The Modern Economy And The Consequences Of The Petrodollar

The American empire is enforced by guns and diplomacy, but relies on the flow of bond purchases of fiat dollars, though it once could rest on much firmer ground.

Historically, the dollar’s convertibility to gold was the key to the system’s function. And yet, the system’s success was also its enemy: former clients regained and surpassed their pre-war living standards and sought power. The problems were visible, but the final decision would be dramatic and quick–the Nixon shock untethered the very definition of value that all economic players could pull on, leaving the world scrambling for footing over the course of the 1970s.

The result of the scramble for hard assets, new economic deals, and rearrangements of the world scene would be a continuation of the American system based on the petrodollar, American military might, and the new engine for American economic growth and leadership: the Fire Economy.

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The problems first emerged in the 1960s as the American system’s prosperity spread to its clients in Europe and Asia. With the rebound in Europe, due to the Marshall Plan and Japan’s growth, American economic dominance declined as the United States’ share of world GDP drifted closer to 25%. Foreign claims to American gold made the system cumbersome and unwieldy with the forced creation of the London Gold Pool to protect the $35 per ounce price of gold. The French openly grumbled about the unipolar dollar world. French President Charles De Gaulle’s initial attack on the dollar was in early 1965 as he discussed the instability of relying on one currency as the world reserve currency. As the anchor position of world reserve currency in the Bretton Woods system, Americans could pay for their debts in dollars their created. American government or private business bonds were priced in dollars, which only the Federal Reserve controlled.

American federal fiscal management had hovered around break-even in the immediate post-war environment, but deepening involvement in Vietnam expanded federal government outlays as the feds reduced taxes through the Revenue Act of 1964. His proposition was for nations to claim their gold and use gold as the ultimate reserve. There may have been a trace of French self-importance or sting at the loss of its empire in his words, but his focus was on the exorbitant privilege held by the United States importing goods that they paid for with the currency that they supplied, a currency that all other nations had to hold as a reserve.

De Gaulle’s concern with the government controlling both the supply of the currency and the stability of the international system hints at the problem inherent in the American domestic political system that Galbraith wrote of. The American political orientation was on the responsibility of the government to do something to help the economy reach full potential and provide employment for all. In the post-Roosevelt political climate and Keynesian worldview, what president would proactively reduce government spending and the money supply, creating a drag on the nation’s GDP?

Certainly not one seeking re-election.

Ultimately, the London Gold Pool would collapse when the French withdrew from the agreement in mid-1967. Pressure on dollar convertibility rose as nations were worried about propping up the dollar, but the system held until another pillar of the post-war system crumbled: oil production. The United States hit peak domestic production in early 1970 and import quotas were removed. Texas could no longer meet the demand at market prices. The United States began an era of massive imports of foreign oil on top of its imports of goods and services. Foreign oil suppliers were paid in dollars that were becoming worth less and less as inflation within the United States rose at rates last seen during the Korean War with sequential inflation rates of 4.4% in ’69, 6.2% in ’70, and 5.3% in ’71. With foreign claims on the dollar creating a situation where the very currency that held the system together could itself experience a run, President Nixon issued Executive Order 11615, issuing an import surcharge, a max cap on wages and prices and most importantly to the international financial world, closed the gold window.

Nixon’s move ended gold convertibility.

The closing of the gold window was intended to be temporary. A new fixed system for exchange rates was worked out in the Smithsonian Agreement in December of 1971, with a new $38 per ounce price for gold with trading bands for currencies. His solution was a domestic political success, but it did not fix the long term problem. Nixon’s concern of an election overrode the solution to the global problem of a working financial order, which is just what Triffin was driving at with his criticism of backing the Bretton Woods system with the dollar. The dollar’s unhinged behavior would continue for the decade, but take a new turn in 1973 and 1974. Japan and the European market firms agreed to float their currencies against the dollar in 1973, but the oil market had slipped from the control of the major American producers to the oil cartel known as OPEC.

