- 1 Gold Window and Petrodollar Need
- 2 What is the PetroDollar in Brief
- 3 Western Monetary System – a History
- 4 London Gold Pool Early Defense of US Dollar
- 5 Knock-on Consequences of London Gold Pool Failure
- 6 The Triffin Dilemma: the Core Issue for any Reserve Currency
- 7 The Petrodollar Standard Begins
- 8 Gold and Petrodollar Standard link (or delink)
- 9 Geopolitical Advantage: United States
- 10 Inbuilt Strains
- 11 Petrodollar is opposite of the Gold Standard – highly inflationary
- 12 The 10 Year Reversal: Largest Creditor to Largest Debtor in the World
- 13 War as Defense of the Petrodollar Standard
- 14 Fundamental Currency Concern under the Petrodollar Standard
- 15 Alternatives
- 16 Conclusion
- 17 Further Reading on the Petrodollar
Gold Window and Petrodollar Need
Gold and oil can never flow in the same directionAnother
The Petrodollar Standard is a system of countries that have agreed to buy oil solely for US dollars, then reinvest the dollars into the US debt complex. Implications underwrite much of the global economy.
In 1971, Richard Nixon infamously closed the gold window. The US was on a gold standard, with a fixed price of $35 per ounce. But the government had expanded the currency base – printing money in order to finance the Vietnam War. Suspecting the lessening value of their dollar holdings, other nations and large traders began to swap dollars for gold. When the trickle became a torrent, Nixon stopped the selling of US gold. Up to this point, other currencies were convertible into US dollars and dollars were convertible into gold. It gave the dollar world reserve status, but also put on pressure to “protect Fort Knox,” where US gold was stored.
The adjacent graph shows the resultant sharp upturn after 1971 in the inflation rate. There was far less need for fiscal discipline without the gold Rottweiler at the government throat. Backing the money with a limited asset (like gold) functions as one of three checks against profligacy. When the issuer overprints, the real treasury is drained; this compels caution, due to the specter of default. The second check is the political one of inflation – the public get restive – and the far more distant third one is hyperinflation, the kind of economic meltdown experienced by the German Weimer Republic. Having disposed of the first, they ignored the second, and took care of the third in perhaps the most ingenious and powerful pre-emptive economic strike in world history. After 1975, other countries would not desire dollars because they were a good medium of exchange – another reason had been devised to ensure they would have to have them, no matter what.
The system has its roots in the dollar diplomacy policy of President Taft. The US decided to push foreign dollar investment (focusing on Latin America) on terms that would favor America. Military engagement was not stressed, but was a definite option. The stated aim was to maintain “stability” in foreign governments in order to ensure US access to and advantage from foreign markets. It was a soft version of the same thing mastered by the British Empire – monetary hegemony. It was a revolutionary mode of empire.
The monetary hegemon controls access to credit markets, foreign exchange markets, has no balance of payment constraints, and has undisputed ability to force a unit of payment (dollars, for example) for conducting trade. The British monetary hegemon was the world’s first, achieved through investment of vast gold reserves – much like the US hegemon began. They were able to set the discount rate (the interest rate charged to commercial banks and other depository institutions) through their central bank and then loan money to other countries in Sterling to facilitate trade. This allowed a consistent method of world payment, which everyone liked. Britain managed to run current account deficits because the currency was so strong and unquestioned. Beginning with 7% of international commerce conducted in sterling, they pushed it to 60% by 1913. World War I initiated a waterfall decline. Patchwork measures were erected, but without a strong anchoring economy, the hegemon failed. Britain eventually lost the world reserve currency due to its inability to convert the pound into gold.
That left the world economy somewhat rudderless until 1944, when the US made its monetary hegemony power grab. But 40 years on, the US had learned the lesson. Leaders recognized that there was no division between foreign policy and monetary policy, or rather, that monetary policy provided the ultimate tool for gaining global dominance. They managed to turn the hegemony, faltering in the 1970s, into global economic domination by linking the dollar to oil.
