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Chapter 4

The Petrodollar System:

Same Game with a New Name

I hereby find that the defense of Saudi Arabia

is vital to the defense of the United States.1

— Franklin D. Roosevelt, U.S. president 1933–1945

There is nothing new in the world except the history you do not know.2

— President Harry Truman

OVERVIEW: In 1971, the Bretton Woods system collapsed after Washington severed the link between the dollar and the international gold standard. The United States was acutely aware that the failure of the “dollars for gold” arrangement could potentially strike a major blow to global dollar demand. In response to these concerns, and with the protection of global demand for the dollar as their highest priority, Washington soon unleashed its craftiest ploy yet: the petrodollar system. With global demand for oil increasing, the Nixon administration held a series of high-level talks with Saudi Arabia and other oil-producing nations, with the goal of requiring every global oil sale to be priced in dollars. In exchange, Washington offered military assistance and protection for the region’s vast oil fields. In this chapter lies the origin of our modern global economy. It is a story that few Americans have heard.

“Dollars for Oil” Replaces “Dollars for Gold”

In the early 1970s, the final vestiges of the international gold-backed dollar standard, known as the Bretton Woods system, had collapsed. Many foreign nations, who had previously agreed to a gold-backed dollar as the global reserve currency, were now having serious mixed feelings toward the arrangement. Nations like Britain, France, and Germany determined that a cash-strapped and debt-crazed United States was in no financial shape to be leading the global economy. They were just a few of the many nations who began demanding gold in exchange for their dollars.

Despite pressure from foreign nations to protect the dollar’s value by reining in excessive government spending, Washington displayed little fiscal constraint and continued to live far beyond its means. It had become obvious to all that America lacked the basic fiscal discipline that could prevent a destruction of its own currency. Like previous governments before it, America had figured out how to “game” the global reserve currency system for its own benefit, leaving foreign nations in an economically vulnerable position.

It is unfair, however, to say that the Washington elites were blind to the deep economic issues confronting it in the late 1960s and early 1970s. Washington knew that the “dollars for gold” had become completely unsustainable. But instead of seeking solutions to the global economic imbalances that had been created by America’s excessive deficits, Washington’s primary concern was how to gain an even greater stranglehold on the global economy.

After America, and its citizens, had tasted the sweet fruit of excessive living at the expense of other nations, there was no turning back.

But in order to maintain global dollar demand, the Washington elites needed a plan. In order for this plan to succeed, it would require that the artificial dollar demand that had been lost in the wake of the Bretton Woods collapse be replaced through some other mechanism.

That plan came in the form of something known as the petrodollar system. To understand the petrodollar system, let us begin by defining what a petrodollar is: a petrodollar is a U.S. dollar that is received by an oil producer in exchange for selling oil and that is then deposited into Western banks.

Despite the seeming simplicity of this arrangement of “dollars for oil,” the petrodollar system is actually highly complex and one with many moving parts. It is this complexity that prevents the petrodollar system from being properly understood by the American public.

If you have never heard of the petrodollar system, it would not surprise me. It is certainly not a topic that makes its way out of Washington circles too often. The mainstream media rarely, if ever, discusses the inner workings of the petrodollar system and how it has motivated, and even guided, America’s foreign policy in the Middle East for the last several decades.

Allow me to provide a very basic overview regarding the history and the mechanics of the petrodollar system. It is my belief that once you understand this “dollars for oil” arrangement, you will gain a more accurate understanding of what motivates America’s economic (and especially foreign) policy. So, let’s take a closer look. . . .

The Rise of the Petrodollar System

The petrodollar system originated in the early 1970s in the wake of the Bretton Woods collapse.

President Richard M. Nixon and his globalist sidekick, Secretary of State Henry Kissinger, knew that their destruction of the international gold standard under the Bretton Woods arrangement would cause a decline in the artificial global demand of the U.S. dollar. Maintaining this artificial dollar demand was vital if the United States were to continue expanding its welfare and warfare spending.

U.S. Secretary of State Henry Kissinger worked his diplomatic "magic" in Saudi Arabia to create the petrodollar system.

In a series of meetings, the United States — represented by then U.S. Secretary of State Henry Kissinger — and the Saudi royal family made a unique agreement.3

According to the agreement, the United States would offer military protection for Saudi Arabia’s oil fields. The United States also agreed to provide the Saudis with military assistance, weapons, and perhaps most importantly, protection from Israel’s growing military arsenal.

The Saudi royal family knew a good deal when they saw one. They were more than happy to accept American military protection of their oil fields along with assurances of intervention between themselves and neighboring Israel.

Naturally, the Saudis wondered how much was all of this U.S. military muscle was going to cost. . . . What exactly did the United States want in exchange for their weapons and military protection? The Americans laid out their terms. They were simple, and two-fold.

1) The Saudis must agree to price all of their oil sales in U.S. dollars only. (In other words, the Saudis were to refuse all other currencies, except the U.S. dollar, as payment for their oil exports.)

2) The Saudis would be open to investing their surplus oil proceeds in U.S. debt securities.

