Tuesday, January 4, 2011

Special Inspector General For Iraq Reconstruction’s “Hard Lessons” Chapter 8 “Treasury’s Triage”

Chapter 8 of the Special Inspector General for Iraq Reconstruction’s “Hard Lessons” review of the American rebuilding effort covers the initial U.S. work to reform Iraq’s economy. Immediately after the March 2003 invasion, Iraq was a wreck. The Iraqi military and government had collapsed, and looting was taking place in many of its urban centers. U.S. officials were caught by surprise at the chaotic situation, and were in panic mode trying to put everything back together again. They focused upon getting Iraq’s ministries and banks to re-open, pumping money into the economy, and then moved onto longer term policies such as reforming the currency system, relieving Iraq’s debt, and trying to implement free market policies. The Americans were largely successful at stabilizing the immediate situation and helping with Iraq’s money and debt, but failed at bringing wide-ranging capitalist principles to the nation.

In April 2003, officials from the Treasury Department arrived in Iraq. They found the country’s finances in tatters. The two largest banks, Rafidain and Rasheed, had been looted, and only two of Rafidain’s 170 branches were still open. The Central Bank of Iraq only had $350 million in gold in its vaults. Almost $1 billion in foreign currency had been withdrawn from its accounts before the U.S. invasion. Government ministries were bankrupt, there was no money to pay civil servants, Iraq’s currency, the dinar, was unstable, and the looting had done an estimated $12 billion in damages

Pallets full of U.S. cash were flown into Baghdad to get the Iraqi government and economy running again (Guardian)

The first order of business for the Americans was to get money flowing again through the Iraqi economy. They got the bank’s to re-open, began paying government employees, reformed the civil service code and pensions, created a budget for the ministries, stabilized the dinar, and temporarily stopped debt payments to build up foreign reserves. This was mostly funded through the Development Fund for Iraq that was created by the United Nations. Since the Gulf War sanctions, Iraq’s oil revenues had been regulated by the international body, and deposited in the Federal Reserve Bank in New York. $12 billion from the Fund was eventually flown to Iraq in new $100 bills, and distributed throughout Iraq with little to no accountability. The priority was to get people back to work and the economy up and running as quickly as possible, so the U.S. skipped the book keeping.

Next the U.S. moved to Iraq’s currency. At the time, the country used two types of money. In Kurdistan there were Swiss dinars, and the rest of the country used Saddam dinars. The latter was easy to counterfeit, and was plagued by high inflation. The U.S. came up with a single dinar and a new exchange rate. In July 2003 CPA head Paul Bremer announced that the Central Bank of Iraq would replace the old notes with the new ones. That process lasted from October 2003 to January 2004.

By the end of 2003 the Americans were working on Iraq’s considerable debt. The Iran-Iraq and Gulf Wars had left the country $130 billion in the hole. The Treasury Department started renegotiation this debt, and got an 18-month moratorium on payments. In December, President Bush appointed former Secretary of State and Treasury James Baker to work on debt relief. He went to the Paris Club made up of 19 industrial countries, and got them to forgive 80% of the $38.9 billion Iraq owed them. In July 2004 the G-8 agreed to an IMF plan to reduce 90-95% of their Iraqi debt. Later, Finance Minister Adel Abdul Mahdi of the Iraqi interim government got the Paris Club to forgive 95% of Iraq’s debt and rescheduled the rest.

CPA’s economic director McPherson wanted free market reforms in Iraq (Oklahoma State Univ.)

The CPA also wanted to transform Iraq from a socialist to capitalist country. That was largely based upon the ideas of the CPA’s economic policy head Peter McPherson. He modeled his plans after Eastern Europe, which went through rapid economic changes after the fall of the Iron Curtain. McPherson's ideas were fully supported by Bremer.

In July McPherson focused upon Iraq’s 192 state-owned businesses. Most of them were closed during the war, and even when opened suffered from a lack of assets, obsolescence, high costs, and surplus employees. The looting and post-war chaos had made their situation worse. At the same time they accounted for 1/8 of the workforce, provided basic services, and included 90% of the country’s industry. McPherson decided to close all but the most efficient ones by freezing their assets and cutting off their money. The Treasury Department objected because they were afraid of the affects upon employment and whether it was legal under international law for an occupying power to carry out such changes. There were also differences within the CPA, and many Iraqi objections. That led the CPA to change course in just a matter of days and re-open the companies that would help with reconstruction such as cement factories. By August a third of the businesses were open again.

The U.S. also wanted to transform Iraq’s banks. Under Saddam they were mostly used for savings and transferring money. The Americans wanted them to support businesses, provide loans, and promote economic growth. The CPA suspended the old banking laws, created the Trade Bank of Iraq, started new regulations, and tried to modernize the banking system and change its credit policies. This U.S. effort was only slightly more successful than the ones aimed at bringing capitalism. By 2010 Iraq’s banks are still dominated by large and inefficient state-run ones like Rafidain and Rasheed, which lack transparency, business models, and have high costs. More importantly, Iraq remains a cash rather than credit based economy. 

In the end, the U.S. was successful at getting the economy, banks, and government up and running again, while its long-term plans were sidelined due to differences within the American camp, and opposition from Iraqis. Billions of dollars were pumped into the country through the CPA’s use of the Development Fund for Iraq, and much of the country’s debt was rescheduled or forgiven. The attempt to bring free market reforms to the state-run businesses and banks were either derailed or were ineffective, while the U.S. never even considered privatizing the country’s main asset, oil, because it didn’t want to appear to be after Iraq’s resources. The insurgency was also taking off, switching the emphasis from the economy to security. The result, was that by the beginning of 2004 the U.S. had largely given up on any ideas of bringing capitalism to Iraq, and simply wanted the economy working in the midst of a growing war with militants. This would foreshadow the coming actions by the Americans, who would score several more tactical victories in Iraq. The larger and more important strategic situation however, was much more difficult for the U.S. to shape because it was largely determined by Iraqis who had their own contested ideas about their country’s future.

SOURCES

England, Andrew, “Calls for bank reform to unlock Iraq’s potential,” Financial Times, 12/13/10

Packer, George, “War After The War,” New Yorker, 11/24/03

Pallister, David, “How the US sent $12bn in cash to Iraq, And watched it vanish,” Guardian, 2/8/07

Special Inspector General for Iraq Reconstruction, “Hard Lessons,” 1/22/09

Sterngold, James, “Another enemy looms – Iraq debt,” San Francisco Chronicle, 5/23/04

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