Right – this is the post that I’ve been building up to on the back of five previous ones:
- Petrodollar Wars 101: What was the Gold Standard? – where I gave the briefest possible history of currency, and how the British Empire brought the world onto the Gold Standard.
- Petrodollar Wars 102: The US Dollar Gold Standard – where I talked about the various failures of the interwar period, Keynes’ grand idea that never was, and how the Americans got their way in the end.
- Petrodollar Wars 103: the Collapse of Bretton Woods – where I listed the various ways to arbitrage gold, how the gold standard forced America into the Triffin Dilemma, and how Mr Nixon suddenly and unilaterally told the French (and everyone else) to sod off.
- Petrodollar Wars 104: Welcome The Fiat Currency – where I explained that there’s really not much of a difference between gold-backed paper money and unbacked paper money provided that the Central Bank behaves itself.
- Petrodollar Wars 105: The Global Currency of Reserve – where I discussed the function of a global reserve currency, how the global reserve currency gets chosen, and why a country might want to have their currency be the global kingpin.
The Historical Timeline
And seeing as I’ve already started with the lists, here’s the summarised historical timeline of events leading up to the Nixon Shock of 1971:
- The British Empire goes onto the Gold Standard in the 1800s, bringing the rest of the world with it.
- As World War I breaks out in 1914, the Gold Standard is abandoned – because who really cares about gold shiny stuff in a wartime situation (I’ve long argued this).
- Immediately after the war, the United States announces that she will be returning to the Gold Standard at the exact same exchange rate as before the War.
- Britain tries to do the same. Stupidly. In a froth of nationalistic gung-ho.
- For a few years, the world attempts to run a Gold Exchange Standard, where the USA and the UK back their currencies with gold, and the rest of the world backs their currencies with US dollars and UK pounds.
- The Great Stock Market Crash of 1929 happens, followed by the Great Depression.
- In 1931, after various speculative runs on the pound, and the annoying transportation of their gold reserves across the Atlantic, the UK takes the pound off the Gold Standard.
- Two years later, FDR does the same thing with the dollar, after people suspect that a money supply limited by a mined commodity just might be prolonging the Great Depression.
- World War II happens. Conversation suspends.
- In 1944, the Allies meet at Bretton Woods to decide on what to do after the War is over.
- John Maynard Keynes, Britain, and the rest of the debtor nations, try to argue for an international monetary system that penalises both the spenders for overspending and the suppliers for oversupplying. And that, in order to do this, there be an international unit of trade that is not printable by any government.
- Harry Dexter White and the rest of the American delegation, being the major (if not only) creditor nation at the table, decide that they’d rather not be penalised for oversupplying, thanks. And seeing as they’re the seller and the creditor at the table, everyone that owes them money is actually going to be using US dollars; and the Americans will make sure that there is enough gold to back them. Understood.
- Everyone concedes, and the world goes onto the US Dollar Gold Exchange Standard. Because that worked so flawlessly during the Interwar Period.
- Almost immediately, America realises that the debtor nations can’t pay with dollars if they don’t have the dollars to start with. So they implement the Marshall Plan and start pumping the recovering European economies with aid. They do the same with Japan (in particular) and other countries (to a lesser extent).
- By the 1960s, things have begun to turn. The recovering economies of Europe and Asia are now recovered; and the American consumer has recently discovered the delight of the cheap foreign import.
- Mr Triffin discovers the Triffin Dilemma when he realises that the US needs to give out more money than it gets back (ie. run a trade deficit) in order to maintain the flow of international trade, but that this ironically makes the dollar seem weaker in the eyes of the rest of the world.
- In 1968, President Johnson declares that the Vietnam War will not be funded by taxes. No word on whether he actually declared the logical conclusion to this: that it would have to be funded by borrowing plenty of dollars and flooding them directly into South-East Asia.