You can almost hear one of the Saudi officials in a meeting saying: “Really? That’s all? You don’t want any of our money or direct ownership of our oil? You just want to tell us how to price our oil and then you will give us military support and protection from our enemies? You’ve got a deal!”

However, the United States had done its homework. They knew that gaining economic favor with the Saudis would be a good start to maintaining their dollar hegemony.

Fast forward to 1974, and the petrodollar system was fully operational in Saudi Arabia. And as the United States had perhaps cleverly calculated, it did not take long before other oil-producing nations wanted in. By 1975, all of the oil-producing nations of OPEC had agreed to price their oil in dollars and to hold their surplus oil proceeds in U.S. government debt securities in exchange for the generous offers by the United States. Just dangle weapons, military aid, and protection from Israel in front of Third World, oil-rich, Middle East nations . . . and let the bidding begin.

Nixon and Kissinger had succeeded in bridging the gap between the failed Bretton Woods system and the new petrodollar system. The global artificial demand for U.S. dollars would not only remain intact, it would soar due to the increasing demand for oil around the world in the decades to come. And from the perspective of empire, this new “dollars for oil” system was much preferred to the former “dollars for gold” system because it had much less stringent economic requirements. Without the constraints imposed by a rigid gold standard, and with global oil transactions on the rise, the U.S. monetary base could be grown at exponential rates.

It should come as no surprise that the United States maintains a major military presence in much of the oil-rich Persian Gulf region to this day, including the following countries: Bahrain, Iraq, Kuwait, Oman, Qatar, Saudi Arabia, United Arab Emirates, Egypt, Israel, Jordan, and Yemen.

The truth is hard to find when you look to the corporate-controlled mainstream media. But it is simple when you follow the money. . . .

"I hereby find that the defense of Saudi Arabia is vital to the defense of the United States." —President Franklin D. Roosevelt

How the Petrodollar System Encourages Cheap Exports to the United States

While the U.S./Saudi agreement may have smelled of desperation at a time of decreasing global dollar demand, it can now be considered one of the most brilliant geopolitical and economic strategies in recent political memory.

Today, virtually all global oil transactions are settled in U.S. dollars. (There are a few exceptions and they will be highlighted in our next chapter, appropriately titled “Petrodollar Wars.”) When a country does not have a surplus of U.S. dollars, it must create a strategy to obtain them in order to buy oil.

The easiest way to obtain U.S. dollars is through the foreign exchange markets. This is not, however, a viable long-term solution as it is cost-prohibitive.

Many countries have opted instead to develop an export-led strategy with the United States to exchange their goods and services for the dollars they need to purchase oil in the global markets. (This should help explain much of East Asia’s export-led strategy since the 1980s.) Japan, for example, is an island nation with very few natural resources. It must import large amounts of commodities, including oil, which requires U.S. dollars. So Japan manufactures a Honda and ships it to the United States and immediately receives payment in U.S. dollars. Problem solved . . . and export-led strategy explained.

The Amazing Petrodollar “Permission Slip”

As you can imagine, the petrodollar system has proven tremendously beneficial to the U.S. economy. In addition to creating a marketplace for affordable imported goods from countries needing dollars, the petrodollar system provides at least three other immediate benefits to the United States.

• It increases global demand for U.S. dollars

• It increases global demand for U.S. debt securities

• It gives the United States the ability to buy oil with a currency it can print at will

Let’s briefly examine each one of these benefits.

The Petrodollar System Increases Global Dollar Demand

In our previous chapter, I explained how global demand for the dollar is important to maintaining a rising levels of prosperity. In many ways, currencies are just like any other commodity: the more demand that exists for the currency, the better it is for the producer. Allow me to develop and refine this thought even further with the following illustration.

Hamburgers, permission slips, and the petrodollar

Let’s imagine that you decided to open a hamburger stand in a small town with a population of 50,000. Of course, not everyone likes hamburgers, so only a certain percentage of your town’s population will actually ever be potential customers. And since you are obviously not the only hamburger stand in town, your competitors will all be attempting to market to the same segment of your town’s population as you will.

Now, as an owner of a hamburger stand in a very small town, would you prefer to have demand for hamburgers from your own town only . . . or would you like to have hamburger demand from other nearby towns and communities, too? (My guess is that you would like to have more customers, as that potentially means more money in your pocket!)

Now, let’s take it a step further with another question. Would you rather have demand for your burgers from your own town and nearby communities only . . . or would you prefer to have all of the hamburger demand in your entire state?

Once again, the answer should be obvious. Every good business owner understands that increasing customer demand is a positive thing for their company’s bottom line.

To put it another way, if consumers all over your state are demanding your burgers, you have just been given a “permission slip” to hire more burger flippers so that you can produce more burgers. (This concept of a “permission slip” created by growing levels of demand is important. So keep it under your hat for a moment.)

Okay, now allow me to go even one ridiculous step further.Imagine that Oprah Winfrey is driving through your state and just so happens to stop in at your growing hamburger stand. (I know — this is getting ridiculous — just bear with me. I really do have a point here.) After Oprah tries your hamburger, she expresses utter amazement at your culinary skills. Oprah is now a raving fan of your burger joint and invites you onto her show to tell the whole world about your hamburgers. It doesn’t take an economist to figure out what is going to happen to the demand for your burgers — it is going to skyrocket.

