In the early 1970s, the final vestiges of the international gold-backed dollar standard, known as the Bretton Woods arrangement, had collapsed. Many foreign nations, who had previously agreed to a gold-backed dollar as the global reserve currency, were now having seriously mixed feelings toward the arrangement. Nations like Britain, France, and Germany determined that a cash-strapped and debt-crazed United States was in no financial shape to be leading the global economy. They were just a few of the many nations who began demanding gold in exchange for their dollars.
Despite pressure from foreign nations to protect the dollar’s value by reining in excessive government spending, Washington displayed little fiscal constraint and continued to live far beyond its means. It had become obvious to all that America lacked the basic fiscal discipline which could prevent a destruction of its own currency.
What exactly petrodollar is?
A petrodollar is a U.S. dollar that is received by an oil producer in exchange for selling oil and that is then deposited into Western banks.
The Rise of the Petrodollar System
The petrodollar system originated in the early 1970s in the wake of the Bretton Woods collapse.
President Richard M. Nixon and his globalist sidekick, Secretary of State, Henry Kissinger, knew that their destruction of the international gold standard under the Bretton Woods arrangement would cause a decline in the artificial global demand of the U.S. dollar (as US Dollar no more backed by gold so low confidence). Maintaining this “artificial dollar demand” was vital if the United States were to continue expanding its “welfare and warfare” spending.
In a series of meetings, the United States — represented by the U.S. Secretary of State Henry Kissinger — and the Saudi royal family made a powerful agreement. According to the agreement, the United States would offer military protection for Saudi Arabia’s oil fields. The U.S. also agreed to provide the Saudis with weapons, and perhaps most importantly, guaranteed protection from Israel.
The Saudi royal family knew a good deal when they saw one. They were more than happy to accept American weapons and a U.S. guarantee to restrain attacks from neighboring Israel.
The Americans laid out their terms. They were simple and two-fold.
The Saudis must agree to price all of their oil sales in U.S. dollars only. (In other words, the Saudis were to refuse all other currencies, except the U.S. dollar, as payment for their oil exports.)
The Saudis would be open to investing their surplus oil proceeds in U.S. debt securities.
However, the U.S. had done its economic homework. If they could get the Saudis to buy into this deal, it would be enough to launch them into the economic stratosphere in the coming decades.
Fast forward to 1974 and the petrodollar system was fully operational in Saudi Arabia.
By 1975, all of the oil-producing nations of OPEC had agreed to price their oil in dollars and to hold their surplus oil proceeds in U.S. government debt securities in exchange for the generous offers by the U.S.
Nixon and Kissinger had successfully bridged the gap between the failed Bretton Woods arrangement and the new Petrodollar system. The global artificial demand for U.S. dollars would not only remain intact, it would soar due to the increasing demand for oil around the world.
And from the perspective of empire, this new “dollars for oil” system was much more preferred over the former “dollars for gold” system as its economic requirements were much less stringent. Without the constraints imposed by a rigid gold standard, the U.S. monetary base could be grown at exponential rates.
The Petrodollar System Encourages Cheap Exports to the United States
Today, virtually all global oil transactions are settled in U.S. dollars. When a country does not have a surplus of U.S. dollars, it must create a strategy to obtain them in order to buy oil.
The easiest way to obtain U.S. dollars is through the foreign exchange markets. This is not, however, a viable long-term solution as it is cost-prohibitive (expensive). Therefore, many countries have opted instead to develop an export-led strategy with the United States in order to exchange their goods and services for the U.S. dollars that they need to purchase oil in the global markets. Japan, for example, is an island nation with very few natural resources. It must import large amounts of commodities, including oil, which requires U.S. dollars. So Japan manufactures a Honda and ships it to the United States and immediately receives payment in U.S. dollars.
The Primary Benefits of the Petrodollar System for US Economy
The petrodollar system has proven tremendously beneficial to the U.S. economy. In addition to creating a marketplace for affordable imported goods from countries who need U.S. dollars, there are more specific benefits.
In essence, America receives a double loan out of every global oil transaction.
- First, oil consumers are required to purchase oil in U.S. dollars.
- Second, the excess profits of the oil-producing nations are then placed into U.S. government debt securities held in Western banks.
The petrodollar system provides at least three immediate benefits to the United States.
- It increases global demand for U.S. dollars
- It increases global demand for U.S. debt securities
- It gives the United States the ability to buy oil with a currency it can print at will
One of the most brilliant aspects of the petrodollar system was requesting that oil-producing nations take their excess oil profits and place them into U.S. debt securities in Western banks. This system would later become known as “petrodollar recycling” as coined by Henry Kissinger. Through their exclusive use of dollars for oil transactions, and then depositing their excess profits into American debt securities, the petrodollar system is a “dream come true” for a spendthrift government like the United States.
