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Volume 23 Number 7

Free Market

July 2003

Dinars or Dollars?
Christopher Mayer

How powerful is economic law, that mysterious aspect of the structure of reality that causes prices to rise and fall and thereby give direction concerning the use of resources? More powerful than the US government, even more powerful than all the governments in the world combined. In Iraq, the US demonstrated that it can overthrow a despotic government but it can't finally control economic forces, particularly as they affect money.

By way of background, in a gold-standard world, there are no exchange rates between currency because they are all defined in terms of the same commodity. In a paper money world, currency values fluctuate. A strong currency is often associated with a strong national government. The US dollar, for example, has been relatively stable in recent years compared to the currencies of, say, developing countries in Africa and Latin America. The assumption is then easily made by some that strong governments and strong currencies go hand in hand, like bees and honey.

It's not always true. The dollar is strong and stable relative to many developing countries, but the overall dollar index reached a four year low this year, during a period of astounding expansions of US government power.

How can we sort all of this out? Does a powerful government make the currency strong or weak? As with many economic matters, though, causality and coincidence are often mistook for one another, when in fact they are very different things. The principles of money operate as a natural law, akin to the fundamental notions of gravity. They are unchangeable by governments no matter their strength or will.

The tale of the Iraqi dinar is interesting in that it illustrates a key concept in understanding the foundations of sound money. After the regime was overthrown, one might have thought that the dinar would be about as popular as Saddam Hussein. However, a perusal of some business headlines shocked some. "Saddam still worth the money," says one. "Saddam Hussein is Scarce, But Not the Saddam Dinar," says another.

As the Wall Street Journal reported on April 24th, "the Iraqi currency is making a comeback— more than doubling in value against the US dollar in the past two weeks." More than doubling in the span of two weeks!

Graced with an image of deposed leader Saddam Hussein, the head of an inoperable government, the notes, incredibly, soared against the almighty dollar. As coalition forces entered Iraq on April 9th, the notes traded at around 4,000 to the dollar. On the 24th, the notes stood at 1,800 to the dollar. Where a single US dollar could once purchase 4,000 Iraqi dinars, it later could only purchase 1,800.

The most delicious irony is that all of this went on while the country was being flooded with greenbacks. US soldiers have been spreading the currency by using dollars to pay the locals and make purchases. As the Journal reports, "Thousands of journalists, aid workers and US reconstruction officials who have descended on Baghdad in recent days have also contributed to this influx of greenbacks." Moreover, the homes of some senior Iraqi officials were looted and found to contain stashes of US dollars.

How could the Iraqis be willing to accept the old currency of a deposed government, when given the option of good ol' greenbacks from America? It would appear to be an easy transition to start favoring dollars. The dollar has reigned as the international currency of choice for so long it seems absurd, on the face of it, to accept dinars instead, especially at rates increasingly favorable to the dinar.  

The answer to this apparent paradox lies in the venerable economic laws of supply and demand, by which money, like any economic good, must still obey.

Quite simply, the dinars in circulation did not increase. No new notes are being circulated because the Iraqi central bank has been shut down, its printing press halted. The country's commercial banks were closed and many Iraqis were unable to access their savings.

The great corrosive rot that eats at the value of fiat currency is the government's ability to print more of it at will. In Iraq, with the dinar, it seems that problem was solved—albeit unintentionally by the US military.

Some writers have tried to peg the resurgent dinar on feelings of national pride and other emotions. They read the stronger dinar as favorable to the psychology of a nation in convalescence. It is always hard to refute or grapple with what feelings of national pride can accomplish. So many wars have been fought, so many lives have been lost, and so much stupidity has been committed with nationalistic sentiments at the heart of it, that it is hard to put anything beyond its pale.

But pinning the resurgent dinar on emotion may be a stretch when another explanation so logical and fundamental is right before us. Those who claim to explain the dinar's appreciation by appealing to psychological arguments are missing the proverbial elephant in the room.

Some of these news pieces also attempt to show, anecdotally, another side of the story by quoting Iraqi merchants and others who refuse to use the dinar and prefer the dollar. There may certainly be those kinds of people in Iraq, but the trading of the currency indicates that their view is a minority view.

Interestingly, in addition to the dollar and the dinar, there is a third currency that circulates in Iraq. It is called the Swiss dinar and has not been produced since before the first Gulf War. The Swiss dinar is supposedly hard to counterfeit and circulates primarily in the northern Kurdish areas of Iraq. The Swiss dinar traded at about eight dinars to the dollar and is viewed as a stable currency (more evidence that money and the state are not inseparable).

Mises knew this. He wrote that "the concept of money as a creature of law and the state is clearly untenable." His book, The Theory of Money and Credit, appeared at the advent of the central banking age, and he foresaw precisely where it would take us: toward inflation and an economy forever plagued by business cycles. Perhaps with Iraq, we have a real-life example of this theoretical insight.

Money is rooted deeper in the fabric of society and operates under a set of fundamental principles that the state cannot ignore. As Mises put it, "If it [the state] wishes to alter any of the exchange ratios established in the market, it can only do this through the market's own mechanism." As a force in the market in command of a great many resources, the state is always the greatest threat to any market. Mises wrote, "It is responsible for the most pronounced disturbances of the market because it is able to exercise the strongest influence on demand and supply." But even given its great powers—through taxation, compulsion, etc.—the state "is nonetheless subject to the rules of the market and cannot set aside the laws of the pricing process."

In Iraq, we see that the plentiful dollar temporarily met its match in the humble but now out-of-print Saddam dinar. The infamous and dangerous Fed Governor Bernanke, who heralded the power of the Fed to print money, should take note. He may need to revise his opinion in the future when the Fed is trying to figure out ways to save the dollar. The first step is to turn off the printing press. .FM


Christopher Mayer is a commercial lender for Provident Bank in the suburbs of Washington, D.C. ( 


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