Nothing for Money

SYNOPSIS: Krugman debunks a theory as to why George W. Bush insists on war in Iraq

I've been getting a number of emails from people suggesting to me that this impending war is all about money - specifically, to ensure that the dollar, and not the euro, remains the world's #1 currency. The idea is that the US economy will be in danger if OPEC members start demanding payment in euros rather than dollars.

With respect to my correspondents, this isn't a plausible argument. It's politically implausible  - who, exactly, in this administration is supposed to be thinking about the role of the dollar as a key currency? The same people who invited the author of The Bible Code to brief the Pentagon? And anyway, the economics are wrong.

Remember the three roles of money: medium of exchange, unit of account, store of value. The dollar plays all three roles to some extent on world markets. It's a medium of exchange: people converting Brazilian reais to Malaysian ringgits (or rather banks making trades in the FX market) normally do so through two transactions against the dollar. It's a unit of account: although most world prices are set in other currencies, the share of prices in both financial and goods markets specified in dollars is larger than you would expect from the raw economic weight of the United States. And the dollar is a store of value: the Fed estimates that about 60 percent of US currency  - that is, actual pieces of green paper - is held outside the US.

But why does all this matter? Does it give the US a special advantage in the world? Well, yes - but not nearly as big an advantage as people imagine. And a change in how OPEC gets paid would make very little difference.

The US advantage comes to the extent - and only to the extent - that the international role of the dollar lets us borrow money more cheaply than we otherwise could. One component of that is clear: because foreigners hold a lot of dollar bills, which pay no interest, we in effect get a free loan of that much money.

Dollar-denominated bank accounts also provide a bit of an interest-free loan, because they are ultimately backed by deposits at the Federal Reserve. But most of the accounts held by foreigners have very fractional backing - they're typically eurodollar accounts, which are only partly backed by accounts in the US, which are in turn only partly backed by deposits.

It's also possible that even our interest-bearing debt commands a better price - i.e., a lower interest rate - because of the dollar's special role. But there doesn't seem to be any evidence of that, and it's not likely to be more than marginal. (Also, the US isn't the only country that can issue dollar-denominated bonds.)

So the main thing is cash overseas - $300-350 billion of bills, mostly in large denominations, hidden under beds, being transferred among criminals, etc.. At an interest rate of 4 percent - say that's a normal rate - this is a subsidy to the US of $12-14 billion per year. Small change, for a $10 trillion economy. It's not even a significant part of our current account deficit.

Moreover, would a change in OPEC settlements really affect this?

There's probably some link between the dollar's role as unit of account/medium of exchange and its role as store of value. But when we say that Saudi Arabia is paid in dollars, what we mean is that oil is paid for with a wire transfer from a London bank, with the sum denominated in dollars. It doesn't mean that green pieces of paper change hands, or even that there is a stash of green paper somewhere being held to back the transaction. What really matters for the cash held overseas is which currency people who don't trust their native currencies think is a good bet. Rumor has it that the Russian mafiya is switching to euros, since Europe is where ill-gotten Russian gains get banked or spent; if so, that's a much bigger deal for seignorage than pricing of Persian Gulf oil.

So this particular conspiracy theory is wrong. Sorry.

Of course, you may well ask, why then are these people so determined to have their war? The answer is because. Just because.

Originally published on the Official Paul Krugman Site, 3.14.03