Maintaining American Economic Hegemony: A Tale of the Petrodollar
Kimo Gandall, Fiscal Policy Contributor
There is a hidden concept in most foreign policy and international trade debates. Most politicians cite the typical talking points: security, trade, alliances… But all of those potential benefits, despite their popularity, tend to discount the most important factor: the dollar.
This economic concept has been coined the ‘petrodollar.’ To put it simply, petrodollars are, “oil revenues denominated in U.S. dollars.” In other words, countries trade oil using dollars as the form of capital required for an exchange.
In 1944, the United Nations created the Bretton Woods system, which pegged the price of currencies to gold. At this point in time, the dollar acted as the method of exchange to purchase gold --- however, in 1968, amid fears of the overvaluation of the dollar in comparison to the relative real price of gold, and on the orders of the Nixon administration, the system was dissolved.
In the wake of this system, the US carefully developed agreements with the Gulf Cooperation Council (GCC) that required that commodities from these nations be traded in the dollar. In exchange, the GCC member countries, such as Saudi Arabia, were permitted to expend their earned petrodollars in relatively safe US based securities, which allowed for GCC member countries to accumulate massive sums of wealth. This process became known as petrodollar recycling, a process in which countries use profits from foreign exchanges to invest in US securities.
Above: The process of petrodollar recycling
Other economists have labeled this process, when examining the process of transfer back into the American economy, as petrocurrency mercantilism, which is virtually the same process. By 1975, OPEC as a whole adopted the dollar as a currency vehicle for trading oil. This process, as seen below, shows the artificial recycling of currency.
The US government's ability to maneuver the dollar into a position that makes the currency vital to trade with the world’s most important commodity has allowed it to take position as the world’s default vehicle currency. This is evident by a 2013 survey by the Bank for International Settlements, which found that the dollar now accounts for 87% of international transactions. This has allowed the United States to continue to borrow at unrealistically low interest rates, which allows the government to continue deficit spending infinitely. Furthermore, the high value of the dollar has allowed the government to print a nearly endless stream of money. As a result, the US government has been able to fund the welfare state we see today --- as long as the demand for the dollar when exchanging oil remains high, the debt is nearly irrelevant. As long as the world needs oil, and as long as oil exporters continue to save petrodollars in bonds and financial institutions, this process is guaranteed.
Other studies have additionally shown that this position gives the United States, “extraordinary privilege,” in negotiating both interest rates globally, and in diplomatic demands (soft power). In essence, the US now has the majority of GCC and OPEC in an economic headlock --- any country that defies the system could easily have their security investments cut off, resulting in the destruction of their economies. This capital, known as ‘hostage capital’, has allowed the US to remain virtually unchallenged in the Middle East as an economic hegemon.
The Oil Apocalypse?
People love to hypothesize the end civilization as we know it --- such prophecies are not only interesting, but attract more media attention. Typically these conspiracy theories hold very little empirical weight (ex: 2012), but in the case of the petrodollar, this threat could be very real. Of course, almost all of threats against the petrodollar are currently only bluffs --- while the Russian government has made moves in state owned companies, such as Gazprom, to change accepted currencies to the euro, the low value of the ruble makes any near future threat unlikely.
Other threats, such as ISIS, pose a more tangible threat, as they seize and disrupt oil refineries and trade. If cities such as Aleppo were to, God forbid, fall to ISIS or other Islamic terrorists, the refineries in the city could be used as a venue to streamline black market oil into countries such as Turkey or Russia, further damaging the average price of oil. Worse, if the Syrian government seizes the city and sides with Russia (as is looking increasingly likely), the oil reserves of the country could be used to further delegitimize the dollar. Finally, nations like China, whose investment in Africa have proven to be concentrated in mineral rich regions, continues to be a worry for dollar traders.
The final threat is internal. Low oil prices, triggered about by a massive supply, has significantly damaged states that rely on oil. While this has damaged countries like Russia, it has also forced nations such as Saudi Arabia to begin to empty massive foreign reserves into the open market to pay for deficits caused by low prices. While the world has yet to see if other petrostates within OPEC, such as Iran or Algeria, follow suit, the threat is always looming --- a wide scale sell off could trigger mass panic creating a global recession.
Thus, a growing trend is becoming increasingly clear: the West’s ability to coerce nations into trading with the dollar is on the decline.
There is, however, good news. With the economic crisis in China, the Russian ruble at an all time low, and the Euro in crisis, the probability of the investors jumping boat from the dollar remains extremely unlikely, at least for the time being --- the problem is not so much whether investors will totally leave the dollar, but if a switch in oil transactions made mandatory by producers could potentially damage the value of the dollar, leading to investors being weary of the currency. The result of this, of course, is the US’s debt crisis escalating --- which, at this point in time, could prove lethal. Therefore, while the dollar is currently safe, power moves by international players could quickly change this situation.
The length of this article is too short to make any serious policy considerations --- has US intervention resulted in more trade with the dollar, or less? Or is it just the naturally changing tide of the marketplace? If future leaders want to preserve our economic hegemony in the world, aggressive actions will likely need to be taken --- with China investing in Africa, the Russians becoming increasingly involved in the Middle East, and the European Union in fiscal crisis, the US will have to take immediate steps to stop the hemorrhaging of Western influence in overseas transactions. This poses a further problem: if the US cannot save the dollar, we will have to take serious steps to alleviating the debt (cutting the budget, raising taxes or borrowing more), all of which would undoubtedly damage the economy, possibly beyond repair. As a conservative, I see only one step forward: a foreign policy that emphasizes America first.
Follow this author on Twitter @Kimo_Gandall