Monday, May 27, 2013

Disowned currency: the odd case of Iraqi Swiss Dinars

A few months back I wrote about the odd case of the Somali shilling. Despite the fact that Somalia's central bank was looted in 1991 and ceased to function thereafter, orphaned Somali shillings continued to circulate, and do so to this day. Along these same lines, so-called "Swiss Dinars" circulated in northern Iraq between 1993 and 2004 despite having been demonetized and discredited by their issuer, the Central Bank of Iraq (CBI). Why did shillings and dinars continue to have value despite being orphaned from/disowned by their issuer? The bigger question at stake is this: what gives so-called fiat money its positive price?

The few bits of information I've found on the Swiss dinar come from a 2004 paper by Mervyn King, then governor of the Bank of England, a short article in the New York Times by Hal Varian, and a 2004 paper by Foote, Block, Crane, and Gray on the economic policy in Iraq. I've found a few odds and ends elsewhere from newspaper and numismatic websites.

The story, in short, goes like this. Having chased the Iraqi army out of Kuwait in 1991, President George Bush Sr. withdrew American troops from Iraq, leaving the Saddam regime untouched but crippled by a wide range of UN economic sanctions. Due to embargoes, the CBI could no longer source paper currency from De La Rue PLC, its UK-based supplier.1 To help pay salaries and whatnot, Saddam began to print dinars locally, as well as sourcing bills from a Chinese based printer.2

Oddly, these new "Saddam" bills didn't circulate at par with the pre-war Iraq notes but traded at a discount. By May, 1992, the older notes were worth around 3 US cents whereas the newer ones traded at 1 cent.3 This is an odd thing to get one's head around. Canada, for instance, recently came out with plastic notes. The plastic notes circulate at par with paper notes, but if they were to trade at a discount, then we'd experience something akin to what Iraqis experienced in the early 1990s -- one issuer, one dinar, two different prices.

There seem to be a few theories for the dinar price discrepancy. The one that makes the most sense to me is that the poor quality of the post-war notes meant that they were easily counterfeited. The new notes were shoddy and lacked a watermark, the paper was thin, easily torn, and the ink ran.4 The pre-war notes, on the other hand, had been printed by De La Rue with modern technology. Traders may have discounted the newer notes for fear that they would be accepting fakes.

The pre-war notes printed by De La Rue were referred to as "Swiss Dinars". King claims that this name derives from the fact that De La Rue's printing plates were manufactured in Switzerland. Foote et al. float another theory that the Iraq dinar, historically a stable currency, was considered to be the Swiss franc of the Middle East.

In any case, the Saddam regime decided in 1993 to get rid of the dual price system by disowning the Swiss dinar. There may have been a few reasons for doing this. One can only imagine that the discount the market levied on post-war currency made the regime look weak. Since improving the quality of the post-war note issue was impossible, the only solution was to remove the Swiss issue. Secondly, this dual system would have limited the ability of the government to turn to monetary financing. The existence of the Swiss dinar along with a competitive alternative meant that there was a degree of market choice in currency use. The market could turn to Swiss dinars, which were fixed in supply, while avoiding post-war currency, which was printed in large quantities, thereby limiting the power of the CBI to print money to pay Saddam's bills. This system would have been akin to a partially dollarized system with the Swiss dinar taking the place of the dollar. Thirdly, the existence of multiple prices would have made transactions more complicated. Removing the Swiss dinar may have been a way to diminish the calculational burden placed on Iraqis by the existence of two sets of prices.

Saddam Hussein disowned the Swiss dinar in a manner calculated to maximize his return. On May 5, 1993, the regime announced that all Swiss dinars had to be turned into the CBI for an equivalent amount of post-war currency over a six day exchange period ending May 10, 1993. After these six days had passed, the CBI would cease to honour the Swiss dinars as their liability. The entire issue of Swiss dinars was comprised of 25 dinar notes, so these were to be exchanged for 25 new dinars. Since the market placed a large premium on Swiss dinars, the par exchange rate effectively overvalued post-war dinars and resulted in an immediate gain to the regime. After all, it allowed the CBI to repurchase far more Swiss dinars for a given amount of new Saddam dinars, and thereby increased CBI seigniorage profits.

The second part of Saddam's scheme was just as mercenary. A large percentage of Swiss dinar notes were owned by Jordanians who did business with Iraq, as well as Emiratis, Palestinians, and Kuwaitis.5 Swiss dinars also circulated in northern Iraq, effectively a Kurdish protectorate. Saddam closed the border over the entire six day exchange period in order to prevent foreigners and Kurds from repatriating their Swiss dinars. As a result, a huge portion of the float was stranded and never converted into new 'Saddam' dinars. By stranding so many Swiss dinars outside of Iraq, the CBI's liabilities were dramatically reduced, leaving its balance sheet unencumbered and ready for an orgy of monetary financing. By 1994, Iraqi inflation had hit 500% annually.6

A strange thing happened. Despite having been forsworn by the CBI, Swiss dinars did not become valueless. Along with US dollars, they continued to be used as a medium of exchange in northern Iraq. The fact that Swiss dinars were fixed in supply -- the Kurdish government did not attempt to print new notes -- helped sustain their price.7 Through the 1990s and early 2000s, the value of the Swiss dinar actually increased. While Swiss dinars were worth 2-3 times the price of Saddam dinars in 1993, they had appreciated to 300 Saddam dinars by 2003. See the chart from King, below.

