The Hidden Costs Of The Petrodollar

In its growth from conceptual white paper to trillion-dollar asset, Bitcoin has attracted an enormous amount of criticism. Detractors focus on its perceived negative externalities: energy consumption, carbon footprint, lack of centralized control and inability to be regulated. Regardless of the validity of these arguments, few critics stop to think comparatively about the negative externalities of the world’s current financial system of dollar hegemony.

This is, in part, because many Bitcoin critics see it as just a Visa-like payment platform, and analyze its performance and costs by “transactions per second.” But Bitcoin is not a fintech company competing with Visa. It is a decentralized asset competing to be the new global reserve currency, aiming to inherit the role gold once had and the role the dollar holds today.

The world relies on the U.S. dollar and U.S. treasuries, giving America unparalleled and outsized economic dominance. Nearly 90% of international currency transactions are in dollars, 60% of foreign exchange reserves are held in dollars and almost 40% of the world’s debt is issued in dollars, even though the U.S. only accounts for around 20% of global GDP. This special status that the dollar enjoys was born in the 1970s through a military pact between America and Saudi Arabia, leading the world to price oil in dollars and stockpile U.S. debt. As we emerge from the 2020 pandemic and financial crisis, American elites continue to enjoy the exorbitant privilege of issuing the ultimate monetary good and numéraire for energy and finance.

The past few decades have seen a vast global rise in economic activity, population, democratic progress, technological advancement and living standards, but there are many flaws in this system that are rarely spoken about and that weigh heavily on billions of people across the globe.

What would the world look like with an open, neutral, predictable base money instead of one controlled and manipulated by one government representing only 4% of the planet’s population? This article explores the seldom discussed and staggering downsides of the current system in the hope that we can replace it with something more fair, free and decentralized.

This essay will explore the rarely discussed creation of the petrodollar and lay out how America has supported brutal dictators, compromised its national security, harmed its industrial base, propped up and protected the fossil fuel industry and even waged conflict abroad, all to bolster the dollar’s status as global reserve currency. While this strategy worked for U.S. leaders for many decades, today the world is inexorably moving to a more multipolar financial structure, and possibly, towards a Bitcoin standard.

I. Birth Of The Petrodollar

The British Empire was the unquestioned economic hegemon of the 19th century, but began to lose steam early in the 20th century, especially after World War I. The United States emerged much healthier than war-torn Europe and as the country with by far the most gold. By the outbreak of World War II, the dollar had unquestionably eclipsed the pound as the world’s most influential national currency.

Governments still relied on gold as the underlying global reserve currency, but U.S. and U.K. policymakers were determined to create a more “flexible” system. In the waning months of World War II, leaders from 44 countries gathered in a hotel in Bretton Woods, New Hampshire, to choose a new financial bedrock. British economist John Maynard Keynes pushed the idea of the bancor, a global unit of account that many nations would manage. But the U.S. preferred the idea of the dollar at the center, pegged to gold at $35 per ounce. Since international trade deficits still had to be settled in gold, America’s substantial control of the world’s gold supply and favorable balance of payments position provided the leverage to get its way.

Over the coming decades, the world shifted to the Bretton Woods standard, with national currencies pegged to adjustable dollar amounts, where the U.S. was trusted to custody and hold enough gold to prop up the whole system. Up until the early 1960s, it did a reasonably good job. Dollars became the dominant medium of exchange for international settlement, backed by a promise to pay in gold. America became the largest creditor nation and an economic powerhouse. However, after the assassination of President Kennedy, the U.S. government chose a path of huge social and military spending. With President Johnson’s “great society” social programs and the invasion of Vietnam, U.S. debt skyrocketed. Unlike World War II or the Korean War, Vietnam was the first American war waged almost entirely on credit.

As Niall Ferguson wrote in “Ascent Of Money,” “In the late 1960s, U.S. public sector deficits were negligible by today’s standards, but large enough to prompt complaints from France that Washington was exploiting its reserve currency status to collect seigniorage from America’s foreign creditors by printing dollars, much as medieval monarchs had exploited their monopoly on minting to debase the currency.”

French economist Jacques Reuff called this the “monetary sin of the West,” and the French government coined the term “exorbitant privilege.” Poor British fiscal policy forced a devaluation of the pound in 1967, and the French, fearing that unsustainable American spending would result in similar negative results, wanted its gold back before a dollar devaluation.

