10/04/2012 07:51 am ET Updated Dec 04, 2012

Déjà Vu: When Money Dies

An important element of national security is the soundness of our currency. Before a currency goes into freefall, its value can be chipped away while a distracted population fails to notice that the currency buys cheaper quality clothing and less food in a package at a grocery store. This can drag on for decades, and sometimes the currency doesn't go into freefall, it simply slowly erodes in value. That's the current situation with the U.S. dollar.

There are two more presidential candidate debates and one vice presidential candidate debate coming up. I'll be watching with interest to see what our candidates propose to do about protecting the value of the dollar in wake of our ongoing financial crisis.

Currency in Freefall

But what happens when a country's currency is in freefall? You need look no further than current turmoil in Iran to find out. Meat is a luxury item. People are hoarding food because prices are skyrocketing. Relative to the dollar, the rial dropped 60% in eight days including a drop of 18 percent on October 1. Yesterday the rate was 36,100 to the dollar, but you couldn't trade the rial for dollars. In other words, the currency stopped being convertible.

When I was in college, I married an Iranian (we divorced in 1981) and eventually moved to Iran for the fateful year that spanned the period before, during and after the Iranian Revolution of 1978/79. I wrote about the currency crisis in my book, Credit Derivatives (Wiley 1998, 2001). The following is an excerpt:

The new government wanted to prevent flight capital from leaving the country. It also wanted to prevent sympathizers to the Shah's regime from getting out of the country alive. It further wanted to preserve a sense of economic normalcy to the outside world.

There was nothing normal about it. Citizens, thought to be beneficiaries of the Shah's largesse, were dragged out of their homes in the middle of the night. Often their accuser was a jealous neighbor. Kangaroo courts called "komites" condemned citizens to death. Their assets were confiscated.

In the panic to leave the country with some of their wealth, citizens found that although there was an official exchange rate of seven Toman (10 rials) to the U.S. dollar, there was no means to convert money. Banks were closed much of the time. The government put a further restriction on conversion of currency. Citizens could take only $1,000 in U.S. currency out of the country and could take only a suitcase of clothing. The idea was to prevent citizens from taking valuable carpets, now labeled national protected works of art, out of the country.

Individuals found ways around these restrictions proving once again: "Governments rise and fall, but the economy goes on." A black market for hard currency quickly sprouted up. There were severe penalties if one were caught exchanging money. Nonetheless, people became cleverer about the exchange.

Merchants were given dispensations to do business. Importers faked invoices to reflect that they had increased orders by 100 percent. In reality, they hadn't doubled their orders with merchants in Europe. They created this fiction so that they could exchange currency for Deutsche marks or dollars. In this way, they accumulated hard currency deposits in Europe. Land and housing values went to almost zero in the wake of the upheaval. This was the time to pick up bargains on the back of someone else's crisis. If you wanted land or a nice house and you had hard currency deposits, you could strike a hard bargain.

People purchased diamonds and gem stones, which were portable currency when they were fleeing the country. People bartered land, Persian carpets, and homes for portable, concealable wealth.

Importers didn't have a problem faking their invoices. This raised no suspicion. The population eagerly purchased freezer chests to keep their meat frozen during the frequent electrical "brownouts" with the new inefficient government. They purchased televisions, stereos, and refrigerators as the only hard goods of value. Money was almost meaningless, so why not have conveniences? Sales skyrocketed.

I discussed threats to the value of the dollar in the first five minutes of this C-Span interview with Brian Lamb in April 2009: