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The Petrodollar phase began in the early 70s when agreement was reached with Saudi Arabia that oil would be priced in dollars only, in return for supplies of military arms.
Around the same time, discussions were also taking place in Saltsjobaden, Sweden to engineer a 400% increase in the price of OPEC petroleum revenues, and to decide what to do with the vast floods of oil-dollars (or petrodollars as they would later become known) that would be created as a result.
In 1974 banking institutions in New York and London geared up to handle the vast flow of dollars, and the Saudi government purchased $2.5 billion in US Treasury bills with their oil dollar surplus. A few years later Treasury Secretary Blumenthal cut a secret deal with the Saudi government to ensure that OPEC would continue to price its oil in dollars only.
Now un-linked from gold, the fortunes of the dollar became reliant on foreign oil - 'black gold' - and free from market-based adjustments. The oil price shocks of 1973, 1974 and 1979 suddenly created an enormous demand for US dollars from countries that needed them to buy oil, and an enormous flow of 'surplus' petrodollars into the New York and London banks resulted - dollars that the OPEC countries simply could not put to use at home.
These surplus petrodollars were then 'recycled' as loans to governments of third world countries desperate to borrow dollars to finance their oil imports. By the late 70's the buildup of billions of petrodollar debts formed the foundation for the 3rd World debt crisis of the 80's.
By happy coincidence the United States, being the only country in the world able to print US dollars, is able to satisfy the continuing American thirst for oil by simply printing more and more dollars (or, to use the scenario on page 1 - simply continue writing cheques).
Essentially the U.S. gets its oil for free while it is priced in dollars.
Unfortunately however such ‘freedom’ comes with a high price-tag, and aligning the dollar with other nation's black gold has put the United States firmly in the red.
With all restraints on fiscal discipline lifted conventional economic wisdom suggests that simply printing more and more dollars - over a period of 30 years - would result in enormous levels of unserviceable debt.
By unhappy coincidence the United States has more debt than any other country in the world: currently running at $8.39 trillion dollars – an all-time high and still climbing. It is also no coincidence that the single-biggest export of the United States is not now steel, agricultural produce or any other form of industrial output. It is the dollar-bill itself.
And this leads us to the final economic link in the chain - how do you stop other nations from calling in your debts and demanding that you make good on them? -
Enter the dollar in its role as the world's reserve currency.
Most countries around the world are forced to control trade deficits and levels of national debt or face currency collapse. Link your currency to gold, stockpile gold and all is well. Link your currency to the oil produced not by you but by other nations and the temptation to abuse that unique economic position may just prove to be too great to resist. But when your currency is the most used by governments and institutions for holding cash reserves then you can continue writing the cheques safe in the knowledge that they are not going to bounce.
But what do you do when your free ride is coming to an end, oil begins to trade in euros and banks reduce their reserve currency holdings of the US dollar?...
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