The law of supply and demand, one of the most relevant and reliable economic
principles, says, simply, "the price of something goes down when everyone
starts selling it". It is one of the reasons rare items, such as diamonds and
gold, are expensive, and common items, such as water and air, are inexpensive.

This principle applies to almost all commodities, but it also applies to
currency itself. If, for example, everyone sold off their Japanese yen, the
value of the yen would drop appropriately. This would cause Japan to pay more
yen to acquire the same products as it did before, effectively making all
prices in Japan go up. Naturally, this would come as a hardship for the
Japanese.

So what would Japan, or any other country, do to avoid this? They would start
a foreign currencty reserve. By keeping a large amount of foreign currency on
hand, Japa guarantees the stability of its _own_ currencty. If everyone were
to simultaneously sell off their yen, Japan could buy them with dollars,
euros, or any other currency (other than their own) they had lying around.
This would use the second arm of the law of supply and demand, "the more
people want to buy something, the more it is worth". Japan could keep the
exchange rate steady by balancing the number of yen sold with the number they
purchase, and keep Japanese prices low. Japan is no fool. They have the second
largest foreign currency reserves on the planet (second only to China + Taiwan
+ Hong Kong) with about $850 billion in various funds. Many countries also
use a gold reserve for a similar reason.

Now, if your contry is going to have a foreign currency reserve, you would
want to use currency that was (a) plentiful (b) stable and (c) widely used,
because (a) you will want to get a lot, and (b) you don't want your currency
to drop at the same time your reserves drop, and (c) as long as you're saving
up someone else's money, it may as well be something you can use in the open
market. The United States is (a) a large economy, the largest in the world (b)
is home to some of the world's largest companies and has a low rate of
inflation, as well as the ability to recover from such disasters as 9/11, and
(c) most international goods, as well as the debts of many small countries,
are measured in dollars. The dollar would seem like a good choice.

So, you buy up a bunch of dollars and save them. Good for you. Because of
this, you're effectively investing in the United States, allowing it to be a
little less cautious. For example, you're supporting the U.S. while it runs up
a trade defecit, for the same reason a bank lends their customers money for a
house -- you know we're good for the money. And not just any money, but
dollars,which you want more of anyway. Overall, it's a good mutual exchange.

Until...

Some have theorized that Iran's movement from selling oil for dollars to
selling oil for euros is the reason the U.S. is planning an attack.
Speculation about a Israeli attack, with U.S. permission and backup of course,
has been mentioned in international news since Jan 2005. The same sort of
rumors abound about Iraq's move to sell oil for euros, just before the U.S>
attacked it and burned it to the ground. In truth, there would be good
economic reason to do so. As oil runs out, supply and demand dictates that the
price will rise. Selling oil for dollars requires that the countries
purchasing oil go through the U.S. currency -- either by depleting their
foreign currency reserves or by purchasing on the spot, either way, the U.S.
wins. And oil is a major international trade good, if not _the_ international
trade good (unlike gold, it is consumed and must be replaced, and unlike food,
it's running out). So if Iran -- owner of 10% of the known oil reserves (Iraq
was a close fourth, by the way) -- moved to euros, which as recently as Jan
2006 they said they were considering, it would cause demand for the U.S.
dollar to drop accodringly, and as such, a rise in prices for the U.S. Our
money would become worth less. Countries would start to move their own foreign
currency reserves away from the dollar, even though we are still a large,
stable economy, because the dollar is not as much worth having as other
currencies.

The first country to make this move? China. As recently as last month, China
has released reports that it might move some of its foreign currency reserves
-- already known to be the largest in the world -- away from dollars. The best
figures show that China has about $500 billion or so in U.S. dollars. By
contrast, the _entire_ U.S. foreign currency reserve is under $100 billion. If
China decided to move even half, even a quarter, of its reserves to another
country, the U.S. could not compensate. The dollar would drop. The drop would
be bad enough at first, but when other countries followed suit -- selling off
their dollars before the price bottomed out -- it would get worse. This,
combined with the U.S.'s record-breaking trade defecit, would effectively
cripple the nation's economy.

Shinarae Lluminus

Heh economics 101 predicting the end of us economy, how cute