Petrodollars

Petrodollars

In 1944, at Bretton Woods, New Hampshire, 44 war-battered countries accepted the US Dollar as the world’s reserve currency.  That made it the currency of global commerce.  In exchange, the US agreed to make the dollar forever convertible to gold at $35 an ounce.  Back then, the US had 80% or the world’s gold reserves; about 21 million tons.  So it was only natural for the dollar to emerge supreme.

Things went smoothly for a while, but due to President Lyndon Johnson’s massive spending on the Vietnam War and his “Great Society” welfare state at the same time, inflation started running rampant.  As a result, the amount of dollar’s in circulation increased dramatically while the amount of gold backing them remained the same.  Other nations, seeing the writing on the wall, began converting their dollar holdings for gold, which in 1971 found US gold reserves under 9 million tons.  So on August 15, 1971, President Richard Nixon closed the gold window for good, leaving the dollar backed by nothing.

This left the US and the rest of the world in dire straits.  Inflation was rampant and would stay that way for the rest of the decade while international commerce was in freefall.  The US desperately needed something to maintain global demand for the dollar and the Nixon/ Kissinger team came up with a brilliant plan. 

Between 1972 and 1974, our government worked out an agreement with Saudi Arabia, the world’s largest petroleum producer that created what became known as the “Petrodollar System”.  In a nutshell, petrodollars are the money oil exporting countries receive from selling that oil, which is then deposited in Western banks.  From the Saudi point of view, they were a weak military nation but they had something that everyone else coveted.  So it was clearly in their best interest to make a deal with the US for military protection from countries the Saudi’s feared, which included our closest ally, Israel.

And what could the Saudi’s do for the US and our guarantee for the survival of the House of Saud?  Well, they gave us a way to be the world’s economic power ever since.  Every barrel of oil purchased from Saudi Arabia would have to be bought with US dollars.  Any country who wanted to purchase oil from the Saudi’s had to first convert their own currencies into greenbacks and then give them to the Saudi Arabian Government.  The rest of the OPEC nations followed in 1975 with their own arrangements to price their oil in US dollars in exchange for our weapons and military protection.

The petrodollar system was a really good deal for both sides.  The Saudi’s and the other OPEC nations essentially got their protection for free.  From their prospective, what do they care what currency they get paid in?  They still get paid.  And the dollar was the best currency to get paid in anyway.

From the US point of view, the system creates an artificial demand for US dollars all over the world.  As global oil demand increases, so does the demand for US dollars.  It follows that as demand for dollars increases, so does the need for a greater supply of them.  It solidified the dollars status as the reserve currency.

Any country can print money, but it’s inflationary.  More money chasing the same amount of goods drives up the price of those goods.  The beauty of the petrodollar system is it allows the US to avoid the inflationary wrath of money printing.  As we increase the money supply, it goes overseas to countries that need the dollars to buy oil and not get spent on US products, driving up their prices.

The petrodollar has greatly benefited the US Government and every US citizen as well.  A great percentage of the dollars we send overseas return to the US in a process called “Petrodollar Recycling”.  The excess dollars that build up in the oil exporting countries need to be recycled.  They can be spent on anything, but most are invested in US dollar denominated assets and that creates liquidity for the financial markets keeping stock prices up.  Recycled dollars also keep interest rates low allowing more Americans to own more homes than any other nation.

 

Until the next time, we’ll watch your money.

 

 

Nicholas W. Bertell ChFC®

Financial Advisor

Redwood Coast Financial Partners, an independent firm with securities offered through Summit Brokerage Services, Inc.,  member FINRA/SIPC.  Advisory services offered through Summit Financial Group, Inc., a Registered Investment Advisor. This material was prepared by Nicholas Bertell and does not necessarily represent the views of Summit Financial Group, Inc., nor their affiliates. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy.  Summit and Nick Bertell are not engaged in rendering legal, accounting or other professional services.  If assistance is needed, the reader is advised to engage the services of a competent professional.  This information should not be construed as investment, tax, or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty.  

Nick Giambruno, Ron Paul Warns “Watch the Petrodollar”, Zero Hedge, 1/14/2016

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