The Organization of the Petroleum Exporting Countries (OPEC) was formed in 1960, but its importance in the global economy took years for the rest of the world to realize. The American empire had fostered decolonization while the network was still grounded in western corporations developing natural resources in the developing world. The “Seven Sisters” oil companies explored and developed deposits in the Arab world based on the concession system. A company would develop and produce the oil in a sovereign space while splitting income from petroleum on a 50/50 basis as set in the 1950 Saudi-ARAMCO Agreement. The creation of OPEC is an act out of the decolonization playbook as nations claimed control and more power over their resources. In Daniel Yergin’s brilliant tome on the history of oil “The Prize”, OPEC’s importance lay in the obvious fact of large untapped deposits, but more consequentially in 1960, the fact that “OPEC’s five founding members were the source of 80 percent of the world’s crude exports”.

OPEC’s rise to prominence was during the period of America’s oil peak. American production had peaked, worldwide demand had dramatically increased, and the oil market had become a seller’s market. This was all in the mix of America eliminating the gold convertibility function to the dollar and rising inflation. Concern grew within the OPEC leadership that America’s inflation problems were producing higher gas prices that the American companies and governments were collecting the lion’s share of through taxation in relation to the crude oil suppliers, OPEC. OPEC nations were faced with the prospect of pumping a limited natural resource for dollars that were losing value not just due to inflation, but due to value across the global currency spectrum. Timed nearly perfectly with the conundrum of what to do about declining real values of oil revenue and the American need for foreign oil, an Egyptian dictator, Anwar Sadat, would begin a war that would see the first real use of the oil weapon envisioned by a previous Egyptian dictator and pan-Arab dreamer Gamal Abdel Nasser.

The creation of the petrodollar was a resolution to twin crises.

There was, of course, the problem of the severing of the dollar from gold, which created a situation where the developed world sold goods and services to the oil exporters for higher and higher prices while the oil exporters received locked in dollar revenue based on production that was no longer backed by gold. The oil exporters were in negotiations with the Seven Sisters over how much to increase the price of oil as Sadat was planning his surprise attack. The surprise attack started a little war called the Yom Kippur War.

In the Yom Kippur War, Egypt and Syria performed a sneak attack on Israel that Israel knew was coming but did not preemptively strike in defense. The Israelis become hysterical early on and demanded assistance from the U.S., since the Soviets were aiding the Egyptians and Syrians. It was a mini-Cold War proxy fight. The U.S. did aid the Israelis, and lo and behold in solidarity, the Arab oil exporters decided to unilaterally lift oil prices and begin the oil embargo of 1973-1974.

The U.S. had balanced its attitudes in the Middle East between the Arab-friendly politicians and the Israel-friendly politicians. This may have been the moment when America went in the tank for Israel. One must wonder how much the American media would have asked, “Who lost Israel?” for twenty-five years like the media and politicians asked, “Who lost China?” Nixon was well acquainted with that concept, as he was one of the fiercest pushers of the red China situation. That question was part of American rational behind the Korean and Vietnam wars, so it is a great unknown how losing Israel would have forced us to idiotically throw American lives into the meat grinder. Without Israel, foreign policy presidential debates would have to find fifteen minutes of material to discuss.

The fighting in the Yom Kippur War ended October 25th, 1973, yet the oil embargo continued until March of 1974. The disengagement of the combatants was at the end of May 1974, so the dates do not line up properly if the embargo was related to the peace process. There is a note in the embargo chronology that in mid-February, some countries (KSA included) saw progress in Yom Kippur war resolution negotiations due to Kissinger’s shuttle diplomacy. Those shuttle dates still do not line up quite so well. What does line up a bit better is the creation of the U.S.-KSA petrodollar agreement of 1974. While the two events happened at roughly the same time, Kissinger was quick to see that they were not linked.

The Saudis are key in this analysis here because they had taken over the role of swing producer from Texas. Saudi Arabia had a larger role due to the global oil game. The KSA’s oil exports were 21% of global oil exports in 1973. Creating a petrodollar system and pulling OEPC into such a system would logically start with the swing producer. Due to their share of the export market and their status as supplier to multiple developed nations, the Saudis announcing they would only accept dollars for their oil set the method of operation for the rest of the OPEC group to follow. Like any cartel, the desire to cheat quotas for personal gain or be a first mover in economic or power terms is strong. Setting up a petrodollar arrangement is not cheating, but it is acting independently and it reaffirmed the link of oil and dollars, instead of a chaotic system of bilateral currency for oil deals.

The initial petrodollar agreement is commonly stated as the U.S. protecting the KSA in exchange for pricing their export oil in dollars to create a base bid for dollars.