By 1971, U.S. debt had simply grown too high. Just $11 billion in gold backed $24 billion in dollars. That August, French President Pompidou sent a battleship to New York City to collect his nation’s gold holdings from the Federal Reserve, and the British asked the U.S. to prepare $3 billion worth of gold held in Fort Knox for withdrawal. In a televised speech on August 15, 1971, President Richard Nixon told the American people that the U.S. would no longer redeem dollars for gold as part of a plan that included wage and price freezes and an import surcharge in an attempt to save the economy. Nixon said closing the gold window was temporary, but few things are as permanent as temporary measures. As a result, the dollar was devalued by more than 10%, and the Bretton Woods system ceased to exist. The world entered a major financial crisis, though when asked about the impact that the “Nixon Shock” would have on foreign nations, Nixon made his position clear: “I don’t give a shit about the lira.”

As David Graeber wrote in “Debt,” “Nixon floated the dollar in order to pay for the cost of a war in which he ordered more than four million tons of explosives and incendiaries dropped on cities and villages across Indochina… the debt crisis was a direct result of the need to pay for the bombs, or, to be more precise, the vast military infrastructure needed to deliver them. This was what was causing such an enormous strain on U.S. gold reserves.”

For the first time in history, the world was in a pure fiat standard. The dollars held by central banks across the globe lost their backing, and there was a geopolitical moment where U.S. dominance was called into question and where a multipolar financial world was a distinct possibility. Adding even more pressure, in 1973 the Arab petroleum exporters of OPEC decided to quadruple the price of world oil and embargo the U.S. in response to its support for Israel during the Yom Kippur War. In just a few years, a barrel of oil rose from less than $2 to nearly $12. Faced with double-digit inflation and declining global faith in the dollar, Nixon and his Secretary of State and National Security Advisor Henry Kissinger came up with an idea that would allow them to keep “guns and butter” going in the post-gold standard era and alter the fate of the world.

In 1974, they sent new Treasury Secretary William Simon to Saudi Arabia “to find a way to persuade a hostile kingdom to finance America’s widening deficit with its newfound petrodollar wealth.” Simply put, a petrodollar is a U.S. dollar paid to a petroleum exporter in exchange for oil. As a Bloomberg report says, the basic framework was “strikingly simple.” The U.S. 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 Treasuries and finance America’s spending.” This was the moment that the U.S. dollar was officially married to oil.

On June 8, 1974 in Washington, Kissinger and Crown Prince Fahd signed agreements establishing Saudi investment in the U.S. and American support for the Saudi military. Nixon flew to Jeddah a few days later to continue working out details. Declassified documents later revealed that the U.S. government confidentially enabled the Saudis to purchase treasuries “outside regular auctions and at preferential rates.” In early 1975, they purchased $2.5 billion of treasuries, beginning a spree that would later become hundreds of billions of petrodollars invested in U.S. debt. Decades later, Gerry Parsky, who was deputy to Treasury Secretary Simon at the time, said that this “secret arrangement with the Saudis should have been dismantled years ago,” and that he was “surprised the Treasury kept it in place for so long.” But even so, he said he “has no regrets” since “doing the deal was a positive for America.”

By 1975, other OPEC nations followed Saudi Arabia’s lead. If you wanted to buy oil from them and their store of nearly 80% of world petroleum reserves, you had to pay in dollars. This created new demand for America’s currency at a time of global uncertainty and even at a time of continued inflation. Industrializing nations needed oil, and to get it, they now had to either export goods to the United States, or buy dollars in foreign exchange markets, increasing the dollar’s global network effect. In 1974, 20% of global oil was still transacted in the British pound, but that number fell to 6% by 1976. By 1975, Saudi imports of U.S. military equipment had risen from $300 million to more than $5 billion. Oil prices, boosted by the premium that came with being able to be sold for dollars, would remain sky-high until 1985.

II. Impact Of The Petrodollar

In his research on the petrodollar, political economist David Spiro argues that OPEC dollar profits were “recycled” into U.S. treasuries to subsidize the “debt-happy policies of the U.S. government as well as the debt-happy consumption of its citizenry.” Petrodollar recycling over time pushed down interest rates and allowed the U.S. to issue debt very cheaply. This system was created and held in place not by pure economics but by politics through the pact with Saudi Arabia. As Alan Greenspan said in 1977, reflecting on his experience as chairman of the Council of Economic Advisers during the Ford administration, the Saudis were “non-market decision-makers.”

Graeber points to petrodollar recycling as an example of how U.S. treasuries replaced gold as the world’s reserve currency and ultimate store of value. The kicker, he explains, was that “over time, the combined effect of low interest payments and inflation is that these bonds actually depreciate in value… economists prefer to call it ‘seigniorage.’”