Petroyuan- China’s counter move to Petrodollar
China is looking to make a major move against the dollar’s global dominance, and it, therefore, has launched crude oil futures on March 26, 2018.
The new strategy is to enlist the energy markets’ help: Beijing may introduce a new way to price oil in coming months — but unlike the contracts based on the U.S. dollar that currently dominate global markets, this benchmark would use China’s own currency. If there’s widespread adoption, as the Chinese hope, then that will mark a step toward challenging the greenback’s status as the world’s most powerful currency.
China is the world’s top oil importer, and so Beijing sees it as only logical that its own currency should price the global economy’s most important commodity. But beyond that, moving away from the dollar is a strategic priority for countries like China and Russia. Both aim to ultimately reduce their dependency on the greenback, limiting their exposure to U.S. currency risk and the politics of American sanctions regimes.
The plan is to price oil in yuan using a gold-backed yuan-denominated oil futures contract in Shanghai, but the road will be long and arduous.
What is the Petroyuan?
To reach this goal, China will pressure Saudi Arabia to trade oil in yuan instead of the U.S. Petrodollar, which would create the new Petroyuan and weaken the dollar significantly. Analysts believe the Saudis will certainly bend to this pressure as a result of China’s immense buying power.
Top Experts Predict Major Disruption in Oil and Stock Markets
Carl Weinberg is the chief economist and managing director at High-Frequency Economics. He told CNBC that once Saudi Arabia starts buying oil in yuan, the rest of the world is sure to follow.
He added that the move would pull between $600 billion and $800 billion in transactions out of the dollar and drive down demand for U.S. securities across the board.
Countries such as Iran, Venezuela and Russia are eager to see a new oil-trading currency because this would allow them to circumvent U.S. sanctions and trade freely in the oil market. This is a powerful alliance shaping up to take aim at the dollar.
How is the Petro-Yuan Different?
According to CNBC, China plans to trade oil in yuan using a gold-backed oil futures contract in Shanghai. This essentially means that if China is successful, the world could end up trading oil primarily through gold-backed currency for the first time since the Nixon administration.
Challenges for Petroyuan
The architects of the “petro-yuan” face an uphill struggle in dislodging the “petrodollar” and, with it, more than four decades of U.S. dollar-priced oil. Attracting interest from entrenched and active markets in Europe, the U.S. and the Middle East — used to price more than two-thirds of the world’s oil worth trillions of dollars – poses another major challenge.
Another obstacle standing in the path of China’s ambitions to price oil in yuan is the currency itself. The yuan is not yet fully convertible, it’s fixed daily, prone to intervention and subject to capital controls.
Given that regime of tight control over the currency, many global players are likely to assume a yuan-denominated oil benchmark would be firmly under Beijing’s thumb.
Why Should We Care? How This Could Impact our Money
While the future of the dollar is looking grim, China is about to usher in a new golden era for precious metals. It’s likely we’ll see investors get extremely bullish on gold. We need to start thinking about the best way to diversify your assets to avoid becoming a victim of the falling dollar.
Even during less uncertain times, gold and silver are always a smart long-term investment. Make no mistake, the global economy is about to experience the kind of seismic shift the world hasn’t seen since Richard Nixon was in office.
Gold vs. Dollar: Where to place the Faith?
With major world economies paying close attention to gold, it’s a good indicator that you should keep your eyes open as well. There are three important factors to keep in mind:
- Gold typically rises when the dollar falls
- A diminishing gold supply will increase demand and cost, especially as China continues to further build its own stockpiles
- China could set a new precedent for gold-backed currency
Amid growing global uncertainty, physical, tangible wealth is seen as the most effective safe haven investment. Whether you become a victim of the falling dollar or thrive as a result will depend on one major indicator: the amount of gold in our vault!
What could be the possible impact on India?
If the dollar starts plunging, Indian imports would tend to go up and exports would tend to decline to lead to widening of trade deficits which could disrupt the domestic industries.
The positive impact could be for the companies having borrowings in dollar-denominated terms as their debt servicing cost would decline thus improving their profitability. More companies would be encouraged to borrow in dollar terms to reduce their cost of capital.
To assess the impact of the launch of crude futures by China on India, more information is required.
Would love to get different views from people with regard to petroyuan, its impact on the global scenario and India. People can connect with us using the comment section below.
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