What is the PetroDollar in Brief
Probably the most important (though little known) mechanism in the political economy of the world is the petrodollar standard. A full expansion follows, but a brief summary here will allow a handle on the subsequent chain of events, the current state of the mechanism, and the consequences. In 1944, the US dollar became the world reserve currency through the Bretton Woods conference, due to the pre-eminence of its economy, which rather than being destroyed by WWII, had profited from it. When the dollar was formally severed from gold – the so-called Nixon Shock in 1971 – officials scrambled (or had a plan already) to put something else in place. They created a political masterstroke – the Petrodollar Standard, which ensured that all oil would be sold in dollars, thus requiring all countries to hold dollar reserves.
Petrodollar maintenance was pretty easy until 2000 and remained manageable until recently, though now it seems to be failing. Only a few realize how deep and extensive the consequences for the US will be when it ends. The US policy of maintaining the standard has created very difficult circumstances for the superpower, one that is no longer tenable as US power declines. The end result will be far more tumultuous than any crisis of the past sixty years. For America, it could easily be worse than WWII or the Great Depression. Oil will be far more expensive, and that’s the least of the problems. The chain of events leading to the creation of the Petrodollar Standard is instructive.
Western Monetary System – a History
At the end of WWII, 44 world leaders met at the Bretton Woods hotel in New Hampshire to create a new economic system. The US, being the only nation on the world stage unharmed by the war, was the clear choice to take the role of leader in geo-politics and the world economy. A certain amount of loyalty was bought by the Marshall Plan. The $50 billion in aid that was extended to Europe was sold to the public under the cover of preventing the continent from going Communist under the Soviets.
A number of quasi-governmental organizations were created at this meeting – the IMF, Bank for International Settlements, and the World Trade Organization. More importantly, all currencies were linked to the dollar, and the dollar alone was convertible into gold – at a fixed rate. It was backed by almost 20,000 tons of it in Fort Knox. This system remained stable for twenty years or so. Countries accumulated dollars because they were the easiest token for world trade, as most counterparties carried and traded in them as well. But during the 60s, Johnson’s Great Society added a big financial burden to the US economy already stretched by military spending, by seeking to provide both “guns and butter” — Medicare and Medicaid. The military industrial complex alone had required a lot of money creation to wage the Vietnam War.
Clearly, both US political parties were (and still are) guilty in the currency debasement. Social programs from the left, military spending from the right, and bank bailouts from both spiraled the size and cost of government to the point that now it is beyond all sense. When money is freely available, it is easy to buy votes. When big money goes into a few pockets, it is easy to buy political influence. And geopolitical power is ultimately maintained at the point of a gun.
In times of currency debasement, people historically turn to gold and silver. This has been happening for thousands of years and is not likely to change. So, when the 1960s spending put pressure on the dollar and when other nations realized the US currency might be unable to anchor the world economy, mass conversion of dollars to gold began. People always want political and economic stability and with WWII still in clear recall, they were desperate for it. If Uncle Sam couldn’t give it, maybe his gold stash could.
London Gold Pool Early Defense of US Dollar
When foreign exchange reserves became too great and the US balance of payments deficit (monetary outflow) kept increasing, some countries got edgy and cashed in. After the amount of dollars flooding the world became disproportionate to the amount of gold backing the currency at $35 per ounce, countries exchanged their US dollars for US gold. In 1960, the open market price of gold spiked to $40. The Federal Reserve and Bank of England worked together to defend the price.
The 1961 London Gold Pool was a protective measure intended to hold down the price of gold by openly controlling the public market for it. A group of 8 central banks, led by the Federal Reserve, agreed to maintain the dollar convertibility into gold at $35 and to defend it with interventions in the gold market. The US put in half the gold and the other 7 nations the other half. It was a public policy promoting a particular public understanding. If investors thought the gold price would be defended by powerful governments at $35 an ounce, they would realize that there was little point in trying to profit from arbitrage – buying low in one market (US government gold, which only a few had access to) and selling high in another (the London gold market, where the pool operated).
Effectively, it was a curb on the demand for gold. But the other nations pulled back-door cheats on the US. By the end of the gold pool, European nations had nonetheless accumulated 12,000 tons of additional gold. US reserves had declined by that amount. In 1967, France pulled out completely and took its gold home. The price could no longer be sustained at the intended level. An attempt to separate the private and government markets for gold was short-lived, as it only created a black market.
