Preparing for the Collapse of the Petrodollar System
The Rise of the Petrodollar System: "Dollars for Oil" Part B #1
by Jerry Robinson
In part one of this four part article series, I provided a background to our modern petrodollar system by explaining the "dollars for gold" arrangement that was put in place by global leaders through the Bretton Woods conference in the final days of World War II.
The article provided a brief evolution of the Bretton Woods agreement from its inception in 1944 to its ultimate demise in 1971. As detailed, in the late 1960's, this "dollars for gold" system had become unsustainable as Washington insisted upon the adoption of a "welfare state" that relied upon massive entitlements and a "warfare state" that required perpetual wars.
In the second installment of this article series, I will further explain the circumstances surrounding the demise of this failed "dollars for gold" arrangement, with a particular emphasis on how its demise dealt a major blow to global dollar demand.
I will detail how the Washington elites sought to replace the lost global dollar demand that had been artificially created through the Bretton Woods system. Their solution would come in the form of something known as the Petrodollar system. The three primary benefits that the Petrodollar system provides to America will be explained.
And finally, the article will conclude with a brief examination of how the Petrodollar system has influenced U.S.-Middle East relations with a specific focus on Israel.
The Same Game with a New Name: "Dollars for Oil" Replaces "Dollars for Gold"
Preparing for the Collapse of the Petrodollar SystemIn the early 1970s, the final vestiges of the international gold-backed dollar standard, known as the Bretton Woods arrangement, had collapsed. Many foreign nations who had previously agreed to a gold-backed dollar as the global reserve currency were now having serious mixed feelings about the arrangement.
Nations like Britain, France, and Germany determined that a cash-strapped and debt-crazed United States was in no financial shape to be leading the global economy. These were just a few of the many nations which began demanding gold in exchange for their dollars.
Despite pressure from foreign nations to protect the dollar's value by reining in excessive government spending, Washington displayed little fiscal constraint and continued to live far beyond its means. It had become obvious to all that America lacked the basic fiscal discipline which could prevent the destruction of its own currency.
Like previous governments before it, America had figured out how to "game" the global reserve currency system for its own benefit, leaving foreign nations in an economically vulnerable position. After America and its citizens had tasted the sweet fruit of excessive living at the expense of other nations, the party was over.
It is unfair, however, to say that the Washington elites were blind to the deep economic issues confronting it in the late 1960's and early 1970's. Washington knew that the "dollars for gold" had become completely unsustainable. But instead of seeking solutions to the global economic imbalances that had been created by America's excessive deficits, Washington's primary concern was how to gain an even greater stranglehold on the global economy.
In order to ensure their economic hegemony, and thereby preserve an increasing demand for the dollar, the Washington elites needed a plan. In order for this plan to succeed, it would require that the artificial dollar demand that had been lost in the wake of the Bretton Woods collapse be replaced through some other mechanism.
According to John Perkins, the author of Confessions of an Economic Hit Man: The Shocking Story of How America Really Took Over the World, that plan came in the form of the petrodollar system.
(Click here to listen to Jerry Robinson's interview with John Perkins.)
But what exactly is the petrodollar system?
First, let’s define what a petrodollar is.
A petrodollar is a U.S. dollar that is received by an oil producer in exchange for selling oil, and that is then deposited into Western banks.
Despite the seeming simplicity of this arrangement of "dollars for oil," the petrodollar system is actually highly complex and one with many moving parts. It is this complexity that prevents the petrodollar system from being properly understood by the American public.
Allow me to provide a very basic overview regarding the history and the mechanics of the petrodollar system.
Preparing for the Coming Collapse of the Petrodollar System
It is my belief that once you understand this "dollars for oil"arrangement, you will gain a more accurate understanding of what motivates America’s economic (and especially foreign) policy.
So, let’s take a closer look…
The Rise of the Petrodollar System
In a series of meetings, the United States — represented by then U.S. Secretary of State Henry Kissinger — and the Saudi royal family made a powerful agreement. (Several authors have worked to compile data on the origins of the petrodollar system, some exhaustively, including Richard Duncan, William R. Clark, David E. Spiro, Charles Goyette and F. William Engdahl).
According to the agreement, the United States would offer military protection for Saudi Arabia’s oil fields. The U.S. also agreed to provide the Saudis with weapons, and perhaps most importantly, guaranteed protection from Israel.
