[Shredd] Everyone up for a Saturday chat?
[BondLady] you betcha
[Shredd] Greetings everyone at BLC. I was researching the two camps of a free float versus a managed float and had some thoughts around this, combined with some interesting material I found. A study out of MIT simply stated what determines exchange rates….supply and demand for foreign exchange.
In other words, the supply source comes from foreign demand for domestic supply of goods and assets. http://web.mit.edu/14.02/www/krugman/1026LEC.pdf
[Shredd] So let’s try to add some logic to simple speculation as to how the Dinar may emerge to its original pre-war glory and beyond.
We know there are basically two schools of thought; a free float or a continued managed float. I say “continued” because that is what the CBI is using now but we know the rate is not representative of what the rate could be today….not even close.
Read More Link On Right
[Shredd] Because of this, the managed float is referred to a “dirty float.” There is, however, another perspective of a hybrid approach the CBI may take which is what I subscribe to. Let me explain.
[Shredd] The IMF released a report titled, “Moving to a Flexible Exchange Rate - How, When, and How Fast?” In this report it states some interesting factors we can consider.
First of all it says that one of the steps to help a country improve the depth and efficiency of its foreign exchange market is to allow some “exchange rate flexibility” to stimulate foreign exchange activity.
[Shredd] Now, some may think the word “flexibility” automatically implies a free float. Well, in order to “stimulate foreign exchange activity”, you need to engage supply and demand, right?
Ok, let’s keep this simple….we have the fundamental of investing here.Why does anyone invest? Return on investment right?
The word “activity” is where this takes place…..trade activity, and in a trade there is a buyer and a seller. I think it’s safe to say the buyer does so in hopes to later sell at a higher rate, right? But low, sell high! A savvy investor will tell you that money is made on the buy, not the sell……let that sink in for a moment!
[Shredd] Ok, back to the topic at hand….a hybrid approach. I’d like to actually speak to the down side of each part to hopefully explain the benefit of the hybrid of the two, ok?
Taking into consideration the above, a managed float where the CBI continues to determine the exchange rate of the Dinar will not stimulate trade because in trade, long and short positions are the source of demand and from an investor’s perspective, it is not possible to speculate when the rate may change so unless they can tuck their principle away for an unknown period of time, they will stay away.
[Shredd] ok, so let's set that aside for now and move onto the free float option.....Now, for a free float, the possibility of market fluctuations, up or down, are certainly there.
The IMF report states that authorities should foster a sense of two-way risk in the exchange rate—the risk that the currency may either appreciate or depreciate—to encourage market participants to take both short and long positions.
Between 1995 and 2001, turnover increased in the foreign exchange markets of countries that adopted more flexible exchange rate regimes and declined in countries that adopted less flexible regimes http://www.imf.org/external/pubs/ft/issues/issues38/ei38.pdf
[Shredd] Any savvy investor knows the immense investment opportunity in Iraq. So what is it going to take to “stimulate” this “activity” needed to affect the exchange rate?
A free float from where it is today certainly has the ability to spawn buys, but what about sells?
These investors don’t need a quick return to make a house payment. Short term gains are key in investing, yes, but not if the rate would be rapidly rising before their eyes…..they will sit on it and watch it grow. While that sounds good, this scenario causes a problem from what we’ve learned above, right?
Stimulating activity is a two-sided process….buying and selling. The problem here is the Dinar exchange rate has so far to travel to simply get close to what the currency supply alone could support and where selling would actually begin to make sense to an investor.
For the Dinar to move to a free float, it must manage the volatile road to get there. Let me explain.
[Shredd] The IMF report states, “Like all other markets, foreign exchange markets are imperfect.
For example, ‘herding’ (when investors buy or sell en masse) and ‘feedback trading’ (trading driven by price movements rather than fundamentals) may result in the misalignment of a currency with a country’s economic fundamentals, with serious repercussions.
