Iran’s currency, the rial, has lost two-thirds of its value in the last six months, much of it after the United States formally withdrew from the nuclear agreement in May. In Washington, the fall of the rial is widely seen as a consequence of U.S. sanctions and a sign of economic collapse that could bring down the Iranian regime. While the first claim is generally true, it is overstated, and the second is based on false assumptions.

Although U.S. President Donald Trump has hurt the Iranian economy, the unexpected depth of the rial’s decline owes less to U.S. policy than to poor decision-making in Tehran and structural weaknesses in Iran’s economy. A proper understanding of the factors that deepened the crisis suggests that the country’s acute hardships may ease or disappear as Iran adjusts to the new situation. Iran’s foreign exchange market needs to be understood on its own terms in order to avoid the common mistake of equating the fall of the rial in the free market with economic collapse, rising poverty, and increasing protests that can weaken the regime.

Did Trump Cause the Crisis?

In the months after January 2016, when the JCPOA went into effect, the optimism in Tehran was palpable. European executives filled five-star hotels in search of investment opportunities, and airport taxi services upgraded their fleets to better suit their foreign customers. During the Iranian fiscal year in 2016–17 (March 2016 to March 2017), Iran’s economy grew by 12.5 percent, even with some U.S. sanctions still in effect.

But by mid-2017, it became increasingly clear that the JCPOA was “ on life support ” and that Iran would not renegotiate the deal. The specter of sanctions took the wind out of the economy’s sails. Even before Trump announced that he would abandon the JCPOA, Western executives began packing their bags. For large international companies, the risk of losing access to U.S. markets far outweighed uncertain profits in Iran. Gross fixed capital formation fell, GDP growth slowed, manufacturing output dropped, and other sectors stayed flat. The exception was oil production, which increased last quarter as buyers rushed to get their last shipments of Iranian oil before U.S. sanctions hit the oil sector in November.

The specter of sanctions took the wind out of the economy’s sails.

While a negative economic shock from the reimposition of U.S. sanctions was inevitable, several policy mistakes intensified the crisis. The most obvious of these was the decision to keep the exchange rate constant for the past six years, from 2012 to 2018, during which time Iran’s prices nearly doubled relative to those of its trading partners. This resulted in 100 percent overvaluation of Iran’s currency, which hurt non-oil exports and employment. Overvaluation is normal in oil-exporting economies like Iran’s. It usually takes an external shock to correct the exchange rate to the benefit of exporters, as sanctions did in 2012 (when the rial fell by 200 percent) and as they are doing again now.

The Iranian government made a second mistake by publicly minimizing the threat of sanctions and their effect on the rial. Instead of assuring investors that the government was aware of the problem and had plans to deal with its economic consequences, officials called the run on the rial a bubble engineered by shady characters inside and outside Iran and pointed to Iran’s trade surplus and its abundant foreign exchange reserves. The assurances rang hollow for Iranians who had lost their savings in the 2012 crisis, when government denial was followed by a 200 percent devaluation. Wealthy and middle-class Iranians responded by converting their rial holdings into foreign currencies and gold, some to protect their savings and others to take it out of the country.

Iran’s Central Bank assisted this flight from the rial by delivering “bags of dollars” (President Rouhani’s description) to licensed money changers, or sarrafis. The government explained this as an attempt to assure investors that the rial was stable and remained a convertible currency. But it made little sense for the government to sell off its scarce reserves, and investors, taking advantage of the government’s mistake, bought all the gold and foreign exchange that the Central Bank was offering.

In April 2018, the Rouhani government fixed the value of the rial at 42,000 per dollar, a devaluation of only ten percent, and shut down the market for foreign exchange altogether, forcing traders into the black market. This, too, was a mistake. Ironically, since U.S. sanctions did not formally come into effect until August, 2018, for several months it was Iran’s own government that had disrupted the country’s foreign trade.

Will the Currency Crisis Cause Economic Collapse and Widespread Poverty?

Negative external economic shocks are not uncommon in developing countries. They usually start with a currency crisis, which then spreads to the rest of the economy. The mechanics of this transmission are quite different in Iran, where, thanks to oil, the government is the principal earner of foreign currency, than in countries like Argentina and Turkey, where this is not the case.

