Thursday, January 26, 2012

The Demise of the Petrodollar

by Marin Katusa

Rumors are swirling that India and Iran are at the negotiating table right now, hammering out a deal to trade oil for gold. Why does that matter, you ask? Only because it strikes at the heart of both the value of the US dollar and today's high-tension standoff with Iran.

Tehran Pushes to Ditch the US Dollar

The official line from the United States and the European Union is that Tehran must be punished for continuing its efforts to develop a nuclear weapon. The punishment: sanctions on Iran's oil exports, which are meant to isolate Iran and depress the value of its currency to such a point that the country crumbles.

But that line doesn't make sense, and the sanctions will not achieve their goals. Iran is far from isolated and its friends – like India – will stand by the oil-producing nation until the US either backs down or acknowledges the real matter at hand. That matter is the American dollar and its role as the global reserve currency.

The short version of the story is that a 1970s deal cemented the US dollar as the only currency to buy and sell crude oil, and from that monopoly on the all-important oil trade the US dollar slowly but surely became the reserve currency for global trades in most commodities and goods. Massive demand for US dollars ensued, pushing the dollar's value up, up, and away. In addition, countries stored their excess US dollars savings in US Treasuries, giving the US government a vast pool of credit from which to draw.

We know where that situation led – to a US government suffocating in debt while its citizens face stubbornly high unemployment (due in part to the high value of the dollar); a failed real estate market; record personal-debt burdens; a bloated banking system; and a teetering economy. That is not the picture of a world superpower worthy of the privileges gained from having its currency back global trade. Other countries are starting to see that and are slowly but surely moving away from US dollars in their transactions, starting with oil.

If the US dollar loses its position as the global reserve currency, the consequences for America are dire. A major portion of the dollar's valuation stems from its lock on the oil industry – if that monopoly fades, so too will the value of the dollar. Such a major transition in global fiat currency relationships will bode well for some currencies and not so well for others, and the outcomes will be challenging to predict. But there is one outcome that we foresee with certainty: Gold will rise. Uncertainty around paper money always bodes well for gold, and these are uncertain days indeed.

The Petrodollar System

To explain this situation properly, we have to start in 1973. That's when President Nixon asked King Faisal of Saudi Arabia to accept only US dollars as payment for oil and to invest any excess profits in US Treasury bonds, notes, and bills. In exchange, Nixon pledged to protect Saudi Arabian oil fields from the Soviet Union and other interested nations, such as Iran and Iraq. It was the start of something great for the US, even if the outcome was as artificial as the US real-estate bubble and yet constitutes the foundation for the valuation of the US dollar.

Read the rest here.


  1. Yep, this sancation action against Iran may have tipped off a faster movement in the depreciation of the dollar. It's like we're punching ourselves in the face.

  2. This article seems very prescient to me. I wonder if Bob or anybody else has an opinion of how long the transition away from the petrodollar will take. Will any event accelerate this transition? Is there any downside for a producing nation to jettison the petrodollar? What is the shortest amount of time required for the majority of producers to switch away from petrodollar? The article says it only took about 2 years for the petrodollar arrangement to become the standard throughout OPEC. Can it be undone just as fast?

  3. as an indian,i find it extremely unlikely that india is paying gold.india/indians never sell(s) gold.even in starvation.thats how we,indian govt does not have that much gold anyway.
    what they have agreed is to use rupees and yen(iran's preference) instead of usd or euro

  4. Its funny how this type of article hits the circuit just when the US$ is hitting an extreme in pessimism. Remember at other US$ extremes people were predicting the demise of the dollar and yet it is still 8.7% (basis US$ Index Spot Continuation)higher than it was at the US$ low on May 4th last year. Law of Contrary Opinion suggests buying US$ right now and you would make money.

    Don't forget if the US is in a bad way, lots of other people have far leakier lifeboats.

  5. The USA is helping India get Iranian oil cheaper.

  6. Bob,

    You're not going to comment on this article? It seems to be full of hogwash.

    1. Bob,

      Here's a start:

      "...its citizens face stubbornly high unemployment (due in part to the high value of the dollar)..." mercantilist nonsense

      "...Every oil-importing nation in the world started saving their surplus in US dollars so as to be able to buy oil..." do nations buy oil? I thought companies and people did.

      "...while essentially letting the US pretty much own the world's oil for free, since oil's value is denominated in a currency that America controls and prints..." what the hell does that even mean? Own the world's oil for free?

      "Finally, the big question: How can one profit from this evolving situation? Playing with currencies is always very risky and, with the global game set to shift to significantly, it would require a lot of analysis and a fair bit of luck. The much more reliable way to play the game is through gold. Gold is the only currency backed by a physical commodity; and it is always where investors hide from a currency storm." Seems like stupid advice given the world isn't on the verge of adopting a gold standard and he just said the US dollar was supported by the oil trade, so the real jig would be to figure out which currency will replace the US dollar as the world oil trade currency and buy it.

    2. Taylor,

      I just don't see these as big deals relative to the overall point of the column.

      Number 1, I give you completely.

      Number 2, is just a little loose aggregate talk; Nation, companies, individuals, whoever needs to but Saudi oil would start accumulating dollars.

      Number 3. This is actually a pretty interesting insight in that it certainly results in the government getting their oil for free in that the government can print any amount it needs to buy Saudi oil, since it is paid for in dollars.

      Number 4. If the dollar loses its reserve status, gold will rocket.

      But, again, I just don't see any of these as a big deal relative to the overall history of the petrodollar provided in the piece.

  7. Consequences would be dire or consequences would be better for US manufacturing and jobs - which is it?

  8. I read this article by Gary North a while back and it made a lot of sense, for my panic sticken mind.

    My problem is he seems to contridict himself when he talks about the debt in general.

    Any clarifacation one way or the other would be appreciated.

  9. @ Anonymous 3:17

    "I read the articles by pro-gold authors, who insist that the decline of the dollar in international reserves is inflationary, and I wonder how they are reasoning. The FED is inflationary. It can inflate to offset rising Treasury interest rates. But without FED action, a reduction in the percentage of dollars in central bank portfolios is price deflationary."

    I'm feeling real plucky, and I'm about to agree with your assesment of North's article. I copy/pasted the above statement and it makes no sense to me what so ever. It's like he suggests that dollars released from central banks(not US) "disappear" instead of flooding the world markets....

    I'm still on board with gold/silver etc. as a hedge...big time. Maybe down the road I'll regret it, but since making major moves into it in 2006 I don't worry at all....

    I also think as a result he greatly underestimates the possibility of rapid deflation, as his major argument is "where do people fleeing the dollar go?"....I think that's pretty evident so far in looking at gold/silver.

    Now I will timidly await a smashing from Dr. North.

    1. Edit: I meant to say "rapid inflation", including price level increases.