The Pool collapsed. For a few years, the US continued to try to impose that two-tier pricing system for gold on the world. But it was unworkable, even with full German support. It only limped through a few years until the Nixon Shock. The two-tier system is still parenthetically existent. The Treasury books gold at $42.22/oz. This is an important element in analyzing the secretive activities of the Fed and central banks, to be discussed later.
Knock-on Consequences of London Gold Pool Failure
With the US running simultaneous trade and balance of payments deficits (a rare situation), West Germany pulled out of Bretton Woods and the Deutsche Mark leapt upward. That economy quickly strengthened. Switzerland followed suit and benefitted. The outflow of gold became a torrent, then a flood. It peaked at 400 tons in a single day. In a helter-skelter weekend, the London gold markets closed for a day, London had a bank holiday, and Nixon pre-emptively closed the gold window, surprising the world. Congress backed the move. US dollars were no longer redeemable for gold and still are not.
The government could have simply repriced gold higher to alleviate the pressure for a time. Unfortunately, this would have clearly signaled a policy of increasing spending. It might not have stopped the gold drawdown, but only slowed it for a time. The US credit card would have found a sharp limit afterward. If the dollar had been devalued compared to gold, then every nation would hawkishly watch the ratio of dollars to US gold. Economic prudence would be enforced.
The Zurich gold pool emerged from the ashes, giving wealthy people a place to hold the asset. It continues to this day, with the Swiss franc one of the most valued world currencies. It was 40% gold backed until 1999, the last currency to sever the tie to gold.
The Triffin Dilemma: the Core Issue for any Reserve Currency
Prior to 1971, the US was caught in the Triffin dilemma, pointed out in 1961 by economist Robert Triffin. It holds for any world reserve currency. The nation issuing the currency is stuck with conflicting domestic and international monetary policy goals. It needs to simultaneously maintain a current account trade deficit – putting out more money than taking in – and a current account trade surplus – taking in more than sending out. Obviously, the two are mutually exclusive. The need for the deficit comes from the need to supply excesses of currency to the rest of the world. The need for the surplus is to maintain the strength and confidence in the currency.
On August 15, 1971, the world lost its connection with ‘sound money.’ Money was no longer connected to a limited supply of a commodity – it became unfixed and has been ever since, floating mainly on an ocean of oil. The dollar was now a fiat currency, mandated for all debts public and private by government decree. In this case, it is not illegal to make or use a competing currency along with the dollar. Local currencies are legal, but the court system will not enforce a contract put outside of dollar terms. If your contract is to be settled in gold or silver, you are on your own collecting. This is the principal method of enforcing use of the dollar.
The actions of Washington were not new. Many nations had gone down the path before. The temptation to inflate the currency to maintain bread, circuses and imperial expansion is as old as government. It has always worked for a time and failed in the end. The length of time it works depends on how forward thinking a government is. Monarchies tend to have a tighter grip on policy because they don’t suffer, inter alia, from constant re-election pressures.
If a government can think in terms of 10 or 20 year plans, it can hold the system in control for some time. The US government has no such checks. The re-election window is largely a 2 or 4 year cycle. Elected power is widely distributed, so each elected official at federal and state levels wants as much money as they can borrow to spend into the population to essentially buy votes. They want the illusion of prosperity, hence the out of control public debt and monetary inflation.
Owning gold in the US was illegal during this period. In 1975, the law was lifted. This, and monetary expansion, led to the famous gold bull market which saw its price rise from $35 to $850 by 1980.
The Petrodollar Standard Begins
But before that, a deal was struck in 1973 with Saudi Arabia, from which the so-called Petrodollar emerged. The US agreed to militarily support the unpopular Saudi Royals, making both the country and its government more or less attack proof. No one wanted to go to war with America. US military backup forestalled any possibility of a successful rebellion. In return for bolstering the regime, the royals agreed to sell Saudi oil only in US dollars. They also agreed to reinvest those dollars back into the US banking and Treasury debt complex. Two years later, every OPEC nation accepted only dollars for oil and was reinvesting likewise. The US supplied military support to the other OPEC nations, as well. The skillful power grab by geopolitical architect Henry Kissinger was even nonviolent. After the heated Six-Day War, this was a very enticing promise.
