Everything Everywhere Daily: History, Science, Geography & More - The Petrodollar System

Starting point is 00:00:00 On August 15, 1971, U.S. President Richard Nixon ended the gold convertibility of the U.S. dollar and simultaneously ended the Breton Wood system, which had governed international monetary policy since the end of the Second World War. The system which replaced Breton Woods wasn't built on formal treaties and conferences. It was a highly informal system that, for the most part, still exists today. Learn more about the petro dollar system, how it came to be and how it works on this episode of Everything Everywhere Daily. What if your perceptions about the past were wrong? ThruLine is a podcast that takes you back in time to uncover the parts of the story that may have gone unnoticed. It effectively turned day into night.

Starting point is 00:00:55 And how it shaped the world now. Time travel with us every week on the ThruLine podcast from NPR. This episode is part four in a series on the international monetary system. If you haven't yet listened, you can go back and listen to the first three episodes. which were the history of money, the gold standard, and the Bretton Wood system. When we last left our international monetary system, Richard Nixon had ended the Bretton Wood system in 1971 by ending the convertibility of dollars for gold. The entire Breton Wood system was built on everyone pegging their currency to the U.S. dollar,

Starting point is 00:01:33 and the U.S. dollar being pegged to gold at $35 an ounce. The reason why Nixon did this was that the U.S. dollar had become overvalued, and the United States didn't have enough gold reserves to cover the dollars that were in circulation. Here I want to take a brief detour to talk about the economics of one currency being the global reserve currency. The problem with this was identified as early as 1959 by the Yale economist Robert Triffon. Triffin figured out that if one currency were to become the world's reserve currency like the U.S. dollar was after Bretton Woods, the system would eventually implode. Whatever the reserve currency was would be in demand all over the world.

Starting point is 00:02:11 countries would need to have the reserve currency, and the country whose currency was used would have to supply tremendous amounts of it to everyone else. The only realistic way to do that would be by consistently running trade deficits. Dollars would have to find a way to get out to the rest of the world. Also, as the reserve currency, it would have to be overvalued, making goods from the issuing company relatively more expensive.

Starting point is 00:02:36 In the case of the United States in the 1960s, the dollar became overvalued relative to other currencies. currencies. Still, all of the pegs were in place, so the outlet for this overvaluation was countries exchanging their dollars for gold because gold became a relative deal. Holding the world's reserve currency is a very mixed bag. This is known as the Triffin dilemma or the reserve currency paradox. On the one hand, selling currencies to other countries basically costs nothing. The United States can produce an almost infinite number of dollars at no cost. And remember that most dollars are electronic, not physical pay per currency.

Starting point is 00:03:15 On the other hand, by overvaluing your currency, you make everything you produce relatively more expensive to the rest of the world. Up until the end of Bretton Woods in 1971, the United States wasn't running serious trade deficits, mostly because of the gold peg. They were exporting gold and dollars. Once Nix had ended this, however, everything changed. The world went from a very managed orderly system of money to one with no central order. This became known as a managed float. National currencies can float in value on an open market, but individual central banks can still take steps to protect their currency.

Starting point is 00:03:52 Hence, a managed float. Once Nixon closed the gold window, there was no longer any need for countries to hold large amounts of U.S. dollars. This resulted in a new agreement in December of 1971 known as the Smithsonian Agreement. The Smithsonian Agreement pledged the G-10 Group of VIII. industrialized nations to peg their currency to the U.S. dollar again, and the dollar would now be converted at $38 per ounce. This new agreement lasted about 14 months, when the open market price of gold diverged from the dollar convertibility rate, and in February 1973, all the currencies

Starting point is 00:04:25 went back to floating again. The United States, however, still wanted to have a strong dollar, and they still wanted everyone to have to use its currency. The problem was, if they couldn't use currency pegs and gold convertibility to make that happen, how would they do it? In 1973, the dollar was sinking in value, coming down from its overvaluation. And there were also several other really big things happening in 1973. In October of that year, several Arab countries invaded Israel in what is now known as the 1973 War, the Yom Kippur War, or the Fourth Arab-Israeli War. The United States supported Israel via arms sales, and in response, the Arab members of OPEC, Organization of Oil Exporting States, issued an oil embargo against the United States and other

Starting point is 00:05:11 Western countries. This caused the price of oil to skyrocket, and long lines for gasoline began appearing everywhere. The U.S. National Security Advisor, Henry Kissinger, saw a way out of this mess. With a single stroke, it might be possible to end the oil embargo and return the U.S. dollar to its place at the center of the world monetary system. Kissinger and the new U.S. Treasury Secretary William Simon began working on a plan whereby the Kingdom of Saudi Arabia would agree to price all of its oil sales in U.S. dollars. In July of 1974, Simon went on what was called an economic goodwill tour. However, unbeknownst to anyone else, the real purpose of the trip was actually what was scheduled on a four-day layover in Jetta, Saudi Arabia. There, Simon and the Saudi King Faisal came to an agreement that has been one of the most defining moments of the last 50 years.

