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First up, lemme give y’all a short background of what happened earlier this year.

Back in February, Western powers decided to team up in order to put pressure on Iran and force it to halt production of uranium, which they believed was being used for Iran’s nuclear power programs. Iran meanwhile, has insisted that its nuclear power program is not for the production of weapons.

Because Iran has ignored prior warnings, the EU, U.K. and U.S. all decided to impose trade-restrictions and sanctions on Iranian imports. The EU also banned all Iranian crude oil imports starting last July.

Seven months later and it seems that we’re now starting to see the effects on the Iranian economy and its currency.

The embargo on Iranian goods has made it difficult for Iranian companies to convert dollars and euros into rials. In fact, the central bank itself is having trouble accessing the 30% of its currency reserves that are invested outside of Iran.

This in turn has led to a sharp rise in inflation and a quick deterioration of the value of the Iranian rial. Iranian officials have said that inflation currently stands at 23.5%, but there are those who believe that it is much closer to a whopping 70%.

Meanwhile, the open market value of the rial has gone spiralling down faster than the stock price of Facebook.

First, let me explain the difference between the “official” rate and the “open market” rate.

If you were to pop open a chart of USD/IRR, you’d see that the price hasn’t really changed much over the past three months, with the pair trading between 12,200 and 12,300. This is the “official” rate, the one that is recognized and used by the government.

The open market rate is the rate that is currently being used in the market. This is the rate used when purchasing goods at your local supermarket or when you pay for cab fare. I like to call it the “people’s rate”.

Looking at the open market rate, you’d see a completely different story.

With all the panic about the state of the Iranian economy, the rial has dropped 50% in value in the open market, with most of that decline occurring over the past two months. Currently, USD/IRR is trading at around 26,000, with rumors that the open market rate has hit as low as 35,000 in the past week alone.

To put this into perspective, before all this mess about Iran’s nuclear program started, USD/IRR was trading at around 10,000 in early 2011.

In order to counter this, the Iranian government has implemented a three-tier system that it had previously used during the post-war period in the early 1990s. The government has set up a center where traders of essential commodities (i.e. meat, sugar, vegetables, etc) can transact at the official rate of 12,260. Meanwhile, importers of metals, minerals, and livestock can trade at a non-reference rate, which is 2% below the open market rate.

The big question is though, how long can the government keep this up?

It has to dig deep into its currency reserves in order to keep such a system going. With the central bank already having problems accessing some of its reserves, it may only be a matter of time till vault goes empty.

Furthermore, Iran could start to feel more heat later on this month, as EU finance ministers are set to meet on October 15 to discuss other sanctions that could force Iran’s hand.

Here are some of the sanctions that will most likely be passed:

  • Freezing of Iranian bank assets
  • Full embargo on Iranian natural gas exports
  • Ban on international insurance of Iranian companies
  • Ban on transactions with the Iranian central bank

The hope is that these methods, along with other potential moves by U.S. legislators, will continue to cripple the Iranian economy and force its government to finally heed the EU and U.S.’s warnings.

This all goes to show how important a role politics plays in the grand scheme of the global economy. While the goal of the sanctions and trade restrictions was to force Iran to shut down its nuclear programs, they have had a dramatic effect on Iran’s economy and its currency.

It’ll be interesting to see how long Iran can hold out or if it’ll finally cave. If Iran remains stubborn, lets see how low the rial can go.