Soon, all oil producers followed suit. Every oil importer needed dollars and every oil exporter received US dollars. All those exporters recycled the dollars right back into the US debt complex. This money was then spent into the general economy (along with a certain amount of new money from the Fed), where it was used to purchase foreign goods, moving those dollars to oil importing countries, to the oil exporters. The cycle of debt has been continually ramped up this way to the present day. In 1973, economics professor, Ibrahim Oweiss, named it the Petrodollar Standard. While it has never been formalized as a standard it remains an open political secret. Everyone in power knows, but no one talks about it.
According to the enigmatic and verbose analyst, Friend of Another, an even more hidden arrangement was created. The Middle Eastern oil powers like accumulating physical gold in holding for times like now. The West restructured the gold market in order to flatten the price of physical or at least link it to oil, so that if oil prices rose with gold, then OPEC could accumulate equivalent amounts without any real income changes. This restructuring hit a bump with the massive gold price spike – everyone else wanted it in times of gold fever. After slamming the price back down and killing the gold bull (by CFTC rigging and raising interest rates), the West and Middle East went back to business as usual.
Whether such deep-state views are true or not, the West began operating an increasingly paper gold market – through futures mainly – as a shadow of its equities and bonds markets. The paper market kept the price down for OPEC enabling it to accumulate physical steadily in the open market.
The technique is called seigniorage – the benefit reaped by exploiting difference in money value and cost to produce. It costs the US next to nothing to produce currency – a tenth of a cent per $100 bill. The oil producers, however, took it at full value, surrendering energy resources in exchange. Seigniorage is wildly profitable, especially without a precious metal standard to enforce responsibility.
Geopolitical Advantage: United States
The US got a second bonus – the agreement meant they were already in place militarily in the largest oil producing countries. When the region gets tense, the system is threatened, and military action is desired, ‘getting there firstest with the mostest’ is a fait accompli. The military has 600 bases in 130 countries and hundreds of weapons caches already set in place.
It’s not hard to see that the system requires perpetual growth. The money supply must constantly expand to service the debt. The use of oil must constantly increase to soak up the money supply and limit inflation. But the two are not organically linked in a supply-demand sense. Imbalances in one do not dampen and correct the other – in fact, quite the reverse can happen. One such scenario, frightful to central bankers, is called deflation.
Deflation is shrinkage, the opposite of growth. A system which incorporates growth is not bad in itself, but a system that requires perpetual growth is a catastrophe in the making. It is obviously unbalanced because it cannot handle normal cyclical processes. The mechanics are a bit complicated, but well worth the brainpower invested in understanding them. Deflation, inflation and so forth will be covered in detail in a separate section. They are quite important.
Petrodollar is opposite of the Gold Standard – highly inflationary
The gold wars are integrally linked to this system of monetary inflation and oil purchases. According to some, gold backing provides a counterweight to monetary excesses. This thesis will be expanded later, but gold clearly provides a brake on monetary creation; even in the absence of an official gold standard, gold still provides a standard. Thus it is an enemy of central banking – it infringes on the ability of central bankers to do as they please. It threatens them with loss of control of the currency when people flee to the safe haven of precious metals. Central bankers will do anything to prevent that – it is the entire basis of their power.
Bretton Woods and the Petrodollar Standard both created an enormous and consistent demand for US dollars. This offered a tremendous boon for the United States – it is the primary source of all the country’s might. The government is allowed to inflate its currency without a rapid decline in its value. No other nation benefits from this privilege. It’s always important to ask, in any given situation, cui bono: who benefits?
The Federal Reserve can print far more money than otherwise possible. This in turn enables the US to fight endless wars. It is also why government, corporate and private debt can go out of control to the extent that it has. For every dollar spent, the US government taxes, borrows from the available supply of dollars, or borrows from the Fed, which creates the money out of nothing. The last borrowing is inflationary, of course. Over the long term, at minimum.
