: Brad Setser

August 7, 2003
Iraq Reconstruction Report

The Coalition’s decision to print a fresh batch of Saddam dinar notes this June drove home the urgent need to select the currency and monetary institutions for post-Saddam Iraq. The decision to introduce a new dinar rather than to dollarize or create a currency board was the right one.

The immediate advantages of introducing new dinars are clear. Saddam’s face won’t be on them. Moreover, the “Saddam” dinar only comes in two sizes. The 10,000 dinar note (worth a bit more than five dollars) is tainted by rumors of counterfeiting and is too large for everyday transactions. In contrast, the 250 dinar note (worth between a dime and a quarter) has not only continued to circulate, it has also appreciated in value relative to both the dollar and the 10,000 note. There is simply no practical alternative to small dinar notes in an economy where many people live on less than a dollar a day. With many payments being made in dollars, more dollars were chasing the same set of dinars. But even in an economy where $50 a month is a good salary, it is not terribly practical to pay salaries in dimes and quarters. New bills in a wider range of denominations should make day to day life in Iraq easier.

The long-term advantages of a new currency backed by a respected central bank are potentially even more important. The Saddam dinar was never a viable candidate for Iraq’s future currency. The only real question was how quickly it would be replaced, and with what. But there were a range of possible replacements other than a new currency and an independent central bank. The Saddam dinar could have been replaced with the dollar, the pound or the euro or a new dinar that was permanently tied to the dollar (or another anchor currency) through a currency board. A currency board effectively would put an Iraqi face on the dollar while locking Iraq’s into following the U.S. monetary policy. In a currency board, monetary policy is committed solely toward the maintenance of a fixed parity between the local currency and the anchor currency. Dollarization requires the immediate commitment to spend scare funds to buy back existing dinar, and a currency board requires an equal commitment of reserves to back a new dinar.


Advantages Over Dollarization

However, there are good reasons to think that neither outright dollarization nor a currency board would be superior in the long-run to an independent Iraqi currency that can float against the dollar. Why? The simple answer is that it makes little sense for an economy that relies heavily on oil exports to adopt the currency of an oil importer. For example, tying Iraq’s monetary policy to that of the United States is a problem when an oil supply shock drives up the world price for oil, slowing the economies of major oil importers while putting additional cash in the pockets of oil exporters. Right now the stagnant U.S. needs relatively low interest rates, while most oil producers are flush (Iraq excepted, given its limited current oil production) and need relatively high interest rates.

Click here for the rest of the article.

Regards,

Marcel Heersema
Iraqi Dinar Opportunity