The petrodollar system is an unofficial monetary system that started in 1974. As parst of the petrodollar system, most global oil exports are priced in US dollars. In return, the United States offers protection and cooperation to Saudi Arabia and other members of the Organization of the Petroleum Exporting Countries (OPEC). Gladstein, Alex: Check Your Financial Privilege. Inside the Global Bitcoin Revolution (2022), pp. 39ff.
The petrodollar system helped to strengthen the US dollar and maintain its status as world-reserve currency after the Bretton Woods system ended. It resulted in high demand for US dollars and helped cement the United States financial and military power.
Until 1933, the United States and other parts of the world were on the gold standard. This meant, all paper money was backed by physical gold. In the case of the Untied States, all circulating US dollars needed to be backed to 40% by gold.
When president Roosevelt issued Executive Order 6102 and outlawed gold ownership for American citizens, he effectively took the United States off the gold standard. The American Presidency Project. “Executive Order 6102—Requiring Gold Coin, Gold Bullion and Gold Certificates to Be Delivered to the Government” Accessed Feb. 24, 2022.
In 1944, towards the end of World War II, global leaders from 44 countries met and drafted the Bretton Woods agreement.
As part of the Bretton Woods agreement, the United States pegged the US dollar to gold at a fixed exchange rate of $35 per ounce. Other member countries that also signed the Bretton Woods agreement pegged their local currencies to the US dollar at fixed exchange rates. Federal Reserve History: “Creation of the Bretton Woods System” Accessed Feb. 22, 2022.
This allowed the United States and most major countries to maintain a peg to gold without having to be on a traditional gold standard.
The Bretton Woods system fell apart when the United States expanded the US dollar supply to fund government programs and finance the Vietnam war.
France and the United Kingdom began exchanging their US dollars and demanded gold from the United States. They feared that the US government wasn’t able to maintain the peg of $35 per ounce of gold. Their fears were valid. In 1971, president Nixon halted convertibility of US dollars into gold. Office of the Historian: “Nixon and the End of the Bretton Woods System, 1971–1973” Accessed March 18, 2022.
This effectively ended the Bretton Woods system. Countries that signed the Bretton Woods agreement, which were promised convertibility of US dollars into gold at $35 per ounce, were left holding paper money.
There were attempts to reform the Bretton Woods system as part of the Smithsonian agreement that repriced gold at $38 per ounce.
But the Smithsonian agreement failed shortly after its inception. Finally, throughout the early 70s, all countries adopted floating exchange rates. Their local currencies became fiat currencies. They weren’t backed by anything but the creditworthiness and faith of the governments that issued them.
With the end of the Bretton Woods system, the dominance of the United States was in question.
While the United States still owned a majority of global gold, this didn’t mean as much in a world where currencies weren’t backed by gold anymore.
In 1973, members of the Organization of the Petroleum Exporting Countries (OPEC) decided to significantly raise the price of oil and embargo the United States for supporting Israel during the Yom Kippur War. Smith, Charles D.: Palestine and the Arab–Israeli Conflict (2006), pp. 329.
At the same time, the United States was facing double-digit inflation, which led to a decline in trust in the US dollar. Federal Reserve History: “The Great Inflation” Accessed March 18, 2022. As a result, Nixon and National Security Advisor Henry Kissinger decided to draft an agreement with Saudi Arabia.
Treasury Secretary William Simon visited Saudi Arabia, paving the path for the petrodollar agreement of 1973. As part of this agreement, the United States bought oil from Saudi Arabia and provided it with military aid and equipment. Bloomberg: “The Untold Story Behind Saudi Arabia’s 41-Year U.S. Debt Secret” Accessed April 1, 2022.
In return, Saudi Arabia invested their petrodollar revenue back into the United States government bond market. Shortly after the Petrodollar agreement of 1973 came into force, Saudi Arabia invested $2.5 billion in Treasuries.
In the following years, other OPEC nations followed Saudi Arabia. Any country that wanted to buy oil from an OPEC nation needed to do so in US dollars. This led to continuous demand for US dollars in several ways.
First of all, countries that wanted to import oil needed to exchange their local currencies for US dollars. Some countries began pricing their own exports in US dollars so they could use dollars to buy oil from OPEC countries. Lyn Alden: “The Fraying of the US Global Currency Reserve System” Accessed April 1, 2022.
The need to pay for oil in US dollars led to more countries acquiring US dollars. This resulted in increased demand.
But there is a second way the petrodollar system propped up demand for US dollars. OPEC countries recycled their petrodollars into Treasuries. Saudi Arabia and other oil producers invested some of their petrodollar revenue back in US government bonds. Spiro, David E.: The Hidden Hand of American Hegemony. Petrodollar Recycling and International Markets (1999).
This led to increased demand for US government bonds, rising bond prices and sinking interest rates.
As a result, the US government could borrow money cheaply and finance its expenses. It also allowed the United States to maintain its military and financial power after Bretton Woods.