The 10 Year Reversal: Largest Creditor to Largest Debtor in the World
A fascinating feature of this hegemon is its rapid transition from world’s largest creditor to world’s largest debtor. This was an incredible innovation in monetary geopolitical control systems. Normally, the process of control was exerted through lending money, but the US showed that being the world’s debtor gave it even more power. As the saying goes – If I owe the bank a million dollars, it’s my problem. If I owe them a hundred million, it’s their problem. The Treasury complex is the largest market in the world. Nobody wants it to fail suddenly because all nations have an economic stake in it. But the BRICS are working to slowly undermine it by converting their share of its power into a new system – probably gold based and decentralized. They seem to be allowing the debt-based construct of the West to tear itself apart from its excesses. Meantime, they are gathering strength to fill the void of US dollar power. That power is fading, it seems, and causing enormous volatility in its wake.
The world has been forced to absorb all US debt. As it ceases to do so, the value of the dollar holdings declines and trade to the US declines, as well. Since the US has been the main Chinese customer for so long, China has had a vested interest in supporting the dollar. But that is gradually ending. The Shanghai Cooperation Organization (SCO) is mounting a slow attack on dollar hegemony. It includes Iran (provisionally), China, Russia and other ‘rogue’ nations. Their trading with each other in non-dollar instruments, including gold,is a threat to the petro-dollar system.
Some governments simply borrow US dollars to purchase oil. US banks buy foreign bonds, thus loaning the money, usually through fractional creation of it. This is one of many mechanisms for petrodollar recycling. The IMF also has a facility for helping poor governments with balance of payment problems to purchase oil.
In recent years, oil producers have questioned the strength of the dollar. The increases in monetary creation are seriously out of step with the increases in oil demand, and cannot be justified by that. Global oil consumption increased by 30% since 1988. MZM means money of zero maturity, i.e. liquidity. That money supply has increased 2000% in the same time frame. There are a lot more FRNs being created than the Petrodollar standard can accommodate. The world is choking on US dollars.
The chart below shows a curve with an upturn in money creation compared to a linear increase in oil consumption. Since Covid, the uptick is terrifying (to those who study such things). Dollars dramatically outpace oil. Moreover, the money supply steepened dramatically since the 2020 crisis while oil consumption has drastically declined.
The petrodollar system has lost its balance – the oil supply may be hitting its peak, unable to increase daily production. Meanwhile, the money supply is hitting its debt limit, and forced to accelerate its increase. This mismatch will become worse and worse, and lead to extreme consequences as the financial, economic, monetary and production systems of the world struggle to cope.
Until now, the US could issue lower interest bonds and run higher deficits than other countries. However, the value of the currency is declining too fast. OPEC investments are losing value. More and more questions are arising about the intrinsic value of a currency that has no brakes on expansion with an out of control government. Most of the countries have people angry about the loss of their national resources and sovereignty to hegemonic empire.
War as Defense of the Petrodollar Standard
While this is not offered as proof of a US political deception, it is worthy of investigation. Is the demand to maintain the petrodollar standard the primary driver of US geo-political activity? Are the military actions and wars conducted under a false flag of fighting terrorism and concern over rogue nations in actuality an effort to maintain the Petrodollar Standard? JPMorgan now operates the Iraq central bank, appointed by the occupying forces. Strangely, they use Iraqi oil as collateral for letters of credit.
The system creates enormous wealth disparities and allows a few elites to plunder the national resources for their own benefit. On the OPEC side, the Saudi Royals are the worst offenders, claiming the titanic underground wealth as their own personal property. The price is growing civil unrest. This has been managed for decades, on the US end, by a number of covert actions and propaganda tools. But these have limits, so the next level of management is the age-old answer of ultimate control: war.
‘We must guard against the acquisition of unwarranted influence by the military industrial complex,’ President Dwight Eisenhower said, just before leaving office. He was ignored. The Carter doctrine claims that the US will, with full right, engage in military activity to protect access to oil. An unbreakable oil supply is officially a matter of the highest national security – a policy definitively in effect today. Jimmy Carter created the Rapid Deployment Task Force to address it, the precursor of Centcom, a military arm responsible for providing stable US control over Middle East oil – not that it needs access to the oil for its domestic needs, but that it must control and protect the Petrodollar standard: that oil, globally, must be purchased in dollars.