Since its creation in 1974, the petrodollar system has changed the world in many significant ways, including:

The creation of a tight alliance between the United States and the Saudi Arabian dictatorship, as well as other tyrannies in the Gulf region.

The steep rise of the “eurodollar” shadow global economy as petrodollars (created outside the control of the Federal Reserve) flooded banks in London and North America and were then recycled into U.S. treasuries or loaned back out to emerging markets.

The financialization of the American economy as the artificially strong dollar made exports uncompetitive, hollowed out the middle class and shifted focus from manufacturing to finance, technology, defense and services, all while increasing the leverage in the system.

Additional stress on the Soviet Union, which was now faced with an increasingly dollarized world market, where the U.S. could print money to buy dollars, but it had to dig oil out of the ground.

Painful issues for emerging market economies, which became mired in dollar-denominated debt that was difficult to pay back and stuck in a system that prioritized dollar accumulation over domestic investment, harming income and triggering debt crises everywhere, from Mexico to East Asia to Russia to Argentina.

Steady growth of the oil and fossil fuels industries at the expense of nuclear power and regional energy independence.

And, of course, the continuation of the U.S. as a military-financial hegemon and the ability of the U.S. to run humongous deficits to finance wars and social programs, all in part paid for by other countries.

There are petrodollar theory critics who say the phenomenon is largely a myth. They say the dollar has been dominant simply because there has been no competition. Dean Baker from the Center for Economic and Policy Research has said that “while it is true that oil is priced in dollars and that most oil is traded in dollars, these facts make relatively little difference for the status of the dollar as an international currency for the economic well-being of the United States.”

Meanwhile, Modern Monetary Theorists like Warren Mosler and Stephanie Kelton downplay the importance of the petrodollar, saying “it doesn’t matter” or “it’s irrelevant” as it does not limit what the U.S. can do domestically and that internationally, it does not matter what oil is priced in because countries can just swap currencies before purchase. Critics point to the fact that the dollar was already the world reserve currency before 1973, and that the pricing of commodities in dollars is “just a convention,” and that “there would be no real difference if the euro, the yen, or even bushels of wheat were selected as the unit of account for the oil market.” They also say the dollars involved in the oil trade are “trivial” compared with other sources of demand.

But the decision of Saudi Arabia and OPEC to price their oil exports in dollars and invest the profits in U.S. debt was not a strict market decision, and not one of fortune or happenstance, but a political one, done in exchange for protection and weapons, and one that sparked countless additional network effects that over time solidified the dollar as the world’s reserve currency. When countries are forced to exchange their own currencies for dollars to buy oil, this strengthens that trading pair for that country, extending U.S. influence beyond energy markets. In “Debt,” Graeber does mention the debate over whether or not oil sales denominated in dollars give any seigniorage to the U.S., but says that regardless, what ultimately matters is “that U.S. policymakers seem to feel the fact that they are symbolically important and resist any attempt to alter this.”

III. American Foreign Policy And The Petrodollar

In October 2000, Saddam Hussein did attempt to alter the petrodollar system when he announced that Iraq would sell oil in euros, not dollars. By February 2003, he had sold 3.3 billion barrels of oil for 26 billion euros. With his French and German trading partners, the “petroeuro” was born, which if expanded would help a euro market develop against lots of other currencies, boosting the euro’s strength and eroding the dollar’s exorbitant privilege. But one month later, the U.S., aided by the United Kingdom, invaded Iraq and overthrew Saddam. By June, Iraq was back to selling oil in dollars again.

Did America go to war to defend the petrodollar? This possibility is almost never discussed in retrospective analyses of the war, which tend to fixate on questions of Iraq’s alleged weapons of mass destruction stockpile, human rights abuses or terror links. But at the time, the euro was actually seen by many as a realistic challenger to the dollar. Given that the ouster of Saddam, in retrospect, helped deter change and give the petrodollar system many more years of dominance, it seems like one of the more reasonable explanations for the most mysterious war in modern American history.

Last year, the journalist Robert Draper appeared on Ezra Klein’s show to discuss his new book, “To Start A War: How The Bush Administration Took America Into Iraq.” With a decade of hindsight, they covered many of the possible motives for the invasion, but ultimately called it a “war in search for a reason.” To this day, there is no consensus for why exactly the U.S. invaded Iraq, and the official reasons have proven to be completed contrived.

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