It also solidified dollar recycling, because those dollars are used to purchase treasury bills and bonds that are held in the U.S. and spent on goods and services provided through the U.S.-KSA economic agreements. In his book “Confessions of an Economic Hit Man“, John Perkins explains how the U.S.-KSA Joint Commission on Economic Cooperation was a means for starting the petrodollar system as well as laundering the American dollars spent on foreign oil back to America for construction and engineering firms. Perkins says that the U.S. frantically worked hard after the embargo to lock the Saudis into a deal. He is wrong. Kissinger arranged for the petrodollar connection through Joint Commission on Economic Cooperation by way of the Technical Cooperation Agreement signed February 13th, 1974. That is right when certain countries (chiefly the KSA) proclaimed progress in the Yom Kippur war talks and that an end to the embargo was in sight. The United States renews this TCA every five years. While JCEC was the final program, it was a follow up to the TCA which was agreed to four months prior to the JCEC’s founding right in the middle of the embargo.

While an act of solidarity during a conflict not involving members, OPEC’s embargo was really about their share of the economic rents in the oil game. It was the start of a long process of reorganizing oil wealth. David E. Spiro’s book “The Hidden Hand of American Hegemony” explains in detail how the petrodollar came to be, with the main key centered on financing all of the net new borrowing from American entities to keep the economy advancing. As Spiro notes, with the “options of competing for OPEC capital or having to convince the American public to spend less and save more,” any American politician will sweat for OPEC’s dollars. It was also one of the first steps in the great scramble for footing in the 1970s after the dollar stopped gold convertibility in 1971. An agreement as broad and open as the TCA does not form overnight. Kissinger’s shuttle diplomacy was a combined effort to bring peace to the west coast of the Middle East and pacify the Saudis into playing the American financial game.

This TCA is nearly half a century old, but the technical agreement makes America a player involved with the kingdom’s nuclear ambitions and regional interests. America was there to protect the kingdom from Saddam in the early 1990s. America’s leadership must recognize that if we allow Iran to seek peaceful use of nuclear technology, their wealthy rivals, and staunch funders of the American dollar scam, will want the same right. The dollar might not have been as good as gold until the end of the decade, but the Kissinger-KSA deal bought the Saudis internal security, modernization, and the best muscle on the global block. The first step was taken in fixing the dollar and creating the FIRE economy with the successful creation of the petrodollar.

The petrodollar did not fix all of America’s economic problems, but it replaced the gold convertibility issue to the important new holders of billions of dollars. The deficits created by Vietnam and Johnson’s Great Society programs created the situation where Nixon closed the gold window, but fiscal and monetary policy, along with the oil embargo, created the stagflation scenario of the 1970s. Nixon’s price and wage controls worked temporarily through the election of 1972, but the 1973 oil embargo created a massive dose of cost push inflation. Oil, being an input without a comparable alternative, bled through all productive sectors of the economy. With manufacturing accounting for a little over one-fifth of the national GDP, the embargo increased prices quickly and by a wide margin before wages could catch up, pushing the nation into recession.

American workers did see nominal wages rise through the 1970s to keep up with inflation, but this rise in wages did feedback into labor cost inflation for producers of goods. American laborers had a few things in their favor: low immigration and free trade being mostly just an academic idea. The labor supply was small and stickier than what modern Americans deal with today. In spring of 1977, famous economist Arthur Okun commented in a debate/interview that the relationship between American businesses and workers were chummier than in past decades. The fear of cost push inflation through pay raises to employees would be a factor with any true economic recovery. While membership was declining, unions were still a major factor in labor cost concerns across the nation, and politically, unions donated $17.489 million towards candidates compared to business interests that donated $12.587 million in the 1976 election cycle. While there are negatives along with positives for the concept of union workers, the union vote and its ability to fundraise were a strong bulwark on political changes, which we will see the Rubinization of the Democrats forever changed.

