Iraq’s Dinar: Still Stuck in the Wild West of Currencies

While most investors realize Iraq is still a dangerous place to travel to, they may not fully grasp the financial risks tied to trading in the nation’s currency, the dinar.

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Worried about the dinar’s illiquidity, the threat of currency fraud and still-unstable situation in Iraq, Wells Fargo (NYSE:WFC) issued a warning this week urging investors to steer clear of the currency.

“Considering that Iraq remains a dangerous place with an uncertain future, we strongly advise investors against taking the risk of buying Iraqi dinar as an investment,” Paul Christopher, chief international investment strategist at Wells Fargo Advisors, wrote in a note in response to investor curiosity about the currency.

Introduced as Iraq’s new currency in 2004 after the fall of Saddam Hussein’s regime, the dinar, which recently traded at about 1,165 dinar per U.S. dollar, is still only available in paper form because most U.S. banks decline to deal it.

That means the dinar is still very much a part of the Wild West of the currency world, an area most investors should probably avoid funneling money to.

Yet investors are clearly curious about the dinar, largely because of yet-to-be-realized hopes that the Iraqi Central Bank will revalue the currency by resetting its exchange rate at a more favorable value. They point to similar economic rebounds and currency revaluations in West Germany after World War II and in Kuwait after Saddam’s 1991 invasion.

Yet Christopher spells out four main risks to buying into the dinar now: the threat of future violence in Iraq, illiquidity, risk of fraud and historical precedent.

While Iraq has clearly made great political strides in recent years, the political unity between Iraq's three competing ethnic groups remains extremely fragile. Plus, foreign influence, especially from that of Iran, threatens to further inflame political tensions.

“Iraq’s post-war experience shows much stronger ethnic divisions than was the case in Germany or Kuwait, prior to their currency revaluation,” Christopher wrote. “While the economy grapples with violence, the prospect of a currency revaluation seems remote.”

But even if the political and violence situations didn’t cast a pall over the dinar, the illiquid nature of the currency makes investment impractical.

Because few of the world’s banks outside the Middle East work with Iraqi banks, most investors are forced to buy actual physical dinar banknotes (rather than the electronic form of the currency like a euro investor would). Dealers in banknotes charge customers for the cost of shipping, handling and buying/selling the dinar in a wholesale market, Christopher said.

“The costs for buying or selling the dinar may absorb most or even all of an investor’s return,” Christopher said.

Without any banks to work with, investors in the Iraqi dinar are often forced to work with Internet trading companies and potentially shady dinar dealers that aren’t closely regulated by the U.S. government. That leaves investors open to the risk of fraud.

Christopher pointed to the fact that the Iraqi dinar trade ranked No. 6 on the Utah Department of Commerce’s list of top 10 frauds of 2006.

“We suggest many [currency] recommendations that we believe have much less liquidity, fraud and principal risk,” Christopher said.