This is not a hidden doctrine. It is not a secret. It is openly acknowledged, but not brought up by leaders or the media, which might anchor it in the public mind. The Bush administration publicly acknowledged after invading Iraq that Hussein had nothing to do with 911 and had no weapons of mass destruction. A number of newspapers carried articles about the fake evidence (yellow cake uranium and other deceptions). The charges against Hussein had been fabricated as an excuse to invade. This is no longer in contention -it’s an unpleasant truth that has just been forgotten.
Iraq boasts the third largest oil reserves in the world. On September 24, 2000, with his country having been under US/UK-initiated, UN-imposed sanctions for a decade, Saddam Hussein announced that Iraq would begin accepting Euros for oil. He did not say that sales of oil to the US would be curtailed – in fact there were none at the time, due to US sanctions. Sales of Iraqi oil to the US could easily have been managed as part of a process of normative trade. But the petrodollar system is not about oil, per se. It is about a system of sustaining the worldwide need for a paper currency by linking it to a true global necessity – oil.
In a 2006 press conference, Bush was asked what Hussein had to do with 911. “Nothing,’ he replied, “and nobody’s ever suggested that Hussein ordered the attack.” After the denials, there were some admissions. Former commander of US Centcom Gen. John Abizaid said, “of course the Iraq War is about oil – we can’t deny that.” Russia, China and France didn’t back the invasion, but any moral reasons they might have had were supplemented by other reasons: they had a vested interest. Agreements were already on the table for billions of Euros. With Hussein gone, the agreements were null and void.
After US forces took Baghdad, they first guarded the oil fields and oil ministry. Looters were allowed to ransack the Baghdad Museum which housed ancient treasures from a long-lost world formerly on that land, widely referred to as the cradle of civilization. Within weeks, Iraqi oil was being sold only in US dollars again. A few years later, the oil fields were officially parcelled out to Western corporations.
In 2007, similarly sanctioned, Iran requested all oil be paid in non-US currencies. The Iranian oil bourse opened in February, 2008 and began selling oil in gold, Euros and other currencies. The drums of war against Iran beat louder every day. The WMDs and connection to 911 were shown to be false about Hussein. Perhaps we should be skeptical of current claims about Iran. Many analysts do not find the accusations of Iranian nuclear weapons development credible. Iran is much stronger than Iraq, with powerful allies. A war on Iran could pull the trigger on WWIII. Caution is an excellent idea. If the issue was about domestic supply for the US, as the government insists, the oil could have simply been purchased – there was no restriction from the Iranian side. The claim of supply shortages is deceptive – it’s about maintaining the Petrodollar standard.
Any notion that a Democrat administration represents peace must be questioned by the $900 billion military budget for 2012, far higher than Bush’s. Military expenses are 59% of the discretionary budget. All this spending is not for defending US sovereign territory. The last attack on the US was Pearl Harbor. No nation is going to attack the US directly. The military spending is for offensive purposes. It is to pursue hegemonic control and to protect the Petrodollar. The ‘kinetic military action’ in Libya, too, was an act of war against a sovereign nation that had never attacked the US. Similar to Iraq and Iran, once under US threat, the Libyan government sought to pursue every avenue towards peace short of abject capitulation, and similarly following rejection of such overtures, Qaddafi pushed for a currency to trade oil – the gold-backed dinar. It never happened.
Saddam Hussein began taking Euros for oil shortly before his demise. Iran first began taking Euros for oil in 2005. Venezuela now accepts foreign payments or the dollar. More and more importers, like North Korea, want to quit using US dollars to purchase oil. Perhaps this portends an ever-growing list of so-called “rogue states”?
According to this analysis, the gigantic US military expenditure (more than all other nations combined) is a necessity. The military is not serving as the world’s policeman or defending the US from its enemies. It is guarding the world reserve status of the currency by forcing the payment of oil in US dollars. It is a very big job, done by coercion, intimidation, largesse, and failing that, by war
Fundamental Currency Concern under the Petrodollar Standard
The US debt machine and standard of living can only be maintained under the petrodollar standard. If any countries manage to back out of it successfully, then others will follow suit. This entrapment generates tremendous resentment toward US hegemony throughout the world. Countries want to get out from under the imperial thumb. Saudi Arabia began talks with China for a protectorate of the Persian Gulf in 2006, for example. If most countries really divest from the reigning oil payment system, there will be no worldwide need for dollars. Only a few will invest in US debt instruments. All that money will come flowing right back to the US. The many creditors may panic and dump all their imperial paper at once.