Capital and labor were not helped by the fiscal and monetary policies that were constantly changing and contributing to the inflation problem. Throughout the 1970s, the federal government ran deficits, flooding the free floating currency exchange pool with dollars. Chairman of the Federal Reserve Arthur Burns employed an easy money policy throughout most of his tenure, which began in 1970 and ended in 1978. Burns’ initial reaction to the oil embargo was to reduce interest rates a full 2%. This added gas to the oil embargo induced inflation fire, propelling inflation higher, rather than inducing growth. Early inflation numbers in the double digits without corresponding growth pushed the Fed to increase interest rates to just under 14%. That move combined with the oil embargo destroyed chances at GDP growth, increased unemployment, but did not tame inflation entirely.

Approaching an election year for the Ford presidency, Burns reduced the interest rate to 5%, where it would linger until the late 1970s. Unemployment did drift downwards to 6%, but real GDP growth was minimal to non-existent. The mechanisms and ideas in place from FDR’s days were not able to tame the inflation dragon.

This did not mean that great minds in and out of government were not attempting to fix the inflation issue. Rather than finding a way to end the temporary closing of the gold window, the academic and civil service minds were focused elsewhere. Deregulation. Ask the common American which president they associate deregulation with and Ronnie Reagan will most likely be their answer. Fighting the government beast was his crusade. The problem with that familiar narrative is that it is untrue. Reagan did not do much of anything for deregulating the American economy. He did dramatically change the tax code and go on a military spending spree that helped our military-industrial complex, thereby protecting revenue streams for our productive economy. In American history, deregulation was a process that had many events outside the Reagan window. Spending a little time evaluating the facts, deregulation was a bipartisan process that academia and the media pushed on behalf of the common man.

Tucked away in a Fortune magazine from 1977, Paul Weaver’s article “Unlocking the Gilded Cage of Regulation” explains the story of deregulation’s promise for America. The post-1932 iron triangle of big business, Congress, and the bureaucracy was being challenged, and in the words of Paul Weaver, was looking corroded. The promise of deregulation was the Milton Friedman mantra of markets will solve problems; markets are supposed to be free, so that they can be efficient, and efficient means good. The economic problem of the mid-’70s was high inflation, and it did doom both Ford and Carter’s presidencies. Deregulation was proposed as a solution to the high inflation problem. In the article, the issue of the Fed being loose with monetary policy in the face of inflation is not cited. Budget deficits are absent from the article. There is no mention of Nixon closing the gold window and allowing the dollar to float, destroying the Bretton Woods agreement and sending all nations on a hunt for a store of value.

There was no need to mention severing the basis for valuing all commodities because economists and civil servants had the answer. Weaver writes that “economists agreed that government regulation was a major cause of the high and rising cost of living.” But there was not a single citation of the ’74 oil embargo that created cost push inflation in the American manufacturing-based economy. Academics were not the only ones pushing the deregulation line. Civil servants were the driving force inside the government. Deregulation proposals were around since Nixon’s first term, but had languished due to more pressing matters. In Weaver’s words, second and third echelon figures in the administration used patrons higher up like Roy Ash (Director of OMB) and William Simon (Treasury Secretary) to put proposals in front of President Ford. Weaver called this crew a cabal.

The problem with this push for deregulation was that the first targets were transportation-related, which naturally had a heavy union presence. This would be tough for a Republican president to attempt when facing re-election. While deregulation was ideologically appealing to the free market GOP, there had to be an edge for the Democrats. While accomplishing nothing of substance, congressional hearings on transportation managed to get Senator Ted Kennedy on the side of deregulating transportation for the savings it would provide Americans. The narrative was set. Deregulate to save the little guy money. With a Democrat in the White House, deregulation rolled through Congress in the late ’70s with Jimmy Carter there to sign bills into law. Carter could do so in the face of the unions because where else were they going to send their campaign cash? Airline deregulation had the good fortune of, in the word of one pilot, bringing the bus stop to the sky.

A major step in fostering the FIRE economy was Carter’s deregulation act on savings institutions. Reading how it was positioned to save consumers money, as well as the social pieces to legislation that were in place prior to its passage, we can see how the link between the left’s social goals and the FIRE interests was formed. One thing that is missing in the analysis of the current economic mess is the addition of post-68 liberalism, full of good intentions but bad results, to the common theme through time of human greed. There have been bubbles in the past. There were panics and crashes, but most of them centered on schemes for making money. Few ever had a social touch to them because socialism itself was a 19th century invention and bankers had minimal regulations. The centralization of power in the USA during FDR’s reign combined with post-68 social justice allowed the banks an opportunity to shake off the chains of regulation and tradition of usury laws to plunder the nation under the guise of the ‘democratization of credit’.

