Resident Scholar Michael Rubin

As markets floundered amid the credit crunch, Iran's leadership celebrated the West's economic crisis. On October 11, Iranian President Mahmoud Ahmadinejad declared, "The claim that the free market manages all things is a huge lie and benefits only thieves and criminals." Two days later, Supreme Leader Ali Khamenei decreed that the West's financial crisis was a sign of "the ineffectiveness of liberal democracy-based policies."

The Iranian leadership may rue their words. Ahmadinejad has run Iran's economy into the ground. On October 11, just a day after Ahmadinejad declared prices in decline, the Central Bank reported inflation above 30 percent. Such figures are still likely low. Both Shahab News and Aftab-e Yazd have noted the tendency of Iranian officials to pull numbers from thin air.

Parliamentarians and journalists might complain but, as the Islamic Republic reverts to a Soviet-style command economy, regime intolerance toward technocratic expertise grows. Hojjat al-Eslam Ha'eri Shirazi, the Supreme Leader's personal representative in the city of Shiraz, explained, "The banking system wants to demand interest rates in exchange for loans to the people. We will not let them do so. And should a couple of banks go bankrupt as a result, so what? What is worse anyway, closure of factories or banks?"

Non-oil sector production is stagnant. Factories may remain open but many do not pay workers. On Oct. 2, for example, tire factory workers staged a protest in front of the Ministry of Labor seeking six months' unpaid wages. In recent weeks, wild cat strikes have occurred in Tehran, Isfahan, Qazvin and Sanandaj. Purchasing power has plummeted.

To mitigate such trends, the government has imposed price controls. On June 11, the daily Resalat reported that the paramilitary Basij, a subdivision of the Islamic Revolutionary Guard Corps, would enforce low prices. Over subsequent days, the Iranian press featured photos of Basij beating merchants whose prices were too high.

The combination of high liquidity, sparked by Ahmadinejad's arbitrary decree lowering interest rates to single digits, no-interest banking and inflation has led wealthy Iranians to pour money into real estate. Housing costs have skyrocketed; Tehran real estate prices rival New York's. The average Iranian family now pays 60 percent of its income for rent, while the Ministry of Housing estimates 1.5 million Iranians are homeless.

To fight economic malaise, Ahmadinejad has raided Iran's foreign reserves. In the past two months alone, Iranian papers have reported more than $15 billion in withdrawals from the reserves to import refined gas and several additional billion dollars to subsidize industrial schemes. Ahmadinejad's reinstatement of subsidies has meant Iran once again must import 40 percent of its refined petroleum needs.

He will need to continue spending. Last winter, Iran ran out of gas. Food prices more than doubled and the Revolutionary Guards had to deploy on the streets of towns and cities to keep order. On October 1, the Parliament's Energy Commission predicted another "severe gas shortage" again within months.

As oil prices plummet, Iranian pessimism grows. In 2006, Tehran planned its budget assuming an oil price of $60/barrel. High oil prices masked Ahmadinejad's incompetence. While Iran's budgetary process has grown more opaque, it appears that Ahmadinejad constructed his budget with the assumption of oil price stability. Now that oil has plummeted, the Islamic Republic is in trouble.

On October 7, Asr-e Iran asked, "How much did we save from the period when oil price was up to $130 per barrel? Did we build up a foreign exchange reserve? The authorities don't provide us with a clear and official answer about the foreign currency reserve?and there is some fear that the entire reserve has gone to imports of junk." The paper's fear is justified.

While Qatar, Saudi Arabia, the United Arab Emirates and Kuwait now boast Sovereign Wealth Funds worth hundreds of billions of dollars, on September 15 an unreleased Central Bank report leaked by an Iranian parliamentarian estimated the Islamic Republic's own future fund to be only $7 billion.

Iran's strategic challenge and nuclear ambitions will be the most immediate foreign policy challenge facing the new administration. The National Iranian American Council, Tehran's de facto lobby in Washington, urges a relaxation of sanctions. So too does the Council on Foreign Relations. Condoleezza Rice offers a defiant Tehran financial incentives.

Such strategies are wrong. Throwing an economic lifeline to a terror-sponsoring regime dedicated to the acquisition of nuclear weapons capability would be nothing short of diplomatic malpractice on a Carter-esque scale. Not only has the Islamic Republic squandered billions on nuclear weapons, destabilizing Iraq and Afghanistan, and sponsoring terrorism, but it has also pitched itself to countries like Venezuela, Nicaragua, Bolivia, Sudan and Senegal as a pillar of an ideology that will defeat liberal Western democracy. Nothing would be a more powerful signal to those applauding Ahmadinejad's rhetoric than watching the Islamic Republic collapse under the weight of its own follies.

Michael Rubin is a resident scholar at AEI.