- At around this time, France, that opportunistic nation of American-despisers, decides that it would like to take advantage of the whole “I give you your dollars, you give me your gold” clause in the Bretton Woods agreement.
- The physical gold proceeds to wend its way back across the Atlantic.
- In 1971, realising that the United States is perilously close to losing all its gold reserves, Mr Nixon unilaterally announces that the US dollar will no longer be convertible to gold at anything other than open-market prices.
The Ramifications and Concerns
I think that we tend to forget that America’s abandonment of the Gold Standard was a decision forced by necessity. And this seems almost inevitable in retrospect, because of two things:
- One of the primary requirements for global reserve currency status is that American exports be demanded the world over (which was the case in 1944); but
- Maintaining global reserve currency status means having a strong dollar and running a trade deficit, which would eventually run the American exporters into crisis – thoroughly negating the above primary requirement.
So the dollar goes off the Gold Standard because there was not enough gold for the dollar to remain on it. But I’m pretty sure that America didn’t want to lose all those great geo-political advantages of being the World’s Central Banker.
What I Would Have Suggested If This Were An Academic Exercise in Strategy
If I were looking at that particular requirement about the importance of American exports, I hope that I (or someone) would have pointed out that the real issue is not so much that the exports be American, but that the sale of the exports take place in dollars. After all – that’s what creates the demand for dollars: the fact that the rest of the world needs them to pay for American goods.
But if the problem is maintaining the demand for dollars… Surely, then, one solution is to find a product that the whole world demands, and make sure that the sale of this product is denominated in dollars? It need not necessarily be an American product, per se.
At this point: a humble pie moment. In one of my first posts on Gold (Why Buy Gold? Buy Oil!), I kept presenting the argument that oil is a much better bet than gold. After all – gold is just pretty. Oil, on the other hand, makes the world go round:
- Need to eat? You need an oil-product to transport the food from the farm to the store you buy it from.
- Need healthcare? You need an oil-product to transport you to the hospital, and an oil-product to transport everyone else there as well.
- Need anything? You’ll need an oil-product.
And the humble-pie is that I kept presenting that idea as though it’s somehow new and I was the only one to realise it. It seems that Mr Nixon and his Secretary of State (Henry Kissinger) beat me to it.
The Denomination of World Oil Trade Into Dollars
In 1973, Henry Kissinger approached the Saudi Royal Family and offered them the following:
- The Americans would offer military protection to the Saudi Arabian oil fields, as well as providing them with weapons and protection from Israel.
- In exchange, all the Saudis had to do was agree to denominate all of their oil sales in US dollars (ie. a dollar monopoly on Saudi oil), and consider investing their surplus oil proceeds in US debt securities.
The Saudis were, like, “sweet – costs us nothing to tell everyone that we’ll only accept US dollars – that’s what they’re paying in anyway!”
By 1975, every single country in OPEC had made the same commitment. And the worldwide trade in oil was denominated in the US dollar. Let’s call it: the Oil Standard.
The Fun Conspiracy Part
Here’s where it creeps in (everything up and until this point has been factual, not speculative). It seems that every time an oil-producing nation attempts to re-denominate its oil sales into another currency, America is suddenly threatened by a weapon of mass destruction….
- Iraq: In 2000, Iraq re-denominated all its oil sales into euros under its Oil For Food program. In 2003, post their invasion, the United States returned Iraqi oil sales back to dollars.
- Iran: In 2008, Iran started an Iranian Oil Bourse which would sell oil in gold and multiple currencies. In March 2012, it announced that it would no longer be settling trades in US dollars. At which point, Iran got hit with US sanctions over its nuclear capabilities. I feel like we should watch this space…
Either way, I think that there is good reason to continue to have faith in the dollar.
The Petrodollar Standard.
Rolling Alpha posts about finance, economics, and sometimes stuff that is only quite loosely related. Follow me on Twitter @RollingAlpha, or like my page on Facebook at www.facebook.com/rollingalpha. Or both.