America has always had a strong anti-centralization streak, as well as a distrust of banks. Even when the Federal Reserve was created in 1913, it had regional banks with some autonomy. Over time, the Fed gained more and more power through different crisis points, and the federal government became more intertwined with the Fed. During the crash of 1929, power and responsibility shifted to the Fed chairman, instead of the NY Fed. Truman sold out the Fed chairman when he wouldn’t play along with banker wishes. The final consolidation happened in 1980. After decades of Glass-Steagall and heavy regulation, how did the Fed and bankers get their way with repealing anti-usury laws?

The first step in the long march was the Civil Rights Commission in the Kennedy Admin finding that blacks had to make higher down payments or pay on quicker schedules. This was considered discriminatory. No attention was paid to borrower history or the financial history of black borrowers. FICO scores weren’t even formulated until 1970, so there was no easy, impartial scoring system for banks to use. In 1974, the US passed the Equal Credit Opportunity Act, which made the act of discriminating on the basis of gender, race, etc., subject to a fine. The Home Mortgage Disclosure Act followed in 1975 that allowed the Fed to track mortgage lending. The problem of redlining districts, where banks did not lend to specific areas for mortgages, was viewed as discriminating against poor blacks, which created the need for the Community Reinvestment Act.

Was redlining even a real, active phenomenon? Professor George Bentson conducted research and wrote an essay for Fortune in 1978 entitled “The Persistent Myth of Redlining” about the lack of evidence to support charges of redlining. Bentson was quick to note that television news segments were “dominated by anti-redlining activists,” yet statistics and studies did not back their arguments. This was not behind urban decay, but a progressive favorite, rent control, might be a culprit that contributed to urban decay and hurt the poor. Bentson’s study found that urban buyers could get conventional mortgages, opposing activists’ claims. There was no difference in appraisals between cities and the suburbs, and interest rates were the same for redline versus non-redlined areas. The one difference was a desire for higher down payments in the city district. Loans differed in terms but reflected the “greater age and lower selling prices” or urban housing stock. Carried to a logical conclusion the banks were acting in favor of poor districts as “lenders favored the central city since they did not charge borrowers much in way of risk premium”.

At the heart of it might be the problem of loan demand and credit worthy borrowers. This did not matter to leftist crusaders. Social justice would find a way, and now banks had to lend to poor blacks (in 1977 blacks were the only oppressed minority of any size if you look at the US census). The good and righteous had triumphed for the poor to now have access to loans that they would easily pay back just as well as whites in their blank slatist minds. As Bentson wrote, the activists aligned with allies in the government did not want more lending but what they desired was to control and “allocate credit” that the private market currently did. The activists were at play even with the Tax Reform Act of 1976 that removed many tax shelters but lightly touched real estate and real estate investment trusts because of subsidies for the poor and elderly.

Banks had a completely reasonable economic defense for not lending to poor risk: anti-usury laws by the states that dated back to the National Bank Act–a law from the Civil War. With states setting anti-usury limits for lending, they couldn’t charge a rate higher than say 12%. Banks would have lent to blacks at the same payment schedules or down payments as whites if they could have charged 15-20%. The banks were legally capped at what they could charge and since interest rate implies the risk of the borrower, the banks were handcuffed. The banks would not take this sudden legal requirement to lend to blacks, who were poorer on average, without special rules to protect their lending. The banks worked this in two ways. First was Marquette National Bank v. First of Omaha Service Corp where the US Supreme Court unanimously sided with the banks that said nationally chartered banks were not subject to state anti-usury laws. Second came the push for deregulation which kicked off with the Depository Institutions Deregulation Act in 1980.

Banks were going to serve the gods of social justice only if they got their proper interest. The DIDA of 1980 was pitched to the public as a way for banks to pay savers more money for savings accounts. Please see President Carter’s words when signing it into law. All about savers as President Carter states, “it’s a major victory for savers, and particularly for small savers”. No words about the sudden repeal of usury limits on loans. Talk about a whitewash of a law. This law repealed the usury statutes, made all banks suddenly subject to the FED and only allowed compliant banks to merge or perform acquisitions. States followed shortly by repealing individual usury laws or raising caps. This allowed for loans to ‘discriminated’ groups to flow at ridiculously high rates previously considered loan shark levels. This also kicked off the credit card industry. By raising the interest rates allowed, credit card companies could not only lend to minorities, but they could target young people, college kids, the unemployed, whatever, it didn’t matter because now you could charge the rate you felt was right for the risk. This also forced banks to merge as scale could create greater pools for deposits, which meant lending at more competitive rates. Bank consolidation has been raging for decades since this act to the point where the top 10 banks in the US control 77% of all financial assets.

