The Rise of The Petro-Dollar System

The United States of America is the current reigning superpower, but have you thought why does it give the US Dollar legitimacy as the international standard for trade?

This story begins in 1944, after the end of World War II. The United States held nearly three-fourths of the entire gold reserves of the whole world. In the United Nations Financial and Monetary Conference—commonly known as the Bretton Woods Conference—it was decided to keep the dollar as the international standard of trade. The dollar was pegged to a fixed value of gold ($35 per ounce). Each country had pegged their value to the dollar and thus, indirectly pegged their value to that of gold.

This was done so as to maintain a fixed exchange rate system, which was free from volatility, so that it could bring stability to the international financial system. The United States benefitted immensely from this because there was an ever-expanding demand for US Dollars. This allowed them to increase their trade deficits without the fear of depreciating their currency. Furthermore, they had the power to print dollars at will to pay back the creditors of the United States.

Over the years, in the 1970s, many countries began to smell a rat—too much United States Dollars were circulating within the international economy, which could not justify its price of $35 an ounce. Thus, countries who had lost confidence in the system began to demand gold. The United States government was now in deep trouble, as it knew that its days of financial hegemony were numbered. Thus, in 1971, the Nixon administration threw a bombshell—it stopped the convertibility to gold. With that, it broke down the Bretton Woods agreements.

The United States now had to find an alternate solution to raise the demand for dollars. In 1973, they came up with an economic masterstroke in which they brokered a deal with Saudi Arabia. The deal was simple: the United States protects the oil fields of Saudi Arabia in return for Saudi Arabia to make all transactions in dollars. In addition, all the profits had to be invested in western banks. As an additional sweetener, they guaranteed protection from Israel. This deal, over time, was effectively accepted by almost all Organization for Petroleum Exporting Countries.

The United States had the insight that the demand for petroleum was going to rise over time—along with the demand for dollars. In addition, they had an ever-increasing amount of funds available in the form of loans, which allowed them to keep the rate of interest artificially low, allowing companies to borrow cheaply and expand their operations. Finally, it had the ability to buy oil with a currency it could print at will. This gave the United States a huge advantage over other countries, who had to find ways to gain dollars—which they could only do by opening up their economies and by trying to export goods to the United States.

This, at the same time, allowed American companies to gain a foothold in these newly opened-up nations. This has given rise to the era of neo-colonialism—an era in which the dominating power no longer has to control the subjected through force. These countries are subjected through the power of economics.

- Tanmay Girish Kulkani