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Will an OPEC Nation's Runaway Inflation Spark an Oil Bull Market?

In the third century, greed got the best of Rome's emperors. As they spent through the silver in the treasury, one emperor after another reduced the amount of precious metal in each denarius until the coins contained almost no silver whatsoever.

It was the world's first experience with currency debasement and hyperinflation. As people saw the value of their savings evaporate, society grew angry and demanded a scapegoat. Christians became that scapegoat, and Romans turned on them with incredible violence.

This pattern - currency debasement leading to social upheaval and violence - would repeat many times over.

In medieval Europe, the number of women on trial for witchcraft climbed in sync with the debasement of currency. In revolutionary France, the Reign of Terror that slaughtered 17,000 wealthy counterrevolutionaries aligns perfectly with the deterioration of the purchasing power of the assignat note.

And in the most vile example: dramatic hyperinflation in Germany in the 1920s allowed Hitler to rise to power by blaming Jews for the country's economic woes.

The connection between currency debasement and social upheaval makes sense - hyperinflation only occurs in times of domestic drama. For example, in 1946 Hungary experienced the greatest episode of hyperinflation on record - in the context of a small, economically limited nation wracked by the Great Depression and then Nazi occupation in World War II. Zimbabwe earned second place in hyperinflation's record books when its dollar inflated 7.96 billion percent from early 2007 to late 2008. The cause? Robert Mugabe's land-reform policy slashed agricultural output and destabilized a fragile society.

That brings me to today. and to Iran, where that volatile mix of domestic drama and hyperinflation is pushing a fragile society to the brink of revolution.

If history repeats itself and Iran descends into revolution, the outcome is both unclear and obvious. In the unclear category: the details of the resulting regime and how far an Iranian revolution might spread through the Middle East. What is obvious, though, are the generalities: a post-revolution Iran would remain Islamist and vehemently anti-US.

Another generality is also crystal-clear. An Iranian revolution - and the potential for that to spawn a new set of Shia-based alliances across the Middle East - would be very good for oil.

And if Iran's currency continues its dramatic nosedive, that revolution - and oil-price spike - might be just around the corner.


Dark Days for Iran's Rial

On October 3, riot police converged on Tehran's Grand Bazaar. With water cannons and batons, they dispersed a large crowd of demonstrators who were calling President Mahmoud Ahmadinejad a traitor for his mismanagement of Iran's economy.

The location was significant: The Grand Bazaar is often described as Tehran's economic heartbeat, and its merchants kick-started the 1979 revolution that ended Iran's monarchy and ushered in the Islamic Republic.

The spark that lit the protest flame this time? The Iranian rial had lost a third of its value against the dollar in the three previous days.

But that was simply the latest drop in a currency devaluation that has been both rapid and profound.

The rial had been slowly losing value against the US dollar since international sanctions against the country's nuclear program took effect in mid-2011. The devaluation was gentle for the first year, but picked up speed in June. A few months later, the currency started to free-fall.

On the weekend of September 8-10, the rial lost 9.7% of its value. On October 1 alone, the rial declined 17%. By the next day the black-market exchange rate reached 35,000 rial to the US dollar, marking an 80% decline in the past year.

The massive devaluation is fanning the flames of Iran's burning fiscal situation. International sanctions over Iran's nuclear program have accomplished one desired aim: major inflation. The Iranian government says inflation stands at 25%, but unofficial estimates put it much higher, between 50-70%.

It all translates into far higher prices on staples like food and fuel. Iranians now pay three times as many rial for meat as they did a year ago. Iran's farmers rely on animal feed and vaccines that are imported and therefore priced in US dollars, and they have to pass on the increased costs to consumers.

In the meantime, unemployment is also rising unchecked. Overall unemployment is close to 15%, while youth unemployment is almost 30%.


The Iranian Influence

Soaring food prices, deteriorating employment prospects, and heavy-handed police tactics kicked off a revolution in another Middle Eastern country not long ago. Tunisian vegetable vendor Mohammed Bouazizi set himself on fire in December 2010 to protest precisely those problems; the ensuing riots started his country down a rapid road to revolution. Tunisia's transition turned heads across the Middle East, and the Arab Spring was born.

Iran's ayatollahs are now facing a very similar situation. The rial is dying and hyperinflation is creating real potential for full-fledged economic panic. Continued protests like the one in Tehran's Grand Bazaar would represent a real threat to the ruling regime.

The response from above is easy to predict. Iran's ruling clerics did not hesitate to use force to repress the widespread discontent sparked by President Ahmadinejad's re-election in mid-2009, and used the same riot police in the Bazaar last week to silence dissidence. Bigger protests will almost certainly draw an even more aggressive response.

The regime will also likely offer up a scapegoat. Ahmadinejad is the most likely candidate - he has been clashing with the conservative elite for several years now, and his second and final presidential term ends next summer anyway.

Will a combination of repression and Ahmadinejad's head silence the masses? Maybe, maybe not. When people see their life's savings evaporate - Poof! - in a pile of worthless paper, they get really mad. And really mad people with little to lose is precisely the fuel that feeds revolutionary fires.

However, don't let Western ideals like democracy and the separation of church and state cloud your idea of a reformed Iran. A new regime in Iran would still be Islamist; indeed, the country would almost certainly remain guided first by religion and second by politics. Generations of Iranians have been taught to believe in Shia Islam above all else, with hatred of the United States coming in a close second. Those pillars of Iranian culture would remain.

As such a new Iran could closely resemble the old Iran - but in the meantime, instability could easily spill across the country's borders. Shia populations in other parts of the Middle East could well gain confidence from Iran's uprising and begin uprisings of their own, destabilizing the region's delicate Shia-Sunni balance.

Suddenly, Shia populations in eastern Saudi Arabia, Syria, Lebanon, Iraq, and Bahrain could demand greater recognition, an end to discrimination, maybe even some form of autonomy. The significance of this cannot be understated. The Middle East is a balancing act on many levels, but maintaining peace between Shia and Sunni Muslims is perhaps the most important balance of them all.

Iran, unsteady after a regime change and constrained by international sanctions, would undoubtedly reach out to these Shia populations. Shia connections around the Middle East, long held back by Sunni rulers, would strengthen. A pan-Shia block of allegiances could emerge, replacing the Iran-Syria-Hezbollah partnership with a bigger, stronger group standing against Saudi Arabian - and American - interests in the Persian Gulf.

Truly, a riled-up Shia population connected through a new, Iran-based set of allegiances stretching across the Middle East is a recipe for regional disaster.

Disaster in the Middle East is a recipe for high oil prices.

Whether the drama remains confined to Iran - where a popular revolution puts a new leader in place who blockades the Strait of Hormuz as a show of strength - or spreads to Saudi Arabia, where a marginalized Shia population finally rises up against their Sunni rulers, Iran's currency woes mean instability and infighting in the world's most important oil region.

 


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