Some people call the petrodollar system Bretton Woods II. Nasdaq: “Credit Suisse: Ensuing New Financial Order Will Benefit Bitcoin” Accessed April 1, 2022. Although the US dollar wasn’t pegged to oil directly in the same way gold was, it was indirectly backed by oil.
The Petrodollar system created an intricate relationship between US dollars, oil and the military.
As part of the petrodollar agreement of 1973, Saudi Arabia received military aid and equipment. In return, they had to sell oil for US dollars on the world market.
There are, however, also theories that certain wars fought by the United States were in defense of the petrodollar system. Gladstein, Alex: Check Your Financial Privilege. Inside the Global Bitcoin Revolution (2022), pp. 42ff.
For example, Saddam Hussein announced in 2000 that he would sell oil for euros instead of dollars. Three years later, the United States invaded Iraq and overthrew Saddam Hussein. Shortly after, Iraq was selling oil for US dollars again.
The reasons for the invasion of Iraq remain debated. Critics of the petrodollar system like Alex Gladstein argue that petrodollar warfare could be a reality. But whether the United States really invaded Iraq to defend the petrodollar system is controversial.
The connection between US dollars, oil and military power is hard to deny after the petrodollar agreement of 1973 though.
The Untied States maintained the petrodollar system for several decades. But more and more countries are pricing oil in other currencies.
China and Russia are transacting in dollars only 33% of the time compared to 89% seven years ago. Lyn Alden: “The Fraying of the US Global Currency Reserve System” Accessed April 1, 2022. Many countries are looking to escape US financial control.
This is accelerating global de-dollarization and paving the path for a more multi-polar financial world. Will the petro dollar end? Just like the gold standard and Bretton Woods ended, the petrodollar system could end.
As geopolitical power and financial interests change, the global monetary system adapts to accommodate new needs.
Critics of the petrodollar system argue that it provides the United States and Americans with a financial privilege. The rest of the world, on the other hand, is subject to financial control by the Untied States.
According to critics like Alex Gladstein and Lyn Alden, the petrodollar system primarily enriches financial elites in the United States.
At the same time, the petrodollar system forces the Untied States to run a constant trade deficit. It has to import goods and services rather than producing them domestically. Gladstein, Alex: Check Your Financial Privilege. Inside the Global Bitcoin Revolution (2022), pp. 41. This leads to fewer jobs for Americans.
According to critics, the petrodollar system has financialized the American economy. It led to an artificially strong dollar, made exports uncompetitive and hollowed out the middle class.
On the other hand, the petrodollar system remains a debated and controversial topic. Some critics point out that the petrodollar system doesn’t really exist as a monetary system. Forbes: “Why The Petro-Dollar Is A Myth, And The Petro-Yuan Mere Fantasy” Accessed April 1, 2022. The fact that most oil is priced in US dollars might merely be a convenience.
According to them, it wouldn’t affect the geopolitical power of the United States or the status of the US dollar as world-reserve currency if OPEC countries decided to stop selling their oil for US dollars. Foreign Policy: “Debunking the Dumping-the-Dollar Conspiracy” Accessed April 1, 2022.
They claim the significance and impact of the petrodollar is overblown. For them, the existence of a petrodollar system is more akin to a conspiracy than an official economic reality.
|↑1||Gladstein, Alex: Check Your Financial Privilege. Inside the Global Bitcoin Revolution (2022), pp. 39ff.|
|↑2||The American Presidency Project. “Executive Order 6102—Requiring Gold Coin, Gold Bullion and Gold Certificates to Be Delivered to the Government” Accessed Feb. 24, 2022.|
|↑3||Federal Reserve History: “Creation of the Bretton Woods System” Accessed Feb. 22, 2022.|
|↑4||Office of the Historian: “Nixon and the End of the Bretton Woods System, 1971–1973” Accessed March 18, 2022.|
|↑5||Smith, Charles D.: Palestine and the Arab–Israeli Conflict (2006), pp. 329.|
|↑6||Federal Reserve History: “The Great Inflation” Accessed March 18, 2022.|
|↑7||Bloomberg: “The Untold Story Behind Saudi Arabia’s 41-Year U.S. Debt Secret” Accessed April 1, 2022.|
|↑8, ↑12||Lyn Alden: “The Fraying of the US Global Currency Reserve System” Accessed April 1, 2022.|
|↑9||Spiro, David E.: The Hidden Hand of American Hegemony. Petrodollar Recycling and International Markets (1999).|
|↑10||Nasdaq: “Credit Suisse: Ensuing New Financial Order Will Benefit Bitcoin” Accessed April 1, 2022.|
|↑11||Gladstein, Alex: Check Your Financial Privilege. Inside the Global Bitcoin Revolution (2022), pp. 42ff.|
|↑13||Gladstein, Alex: Check Your Financial Privilege. Inside the Global Bitcoin Revolution (2022), pp. 41.|
|↑14||Forbes: “Why The Petro-Dollar Is A Myth, And The Petro-Yuan Mere Fantasy” Accessed April 1, 2022.|
|↑15||Foreign Policy: “Debunking the Dumping-the-Dollar Conspiracy” Accessed April 1, 2022.|