The Shah's Atomic Dreams

More than three decades ago, before there was an Islamic Republic, the West sought desperately to prevent Iran's ruler from getting his hands on the bomb. New revelations show just how serious the crisis was -- and why America's denuclearization drive isn't working.

Of the many inaccuracies and obfuscations of the Iranian nuclear negotiations, one of the most persistent has been the claim that, in questioning the ultimate goals of the Islamic Republic's nuclear program, the West is seeking to enforce a duplicitous double standard. According to this line of rhetoric, Mohammad Reza Pahlavi, the last shah of Iran, was a Western ally -- or, in the language of the regime, a "lackey" -- and thus America and Europe were willing and eager to help him get not one, but many, reactors. But since the creation of the Islamic Republic in 1979, these critics allege, Iran is being singled out and persecuted. In 2006, Iranian President Mahmoud Ahmadinejad told Der Spiegel, "It's interesting to note that European nations wanted to allow the shah's dictatorship the use of nuclear technology.… Yet those nations were willing to supply it with nuclear technology. Ever since the Islamic Republic has existed, however, these powers have been opposed to it."

Even some progressive intellectuals in the West have bought into this story, either supporting the regime's program or at least criticizing the U.S. stance on Ahmadinejad's current program as hypocritical given its past lenience toward the shah. The U.S. government itself, in what must be considered an inexplicable failure of public diplomacy, has never challenged this narrative -- although it has access to hundreds of pages of documents that disprove the regime's allegations.

In fact, Washington was involved in a long-standing and frequently behind-the-scenes diplomatic tussle with the shah over the purpose of his nuclear program. Recently declassified documents from the Carter and Ford presidential libraries; the departments of defense, energy, and state; and the National Security Council (NSC) show that every element of today's impasse between the U.S. government and the Islamic Republic was also present in the negotiations with the shah. These range from Iran's insistence on its Nuclear Non-Proliferation Treaty (NPT) right to a "full fuel cycle," its complaint that the United States was singling it out for guarantees no other country was required to give, and finally the U.S. offer to make Iran part of an international consortium to enrich uranium outside Iran, the so-called "Russian solution." The shah repeatedly insisted that at least he did not want a nuclear bomb -- yet he was adamant that Iran not be treated as a second-class citizen. These negotiations, details of which have not been published before now, don't just expose the regime's lies about the alleged U.S. double standard, they also offer a useful guide for Western negotiators in navigating the waters of Iranian nationalism, both real and feigned.

Iran's nuclear program began in 1959 with a small reactor given by the United States to Tehran University as part of the "Atoms for Peace" program announced by President Dwight D. Eisenhower in December 1953. But that only whetted the Iranian monarch's appetite: With his increased oil revenues, and with his new vision of Iran as the hegemonic force in the region, a nuclear program became for Shah Pahlavi the symbol of progress and power. He summoned Akbar Etemad, a trained nuclear physicist, to the royal court in 1973, told him of his desire to launch a nuclear program, and asked Etemad to develop a master plan.

Two weeks later, the shah met with Etemad again. He quickly read the 13-page draft document Etemad had prepared, then turned to the prime minister and ordered him to fund what turned out be one of the most expensive projects undertaken by his regime. There was no prior discussion in the Majlis, where the constitutional power of the purse lay, or in any other governmental body or council. Like every major policy decision in those days, it was a one-man act. Thus was launched Iran's nuclear program.

The shah's plans called for a "full-fledged nuclear power industry" with the capacity to produce 23,000 megawatts of electricity. By 1977, the Atomic Energy Organization of Iran (AEOI) had more than 1,500 employees (who were, on the shah's orders, allowed to become the highest-paid government employees). Pahlavi had arranged for the training of Iranian nuclear experts around the world (including a $20 million endowment at MIT), engaged in an intensive search for uranium mines in Iran and all over the planet, and launched several nuclear research centers across the country. AEOI was in those days one of the most heavily funded programs in the country. In 1976, its budget was $1.3 billion, making it, after the country's oil company, the single biggest public economic institution in the country.

While Germany and France showed immediate eagerness to sell Iran its desired reactors, the United States was initially reluctant to sell any, "without conditions limiting [the shah's] freedom of action," according to the text of a U.S. governmental memo. The German company Kraftwerk signed the first agreement to build the now-famous Bushehr reactor with an initial completion date of 1981 and an estimated cost of $3 billion. As Bushehr was located in a dangerous zone that was prone to frequent and strong seismic activity, extra funds were set aside to protect the site against the dangers of an earthquake. It was said at the time that the German government was so eager to find a foothold in the Iranian market that it guaranteed Kraftwerk's investment against any loss. U.S. companies, on the other hand, were barred from these contracts until Washington's concerns about the shah's intentions were addressed.

