A little dollars and sense

A variety of strategic reasons have been suggested for the US assault on Iraq, some plausible and others on the wilder fringes of speculation. One idea been popular in the twilight world of conspiracy theorists - alongside the notion that the Rothschilds secretly control the US central bank - is that the war was about protecting the US dollar's international economic dominance.

On this view, the "real reason" for the war on Iraq was Saddam Hussein's decision in 2000 to take Iraq's oil revenues in euros rather than dollars. The invasion, so this argument goes, was to warn away other Opec member countries from doing the same.

One of the internet's conspiracy theorists, William Clark, put it this way: "Although completely suppressed by the US media, the answer to the Iraq enigma is simple yet shocking - it is an oil currency war." Sadly for the swivel-eyed conspirati, this "simple yet shocking" answer is completely wrong.

People who worry about the dollar's international primacy are confused about how exactly currencies are used, as well as exaggerating by how much the US economy benefits from oil sales between, say, Kazakhstan and South Korea being denominated in dollars.

Yes, international oil trade is generally conducted in US dollars, as is much other trade in commodities and goods, and the dollar's use in international transactions is larger than the US economy's share of world trade. But, then, so is the Swiss franc's share. All that tells you is that most companies and countries prefer to do business in some currencies (dollars, Swiss francs, euros) than others.

Open any reputable economics textbook and you will find a chapter on the role of money. They pretty much all say the same thing: money is a unit of account, a store of value and a medium of exchange. The US dollar is regarded a reliable store of value - in the same way that gold, sterling or Swiss francs are - because of the strength of the US economy and the stability of its institutional support.

But the "medium of exchange" and "unit of account" elements are just functions of liquidity and convenience. If South Korea buys oil from Kazakhstan by converting Korean won into US dollars, then Kazakhstan can either keep the payment in dollars or convert it into Kazakh tenge for domestic use. In any case, all that happens is a transfer from one bank account outside the US to another one.

For all three reasons of value, exchange and account, the world's central banks tend to hold large proportions of their foreign exchange reserves in US dollars - in part because, as in the Kazakhstan example, that's what they receive a lot of in the first place.

So what does the US gain from the dollar's international role? In theory it means the US can borrow money more cheaply, receiving a lower interest rate for dollar-denomi nated loans or bonds than would otherwise be the case, because those dollars have to go somewhere. Unfortunately, there is no evidence that US interest rates would be higher if the dollar were not a widely held reserve currency - for many years Germany paid lower interest rates on its bonds than the US, despite the German mark not being internationally as popular.

The only tangible benefit comes from forgone interest that would have been paid on US currency - actual notes - held outside the US. According to the Federal Reserve, about $300bn in hard cash circulates outside the boundaries of the US, with much of it held by criminals and black-economy participants.

The US economy does gain a benefit from this, but it is only a tiny benefit. If this hoard were kept in interest-bearing assets, the US economy would be paying out about $10bn a year in one way or another. Instead, the US economy is subsidised to that extent. In an economy the size of the US, that is chicken-feed - the equivalent of £25 a year to an average full-time wage earner in Britain.

Let's be clear what this does not mean. Just because Kazakhstan has a US dollar-denominated bank account in London or Basle does not mean that it is in hock to the US, or that it is forced to buy American assets or exports. Nor is Kazakhstan subsidising the US economy, at least not to any appreciable extent.

It certainly does not mean the US somehow gets to import oil for "free" because it pays for it in dollars - it can't simply print money to pay for barrels of black stuff. Or, to be theoretically correct, it could do so but not for long - the value of the US dollar would sink on foreign exchange markets as a result, and cost the US economy far more.

If Opec tomorrow switched to demanding that its contracts be paid in euros, would the US economy collapse, as some have predicted? No. The US economy has its own problems, but how Kuwait or Algeria gets paid for oil is not one of them. There are enough plausible, worrying justifications for why the US administration was so determined to invade Iraq without the US dollar being one of them.