The Swiss dinar also appreciated over that time period vis a vis the US dollar, as King's second chart shows.

Why would a disowned currency continue to be valued? One possibility is that the Kurds had a demand for currency as such, and whatever bits of colored paper already happened to circulate in northern Iraq would, perhaps by virtue of necessity and tradition, continue to be used despite their lack of credit. The problem with this explanation is that if peoples' demand for currency is so easily satisfied by unbacked coloured bits of paper, why didn't Kurdish businesses and consumers also create unbacked colored paper and spend these bits, earning large profits? A central authority might be able to preserve their monopoly by threatening businesses that issued competing brands of unbacked coloured paper, but no such central authority existed in northern Iraq. Something else seems to be working behind the scenes.

Another explanation for the continued positive valuation of Swiss dinars is that Kurds anticipated that their disowned dinars were likely to be reclaimed by a future central bank. For instance, if northern Iraq was ever to made sovereign, a new Kurdish central bank would likely adopt the Swiss dinar as their liability.

This reclamation of Swiss dinars is exactly what occurred, although not via an independent Kurdish state. As we all know, the US invaded Iraq in March 2003. On July 7, 2003, the head of the Coalition Provisional Authority, Paul Bremer, announced that an entirely new dinar was to be issued in October. Both post-war Saddam dinars and Swiss dinars would be exchangeable with these new dinars. Thus ended the decade-long disownership of Swiss dinars. Once again, these notes were the liability of a central bank.

Mervyn King gives a particularly detailed account of how this worked. Beginning in 2002, speculation concerning a US invasion of Iraq began to mount. Coinciding with war speculation was a sharp rise in the value of the Swiss dinar, which moved from 18 dinars to the dollar in May 2002 to 6 dinars a year later. According to King, the dinar's bull market was a function of expectations that a US invasion would bolster both the independence of the Kurdish state from Saddam, as well as the likelihood "that a new institution would be established governing monetary policy in Iraq as a whole that would retrospectively back the value of the Swiss dinar."

The Kurdish government, unhappy with the deflation and its effect on the economy, did their best to discredit Swiss dinars. They began to pay a larger proportion of government employees in dollars in order to underscore their support for that currency and tried to persuade currency speculators that the Swiss dinar would be worthless if Iraq united and a new central bank was formed.8

Foote et al point out the flipside of Swiss dinar appreciation -- the depreciation of Saddam dinars. Because these notes featured a smiling Saddam Hussein, fears that they would be disowned by the issuer once the Coalition took over caused them to weaken dramatically. That this fear would arise is not surprising given that Saddam had disowned Swiss dinars just ten years before. Whereas the Kurdish government tried to discredit Swiss dinars by paying government workers in dollars, the Coalition did the opposite and tried to alleviate fears concerning post-war Saddam dinars by choosing to pay government salaries with these notes. This decision signaled that there was a place for Saddam notes to play in a post-Saddam Iraq and caused their price to improve.

Interestingly, both interventions give a chartal flavour to the story. As the case of the Swiss dinar illustrates, government support is by no means necessary for a currency to have positive value. The appearance of monetary phenomena does not require the state as a prerequisite. But that doesn't mean that governments can't influence that value by choosing to modify their transactions behavior as a way to signal their support, or lack thereof, for a currency.

The final conversion price was set at a price that implied 150 Saddam dinars to 1 Swiss dinar. The conversion process began in October 2003 and ended by January 2004, officially ending Iraq's one-dinar-two-prices era, surely one of the odder periods in monetary history. Unfortunately, pinning down the exact reasons for the continued circulation of Swiss dinars despite being disowned is almost impossible to do. We've got theories, but confirmation is tough to come by. The difficulty of understanding monetary phenomena is a constant theme of this blog, as I hope my account of Somali shillings, Yap stones, and bitcoin all illustrate.

1 King credits De La Rue as the printer of Iraq's currency
2 From Joel's coins.
3 These two articles describe the discount: New York Times, May 16, 1993 and Philadelphia Inquirer, May 19, 1993
4 New York Times, May 16, 1993
5 Philadelphia Inquirer, May 19, 1993
6 According to Foote et al.
7 Writes King: At no stage did the Kurdish groups lay claim to the Swiss dinar as their currency – they had no control over it – as shown by the interview given to Gulf News on 30 January 2003 by the Kurdistan Regional Government Prime Minister Barzani who said, “We don’t have our own currency”.
8 New York Times, January 18, 2003


  1. Yes Dinar is the official currency of Iraq & there are, however, some fundamental problems with the Iraqi dinar scam that potential buyers should be aware of before they begin investing in one of the most illiquid currency markets in the world:

  2. Is there a complete article covering the history of Iraqi Swiss dinars? There's a shocking lack of material online.