The government then has two choices: have the Federal Reserve monetize the debt (which it’s already doing) or default. No government using its own fiat currency for debt has ever defaulted. They always try to print their way out. Some of the moneys coming in will recycle through the government debt complex, but most will go to buy US assets and resources. When countries no longer need to hold dollars, they will buy up pieces of the US (and anywhere else in the world they can). They will want out of those massive stockpiles of depreciating money.
Freeways could turn into Chinacorp toll roads, foreign banks will appear, private schools will be foreign owned, as will airlines, land, and almost everything else. It’s already happening. The People’s Bank of China is opening four branches here, with the Fed’s blessing. It’s a gradual insertion, with more to follow. They will use their dollar holdings and be allowed to multiply them through the US fractional reserve system. A somewhat antagonistic foreign creditor will be able to create US currency in the fractional reserve system.
The enormous influx of dollars will combine with a second inflow – new currency issued by the Fed, especially post-Covid – the largest money printing ever. With no one buying government debt using existing dollars, the Fed will be forced to print massively, purchasing government debt itself, monetizing it. Enormous inflation should follow. When people want to protect themselves from serious inflation, they turn dollars into assets. But this only exacerbates the pace of inflation. Dollars go down because lots of wealth is transferring away, increasing the velocity of money and decreasing its desirability. The value of assets rises, because so many want to transfer their wealth into them and out of the currency.
That’s conventional supply and demand theory, at least. In this case, it will be slow. Also, because the dollar is so deeply integrated into the world economy, it will be volatile. It’s actually amazing that the dollar has done so well since the 2008 crisis. However, the Fed has tools to prop it up while simultaneously printing. Plus, it takes time for demand to reverse at all economic levels in the globe.
Interest rates should rise to extreme levels unless the Fed can hold them down. Companies relying on short-term debt to finance long-term operations will be in deep distress. The price of oil will go sky-high. Oil and commodity dependent businesses will fail. Theatrical political divisions between left and right will become extreme with each side blaming the other. Debt encumbered assets will dramatically lose real value, although nominal prices may rise due to extreme inflation. People with a floating interest rate will be forced to default. The derivatives complex will go haywire, spiraling the world’s largest banks into open insolvency. The US currency might even hyperinflate and face extinction.
The US (with British, Canadian and a few other) leaders are therefore highly invested in maintaining the petrodollar standard. A number of other countries – the BRICS, mainly – are looking to escape or subvert it. Some countries are waiting on the sidelines and hedging to see how it plays out – Germany is probably the most important. The battle is on.
The most desirable asset during such dangerous times for the wealthy is gold; for poor people, silver; and for the middle class, a balance. Bitcoin and Ethereum will also play a role, but their instability makes them a poor choice for a central investment plank.
One government/central bank strategy is to keep the allure of gold down. The gold market must be seen as highly volatile. So reminiscent of campaigns against the leadership of the targeted “rogue states,” the campaign of slander begins: “It’s very easy to invest at the wrong times, it doesn’t behave as it should, and if you buy at the wrong time, you’ll lose your shirt. It’s not worth the risk. It’s a ‘barbarous relic.’” That’s the message. The establishment mouthpieces are sowing propaganda. “Gold just sits there and does nothing,” Warren Buffet said. His partner, Charlie Munger, strangely said “Gold is something pre-holocaust Jews sew into their clothes. It’s not for civilized people.” They try to push the big money – pension and hedge funds – into Treasuries, the safe investment of the last 40 years.
But like it or not, gold is the historical sound alternative to a government mandated currency. Like the US dollar, it is universally recognized as money. Unlike the dollar, it has been so for 5000 years. Gold is the enemy of fiat currency, and even though the dollar was born as gold-backed currency, it has turned on its parent and seeks to destroy it. But it’s impossible to destroy the idea of gold as money. Most people in the world refuse to believe it’s not. Only a select population does. Most are in the US. They have a vested interest in believing that because the petrodollar standard has been so beneficial. However, that is the set of people needing to understand it most, because the failure of the petrodollar will have the greatest negative impact on the US, for obvious reasons. Failing to realize the refuge of gold will cause many people’s savings to be wiped out.