The shah was adamant that Iran should enjoy its "full rights," as he put it at the time, within the NPT -- an agreement Iran had immediately signed upon its formulation and that calls for non-nuclear states to forfeit the search for a nuclear bomb in return for easy access to the peaceful uses of nuclear energy. But Iran not only insisted on the right to have the full fuel cycle, it also was interested in processing plutonium -- a faster way to a nuclear bomb than enriched uranium.

In remarks that echo Ahmadinejad's provocative boasts today, in February 1974, following a Franco-Iranian agreement to cooperate on uranium enrichment, the shah told Le Monde that one day "sooner than is believed," Iran would be "in possession of a nuclear bomb." The shah's surprising comment was at least partially in response to the 1974 Indian test of a nuclear weapon.

Realizing the repercussions of his comment, the shah ordered the Iranian Embassy in France to issue a statement declaring that stories about his plan to develop a bomb were "totally invented and without any basis whatsoever." The U.S. Embassy in Tehran, conveying the shah's message, reassured the State Department that he was "certainly not yet" thinking about leaving the NPT or joining the nuclear club.

But even as he was trying to reassure Washington of his intentions, the shah did indicate that, should any country in the region develop the nuclear bomb, then "perhaps the national interests of any country at all would demand that it would do the same," according to the text of discussions with the U.S. ambassador. Assadollah Alam, the shah's court minister, claimed more than once in the journals he kept from the early 1970s until his death that, in his view, the shah "wanted the bomb" but found it expedient to adamantly deny any such intent at the moment.

According to Defense and Energy department memos from the time, the United States was particularly worried that "the annual plutonium production from the planned 23,000 MW Iranian nuclear power program will be equivalent to 600-700 warheads." Nonetheless, by June 1974, the United States was finally willing to sell Iran nuclear reactors but only after, as another U.S. memo put it, "incorporating special bilateral controls in addition to the usual" international safeguards. These safeguards were, in the mind of U.S. officials, necessary not just because of concerns about the shah's intentions but because "in a situation of instability, domestic dissidents or foreign terrorists might easily be able to seize any special nuclear materials stored in Iran for use in a bomb."

While the shah was willing to consider some of these safeguards, he was insistent that Iran not be treated differently from any other country. By then, Iran had already signed letters of intent with German and French companies for four nuclear power plants, and the shah had signaled his plan to procure eight more from the United States. The State Department not only favored the sale of these reactors but even encouraged the Bechtel Corporation to convince the shah to invest up to $300 million in a jointly owned uranium enrichment facility in the United States. These proposals were all predicated on the shah's willingness to accept more rigorous controls over plutonium processing -- something that was of particular concern to the United States. Although eager to offer such assurances, the shah flatly rejected the idea of affording the Americans a veto on reprocessing of U.S.-supplied fuel.

As negotiations on these issues lingered, seeming to reach an impasse, and the shah held firm to his rejection of any U.S. veto right, the Defense Department recommended that the United States reconsider its hard-line approach and accept the shah's demands. Pentagon officials wrote about their concern that the shah's unhappiness over this issue carried the threat "of poisoning other aspects of U.S.-Iran relations." The fact that France and Germany were more than happy to sell to the shah what the United States was withholding, and the fact that the shah had made clear gestures of possible cooperation with India on Iran's nuclear program, made the case for a U.S. reconsideration of its position more urgent. President Gerald Ford, and later his successor Jimmy Carter, agreed to accommodate the shah, but still only to the extent that U.S. proliferation concerns were met. Under Carter, finally, the shah was willing to make the kinds of concessions that proved he wasn't seeking a bomb -- such as forgoing plans for plutonium processing plants -- and the president permitted U.S. companies to sell reactors to Iran in 1978.

But by this point, the first hints of internal political trouble had already appeared on the horizon in Tehran. Within months of this crucial agreement, the shah was too preoccupied with the evolving domestic crisis to pay much attention to the nuclear negotiations. The shah's vacillations, as much the result of his indecisive character as of the medications he was taking to fight the onset of cancer, combined with the Carter administration's failure to develop a cogent policy on Iran, helped enable the rise of the revolutionary clerics and the establishment of the Islamic Republic.

