I have been wanting to write this article for quite some time. When I first heard this term 'Petrodollar' I was quite intrigued and wanted to know more about it. I follow world news and events closely and I always wondered, how did the US become so dominant in world events and establish itself as a global power. Is it their work ethic, their democratic values, openness to accepting different cultures, is it technology, innovation, yes these are some of the factors that did help in the rise of US as a global power.
However, I did come across some very interesting theories which compelled me to ask the question, are there few more compelling reasons that helped shape the future and world events that are as of today. And yes, after some research I did feel that the US financial system, backed by strong political strategy and leveraging important diplomatic relationships with oil producing countries had a major role in elevating US to a dominant global force as it is today.
Its relevance with the creation of the Petrodollar system is closely knit and we will discuss in depth about it in my next article. But first let us dive a little in world history. America's rise to superpower status began even before its 1917 entry into World War I. American politicians were already busy devising a strategy to gain dominance over world politics. And one of their core strategies even then was to elevate the dollar as the foremost international reserve currency, replacing the pound sterling.
One of the shaping instruments for America in this objective was the creation of the Federal Reserve in 1914. The outbreak of war in Europe lead to a financial crisis for the European nations. During that period the American exports to Europe increased substantially to help in war efforts and ammunition. America also played an important role in lending and providing financial help to their Allies in Europe. As the conflict accelerated, role of the Federal Reserve assumed greater importance as a central bank and transformed the US dollar into a major international currency.
The federal reserve holding grew as more and more gold entered the country in exchange for US exports. At that time there was a gold standard, which means that every dollar was partially backed by gold. The federal reserve transformed these holdings into government securities which became an important monetary tool for the war. Purchase and sale of these securities, helped shaped the importance of the dollar and strengthened monetary policy. Increasing war expenses led to more dependence on the dollar, and the platform was already set for the dollar to become the dominant global currency. The British pound and European currencies became unstable and businessmen and traders turned to the dollar as the preferred medium of exchange.
After world war II, with the help of Bretton Woods agreements in 1945, the US dollar replaced the British pound sterling as the worlds reserve currency. The Bretton Woods agreements was an important landmark in shaping a world financial order, which led to the creation of the United Nations and the strengthening of other international organizations. The International Monetary Fund was set up to enforce a set of fixed exchange rates that were linked to the dollar. All other currencies were valued in terms of US dollars and thus were indirectly linked to the gold standard.
Before we go further let us understand the meaning and significance of a world reserve currency. A reserve currency is held in significant quantities by many governments and institutions as a means of international payment. Gold and silver were predominantly used prior to the Bretton Woods agreement, after which reserves included the US dollar. Being a world reserve currency has many benefits. The dollars status as a world reserve currency increases the demand for dollars globally. The price of dollars compared to other currencies, the exchange rate increases. The price of US goods is now more expensive to foreigners, compared to other goods, which reduces the demand for the higher priced US exports. However foreign goods are less expensive to US firms and households which in turn leads to increase in imports. The standard of living also increased substantially due to the ever increasing demand for dollar by countries to facilitate trade transactions.
As the dollar was closely linked to gold, after WWII the US had accumulated 80 percent of the worlds gold and 40 percent of the worlds production. The gold-dollar standard which was prevalent, pegged the dollar at $35 per ounce of gold. This dollar linked by gold was the dominant world reserve stand for quite some time till 1971. However, due to the Vietnam war, the US had spent almost 500 billion dollars, hence depleting most of its gold reserves. The US treasury was running out of gold and had only 10 billion dollars in gold left by 1970.
In August 1971, Nixon suspended the dollar conversion into gold. The dollar was now in threat of being overturned as the dominant reserve currency of the world. This put America at a large risk to be overthrown as the worlds superpower due to the diminishing value of the dollar. During that time the US also faced an acute shortage of its energy resources and imported almost 60 percent of its oil primarily from Saudi Arabia.
In a desperate attempt to maintain global demand for US dollars, an important and landmark system was created which was called the petrodollar system. This deal was struck with Saudi Arabia in 1973 and holds important global significance and gives dollar its true muscle and dominance even to this day. I want to cover this deal and speak about the petrodollar system and its effects on the global financial system in greater depth in my next article. It could be seen that whenever any attempts were made to challenge or threaten the dominance of the US dollar as the world reserve currency, America has responded and strongly. America's efforts and world events leading to the dollar becoming a world reserve currency is a very important factor in upholding Americas relevance in world politics as a global power even today. We will dive in further into the petrodollar system and the great impact it has on our world to this day, in my next article...