The most remarkable thing about this change, is the power of antidiscrimination to radically change a concept that had existed for centuries. Anti-usury law and feelings are widespread around the globe. Most religions had codes against it, and even when money lending became widespread in the English speaking world, there were still caps to the rate of interest a lender could charge. A deep seated anti-usury feeling in our culture was overturned because the banks were forced to make bad loans on riskier clients. These clients were protected by antidiscrimination crusades that in other fields like education, crime, school discipline, cognitive tests, illegitimacy, deny the results of the observable world. In the financial world, there are two schools of thought: 1. there is a rate for every risk and 2. some risks are immeasurable. Because of usury limits, the banks couldn’t charge the appropriate rate for a risk so they did not lend. Forced to lend, the banks would demand the freedom to charge the appropriate interest rate. The democratization of credit that started in the 1980s peaked 25 years later with vegetable pickers getting $700,000 mortgages. Must lend; we can’t even be construed as discriminating against anyone! That doesn’t make as much sense as the banks saying, “Thank God we can charge higher rates now and we’ll use this new fangled FICO score to charge minorities more anyway!”

The entire deregulation avalanche can’t be blamed on the CRA and the moral crusade for lending to blacks. The repeal of anti-usury laws cannot solely be blamed on the CRA as the 1970s inflation monster had to be killed. The 70s inflation was simultaneously hurting consumers with raw material cost increases and crushing producers through input costs as well as labor cost increases. The federal government would not reduce expenditures as rates jumped as it might cause a recession, so Volcker had to raise rates to force a recession. Many experts have written on that, but no one has mentioned how banks were forced to lend more to risky clients than they could not charge the appropriate rate of interest, forcing the courts + governments in the US to repeal anti-usury laws. The liberals fighting for social justice had no clue how this would open the front door to banks running everyone up at interest rates long considered excessive and criminal. It is just another failure on their part to see their fight and intentions carried to their conclusions.

Deregulation took a breather for a solid decade or so with Reagan signing some international deregulation acts, but nothing major. The low hanging fruit had been picked. On the narrative front, Americans were being reminded how Reagan wanted to destroy the environment safeguards that were newly installed in the ’70s. Reagan was handcuffed by his party membership. Deregulation would have to wait for another Democrat to enter the White House and bring all of those free marketers dreams to life. NAFTA, the Telecom Dereg Act, and of course the Gramm-Leach-Blilely Act of 1999. Check the vote totals. These all passed Congress with large majorities because the GOP could claim ideological victory and the Democrats could claim it saved the little man money. When Bill Clinton signed the law to make student loans non-dischargeable, it was hailed as a new law that reduced the cost of borrowing for poorer students. Debt slavery was not mentioned.

The Fortune article was right in more ways than it could imagine. Near the end of the article, Weaver discusses the weakening hold of the old iron triangle and the pressure from new businesses and new avenues of change. What Weaver was hinting at was the decade long process of the old post-war productive economy and sound money policies wandering for new, solid footing before finding it in the petrodollar, Volcker-era FIRE economy. Weaver did make an observation that few dare admit today when he wrote,

[T]he central political trend of recent decades has been the decline of the traditional interest aggregating political party + the rising influence of the press, the public interest group, the intellectuals and the professions.

Kenneth Galbraith would call the professions the technostructure, and that was the educated, technical managers and experts that managed our economy and cuddled up to government planning. Some readers would look at Weaver’s ascendant coalition and call it the progressive brain trust.