Among other things, an overvalued currency undermines the competitiveness of the country’s exports, while an undervalued exchange rate could stoke inflation.”
[Shredd] still with me? of course you are!!! To think the CBI will not manage this volatility is ludicrous and this is why I subscribe to a hybrid approach.
To move from the extremely undervalued rate of today to a free float regime means the CBI has to be able to say that they are fully confident the market’s ability to determine the rate appropriately, with little or no risk and at an acceptable pace….and without any intervention of the CBI.
[Shredd] We have seen the most support that a goal exchange of one dinar to one dollar exists. We also know it won’t stop there based in part on the wealth of Iraq and of course the historical support of a stronger rate. The question has always been around the timing and method.
On the administrative side of this change, there are challenges where a hybrid approach is supported. It was nice to see Najib’s comments: “There is a problem may occur when the implementation of the project, which is the issue of indebtedness among citizens, indicating
For example, when you borrow a person million dinars Upon implementation of the project will become a thousand dinars, in the case of recovery of debt would anger the citizen creditor, so that this issue needs to legislation…” http://www.bondladyscorner.com/t71090-parliamentary-the-process-of-switching-the-currency-when-you-delete-the-three-zeroes-which-do-not-need-to-legislate-law
[Shredd] There is plenty of support via articles that one of the key concerns of the CBI is to manage not only counterfeiting but to also educate the citizens so they don’t get taken advantage of but are also protected when the new Dinar emerges and the exchange rate changes (two separate events btw).
The most recent article came from Abdulhusain al-Yaseri who said: “He said the massive sum of banknotes in circulation raised the possibility of faked banknotes and has been cited as one reason for the latest slump in the dinar’s value from around 1120 to more than 1250 vis-à-vis the U.S. dollar.
However, he said the bank had in place a plan to remove three zeros from the dinar, and issue a 100 dinar note that will be equivalent to $100. He said it was in Iraq’s interest to print new currency with lower denomination, the thing that “will make easier to detect forgeries.”
[Shredd] The IMF report states that transparency in changing to a new exchange rate regime “helps build confidence in [it], especially in the aftermath of a forced exit.” I believe the CBI has been doing this in their communication plan to the Iraqi people.
Lastly, the IMF report clearly states the trade-offs in choosing between a rapid exit from a peg and a more gradual move to a floating exchange rate regime:“For a country with a strong macroeconomy and a prudent monetary policy, a rapid approach can be a more credible signal of commitment to exchange rate flexibility than a gradual approach, while allowing the country to limit its interventions in the foreign exchange market and thereby conserve its foreign exchange reserves.”
“However, a gradual approach is preferable if a country lacks the appropriate institutional framework, including a deep foreign exchange market and the ability to monitor and manage exchange rate risk; such a country runs a high risk of experiencing excessive exchange rate volatility if it moves too quickly.”
[Shredd] There you have it….the two sides of the coin per the IMF! Does Iraq have a strong macroeconomy (unemployment, national income, rate of growth, gross domestic product, inflation, price levels) and prudent monetary policy or does it lack institutional framework?
Well, from what I’ve seen, Iraq has very strong reserves to support a monetary policy change, their rate of growth is phenomenal, inflation is being kept in check, investment is coming into Iraq and infrastructure is growing.
So, in summary, based on what we have been told via statements from the CBI, economic and investing principals and banking administration, I believe we may see a hybrid approach to the Dinar exchange rate increasing. Hopefully this was helpful for you all in looking at the scenarios for the upcoming change
[Shredd] Shredd - out
[Cutter1] Shredd tyvm
[sisterbreen] ty ty
[tlm724] Thank you Shredd I am so glad you are on this team !
[BondLady] ty so much shredders your wisdom for us is priceless ty ty ty
[Shunshine] ditto what BondLady said ty
[hokieproud] Shredd Thank you for taking the time to explain, much appreciated
[Shredd] Your quite welcome and thank you all !