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Mohamed Fathalla
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Have you ever wondered about the reasons that made the United States dollar dominating the world; despite the fact that the United States, unlike Britain and France did not colonize half of the earth, the US has managed to control global economy and the US dollar is the main currency of the world businesses; in addition to that, normal people and private entities are dealing with the dollar as a safe haven for their long term savings investments. It is exactly the same as investing in governmental bonds or spot gold, but how did the USD get this power, and why dollar price is moving against the Gold and OIL prices. The answer is simple “PETRODOLLAR”.

From ‘GoldDollar’ to ‘PetroDollar’

On August 15th 1971, USA president Richard Nixon shocked the world by ending the Gold convertibility system. Gold convertibility system was born during the mid 40s within world war 2nd, when the USA appeared to be the new superpower upon an agreement known by Breton woods.  Upon Breton woods, it was agreed to establish the international monetary fund (IMF) which will work on ensuring the exchange rate stability by fixing rates between currencies. After this agreement, the US Dollar replaced gold as the exchange of any other currency or commodity. 1 USD set at 35 ounce of gold.

The US dollar extremely got overvalued; the overvaluation led to the unbalance in the American trade conditions. Moreover, the Vietnam War has made the Federal Reserve print more money, which made the idea of converting dollars into the US gold impossible. In addition, gold producers themselves, who are selling gold to the Federal Reserve, were using these dollars to buy it again for a cheaper price, it’s a closed circle.

And finally the cost of extracting and refining gold was much more bigger than 35 ounce per dollar. The inevitable result of finding new monetary system, pushed Nixon to give on his famous speech for ending this system as “we must protect the dollar from the attacks of the international speculators”, then he continued to say that he ordered the secretary of treasury to stop the convertibility of dollar to gold or any other assets, and to initiate a “New monetary system”. That was the birth of Petrodollar system.

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1973 – The Oil Breakthrough

In October 1973 the war in the Mideast breakout resulted oil embargo from the Arab producing countries (OAPEC) until March 1974 (also known as 70s oil crisis). They call it the crisis; however, I call it the oil breakthrough. The world has seen many crises during the 20th century; for instance, Mideast wars in 1948, 1956, 1967 which in all of these dates the Suez Canal (an important oil transportation route) was closed. In addition to that, the Mexico nationalization for oil wells in 1938 and Iran nationalization for oil wells in 1951.

However there were many oil crises and embargos in the 20th century, the world didn’t panic. Why? According to Raymond Vernon in his books “The Oil Crisis”, before the 60s oil importing reliance was on the European resources;  however, by the 60s the shift was made towards the Arab gulf countries oil which was featured by low cost. The second reason is obvious, which is the end of gold convertibility era. From my humbled perspective the real crisis was during the period of August 15th, 1971 and March 1974, where the world found itself left with no monetary system.

Find out how oil prices can affect your wallet

The actual crisis period (1971-1974) threatened the US by stripping it off its worldwide pioneering, if they didn’t find an alternative to the Breton woods system. As fast as the 1973 oil embargo occurred, the Federal Reserve came up by the Petrodollar idea which was proposed by two men Ibraham Oweiss (American economist) and Peter Peterson (US secretary of commerce).

Sooner, Henery Kissinger (the famous US secretary of foreign affairs) made a visit to meet the king of Saudi Arabia (King Faisal) in 1974 as the biggest oil producer worldwide in order to convince him to go forward with the petrodollar system.

The idea has three axes a) the kingdom of Saudi Arabia accept to dominate its oil in US dollars only and convince other OPEC countries by the same idea, b) the oil revenues will reinvested in US treasuries (the recycling) c) USA will offer full military security to  Saudi Arabia. Those three axes offered the USA a new hegemonic after the end of the gold era.

Pros of The Petrodollar System

On contrary to the gold dollar system that made the Fed to pay 35 gold ounce per every dollar they print (as a liability), the petrodollar made a spontaneous cover to every newly printed dollar (without any liability). Many of capital markets traders cannot clear up the reason of why the dollar price is moving against oil price; in other words, if every barrel of oil equals X number of dollars, the more oil barrels sold the more US dollars demanded and the prices of both surge together and vice versa.