Starting point is 00:06:03 King Faisal agreed to price all oil sales in U.S. dollars and then agreed to invest much of their dollar surplus into U.S. treasury bonds. In exchange, the United States agreed to buy Saudi oil and dollars to sell weapons to Saudi Arabia in dollars, and also agreed to use the U.S. military to protect Saudi Arabia and keep the House of Saud in power. This was a great deal for Saudi Arabia. They had their security insured, and it didn't have to cost them a dime.

Starting point is 00:06:31 They were able to price their primary export in a high-price, stable, stable, currency, and investor proceeds in a stable and safe way. This agreement turned out to be one of the most important international agreements of the latter half of the 20th century, and no one knew about it for over 40 years. The agreement was kept secret until 2016 when the story was broken by Bloomberg News, which filed Freedom of Information Act requests to break the story. Neither side had any incentive for the story to go public, and it was basically kept a secret for the entire time.

Starting point is 00:07:04 Within a year of their agreement, all OPEC members had agreed to price their oil and dollars following the lead of the biggest oil producer, Saudi Arabia. Now all of a sudden, everyone in the world needed U.S. dollars once again to buy and sell the world's most important commodity, oil. Oil-producing states needed to do something with their surplus of dollars, and U.S. treasuries provided an easy way to absorb almost all of this money. Henry Kissinger dubbed it Petro Dollar Recycling.

Starting point is 00:07:33 For the most part, it's still in place today. Many people are confused by what petro dollars are. Petro dollars are just regular U.S. dollars used to buy and sell oil. They aren't a special or different currency from the U.S. dollar. This increased global demand for the U.S. dollar has also led to increased use of what are known as Eurodollars. Eurodollars are also sort of a misnomer. A euro dollar is any bank account that is dominated in U.S. overseas. It doesn't necessarily have to have anything to do with Europe. As far as establishing

Starting point is 00:08:05 demand for U.S. dollars, the petro dollar system has worked far better than the Bretton Wood system actually did. Today, 90% of all foreign exchange trades involve the U.S. dollar. 60% of all foreign exchange reserves are in U.S. dollars, as is 40% of all global debt. There are certainly benefits to having a reserve currency. One of the biggest exports of the United States over the last 50 years has been dollars. It isn't something people usually consider an export, but it actually is. However, as I mentioned before, having the reserve currency is a double-edged sword. The predictions of Robert Triffin have pretty much come true. What was the last year that the United States had a trade surplus? 1975. The same year that all the OPEC countries came on board and started pricing oil

Starting point is 00:08:53 and dollars. The petrodollar system has survived since the mid-1970s, but there have been constant attempts over the years by oil producers to skirt the system. Iraq, Libya, Venezuela, and other countries at various times have threatened to stop pricing oil and dollars. Talk of ending the petrodollar system has accelerated in the last few months. The problem is there really isn't a viable replacement. The Chinese yuan is often floated as being a replacement. However, it isn't necessarily something that China wants. The Chinese yuan has been one of the world's most managed currencies over the last several decades, so it would remain undervalued to encourage Chinese exports. If the yuan became the world's reserve currency, the reserve currency paradox could undo their

Starting point is 00:09:38 entire export-based economy. One possible replacement for the petrodollars system would be to create a single currency for the whole world, which would benefit no one country, and in particular, a currency that wasn't controlled by any one country. In my fifth and final episode in this series on international monetary policy, I'll be exploring one possible future for money, how it was developed, and how it works. Bitcoin. Everything Everywhere Daily is an Airwave Media podcast.

Starting point is 00:10:10 The executive producer is Darcy Adams. The associate producers are Thorpe Thompson and Peter Bennett. Today's review comes from listener Jake over on Instagram. He writes, Hey, Gary, I just wanted to say thank you for the podcast. I've listened to every single episode, and they are great. They keep me entertained every morning on my drive into work, and I look forward to them every day.

Starting point is 00:10:28 keep up the good work. Thanks, Jake. Congratulations on your membership to the completion club. You will find the keys to the clubhouse in your locker. Just make sure to lock everything up when you're done. Remember, if you leave a review or send me a boostogram, you two can have it read on the show.

Everything Everywhere Daily: History, Science, Geography & More - The Petrodollar System

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.