How Dual Exchange Rate Systems Create Global Security Vulnerabilities

ByBradley Gullett

The Wall Street Journal recently reported that Iraq had become a hotbed for financial exploitation by Iranian-backed Iraqi militias¹. The scheme resembled the following series of steps:

  1. A person in Iraq would acquire a prepaid or debit card at the official dinar-to-dollar exchange rate
  2. Smuggle the cards to other countries in the region
  3. Withdraw the cash or process fake transactions in dollars
  4. Move the dollars back to Iraq where they would be exchanged for dinars at the higher, unofficial dollar-exchange rate

Essentially, financial arbitrage was conducted against a system with more than one exchange rate. For context, when governments try to protect official reserves by restricting access to foreign currency, the black market creates a parallel, weaker rate².

For America and the West, it’s certainly a problem anytime an adversary or destabilizing force identifies a new way to generate tons of money. Predicting and preventing the next scheme is always difficult. However, there are always lessons to learn and themes to unpack.

Susceptible Currencies

Where else might this happen?

Currency arbitrage is not a new concept, and the following countries maintain currencies with dual or multiple exchange rate systems³:

  • Iran – Iranian Rial (IRR)
  • Venezuela – Venezuelan Bolívar (VES)
  • Argentina – Argentine Peso (ARS)
  • Nigeria – Nigerian Naira (NGN)
  • Lebanon – Lebanese Pound (LBP)
  • Zimbabwe – Zimbabwean Dollar (ZWL)

Arbitrage opportunities are present in all of the above, often leading to corruption, sanctions evasion, and illicit finance⁴.

Venezuela, for example, fell victim to hyperinflation due to the destruction of its currency value. The politically connected profited from access to the higher official rate over the much lower market rate⁵.

Following a financial collapse in Lebanon in 2019, an official rate of 1,500 LBP/USD was established, far lower than the black-market rate of over 90,000 LBP/USD. Once again, the politically connected benefited. Bank depositors were restricted from accessing their funds, and new attempts to change the official rate are often met with skepticism by the public⁶.

There are other, follow-on implications to the exploitation by elites and public mistrust.

Shadow Banking & Economic Despair

Shadow banking emerges, denting the real economy. As local currencies weaken, the flight to USD or euros occurs, and those with access to these more stable currencies achieve more prosperity, while those that don’t suffer.

Central banks lose the effectiveness of their monetary policy, and economic inequality increases.

As the powerful get stronger, stable government structures weaken, becoming captive to kleptocracy. Reforms to prevent future loopholes and corruption become a pipe dream⁴.

Geopolitical Effects

Shadowy financial networks often reach across borders. Regional allies of the West find it more difficult to combat or quell bad actors as sanctions lose their bite⁴.

Despite the good intentions of foreign aid, money and resources end up in the underground ecosystem. As corrupt systems are further enriched by Western institutions, credibility deteriorates.

An attempt by the U.S. or others to influence financial institutions in-country to remedy the situation leads to agitated local governments, creating an influence opportunity from Russia or China, who offer alternative financial infrastructure⁴.

Perhaps most unfortunately, skilled citizens depart their home countries for less corrupt systems. Those who remain are sucked into a cycle of dependency on the state, with little hope for a more prosperous future⁷.

In Closing

Currencies with more than one exchange rate become prime candidates for exploitation by bad actors, with real consequences for governments and their people. The corrupt and ill-intentioned get rich, while the citizenry bears the brunt. Regional allies of the West fight an uphill battle to manage the resulting instability.

Footnotes / Sources
  1. Wall Street Journal – “Iran Uses Iraq’s Dollar Supply to Evade Sanctions, Fund Militias”
  2. IMF Country Reports – Dual exchange rate analysis
  3. Atlantic Council – “Sanctions, Corruption, and Illicit Finance in the Middle East”
  4. Atlantic Council, IMF, and various World Bank insights on corruption and informal finance
  5. Reuters – “Currency Arbitrage in Venezuela Fuels Corruption”
  6. Bloomberg – “Lebanon’s Currency Collapse: A Black Market Reality”
  7. Brookings – “Brain Drain: When Smart People Leave Bad Governments”

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