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United States World Position Will Be Undone With The End Of The Petrodollar

The Statue of Liberty in New York City is a symbol of the U.S.

Many Americans are totally unaware how dependent their standard of living has become, to the global role of the United States dollar (USD). The petrodollar system, has supported the United States (U.S.) currency in the world economy, since the early 1970’s. The premiere reserve position the American dollar has held for over forty years, has become largely dependent on the international trade in crude oil.

The petrodollar system of rules, has allowed the United States government and Americans to live far beyond their means for decades. It has permitted the country to run massive government and trade deficits, year after year. The enormous national debt that now exceeds $20 trillion USD and is larger than the GDP (Gross Domestic Product) of the country, is only possible in a world that needs American dollars.

The west front of the United States Capitol building. where Congress meets

The totally unsustainable social spending, that irresponsible politicians have promised and now delivered to the American public, is only manageable through the runaway creation of paper money. This excess cash is absorbed by a global economy, that needs it in abundance, in order to pay for their importation of oil.

The United States government worked to establish the petrodollar system, once the post war Bretton Woods agreement was no longer feasible to maintain.

International Monetary Conference was held at Bretton Woods in New Hampshire, United States

Bretton Woods was set up in 1944, as World War II was winding down. The accomplishment of the international conference, was to create a system of fixed rates between major currencies of the day. This guaranteed the stability of the global financial market.

This exchange rate was secured by the United States dollar, which would now replace gold, as the regular medium of exchange among nations.

USD would keep its worth, because of the link to gold. It was set at a fixed rate of $35.00 USD per ounce of gold. The ability to convert dollars into gold bullion, reassured holders of American currency, that their foreign exchange reserves would maintain value over time.

John Maynard Keynes (right) and Harry Dexter White at the inaugural meeting of the International Monetary Fund’s Board of Governors in Savannah, Georgia, U.S., March 8, 1946

Nations and investors had confidence in the system because the United States owned 63% of the world’s official gold reserves. This equated to a total of 574 million ounces or 17,937.5 metric tons at the end of World War II.

The International Monetary Fund (IMF) was founded at the same time, to assist nations with short term liquidity issues and to fix rates of exchange between major world currencies.

Over time, the American dollar became extremely overvalued. This resulted in a serious negative effect on trade. Imports into the United States continued to get cheaper, but exports became increasingly expensive.

Ultimately, it was causing job losses in the American export sector. The ongoing American trade deficit would soon arrive.

There were two major policy decisions in the 1960’s, that would cause the Federal Reserve Bank to print more money to cover the fiscal shortfall.

One was the domestic policy, that would be labeled the War on Poverty. The other was he decision to finance the American military involvement in Vietnam,without raising taxes to pay for it.

The surge in the printing of money, was not accompanied by a corresponding increase in economic growth. The result was a rise in the rate of inflation. Domestic price stability a feature of the post war era, was rapidly coming to an end, as the decade began to wind down.

Under a gold bullion standard, paper notes are convertible at a preset, fixed rate with gold bullion.

The increase in the inflation rate in the United States, would ultimately end the post war fixed exchange rates and undo the link to gold.

As the value of the dollar continued to shrink in the 1960’s, the convertibility into gold was becoming impossible. The huge reserves of gold acquired earlier in the century by the United States, were rapidly being depleted, as more nations were exchanging inflated dollars for gold.

From 1950 to 1969 both West Germany and Japan fully recovered, from the total devastation created by losing World War II.

During this time the share of world output produced by the United States, dropped from a commanding lead of 35% to a more moderate 27%. In comparison to today, that share has dipped even further to just 22%, of world GDP and only 17% of Gross World Product.

Charles De Gaulle on the left and Konrad Adenauer Chancellor of West Germany, in 1961.

It would be the nation of France, that would hasten the end of the Bretton Woods system of fixed exchange rates, backed by gold convertibility.

In the view of the French, it was the rest of the world that was supporting the American standard of living and providing indirect subsidies, to multinationals based in the United States. This view was shared by many other countries at the time.

In early 1965, French President Charles de Gaulle announced his intention to exchange his dollar reserves for gold.

The following year central banks outside the United States, were holding $14 billion USD in their reserves. At the same time, the United States only had $13.2 billion USD in gold as reserve.