China, Russia, India, Iran, Brazil, and South Africa, called the BRICS, are systematically delinking oil from the dollar. These countries have instituted trades in their respective currencies for other goods in addition to gold. [Russia and China, in 2012, announced a major deal to trade oil in Yuan – the Chinese currency]. More and more, these nations are accumulating gold and using it as money.
The BRICS trade movement, away from US dollar hegemony, is creating an enormous strain on the Western government financing and the entire Western debt and banking system. There are other strains: out of control sovereign debt, the need to continually increase debt to counter deflation, real estate collapse, derivative issues, and endless and pervasive corruption. All these have contributed to a huge loss of trust, which are fundamental for a fiat economy, which runs on trust in the currency and on counterparty good faith.
The Machiavellian genius of the petrodollar standard — that nations have no choice, they must obtain dollars to get oil- has had a multitude of ramifications. It’s why Asia has developed an export-led strategy tied directly to the US. It’s also why the US is drowning in cheap foreign goods. Every country needs oil, requires dollars to get it, and must export – whatever – to the US to get those digital tokens.
The US gets three massive advantages right out of the gate. Because everybody must have dollars, they are worth more than any other currency and continue to be the de facto world reserve currency. Second, nations that reap a lot of dollars for their oil become a pre-arranged, automatic market for US debt. Third, the US can buy all the oil it wants for nothing, just by turning on the printing press. For forty years, that incredible inflation of dollars has caused enormous price rises, and US wage rises, sending American manufacturing to lower wage countries. It led to the creation of the warfare/welfare state, then became necessary to enable it to continue to function.
That Niagara Falls of dollars churned out by the fractional reserve multiplier may get soaked up overseas, but all things come to an end. The system is breaking down. There are a lot of dollars in some hands, especially in the East and Middle East, and there’s a lot of debt around other necks, especially Western financial organizations, governments, and citizens. A big enough debt yokes creditor to debtor, because if debtors are unable to pay, then creditors are unable to collect on their worthless assets.They are both in the same boat. They are both bankrupt – as is evidently the case with southern European banks and their failing sovereign debt assets. Most of that money has left the US. Even as it’s recycled through debt mechanisms, the debt grows without the available currency growing. This is the concern over debt deflation. And that’s the razor knife right now we are walking on – deflation on one side and inflation on the other.
While any economic system has an element of artificiality to it, this system is artificial on a much grander scale. Enormous debt imbalances, trade imbalances, and cash flow imbalances all stem from this system. The numbers are in the multi-trillions. Add derivatives and it exceeds the global economy by orders of magnitude. The petrodollar system is the world economy, the backbone of the globalized trading system. When the system comes to an end, and it will, the unwinding of it will cause international havoc. Gold stands in the background.
While other currencies will be exchangeable for oil, no currency will become the single choice. No country wants to own the reserve currency, because the rapid increase in demand would drive up their export prices and their industry would collapse. The slow decline of US manufacturing illustrates the problem. Being the holder of the global reserve currency drives up the cost of living, wages and asset prices in the issuing country. For producers, this means they cannot compete using US labor. If a company can pay someone $5 a day, like Apple does, then truly US-based companies are sunk. That’s why US manufacturing has been gutted. It’s why the US economy has shifted to become a FIRE (finance, insurance and real estate) economy. Any country with a sharply rising currency value loses its export industry. A nation like China is export dependent just to keep its populace employed and happy. Germany will be in a similar situation if it exits the Euro.
A group of strong currencies is likely to emerge to supplant the dollar over time. Certain countries want to participate and develop a strong world reserve currency without being the sole issuer of that currency. That’s why so many of these countries are holding more and more gold. Those with political awareness realize that the story of Middle East tensions is being utilized in a crafty game of chess.
Further Reading on the Petrodollar
The Senate finance committee investigated an effect on the stock market from Petrodollars.
Here is a detailed academic treatment of the Petrodollar from ‘back then.’