Admiration for the American military victory on the battlefield in Iraq has not yet translated into confidence in the stability of the U.S. economy.  Indeed, early indications would suggest that international investors are much less sanguine about the chances for success in postwar Iraq--and fearful that the United States government could become bogged down in a Middle Eastern sinkhole that will have negative repercussions on the domestic front.  The economic consequences of the peace may prove more costly for the United States. 

This, in turn, has real implications for the scope of U.S. efforts to transform the Middle East in the wake of Saddam Hussein's deposition.  After all, reconstruction has to be financed.  Since taxes are unlikely to be raised to pay for any of these projects, the war and its aftermath will be paid for by borrowing.  And if capital is not flowing into the United States, it becomes much more expensive to finance the postwar operation.  (A related question, then, becomes the degree to which the United States wishes to become even more indebted to China--the Chinese already hold some $100 billion in U.S. Treasury Securities, and they view becoming one of the chief creditors of the United States a way to extend their influence.) 

Back in February, I noted that concerns about the stability of the dollar in the run-up to military action against Iraq were causing international investors to search for alternative ways to preserve the value of their assets, notably by turning their dollar holdings into euros and gold. (http://www.inthenationalinterest.com/Articles/vol2issue7/vol2issue7eliason.html).

What is interesting to observe is that this process slowed during the first weeks of the war.  When the various doomsday scenarios--the nightmare of urban combat in Baghdad, the whole-scale destruction of the oil fields, the unleashing of weapons of mass destruction--did not materialize, the dollar began its recovery against its two hedges.   

As the war has wound down, however, investors have become more nervous over the apparent lack of a well-thought out plan for Iraqi reconstruction.  Moreover, the rhetoric of some within Congress and the Bush Administration worries those who fear that a broad-based, international reconstruction effort will not be put into place--dropping not only the primary responsibility but also a large portion of the cost onto the shoulders of the United States. 

Concerns about the strength of the dollar have led to a renewed appreciation of the euro against the dollar.  On April 7, the dollar was trading at 1.0582 against the euro; by April 17, the dollar had declined in value, to 1.092 to the euro.  After the Easter recess, the euro has continued to appreciate against the dollar, closing at the rate of 1.0971 to the dollar. 

Gold has also resumed its upward rise.  Gold had begun to lose value vis-à-vis the dollar in the first stages of the war, falling to $321.35 per ounce by April 9.  Since then, it has begun to regain lost value against the dollar, as confidence in the greenback has begun to wane.  On April 15, the price had appreciated to $324.70 and then, following Easter, to $327.00 per ounce and is now trading in the mid-$330 range.  East Asian purchases of gold have also been accelerated by fears of a rising oil price in the wake of an OPEC announcement to seek production cuts (on April 21 light crude for May delivery had risen to a price of $31.08 per barrel). 

What is interesting to observe is that the markets respond positively to "multilateralist" signals sent by the administration--when the U.S. seems to indicate that it will work with other partners (and by implication spread the burden) in reconstruction efforts.  Conversely, unilateral signals worry investors who then believe that Washington is recklessly making commitments that it cannot fulfill. 

Repairing bridges with European partners and creating a broad-based coalition for Iraqi reconstruction may not only make good political sense, but could also restore confidence in those international investors who have been quietly selling their dollar holdings.

Arthur Eliason is an independent consultant in international business and economic affairs.