In reality only $3.2 billion USD would be available to cover foreign holdings, since the rest was needed to cover domestic financial assets.

The monetary situation was reaching the breaking point. By 1971, the money supply in the United States had already increased by 10%.

Deutsche Mark

The same year, West Germany decided to abandon the Bretton Woods agreement.

In order for the Germans to remain in the system, they would have been forced to revalue their currency. This would of had a detrimental effect on their export sector.

The abandonment of the aforementioned, subsequently helped the German economy over the next few months. Simultaneously, the American dollar dropped a total of 7.5% against the Deutschmark.

Worried about a possible American devaluation of the dollar, other nations soon began to redeem their USD for gold bullion. By August, the United States government itself was considering a devaluation, as as the dollar was dropping in value, against numerous European currencies.

Gold prices (US$ per troy ounce) from 1914-2017, in nominal US$ and inflation adjusted US$

United States gold reserves had already shrunk to a low of 286 million ounces, which was just under 8938 metric tons.

After Switzerland left the system, the pressure was mounting for the United States to somehow modify the Bretton Woods agreement.

These events in their entirety, finally compelled the American President Richard Nixon, to announce the unilateral cancellation of the direct international convertibility of the United States Dollar to gold.

By 1973, the entire regime of fixed exchange rates had collapsed. What replaced it, was a system of free floating exchange rates, still in existence today.

Richard Nixon, 37th President of the United States

There was a great deal of financial uncertainty in the early 1970’s. The dollar continued to lose valuation, as speculators took advantage of the situation.

The central bank of Japan was forced to purchase billions of American dollars, to keep the yen at its old rate. However, this action could not in itself, prevent the further deprecation of the United States dollar.

The United States government began to look for an alternative, in maintaining the premiere role the dollar had in international finance.

This is what provided the impetus, to establish a new regime to the benefit of the United States and its currency. The petrodollar system would be the ingenious result, of this desire to maintain financial hegemony.

The United States needed a way to motivate countries to continue to use and hold American dollars. The key to this challenge was Saudi Arabia and the commodity it exported in great abundance. Crude oil would provide the vehicle, to reassert American dominance.

Henry Kissinger

The 1973 Arab oil embargo against the United States and other Western countries that had supported Israel in the Yom Kippur War, demonstrated the power that OPEC (Organization of the Petroleum Exporting Companies) had over the world economy.

Influential business leaders and the American Secretary of State Henry Kissinger contrived a plan, that would use oil to not only rescue banks and other financial interests, but to save the United States dollar itself.

Kissinger would soon negotiate a new financial order with the Saudi Arabian monarchy. The Saudis would demand dollars for the sale of their oil as would other members of OPEC. In return, the United States would provide military aid and security to the kingdom.

The Saudis would also pledge to prevent another oil embargo.

William E. Simon
Former United States Secretary of the Treasury

Another more covert meeting would take place between United States Treasury Secretary, William Simon and the Saudis. An agreement was reached that would use much of the proceeds from Saudi oil sales, for reinvestment in the United States.

A large portion of the total, would subsequently be used to purchase American debt, in the form of U.S. Treasuries.

The deal worked out between the United States and Saudi Arabia in 1974, has delivered to the former tremendous advantages. The demand for American dollars, paralleled the rising need for crude oil in the global economy.

The new system provided the foundation and framework for decades of expansionist American monetary policy. It would provide the necessary funding for a massive expansion in U.S. entitlements. It would also assist the United States in maintaining the strongest military globally and allow it to easily project military power, anywhere in the world.

World map showing real GDP growth rates for 2009 (countries in brown were in recession.)

The financial crisis of 2008 and 2009 along with the Great Recession, highlighted the unraveling of the petrodollar system.

The signs of slow degradation were already there, which would now be accelerated enormously. The doubling of American national debt under the Obama Administration, was viewed with increasing alarm overseas.

Investors abroad, began to question the safety of their investments in United States dollars. This concern became even more intense, when the credit worthiness of the United States was downgraded in 2011.

The intergovernmental argument over raising the debt ceiling, brought far more attention to the increasingly unstable American financial system.

U.S. Deficit and Debt Increases 2001–2016

A number of leftist politicians at the time argued, that the debate over the raising of debt levels caused the downgrade. This assessment is incorrect. It was the rapid increase in government deficit spending itself, that was leading to a reappraisal of the economic and fiscal stability of the United States.