The demonetization of gold left the dollar free floating and at the mercy of politicians angling for re-election and an enabling Federal Reserve controlling monetary policy. To unleash the FIRE economy and give power to later policy changes, the dollar needed to be secure. As late as fall of 1979, TIME was running articles on rampant, seemingly never-ending inflation and the fear of re-aligning foreign interests. The Carter administration tried to protect the dollar with Fort Knox sales as well as sales of Treasury bonds denominated in Deutschmarks (Carter Bonds) to collect foreign currency reserves. Fort Knox gold bullion sales continued, and Arab oil exporters worried about dollar defense. The Kingdom of Saudi Arabia and Iran flirted with currency holdings diversification, and the approaching 1980 election cycle made all foreigners worry about Carter’s inflation fighting. Critical for Carter, unions avoided punishment for not complying with voluntary wage freezes, feeding the cost push inflation problem. Inflation needed to be stopped. Carter’s best move created consequences even he did not expect. Carter nominated Paul Volcker for chairman of the Federal Reserve.

Volcker raised prime rates immediately and did not have a Burnsian need to please the president. Volcker wrung inflation out of the economy by forcing it into recession. The deregulation act and usury law repeals allowed Volcker to raise prime rates as high as 20% and fight the cost push inflation beast. As the productive economy was still the growth engine of the American economy, sending interest rates up cut off lending on many productive projects. With production down, employees were laid off, sending unemployment above 10%. Unemployment remained above 8% for multiple years. His moved hurt the financial realm as it slammed the brakes on the 1970s housing boom by destroying the access to credit for marginal borrowers as well as crush home prices in growth markets. Volcker was also helped by the oil glut of the early 1980s combined with the conservation movement by American drivers. Oil imports dropped by several million barrels per day due to the trend of smaller, gas sipping cars since roughly half of all American oil use is tied to automotive gas fuel consumption. Volcker’s act worked though as inflation dropped from double digits to 4%. His heavy hand on monetary policy sent a message to the international money managers that the dollar would be secure, which was backed by the US dollar index rising steadily from the low 90s in 1979 to a generational high above 140 before the 1985 Plaza Accord. The petrodollar was on firm ground because Volcker made oil exporters believe it was as good as gold.

Earlier, I referenced how these nearly fifty-year-old agreements sucks America into siding with or aligning with the Saudis and their Wahhabist strain of Islam. While this pulls America into fights it does not want, it also provides an avenue for America to put pieces on the chessboard that it cannot directly sell to the American public. Operation Cyclone was the name for the CIA-Saudi program of funding, arming and training the Afghan warriors that gave the Soviet Union its version of a Vietnam War. Books and documentaries have been written about the amount of Saudi money that poured into Pakistan as Islamic warriors crossed the border into Afghanistan to wage holy war. America used the Saudis for funding levels it could not sell Americans.

Like most of the effects of the petrodollar, there are the downsides to its creation. Throughout the ’80s, America was watching the Pakistanis for signs of an illegal development of nuclear weapons. America was partially hamstrung in how they could properly address and curtail the Pakistanis because of the Afghan operation that the Pakistanis were housing and Saudis were financing. It has been suggested that the Pakistanis built their nuclear weapons program as an indirect program for the Saudis, so that the Saudis could have a bomb if the Shia Iranians developed one. The Saudi usefulness and petro-millions also radically transformed Pakistan from what once was a nation with women wearing jeans and remnants of the old Anglo Empire service to a thoroughly Islamified nation. Pakistan is now a nation that sees a three sided war for control all while nuclear bombs are moved via trucks around the country at any given moment.

This still haunts us to this day. The public debate and media cheer-leading for more intervention in Syria was never really about American interests. This was a moment where America, via its petrodollar alliance, had to perform for its vassals, and it has been a long propaganda campaign by U.S. media and the administration to prod and push the American public into supporting military intervention in Syria’s Civil War. There has been discussion of atrocities, but it turned out those atrocities were perpetrated by the jihadis America supported. We are told it is about toppling a dictator to install democracy, which will put another Islamist party in power that is aligned with Al-Qaeda-ISIS-Al-Nusra. No one with any reach outside of Zero Hedge has discussed what it is really about, which is a nice, fat natural gas pipeline for the Saudis and Qataris (links 12). We will not get the gas, but we support this because the Qatari and Saudi billionaires are in our billionaire dollar bloc.

