Over the past few weeks, I have been seeing a number of articles on various sites discussing how the U.S. dollar’s dominance as the world’s reserve currency could be under attack. Over the past several years, I have even made similar comments through articles such as these:
- Could China And Russia Be Trying To Kill The Petrodollar Standard?
- Could International Support For The U.S. Dollar Be Waning?
- Could These Events Threaten The U.S. Dollar’s Reserve Status?
- China Ramps Up Threats To U.S. Dollar As Reserve Currency
I have done a few more articles than these over the years, most of which can be found at Seeking Alpha. These are simply the ones that I was able to find with a quick search, but they should be sufficient to get the point across to most people that are still somewhat unfamiliar with the idea that the United States appears to be gradually losing the privileged status in the global financial system that it has enjoyed since the 1940s. Of course, gold bugs and most crypto-currency fanatics are already quite familiar with these ideas.
Unfortunately, it appears that the international rejection of the U.S. dollar has strengthened over the last year. This is partly due to the United States imposing various sanctions against Russia following the outbreak of war in Ukraine. This article will not focus on this and frankly, it does not matter whether you believe that these sanctions were justified. The basic point is that many nations in the world, particularly the emerging world, believe that the United States has gone too far and that the nation’s control of the reserve currency is a direct threat to their own sovereignty. Thus, these nations have begun searching for alternatives. As many of these nations are among the wealthiest in the world in terms of raw materials, this is something that we should not ignore as investors.
First, we will begin by discussing why the U.S. dollar achieved the privileged position that it currently enjoys and why it is vital for the lifestyle of most Americans.
The Origins Of The Modern Petrodollar System
The U.S. first obtained its position as the global reserve currency in 1944, which saw representatives from all 44 allied nations gather together to reform the international monetary system. The whole point of these reforms was to prevent a repeat of the events that occurred following the end of World War I. These events were widely blamed for causing World War II and include the hyperinflation in Weimar Germany and the Great Depression. These events were widely blamed for causing the rise of the Nazi Party in Germany as desperate people turned to that as a solution for the economic and financial troubles that they were facing.
The system that came out of the 1944 conference was dubbed the “Breton Woods” system. This system called for a system in which all foreign exchange rates were fixed to one another. The U.S. dollar was chosen as the currency to which all others would be linked as the United States had the largest gold reserves at the time. Basically, every country in the world would back their national currencies to U.S. dollars and the U.S. dollar was backed by gold.
The Breton Woods system worked reasonably well until the 1960s. At around that time, there were some countries that became upset with the fact that they were trading real goods and services for a paper currency that could be freely printed by the United States. In addition, the United States found that its own flexibility was limited as its government could not spend as freely as it wanted on both the Great Society programs of the era and the Vietnam War. The United States’ debt was rising at the time. This is evident in the fact that the last time the U.S. national debt went down in any given year was in 1957. Various nations began demanding gold in exchange for the U.S. dollars that they received via trade and this strained the gold stockpile of the United States.
On August 15, 1971, the United States ended the convertibility of the U.S. dollar to gold. This occurred within days of a rather infamous incident in which the French sailed a warship into the harbor of New York City and demanded gold for their U.S. dollar holdings. This illustrates the problem that the Breton Woods system was causing for an increasingly fiscally irresponsible United States. Unfortunately for the United States, once the gold-backing of the U.S. dollar ended, inflation began to spiral, driven by mounting debt and a growing money supply.
In 1973, Richard Nixon sent Henry Kissinger to negotiate a deal with Saudi Arabia, the world’s largest exporter of oil at that time. The deal that was reached resulted in Saudi Arabia requiring that any nations wishing to purchase its oil do so with U.S. dollars. In exchange, the United States would provide Saudi Arabia with military arms and protection. Other oil-exporting nations soon implemented the same requirement as Saudi Arabia, which resulted in the entire oil trade being conducted in U.S. dollars.
This ultimately created an artificial demand for U.S. dollars. After all, any country that wanted to import oil must retain a surplus of U.S. dollars to use to purchase the oil. In addition, oil-exporting nations began to build up a surplus of U.S. dollars, which they used to purchase U.S. Treasuries, thus allowing the United States to finance its deficits for much cheaper than would be possible if the U.S. dollar was priced by a free market. This has essentially been the system that has worked pretty well through to the present day, at least for America.
As mentioned earlier, there is growing discontent over this system, which has been amplified by the perception that the United States has been using the U.S. dollar as a weapon against those countries that it does not like. One example of this is Russia, which has been the target of various economic sanctions since 2014. Once again, whether you believe that these sanctions were fair or not is immaterial. The point is that various emerging nations, particularly Russia, China, India, and a few others saw this as the United States attempting to impose its will on other nations. They began looking for ways to reduce their exposure to the U.S. dollar, as I illustrated in the articles linked above.
In 2022, various media outlets reported that Saudi Arabia was in talks with China to accept yuan for oil as opposed to U.S. dollars. This is a continuation of a 2017 deal between China and Russia in which China purchases Russian oil and natural gas using yuan instead of U.S. dollars. It makes a lot of sense for Russia to be accepting yuan instead of U.S. dollars given the current political climate, but Saudi Arabia’s willingness to consider it likely comes as something of a shock to most readers and even government officials.
Reportedly, Saudi Arabia is unhappy with America’s increasing reluctance to fulfill some of its security commitments between the two nations. However, it is also possible that Saudi Arabia would rather work with China, which imports considerably more crude oil than the United States. Regardless, the reasons are not necessary here as it is the effect that is most important.
Effects Of The Killing Of The Petrodollar
Should Saudi Arabia begin accepting yuan as payment for crude oil, it seems likely that other oil exporters will begin to follow suit. The consequences of this are, admittedly, unknown. However, some combination of the following seems likely:
- Inflation in the United States will begin to take off as the money supply swells. Nations will no longer need to hold U.S. dollars in reserve to purchase crude oil so they will likely begin selling dollars and buying other currencies in order to diversify their currency reserves. This will push down the value of the U.S. dollar versus other currencies. As the United States imports most of its consumption, inflation will ensue.
- The U.S. government will no longer be able to finance its operations as cheaply. While this could result in spending cuts, that seems unlikely. The more likely scenario is that the government will attempt to monetize the deficits using the Federal Reserve, which will further stoke inflation.
- Gold, bitcoin, and various other assets will skyrocket. The exception might be the stocks of companies that collect most of their money from domestic consumer spending.
- Crude oil skyrockets and the domestic economy begins to collapse under the weight of increasingly unaffordable energy prices.
- Civil unrest increases as food, energy, and other necessities become unaffordable to the masses. This is a similar situation to what happened in Weimar Germany during the 1920s and 1930s.
It seems likely that people holding gold and crypto-currency will be in better shape than most others. Oil companies will also likely do fairly well. I will admit that I hope that I am wrong with some of these predictions, especially numbers four and five. However, it may be wise to have some of your assets exposed to things that will do well in such an environment, just in case.