A revolutionary transformation of the entire global monetary system is currently underway, being driven by an almost perfect storm.
The implications of this transformation are extremely profound for U.S. policy in the Middle East, which for nearly the past half century has been underpinned by its strategic relationship with Saudi Arabia.
RISE OF THE PETRODOLLAR
The dollar was established as the global reserve currency in 1944 with the Bretton Woods agreement, commonly referred to as the gold standard.
The U.S. leveraged itself into this power position by holding the largest reserve of gold in the world. The dollar was pegged at $35 an ounce — and freely exchangeable into gold.
By the 1960s, a surplus of U.S. dollars caused by foreign aid, military spending, and foreign investment threatened this system, as the U.S. did not have enough gold to cover the volume of dollars in worldwide circulation at the rate of $35 per ounce; as a result, the dollar was overvalued.
America temporarily embraced a new paradigm in 1971, as the dollar became a pure fiat currency (decoupled from any physical store of value), until the petrodollar agreement was concluded by President Nixon in 1973.
The quid pro quo was that Saudi Arabia would denominate all oil trades in U.S. dollars, and in return, the U.S. would agree to sell Saudi Arabia military hardware and guarantee the defense of the Kingdom.
According to a report that appeared in the Huffington Post:
As a result of this agreement, the dollar then became the only medium in which energy exchange could be transacted. This underpinned its reserve currency status through the need for foreign governments to hold dollars; recirculated the dollar costs of oil back into the U.S. financial system and — crucially — made the dollar effectively convertible into barrels of oil. The dollar was moved from a gold standard onto a crude oil standard.
U.S. interest rates were then managed so that oil exporters (who formerly looked to gold as the basis of their reserves) would be indifferent to whether they stored their currency reserves, earned from oil exports, in U.S. treasuries, or in gold. The value was equivalent.
Death of the Petrodollar
In what may ultimately wind up being the death blow to the petrodollar, since 2008, the U.S. government has maintained a policy of zero interest rates and “quantitative easing.”
Once energy producers became aware of the U.S. economic dependence on low-interest rates, they understood that they would never again be able to regulate the price of oil relative to U.S. treasuries. Anything more than a nominal hike in interest rates would effectively implode the global financial system, as the U.S. had become too financialized.
The petrodollar system, which had allowed the U.S. dollar to replace gold as the backing for the oil trade from 1973-2002, was essentially broken.
With no regard for the underlying systemic weakness of the entire petrodollar system the U.S. began to rely heavily on economic sanctions as a means of forcing geopolitical capitulation. It was virtually inevitable that potential targets of such actions would eventually attempt to mitigate these hegemonic actions by the U.S.
Although essentially a response to the aggressive posture of the West, these economic actions have potentially created an environment ripe to put the final nail in the coffin of the petrodollar.
In the greatest of irony, central banks from states such as China, Russia and Brazil, which vehemently oppose an interventionist U.S. foreign policy, ultimately finance the U.S. war machine by purchasing U.S. Treasury debt as a means of protecting their economies.
But in what appears to be an effort to hedge against U.S. imperialism, both China and Russia have become big buyers of physical gold. Russia’s present gold reserves would back 27 percent of the ruble money supply, according to the Huffington Post.
That ratio is far in excess of the U.S. Fed’s original stipulated gold coverage minimum, as well as in exceeding that of any other major country. In addition, Russia is typically is a net exporter of goods and energy, so their gold reserves are likely to continue to increase.
A report on China’s gold reserves appeared in the Financial Times, stating:
China ended years of speculation about its official gold holdings by revealing an almost 60 percent jump in its reserves since 2009.
The country’s central bank said its gold reserves were 1,658 tonnes (53.31 million fine troy ounces) as of the end of June. In April 2009, reserves were 1,054 tonnes.
The purchases show how China is seeking to diversify its reserves away from the US dollar at a time when the price of gold has fallen to near its lowest price since 2010.
“In 2014 Russia and China signed two mammoth 30-year contracts for Russian gas to China. The contracts specified that the exchange would be done in Renminbi [yuan] and Russian rubles, not in dollars. That was the beginning of an accelerating process of de-dollarization that is underway today,” strategic risk consultant F. William Engdahl writes in his article for New Eastern Outlook.
Russia and China are now creating a new paradigm for the world economy and paving the way for a global de-dollarization.
“A Russian-Chinese alternative to the dollar in the form of a gold-backed ruble and gold-backed Renminbi or yuan, could start a snowball exit from the US dollar, and with it, a severe decline in America’s ability to use the reserve dollar role to finance her wars with other peoples’ money,” Engdahl concludes.