The petrodollar system is a complex and essential system on which the world economy relies deeply. The system dates back to the late 19th century, when the British Empire dominated all trade and commerce. At the time, the British pound sterling was called the “reference currency”. This currency had to be used to purchase any merchandise on the international market. Furthermore, it was in the hands of any nation that sold these commodities. Throughout the 1800s and early 1900s, Britain satisfactorily controlled this currency, primarily due to its military capabilities and international presence.
After World War II, an important meeting was held in Bretton Woods, New Hampshire. The meeting determined that the United States would become the new anchor currency of the Bretton Woods system. In the deal, the United States would allow other nations to sell their dollars for gold. As time passed, the realities of the Triffin Dilemma came true.
In 1971, West Germany, Switzerland, and France decided to sell their dollars for gold; then they left the Bretton Woods system that same year. Ultimately, the United States was running out of gold to back its dollars. How could the United States preserve this system? In 1971, the Nixon Shock occurred, ending the convertibility of the US dollar to gold and ultimately ending the Bretton Woods system. Furthermore, this established a new system, which was called the petrodollar system.
What exactly is a petrodollar? It is a US dollar earned by the Organization of the Petroleum Exporting Countries (OPEC), when it sells oil to another nation. The term was first used by Ibrahim Oweiss in 1973.
In the 1970s, many geologists knew that the Middle East had huge oil reserves. Subsequently, US foreign policy experts decided to maintain a military presence in the Middle East, mainly in nations such as Saudi Arabia, Lebanon, Kuwait, Qatar and Bahrain. This policy would ensure that these nations sold oil in US dollars and the United States would protect them from potential threats like the Soviet Union.
So how would this petrodollar system benefit the United States? In the 1970s and 1980s, many OPEC nations had surpluses of petrodollars. Their economies weren’t sophisticated enough to re-invest in their own economy. Where did these petrodollars end up? The OPEC nations reinvested the petrodollars in the US and European economies, which were run by commercial banks. In addition, these banks allowed OPEC nations to invest in US government securities. The whole process became known as petrodollar recycling, a very efficient and lucrative system for both OPEC and the US.
As the 1990s approached, the United States made sure that its foreign policy focused on the Middle East. This would ensure that the petrodollar system would remain intact and would not be challenged by any OPEC nation. In 1991, Saddam Hussein invaded Kuwait. At the same time, Hussein posed a serious threat to Saudi Arabia (remember, Iraq eventually captured the city of Khafji, Saudi Arabia). The United States considered that Saudi Arabia could not be left vulnerable to the Iraqi army. The first strategy the United States attempted was to financially punish Hussein. The United States urged OPEC to significantly increase oil production. Saudi Arabia, Bahrain, Qatar and the United Arab Emirates increased oil production. Hypothetically, this would lower the price of oil, which it did, forcing Iraq’s revenues to plummet. This strategy worked only for a short period of time, eventually the United States had to intercede militarily. The United States and the coalition liberated Khafji and later all of Kuwait. What would have happened if Saudi Arabia was completely invaded by Iraq? Could Hussein be left with huge oil reserves? Once again, it must be remembered that Hussein could have had control over the oil fields of Iraq, Saudi Arabia and Kuwait. Also, what if Hussein sold oil in a currency other than the US dollar?
Over the next decade, the United States would maintain a strong military presence in Saudi Arabia and other Middle Eastern nations. This strategy ensured that the petrodollar system remained dominant and that all oil was only sold in US dollars. The main side effect of the strategy was terrorism against the United States.
In 2000, the petrodollar system faced an unprecedented challenge. Iraq’s Oil-for-Food program, which conducted all oil transactions in US dollars, was transferred to the euro by Hussein. Washington became exceptionally apprehensive about Baghdad’s move. What if other OPEC nations followed the Iraq plan? In 2003, Hussein finally realized the deadly mistake he made. Hussein found himself in a dangerous situation when the United States invaded his nation. In subsequent years, Muammar Gaddafi would exchange Libya’s currency for the golden dinar. Many OPEC nations are in Africa, so these nations would be tempted to ditch the US dollar. Gold is another option to sell oil; just like the euro. In 2011, Gaddafi would also realize that he was threatening the supremacy of the petrodollar system.
There is still another nation that wants to see the death of the petrodollar system, it is Iran. The Iranians are selling all their oil in yen and euros and no longer accept US dollars. On the other hand, they are believed to be building a nuclear weapons program, just like Iraq did. Some believe that Iran has the right to use civil nuclear energy, and they do. The problem is that Iran does not fully meet the standards of the International Atomic Energy Agency (IAEA).
Iran is playing an exceptionally dangerous game with Washington. If they continue to discontinue the US dollar, more economic sanctions will be imposed on them. Some wonder; Why isn’t Iran still using US dollars? Others ask; Why isn’t Iran trying to become an ally of the United States and submit to the petrodollar system? These are relevant questions. The reality is that many anti-American nations like Iran want to see the death of the petrodollar system. Furthermore, they believe that America’s system of neocolonialism should end now.
So what would really happen if the petrodollar system ended tomorrow? Would the United States allow this system to stop? The United States would not allow the system to end because it would harm not only the American economy, but the world economy as well. If the petrodollar system ended tomorrow, we would be in unfathomable trouble. First, colossal amounts of US dollars would be returned to the US economy, causing massive inflation. Second, oil prices would skyrocket to unprecedented levels. Third, the Federal Reserve would raise interest rates to lower the overall US money supply. Ultimately, people with adjustable rate debt would be buried and huge layoffs would ensue as businesses suffered from high interest rates.
Proponents of the petrodollar system would argue that the system benefits the United States enormously. It allows the United States to borrow huge amounts of money at extremely low interest rates. In addition, it allows the recycling of petrodollars to continue. Proponents also claim that the relationship between the United States and OPEC has improved due to the recycling of petrodollars. They state that the United States and Saudi Arabia, Bahrain, Qatar and Kuwait have excellent relations with the implementation of the system.
Critics of this system believe that a gold standard should be implemented immediately, they may be right. Although many economists call for a basket of fiat currencies, which can be used to trade oil, supporters of the gold standard are stubbornly against this. They believe that the petrodollar system is a nuisance and invites terrorism against the United States and its interests abroad.
Historically, nations like Iraq and Libya threatened the economic superiority of a world superpower and faced the consequences. Some believe that Iran must take this into account and may want to rethink their foreign policy towards the US.
The petrodollar system shows precisely how complex the economy is and how it works for both OPEC and the US The petrodollar system is what shaped and will continue to shape US foreign policy. It is a system that it will be tested in the future by potential adversaries of the United States. Many economic and energy experts don’t get it; Why don’t the OPEC nations simply submit to the petrodollar system? It would be an easy way to avoid a confrontation with the US The future will bring new challenges to the system and we have to wait for nations to choose to play by US rules or unfortunately there will be a lot of military conflicts in the country. future.