In both Argentina and Turkey, for example, private banks owe large dollar-denominated debts to foreign lenders. After a shock, these debts quickly become more expensive to service and repay. To prevent bank failure, the government raises interest rates, which hurts output, or extends credit to the banks, causing inflation.

Curiously, unlike those of Argentina and Turkey, Iran’s currency crisis may help its banking system. This is not because Iranian banks are healthier—to the contrary, they have been insolvent for years—but because their large debts are in rials, and inflation can erase them. The banks had been suffering from the collapse of Iranian real estate prices five years ago. But devaluation has set off very rapid inflation, likely to surpass 50 percent this year, which will increase the value of real estate and other assets that banks own.

Devaluation affects incomes in Iran differently than it does those in a typical country.

Similarly, devaluation affects incomes in Iran differently than it does those in a typical country. The Iranian government can allocate the foreign exchange it earns from oil to subsidize specific sectors or population groups. In Argentina and Turkey, the government is a net buyer of foreign exchange, so it cannot do that. This is why speaking of the exchange rate in Iran, as is routinely done, is misleading. Currently, Iran has three different exchange rates. First is the rather thin free market rate, which, according to a Central Bank official, accounts for only three percent of the currencies traded. Last week, this rate hovered around 140,000 rials per U.S. dollar. Second is a market in which licensed exporters and importers trade. The rate in this market in recent weeks has been around 90,000 rials per dollar. Finally, the government sells as much as half of its foreign exchange earnings at a much lower rate of 42,000 rials per dollar, in order to import basic household necessities and goods needed for industrial production.

Because of these multiple exchange rates, devaluation does not affect all sectors equally. Since April 2018, while the free market exchange rate has fallen by more than 60 percent, the Consumer Price Index has increased by only 16 percent. Hence, it is misleading to measure the rate of decline in living standards by the fall in the free market value of the rial.

Iran’s poverty rate is generally low by international standards—less than ten percent, according to a World Bank study . Some eight million Iranians receive allowances from two welfare agencies, and about 50 million receive monthly cash transfers worth about $100 per month for a family of four (in Purchasing Power Parity dollars). The cash transfer program , established in 2010 by former president Mahmoud Ahmadinejad, did a lot to help poor and middle-class Iranians weather the crisis in 2012.

Rouhani’s policy has been to gut that program, letting the value of the monthly transfers decline by about three-quarters since 2012, and essentially replacing them with transfers from welfare institutions, one of which is a religious charity. The new arrangement shortchanges the lower middle class, which does not fall under official protection. The anger of this group was on display during the protests that engulfed smaller urban areas of Iran last January.

The Future in the Balance

The resumption of U.S. sanctions has dealt a severe blow to Iran’s economy, but this cannot really be measured by the extent of the decline in Iran’s currency. What happens to Iran’s economy depends largely on how employment and real incomes respond to the devaluation. Even then, how the Iranian public will respond to economic hardship remains the greater unknown: Will Iranians urge their leaders to give in to U.S. demands, as the Trump administration hopes, or will they give up on electoral politics and relations with the rest of the world, as Iran’s hard-liners hope?

Iran’s government has responded to worsening economic conditions with programs that offer the poor greater protection from the worst consequences of the sanctions. But the larger economic problem remains high youth unemployment. A third of men and half of women under 30 with college degrees are unemployed. A cheaper rial can help the government create jobs by increasing the demand for Iran’s non-oil exports. But there is a limit to job creation so long as U.S. financial sanctions block Iran’s access to global banking. Iran now depends on the European Union, China, and Russia to deliver access to global markets, as these powers try to salvage what is left of the nuclear deal to which they are parties. Whether these powers can open a lifeline for the Iranian economy remains an open question.

Back in 2012, when a similar crisis engulfed the country, Iranians blamed the Ahmadinejad administration for its incompetence and its hostile stance toward the West. They continued to hope that by electing a more moderate administration, they could reverse four decades of isolation. Millions of Iranians voted in the last two presidential elections for globalization and normalizing relations with the West. If the outcome of those hopes appears to be nothing but hardship and betrayal, odds are that Iranians will heed their country’s strongest voices—the ones calling for giving up on the West and turning inward and eastward instead.