The Petrodollar Era — What is the Endgame?

After World War II, a new international monetary system called Bretton Woods was created. Bretton Woods established three main things: (1) the U.S. dollar was to be an international reserve currency, (2) the U.S. dollar would be backed by gold at a price of $35 per ounce, and (3) any country could exchange dollars for gold. Countries running trade surpluses with the US sought to exchange their dollars for gold, and this rapidly shrunk US gold reserves. This then led to the so called Nixon shock — President Richard Nixon effectively ending the Bretton Woods system in 1971. The world economy entered a new era: the US Dollar became the global reserve currency. The US made no effort to rein in deficit spending, in fact quite the opposite. Therefore, the US needed to continue to find ways to sell government debt (i.e. to find buyers of US Treasury Securities) without driving up interest rates. By 1974, the enormous flood of dollars from the US into top-oil-exporter Saudi Arabia suggested a solution. That year, Nixon sent new US Treasury secretary William Simon to Saudi Arabia with a mission… The task: neutralise crude oil as an economic weapon against the US and find a way to persuade a relatively hostile kingdom to finance America’s widening deficit with its newfound petrodollar wealth. The basic framework was simple: the US would buy oil from Saudi Arabia and provide the kingdom military aid and equipment. In return, the Saudis would plow billions of their petrodollar revenue back into US Treasuries and therefore finance America’s spending. A win-win: the Saudis would receive protection from geopolitical enemies, and the US would get a new place to unload large amounts of government debt. This became known as “petrodollar recycling” By spending on oil, the US was creating new demand for US debt and US dollars. Moreover, since Saudi Arabia dominated the OPEC — the Organisation of the Petroleum Exporting Countries — this dollar deal was extended to OPEC overall, which meant that the dollar became the preferred currency for oil purchases worldwide. And so the petrodollar era began… This petrodollar system has had massive implications for US foreign policy. Although they have tried to keep it under wraps, Saudi Arabia is believed to be one of America’s largest foreign creditors. Undoubtedly, Saudi holdings of US debt and other assets are significant. All else being equal, the US should be growing less dependent on foreign holders of debt, certainly in terms of Saudi and OPEC-held debt, since the global role of OPEC and the Saudis has been diminishing in terms of global market share. But all else isn’t equal, and the US has been piling on ever-larger amounts of debt in recent years. In 2019, for example, the annual deficit topped one trillion. This immense growth in debt obviously makes the US regime more sensitive to changes in demand for US debt, and ever more reliant on foreign demand for both US debt and US dollars. In order to avoid a crisis, the US must ensure that interest rates remain low and that foreigners want to acquire both US dollars and US debt. Were petrodollars and petrodollar recycling to disappear, it would have a twofold effect on US government finances: First of all, a sizable decline in petrodollar recycling would put significant upward pressure on interest rates. The result would be a budget crisis for the US government, as it would have to devote ever-larger amounts of the federal budget to payments on the debt. The other option would be to have the US central bank monetize the debt by purchasing ever-larger amounts of it to make up for a lack of foreign demand. But this would lead to growing price inflation. Furthermore, if participants began to exit the petrodollar system (and, say, sell oil in euros instead) demand for dollars would drop, exacerbating any scenarios in which the central bank is monetizing the debt. This would also generally contribute to greater price inflation, as fewer dollars will be sucked out of the US by foreign holders. The result could be ongoing declines in government spending on services, and growing price inflation. The US regime’s ability to finance its debt would decline significantly, and the US would need to pull back on military commitments, pensions, and more. Either that, or keep spending at the same rate and face an inflationary spiral. Or…how about another option? Anyone fancy a Great Reset?