International investments are often made in dollars regardless of the country of origin. This has been the case since the Bretton Woods Agreement made in 1944. This conference solidified the hegemony the American dollar was rapidly achieving. Although that agreement set up permanent exchange rates which would later be dismantled, it still allowed the United States Dollar (USD) to achieve a role of primacy in international trade and investment.
The only real competition in the international arena for the USD was the British pound which ended with the devaluation of the pound in 1967 by 14.3%. Investors world over then decided to dump the pound en masse and convert their pounds to USD. This diminution of the pound was initiated by the British government in attempt to make the British economy more competitive. The result it must be noted, did not achieve the desired results and did great damage to the currency and prestige of the Britain.
British Pounds
The plunge in the value of the pound regardless of the politics, was ultimately the result of the declining strength of the British economy. The British economy did not fare well in the 1950’s and 1960’s in comparison to a number of other nations in Europe.
The German mark which continued to appreciate in the 1960’s although popular in Europe, and with many international investors, failed to replace the British pound in international use and trust. The role the pound had enjoyed from the end of the Napoleonic Wars in 1815, to the advent of World War II in 1939, could not be easily duplicated.
The American dollar next became the currency of choice for many investors because the American economy, government and military dominated the world since the end of World War II. The United States economy had already become the largest in the world since 1872. That was the year that the American economy overtook Britain.
American and British Representatives at Bretton Woods
World War I and its aftermath set the USD for what would become its premier role after World War II. The former wealthy nations of Western Europe were essentially bankrupt after World War I. Politicians at the time had promised when their side won the war, the losing side would pay for the enormous costs, that had been expended on the war effort.
Treaty Of Versailles Ending World War I
The ultimate success of the Allies in 1918 was largely the result of the American entry into the war in 1917. It tipped the balance against the Central Powers largely led by Imperial Germany and Austria-Hungary. The Allies lead by Britain and France presented the Germans with a bill of reparations, larger than the German economy in total. These payments, later readjusted were to continue until the 1980’s. The last actual payment of $94 million USD took place in 2010 which was 92 years after the first reparations had begun.
Hyperinflation in Germany 1920’s
Since the Germans were bankrupt themselves at the end of World War I, they could not afford these huge reparations. The result was the inflation and destruction of the German Mark in 1922 and 1923. The United States insisted the massive loans made by France and Britain during the war, needed to be repaid to American banks and other institutions. The former Allies said the repayment was now contingent upon the German payments to them. What resulted was new loans of American money to the Germans. This allowed the moribund German economy to recover and to continue payments to the French and British who then were able to repay their debts to the Americans.
The Stock Market Crash of 1929 and the subsequent arrival of the Great Depression brought the scheme to an end. The unilateral cancellation of debt made by the Germans in the 1930’s under their new fascist government mirrored an earlier repudiation of debt made by the Soviet Union (Russia) in the 1920’s.
American Stock Market Crash 1929
The end of World War II when most of Europe and East Asia laid in ruins necessitated an infusion of American money to help them recover economically. The American sponsored Marshall Plan in Europe, provided the seed money in the form of a cash infusion. This would allow the Europeans to buy the necessary inputs to get industry moving again.
The need to hold USD throughout the post war era had become solidified only enhanced by what had been achieved at Bretton Woods.
Site of Bretton Woods Conference
The foundation of Bretton Woods was based on a fixed exchange rate, and the promise among nations that USD could be converted into gold, at a set rate of $35.00 an ounce. By the late 1960’s the world was awash in dollars. The United States government had decided to fund the Vietnam War and began financing the Great Society Anti-Poverty Program through inflation, rather than a major increase in taxes. As dollar holdings increased internationally, nations particularly France, followed by Germany and Britain decided to convert the surplus into gold. This eventually forced the United States to abandon the gold standard and the set rate of exchange in 1971.
The United States was now faced with a much lower demand for American dollars. The artificial high demand for USD created by the Bretton woods system had now collapsed. The American government was left with excessive government spending with no real will to fund it at the domestic level.
The solution to this problem would arrive in short order. It became clear that the United States would only be able to continue to fund the expanding welfare state and military, by creating a new international demand for American dollars.
American President Nixon and Kissinger Setting Up The Petrodollar System
The United States government negotiated an agreement with the King of Saudi Arabia. What would result is what we today call the petrodollar.
The new understanding between the United States and Saudi Arabia would soon reignite the demand for American dollars once again. The United States would now guarantee the security of the oil fields in Saudi Arabia. They also agreed to provide the Saudis with weapons and protection from Israel if that became necessary. What the United States asked for in return was relatively simple to understand. The Saudis would price the oil they sold internationally in dollars only. All sales of oil from the kingdom would be in USD moving forward. No other currency would be allowed. The other provision was that the Saudis would invest the subsequent oil profits generated, in American government debt securities.
By 1975 all of OPEC (Organization Of Petroleum Exporting Countries) had agreed to price their oil in dollars and also to use their surplus oil proceeds to buy American debt. Over time American military presence in the form of bases and naval operations, would become commonplace in the oil producing part of the Middle East.
The soaring demand for oil internationally, would guarantee that nations around the world, would need to hold large quantities of American dollars. The agreement negotiated under the Nixon administration can be seen as one of the most brilliant economic strategies of the 20th century. It can also be ranked as one of the best geopolitical moves of the century as well.
The strategy would continue to allow the United States an economic and military hegemony that would ultimately be paid for in petrodollars.
Since nations need USD to purchase oil they have two options to achieve this. It can be done through foreign exchange markets which is cost prohibitive, or exports to the United States. This is why so many nations in East Asia, Latin America and Europe made the United States their major trading partner. It also has facilitated the use of the dollar in so many other economic and business activities on a global scale.
Crude Oil Prices
This economic system is enormously beneficial to the United States. It provides an abundance of goods and services to the American marketplace at very reasonable prices. It also allows the United States the ability to profit on almost every oil transaction in the world. First, by selling the world dollars to enable them to buy oil, and then borrowing the oil profits generated, to finance additional government debt.
It also allows the United States three great benefits. It increases the global need and demand for USD. The demand for American debt sold abroad increases as oil revenues increase. Furthermore, it allows the United States to buy oil with a currency it can print at will.
This financial system has allowed the United States to continue to live beyond it means in social and military spending. It also permitted the assets of America in stocks, real estate, bonds and the like to become much more valuable. It has led to massive foreign investment in the United States.
Bank Failure In The United States
The downside is that it allows Americans an illusion of national wealth and prosperity that is not paid for. So much of today’s economic activity in the United States is debt driven.
When the present petrodollar system ends as it soon will, it then cancels the international license the United States holds to print dollars indiscriminately. The recent run up in American government debt, has only hastened the day of reckoning. The rest of the world cannot be expected to fund the flagrant and excessive lifestyle that Americans have become accustomed to. As the international demand for USD declines and the supply continues to increase, it will create hyperinflation in the United States as the value of the dollar collapses.
Americans will soon face very difficult choices with the end of the petrodollar system, which unfortunately has already begun to unravel.
Consumer Prices In the United States