The Saudi royal family knew a good deal when they saw one. They were more than happy to accept American weapons and a U.S. guarantee to restrain attacks from neighboring Israel.
Naturally, the Saudis wondered how much all of this U.S. military muscle was going to cost…
What exactly did the United States want in exchange for their weapons and military protection?
The Americans laid out their terms. They were simple and two-fold.
1) The Saudis must agree to price all of their oil sales in U.S. dollars only. (In other words, the Saudis were to refuse all other currencies except the U.S. dollar as payment for their oil exports.)
2) The Saudis would be open to investing their surplus oil proceeds in U.S. debt securities.
You can almost hear one of the Saudi officials in a meeting saying: "Really? That's all? You don't want any of our money or our oil? You just want to tell us how to price our oil and then you will give us weapons, military support, and guaranteed protection from our enemy, Israel? You've got a deal!"
However, the U.S. had done its economic homework. If they could get the Saudis to buy into this deal, it would be enough to launch them into the economic stratosphere in the coming decades.
Fast forward to 1974 when the petrodollar system was fully operational in Saudi Arabia.
And just as the United States had cleverly calculated, it did not take long before other oil-producing nations wanted in on the deal.
By 1975, all of the oil-producing nations of OPEC had agreed to price their oil in dollars and to hold their surplus oil proceeds in U.S. government debt securities in exchange for the generous offers by the U.S.
Just dangle weapons, military aid, and guaranteed protection from Israel in front of third world, oil-rich, Middle East nations… and let the bidding begin.
Nixon and Kissinger had successfully bridged the gap between the failed Bretton Woods arrangement and the new Petrodollar system. The global artificial demand for U.S. dollars would not only remain intact, it would soar due to the increasing demand for oil around the world.
And from the perspective of empire, this new "dollars for oil" system was much more preferred over the former "dollars for gold" system as its economic requirements were much less stringent. Without the constraints imposed by a rigid gold standard, the U.S. monetary base could be grown at exponential rates.
It should come as no surprise that the United States maintains a major military presence in much of the Persian Gulf region, including the following countries: Bahrain, Iraq, Kuwait, Oman, Qatar, Saudi Arabia, United Arab Emirates, Egypt, Israel, Jordan, and Yemen.
The truth is easy to find when you follow the money…
The Petrodollar System Encourages Cheap Exports to the United States
While the U.S./Saudi agreement may have smelled of desperation at a time of decreasing global dollar demand, it can now be considered one of the most brilliant geopolitical and economic strategies in recent political memory.
Today, virtually all global oil transactions are settled in U.S. dollars. (There are a few exceptions and they will be highlighted in our next article appropriately titled, The Petrodollar Wars.) When a country does not have a surplus of U.S. dollars, it must create a strategy to obtain them in order to buy oil.
Preparing for the Collapse of the Petrodollar System The easiest way to obtain U.S. dollars is through the foreign exchange markets. This is not, however, a viable long-term solution as it is cost-prohibitive.
Therefore, many countries have opted instead to develop an export-led strategy with the United States in order to exchange their goods and services for the U.S. dollars that they need to purchase oil in the global markets. (This should help explain much of East Asia’s export-led strategy since the 1980's.)
Japan, for example, is an island nation with very few natural resources. It must import large amounts of commodities, including oil, which requires U.S. dollars. So Japan manufactures a Honda and ships it to the United States and immediately receives payment in U.S. dollars.
Problem solved… and export-led strategy explained.
The Primary Benefits of the Petrodollar System
The petrodollar system has proven tremendously beneficial to the U.S. economy. In addition to creating a marketplace for affordable imported goods from countries who need U.S. dollars, there are more specific benefits.
In essence, America receives a double loan out of every global oil transaction.
First, oil consumers are required to purchase oil in U.S. dollars.
Second, the excess profits of the oil-producing nations are then placed into U.S. government debt securities held in Western banks.
The petrodollar system provides at least three immediate benefits to the United States.
It increases global demand for U.S. dollars
It increases global demand for U.S. debt securities
It gives the United States the ability to buy oil with a currency it can print at will
Let's briefly examine each one of these benefits.
1. The petrodollar system increases global dollar demand.
Why is consistent global demand for the dollar a benefit? In many ways, currencies are just like any other commodity: the more demand that exists for the currency, the better it is for the producer.