Your hamburger demand is now global. Congratulations!

As the demand for your hamburgers increases dramatically, so too the supply must increase. Your newfound global hamburger demand has given you a “permission slip” to buy even more frozen patties and hire new fry cooks.

The important concept here is that a growing demand “permits” the producer to increase his supply.

Now, let’s conclude our hamburger illustration by imagining that an up-and-coming rival hamburger company becomes a major competitor with your hamburger restaurant chain. As many of your customers begin visiting your new competitor, the demand for your hamburgers begins to wane. As the demand for your burgers drops, you no longer have a “permission slip” to buy as many frozen patties as you had before. As demand for your burgers continues to fall, it makes little sense to hire more workers. Instead, to remain competitive, you must lay off workers and buy fewer frozen patties just to keep your company afloat. Furthermore, you may even need to sell your existing burgers at a discount before they spoil.

If you chose to ignore the warning signs and continue hiring new employees and buying more patties than were actually demanded by your customers, you would soon find your company nearing bankruptcy. At some point, logic would dictate that you must decrease your supply.

So how does this apply to our current discussion on the U.S. dollar?

Let us now apply the same economic logic that we used to explain the increasing and decreasing demand for your hamburgers to our discussion on the global demand for U.S. dollars.

If it is only Americans who “demand” U.S. dollars, then the supply of dollars that Washington and the Federal Reserve can “supply,” or create, is limited to our own country’s demand.

However, if Washington can somehow create a growing global demand for its paper dollars, then it has given itself a “permission slip” to continually increase the supply of dollars.

This is exactly the type of scenario that the petrodollar system created in the early 1970s. By creating direct incentives for all oil-exporting nations to denominate their oil sales in U.S. dollars, the Washington elites effectively assured an increasing global demand for their currency. And as the world became increasingly dependent on oil to run their economies, this system paid handsome dividends to the United States by creating a consistent global demand for dollars.

And, of course, the Federal Reserve’s printing presses stood ready to meet this growing dollar demand with freshly printed U.S. dollars. After all, what kind of central bank would the Federal Reserve be if they were not ready to keep our dollar supply at a level consistent with the growing global demand?

FACT: The artificial dollar demand created by the petrodollar system returned to Washington the “permission slip” to supply the global economy with freshly printed dollars that it lost after the demise of the Bretton Woods system.

The artificial dollar demand created by the petrodollar system has “permitted” Washington to go on multiple spending sprees to further create their “welfare and warfare” state. And with so many dollars floating around the globe, America’s asset prices (including houses, stocks, etc.) naturally rose. After all, as we have already demonstrated, asset prices are directly related to the available money supply.

With this in mind, it is easy to see why maintaining a global demand for dollars is vital to our national “illusion of prosperity” and our “national security.” (The lengths to which America has already gone to protect the petrodollar system will be explained in our next chapter.)

When, not if, the petrodollar system collapses, America will lose its “permission slip” to print excessive amounts of U.S. dollars. Just like the hamburger stand owner who loses customers to a rival company, the United States will no longer be able to print dollars as the demand for them will have decreased. When this occurs, the amount of dollars in existence will far exceed the actual demand. This is the classical definition of hyperinflation. Since 2006, I have been teaching that America’s bout with hyperinflation will be tied in some way with a breakdown of the petrodollar system and the artificial dollar demand that it has created.

When hyperinflation strikes America, it will be very difficult to stop without drastic measures. One possible measure will be a quick and massive reduction in the overall supply of U.S. dollars. However, with a reduction of the supply of dollars will come a massive reduction in the value of assets currently denominated in dollars. I will provide a potential scenario of a coming petrodollar collapse along with personal strategies that you can take.

The petrodollar system increases demand for U.S. debt securities.

In addition to creating an artificial demand for dollars, the petrodollar system also provides Washington with instant buyers for its debt securities, providing America with a double loan from virtually every global oil transaction. Considered one of the more brilliant aspects of the petrodollar system, oil consumers are first required to purchase oil in U.S. dollars. Second, the excess profits of the oil-producing nations are then placed into U.S. government debt securities held in Western banks.

This system would later become known as petrodollar recycling, as coined by Henry Kissinger. Through their exclusive use of dollars for oil transactions, and then depositing their excess profits into American debt securities, the petrodollar system is a “dream come true” for a spendthrift government like the United States.

Despite its obvious benefits, the petrodollar recycling process is both unusual and unsustainable. By distorting the real demand for government debt, it has “permitted” the U.S. government to maintain artificially low interest rates. Washington’s dependence upon these artificially low interest rates allows large amounts of reckless spending to continue unchallenged. But unless the United States has discovered a novel way of defying history and the basic laws of economics, the massive economic distortions and imbalances generated by the petrodollar system will eventually self-correct when the artificial dollar and U.S. debt demand is removed. That day is coming.

The petrodollar system allows the United States to buy oil with a currency it can print at will.