The day of financial reckoning for the United States, is now rapidly approaching. It will happen when the oil producing nations of the world, will no longer accept payment in USD. There is increasing evidence that these nations as a group, will be requesting gold.

More nations are now trading oil outside the petrodollar system. In 2013, Russia agreed to provide China with the equivalent of $270 billion USD of oil. No American dollars will be used in the transaction, the largest energy deal to date.

Several OPEC nations are already accepting transactions in crude oil in currencies other than USD. In 2014 for example, Qatar agreed with China, to be the first oil nation dealing with oil sales in Chinese yuan.

Fluctuations of OPEC net oil export revenues since 1972

In December 2015, China and the United Arab Emirates agreed on a currency swap in the sales for oil.

As of January 2016, India and Iran reached an agreement to settle oil sales by using Indian rupees.

Taken together, these actions indicate that the Persian Gulf oil states are seeking ways to reduce their exposure and dependence on the American dollar.

The order imposed by the United States and its allies in the Middle East, beginning in the early 1970’s, is now unraveling. The inaction of the American President Obama in preserving the regional balance of power, has seriously undermined the security of many nations in the area.

Iran Nuclear Deal. The ministers of foreign affairs of the United States, the United Kingdom, Russia, Germany, France, China, the European Union and Iran March 30, 2015.

The overly optimistic and some would say naivety of the American sponsored nuclear agreement with Iran, only enhances the lack of safety felt by nations in the Middle East.

As part of the understanding, international sanctions were lifted on Iran. This step has been locally interpreted, as a weakening of the American commitment to Saudi Arabia. It has made the kingdom, strategically more vulnerable.

The vital relationship between Saudi Arabia and the United States, is far more fragile as a result of domestic American politics.

Last year a bill was passed by the American Congress, allowing the kingdom to be held financially liable, for the September 11th.2001 terrorist attacks in New York City. Although the legislation was vetoed by President Obama, the bill received overwhelming support in Congress, so it was passed over the objections of the President.

The Saudi Arabian government first warned that if the bill became law, they would sell large amounts of American debt. This would be achieved by the liquidation of United States bonds. Now it seems that the Saudis are awaiting to see, if there will actually be any successful law suits brought against them.

The New York Stock Exchange is the largest stock exchange in the world.

It is not an idle threat, Saudi Arabia alone, holds close to $120 billion USD in U.S. Treasury Securities.

The United States will soon face situations where monetary policy, will need to be used in defense of the American dollar abroad, rather than in response to domestic economic conditions.

As more nations especially oil producing ones, abandon the dollar, it will put increasing pressure on the United States, to raise interest rates to attract more foreign investment. The money will be sorely needed, to finance the ever increasing twin deficits in government spending and trade.

Ever higher interest rates, will slow United States economic growth, putting even more pressure on the American dollar.

As foreign investment begins to decline, it will be impossible for the United States to continue to fund the massive social entitlements, that together carry a future liability close to $120 trillion USD.

Risks due to increasing entitlement spending, according to GAO’s projections of future trends

Finally, American citizens will then understand, that indeed the rest of the world was supporting their unsustainable lavish living standards.

By this time, an increasingly desperate American government, will be imposing capital controls and far harsher methods to enforce rising taxation rates on individuals and corporations.

More troubling, there will be efforts made to tap the last major source of cash available. These would be the enormous retirements and pension funds, owned by numerous entities and individuals.

After a number of unending financial crises, the government of the United States will face some difficult choices.

The first option will be to inflate the currency, so debt would be repaid with cheaper and cheaper dollars. The resulting hyperinflation, will necessarily destroy the United States Dollar.

The second option would be to engage in a massive sale of government owned land, property and businesses. Of course many of these assets might have limited appeal to individuals, living outside the United States.

The third option would be to declare bankruptcy. This would simply mean the United States would no longer redeem debt held by investors. It could be a negotiated insolvency, where bondholders agree to get paid less than the face value of their investment, or a complete default.

These alternatives will not be easy choices, and the coveted American standard of living will be dealt a devastating blow. For the first time in generations, the United States government will have to learn to live within its means. That is expenditures would be determined by the amount raised by taxation. It will not be an appealing prospect, but unfortunately a necessary one.

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