So why the US dollar is unlike the Canadian dollar price – Canada is a big oil exporter – which moves along with oil price, or Aussie and Kiwi which move with commodities prices. The answer is in Axis [c], the oil revenues are invested directly in the US bonds which will soar every time the US or any other country buy a barrel of oil. As a result, bond yields will drop, taking the new dollar investments to other assets as the US stocks and other currencies. The second reason is that speculators were always playing the musical chairs game by trading the commodities against dollar, trying to find a save haven.

The chart shows the strait downward direction for the US 30 years yields since 1987 as a result of the petrodollar huge amount recycling

Liquidity provided to the Federal Reserve another benefit. That was declared by the fed meeting directly after the petrodollar agreement in December 17th, 1974 by the statement of Mr. Holmes “…..but there is a possibility that a very large petro-dollar transaction may provide the Treasury with the cash it needs via an issuance of special securities directly to a foreign account.“.

Cons of The Petrodollar System

Ishak Ibraham, “Black Gold & Holy War” author, summarized the cons in two points a) the big amount of Saudi Arabia investments in the US Debt market makes the US economy relying on the Saudi OPEC money. b) If Saudi Arabia will decide to change the system to receive money in another currency, the dollar will collapse. c) Some voices warn from the relationship with Saudi Arabia, raising red flags highlighting the possibility that Saudi Arabia export terrorism to US relying on what happened in 9/11 and the secret report about the accident (the 28 pages) which is classified until now, might condemn Saudi Arabia for the attacks.

Facts on the table

Now let’s see the oil map and its current movement. On the production side the USA comes first by 11.7 million barrels a day, then Saudi Arabia comes second with 11.5 million, Russia, China, Canada, and Iran are exporting 6.8 million a day. On the other side, the biggest importers are USA followed by China, Japan, and India.

From the previous chart we can notice a very important thing, the USA was the first producer by the beginning of the petrodollar despite the fact that they chose to be the biggest oil importer from OPEC just for political reasons.

Despite shifting the US economy from industrial economy to capital circulation economy, the US is still the biggest producer & the biggest importer of oil.

Saudi Riyal vs Russian Sanctions

As the dollar dominated itself by the oil, SAR(Saudi Arabia Riyal) dominated itself by the dollar. This means that every 1 dollar = 3.75 Riyals constant goes up and down with the dollar. The idea of trading the oil itself does not guarantee the full protection of the currency. Russia is one of the countries who refused to subside to the petrodollar system. I was in Russia by the time of sanctions when the  Ruble prices fell from 25 to 80 versus US Dollar, oil prices propped dramatically from 140 to 25 a barrel.

Russia tried to conduct bilateral Ruble cross currency swap agreements with china, India and other countries; however, the situation did not improve. The trick was easy, US decreased its importing from Saudi Arabia oil and relied more on the local oil to make the supply much bigger than the demand.

Although American companies stopped working in Russia. Saudi Arabia, Venezuela, any other country cannot defeat the petrodollar system for one reason that you will know by the end of this article.

On the other hand, you can find countries like Norway which is the ninth oil exporter country and third natural gas exporter. Although Norway currency (corona) is floating and not pegged to USD, the government can control the price and protect itself from strong deflation by recycling the oil revenues in Euro, Dollar and Pound fund.

The Future Shock

If you hold a calculator, with a very simple calculation according to the numbers, you will concludes that the oil have 60 more years to be consumed. As a result, scientists backed up by governments are working on implementing the renewable resources of energy. Yes, I said implement and not find, because the renewable resource of energy is on land and not on paper.

There are many big companies using the renewable resources for cars, planes and factories. Tesla, Mercedes, BMW, BYD, Peugeot, Renault are examples for vivid cars walking down the street. Also, you have Canadian solar, REG, Brookfield and other companies that making their money through trading the renewable resources of energy. Moreover, they have a very high volume shares in the stock market.

So, the problem for the US is that the Petrodollar system, by force of nature, will die, and the US has to find different domination rather than the Saudi oil.

Conclusion

Despite this long article, there is a lot of excluded information. In general, the main conclusion of a very long research I did is as following:

  • Gold was, is and will be the absolute source of commercial transactions and safe heaven source.
  • Changing from gold convertibility to petrodollar was inevitable.
  • Gold convertibility, petrodollar, and any new system will be depended on technology.
  • Petrodollar proved its strength in the past, but might losing its steam in the future.
  • The new system will be determined by the one who owns the TECHNOLOGY.
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