No sooner had Ayatollah Ruhollah Khomeini come to power than he ordered all work on Iran's nuclear program stopped, criticizing the shah for ever pursuing such a program. Within a few years, Khomeini changed his mind, but by then the West was much more distrustful of Iran's intentions. The real break came when the West learned in 2002 that the Iranians had built at Natanz an enrichment facility with the capacity to house a cascade of 50,000 centrifuges and that the hard-line Islamic Revolutionary Guards Corps was increasingly in charge of the country's nuclear program (as well as its economy and politics).

Unfortunately, the U.S. response since then has enabled the kind of hysterical accusations lodged against it for supposed nuclear hypocrisy. Instead of making it clear to the people of Iran that a democratic, law-abiding government could have easily, and at much less cost, achieved the enrichment rights guaranteed under the NPT -- and instead of encouraging Iranian democrats who have repeatedly declared their opposition to a nuclear bomb for Iran -- the United States has offered unrealistic ultimatums and changed its course again and again, allowing the regime to mischaracterize America's approach and create its own nuclear reality.

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Fault Lines

Global Thinker No. 26 Raghuram Rajan's look at the fissures that brought about the global financial crisis -- and which are still at work today.

Although I worried about banker incentives and regulatory motives at the time of the financial crisis, and although many more commentators and regulators have since come around to my point of view, I have come to believe that these issues are just the tip of the iceberg. The true sources of the crisis we have experienced are not only more widespread but also more hidden. We should resist the temptation to round up the most proximate suspects and pin the blame only on them. Greedy bankers can be regulated; lax government officials can be replaced. This is a convenient focus, because the villains are easily identified and measures can be taken against malfeasance and neglect. What's more, it absolves the rest of us of our responsibility for precipitating the crisis. But this is too facile a response.

We should also resist the view that this is just another crisis, similar to every financial crisis before it, with real estate and foreign capital flows at its center. Although there are broad similarities in the things that go wrong in every financial crisis, this one centered on what many would agree is the most sophisticated financial system in the world. What happened to the usual regulatory checks and balances? What happened to the discipline imposed by markets? What happened to the private instinct for self-preservation? Is the free-enterprise system fundamentally broken? These questions would not arise if this were "just another" crisis in a developing country. And given the cost of this crisis, we cannot afford facile or wrong answers.

Although I believe that the basic ideas of the free-enterprise system are sound, the fault lines that precipitated the crisis are indeed systemic. They stem from more than just specific personalities or institutions. A much wider cast of characters share responsibility for the crisis: it includes domestic politicians, foreign governments, economists like me, and people like you. Furthermore, what enveloped all of us was not some sort of collective hysteria or mania. Somewhat frighteningly, each one of us did what was sensible given the incentives we faced. Despite mounting evidence that things were going wrong, all of us clung to the hope that things would work out fine, for our interests lay in that outcome. Collectively, however, our actions took the world's economy to the brink of disaster, and they could do so again unless we recognize what went wrong and take the steps needed to correct it.

There are deep fault lines in the global economy, fault lines that have developed because in an integrated economy and in an integrated world, what is best for the individual actor or institutions is not always best for the system. Responsibility for some of the more serious fault lines lies not in economics but in politics. Unfortunately, we did not know where all these fault lines ran until the crisis exposed them. We now know better, but the danger is that we will continue to ignore them. Politicians today vow, "Never again!" But they will naturally focus only on dealing with a few scapegoats, not just because the system is harder to change, but also because if politicians traced the fault lines, they would find a few running through themselves. Action will become particularly difficult if a more rapid recovery reinforces the incentives to settle for the status quo. This book is, therefore, an attempt to heed the warnings from this crisis, to develop a better understanding of what went wrong, and then to outline the hard policy choices that will tackle the true causes of the crisis and avert future ones.

Let us start with what are widely believed to be the roots of this crisis, which is, in part, a child of past crises. In the late 1990s, a number of developing countries (in the interests of brevity, I use the term developing for countries that have relatively low per capita incomes and industrial for those that have high per capita incomes), which used to go on periodic spending binges fueled by foreign borrowing, decided to go cold turkey and save instead of spend. Japan, the second largest economy in the world, was also in a deepening slump. Someone else in the world had to consume or invest more to prevent the world economy from slowing down substantially. The good news for any country willing to spend more was that the now-plentiful surplus savings of the developing countries and Japan, soon to be augmented by the surpluses of Germany and the oil-rich countries, would be available to fund that spending.

In the late 1990s, that someone else was corporations in industrial countries that were on an investment spree, especially in the areas of information technology and communications. Unfortunately, this boom in investment, now called the dot-com bubble, was followed by a bust in early 2000, during which these corporations scaled back dramatically on investment.