In the second link, Zero Hedge does a great job of explaining why the Assad regime stands in the way of Qatar and Turkey’s ambitions to transport and deliver gas to European markets. This is a win for Qatar and the Saudis, as the Saudis do support the Islamist rebels and a new market for gas exports. The entire gas pipeline system, which Turkey has the control center piece to, is a way for non-Russian gas to make its way to energy-hungry European markets. This is a win for Europe, as they get cheaper natgas and can’t be threatened by the Russians (loss for them). Israel wins by destroying Assad, which will weaken Iran and secure Israel’s borders. Al-Qaeda and Islamists get a win, what? This is a win for America because….wait, there is no win.

This is just a required duty of running the global empire. America must perform for the rich clients that buy our debt with their oil and gas rents. Qatar is home to a giant American Air Force base, which we built after we moved operations out of Saudi Arabia. The Saudis and Qataris are massive purchasers of U.S. debt, with both of their sovereign wealth funds in the global top 10 (if you consolidate China’s). Those funds also buy up a ton of debt and equity of American businesses. We need to recycle that money. We need to make sure our interest rates stay low for the marginal American borrower. How will the Qataris get more? Export more gas!

There is talk that the petrodollar is done. The recycling of dollars into U.S. debt does not look or flow the same as before, and American oil and gas production has changed even American reliance on exports. The basic agreement constructed in the ’70s is potentially over. If the Saudis and other oil and gas exporters are not integral to the American political economic system, then how can even the American elite justify adventuring in wars of choice on behalf of these oil sheikdoms?

Transitioning to a new system is fraught with unknowns, but it does offer opportunities.

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10 Comments

  1. Executive Summary: since a fiat dollar ultimately can only be “spent” in the US, the purchase of oil from Islamic countries necessarily increases Islamic influence in the US via the purchase of legal influence (lobbyists), mass media (Twitter, etc.), and social programming (university endowments, mosque-building, etc.).

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    1. Thank you

      Reply

  2. Coming soon is a Shaghai oil contract in onshore yuan. Consider that on the same exchange there is a gold contract also priced in onshore yuan. Imagine how the two may interact.

    I read a good essay on this recently. I will research and return to treat this in more detail.

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  3. but no one has mentioned how banks were forced to lend more to risky clients than they could not charge the appropriate rate of interest

    but no one has mentioned how banks were forced to lend more to risky clients and that they could not charge an appropriate rate of interest

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  4. Only a moron would argue for a return to the gold standard.

    Enter Ryan Landry, right on cue

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    1. SecretForumLurker February 13, 2017 at 11:10 am

      These seems a long review of the petrodollar and then how Volcker made it work to act like gold to oil producers, therefore setting the ’80s onward financial boom

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  5. SecretForumLurker February 13, 2017 at 11:14 am

    Couldve used a long section on how Qatar or others adopted the petrodollar and then why those nations did not pull America in one direction or the other for foreign policy. Why does Saudi Arabia have such sway if others use it? Is it purely their vast hoard of dollars and the amazing flow of dollars they provide? I’ve read how the Saudis owned so much of Citigroup that besides Democrat connections, there was no way America was going to wipe out Citi shareholders because the losses to Prince Alaweed or whoever would have been catastrophic. Once again, the feds pick elites over us.

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  6. US shale production increases, with accompanying environmental issues, were pursued to decrease the susceptibility of the US and world economies to the vagaries of Saudi and other ME intrigue. US effective capacity increase reduced the KSA swing production position and negated somewhat their ability to manipulate prices. They tried with price cuts and that exposed their own frailties.

    Long term outlook for KSA is not good as they will run down oil and currency without any material income-generating or human capital increasing investment. Shirtsleeves to shirtsleeves in a few generations. To the extent that they acted as a brake on further Gulf excesses, that decline means greater instability in neighboring countries. One bright note is that a reduction in madrasah funding will ripple through the Sunni community with a type of jihadi-in-training capacity reduction.

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  7. Excellent overview. The petrodollar system seems like a credit line that keeps getting bigger even as the borrower keeps paying his mortgage with the 75th refinancing. At some point this rock seems likely to roll back down on Sisyphus. Having a secure manufacturing base like America once had before it became World Policeman seems to be a more reliable means of securing our nation’s finance’s, not to mention national security, than propping up oil sheikhdoms. Only if the Pentagon could get itself off its addiction..

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  8. The gold standard offers little long-run advantage for the United States relative to what you describe as the “petrodollar system”.

    Reply

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