As the U.S. economy slowed, the Federal Reserve went into overdrive, cutting interest rates sharply. By doing so, it sought to energize activity in sectors of the economy that are interest sensitive. Typically, such a move boosts corporate investment, but corporations had invested too much already during the dot-com boom and had little incentive to do more. Instead, the low interest rates prompted U.S. consumers to buy houses, which in turn raised house prices and led to a surge in housing investment. A significant portion of the additional demand came from segments of the population with low credit ratings or impaired credit histories -- the so called subprime and Alt-A segments -- who now obtained access to credit that had hitherto been denied to them. Moreover, rising house prices gave subprime borrowers the ability to keep refinancing the low interest rate mortgages (thus avoiding default) even as they withdrew the home equity they had built up to buy more cars and TV sets. For many, the need to repay loans seemed distant and remote.

The flood of money lapping at the doors of borrowers originated, in part, from investors far away who had earned it by exporting to the United States and feeding the national consumption habit. But how did a dentist in Stuttgart, Germany, make mortgage loans to subprime borrowers in Las Vegas, Nevada? The German dentist would not be able to lend directly, because she would incur extremely high costs in investigating the Vegas borrower's creditworthiness, making the loan conform to all local legal requirements, collecting payments, and intervening in case of default. Moreover any individual subprime homebuyer would have a high propensity to default, certainly higher than the level of risk with which a conservative private investor would be comfortable.

This is where the sophisticated U.S. financial sector stepped in. Securitization dealt with many of these concerns. If the mortgage was packaged together with mortgages from other areas, diversification would reduce the risk. Furthermore, the riskiest claims against the package could be sold to those who had the capacity to evaluate them and had an appetite for the risk, while the safest, AAA-rated portions could be sold directly to the foreign dentist or her bank.

The U.S. financial sector thus bridged the gap between an overconsuming and overstimulated United States and an underconsuming, understimulated rest of the world. But this entire edifice rested on the housing market. New housing construction and existing housing sales provided jobs in construction, real estate brokerage, and finance, while rising house prices provided the home equity to refinance old loans and finance new consumption. Foreign countries could emerge from their slump by exporting to the seemingly insatiable U.S. consumer, while also lending the United States the money to pay for these imports. The world was in a sweet but unsustainable spot.

The gravy train eventually came to a halt after the Federal Reserve raised interest rates and halted the house price rise that had underpinned the frenzied lending. Subprime mortgage-backed securities turned out to be backed by much riskier mortgages than previously advertised, and their value plummeted. The seemingly smart bankers turned out to have substantial portions of these highly rated but low-quality securities on their balance sheets, even though they must have known what they contained. And they had financed these holdings with enormous amounts of short-term debt. The result was that short-term creditors panicked and refused to refinance the banks when their debts came due. Some of the banks failed; others were bailed out even as the whole system tottered on the brink of collapse. Economies across the world went into a deep slump from which they are recovering slowly.

This narrative leaves many questions unanswered. Why was the flood of money that came in from outside the United States used for financing subprime credit? Why was the United States, unlike other economies like Germany and Japan, unable to export its way out of the 2001 recession? Why are poorer developing countries like China financing the unsustainable consumption of rich countries like the United States? Why did the Federal Reserve keep rates so low for so long? Why did financial firms make loans to people who had no income, no jobs, and no assets -- a practice so ubiquitous that it attracted its own acronym, NINJA loans? Why did the banks -- the sausage makers, so to speak -- hold so many of the sausages for their own consumption when they knew what went into them?

I attempt to address all these questions in this book. Let me start by saying that I do not have a single explanation for the crisis, and so no single silver bullet to prevent a future one. Any single explanation would be too simplistic. I use the metaphor of fault lines. In geology, fault lines are breaks in the Earth's surface where tectonic plates come in contact or collide. Enormous stresses build up around these fault lines. I describe the fault lines that have emerged in the global economy and explain how these fault lines affect the financial sector.

One set of fault lines stems from domestic political stresses, especially in the United States. Almost every financial crisis has political roots, which no doubt differ in each case but are political nevertheless, for strong political forces are needed to overcome the checks and balances that most industrial countries have established to contain financial exuberance. The second set of fault lines emanates from trade imbalances between countries stemming from prior patterns of growth. The final set of fault lines develops when different types of financial systems come into contact to finance the trade imbalances: specifically, when the transparent, contractually based, arm's-length financial systems in countries like the United States and the United Kingdom finance, or are financed by, less transparent financial systems in much of the rest of the world. Because different financial systems work on different principles and involve different forms of government intervention, they tend to distort each other's functioning whenever they come into close contact. All these fault lines affect financial-sector behavior and are central to our understanding of the recent crisis.