Today most of the world’s trade is conducted in US dollars (USD). This is the “defacto” global reserve currency for trading between most nations.
Bretton Woods And Petrodollar System History Around the end of World War 2 (WW2) the “Bretton Woods” system was setup by a group of 44 nations in a conference held at Bretton Woods, New Hampshire (USA).
This monetary system established the rules for commercial and financial relations among the participant nations which included United States, European nations, Australia and many others. Member nations would peg their currencies to the US dollar, and the US would peg the US dollar to gold, at a price of $35 an ounce.
The central role of the dollar in world trade eventually forced the US to run a persistent trade deficit. By the early 1960s, the US dollar's fixed value against gold (35$ per ounce) was seen as overvalued. The profligate spending due to the Vietnam war and the welfare programs during the 1960’s meant that the dollar was seen as being overvalued against its gold reserves. A few countries tried to withdraw the gold that they had sent to the United States for safekeeping.
After a run on its gold reserves, in August 1971, then-President Nixon declared a temporary suspension of the dollar’s convertibility into gold and thus the original Bretton Woods system collapsed. By 1973, the Bretton Woods system was replaced by freely floating fiat currencies. The dollar subsequently lost 20 per cent of its value (devalued against gold).
Unconditional support by the United States for Israel during the 1973 Yom Kippur war angered the Middle Eastern Arab states. These oil producing OPEC states placed an oil embargo on the United States. As a result of this, the price of oil quadrupled, causing a severe economic shock for US and other oil importing nations. This added to the stagflation of the 1970’s increasing economic misery in United States. To better relations with Saudis and bring down oil prices, President Nixon in July 1974 sent his Treasury Secretary William Simon on a secret mission to negotiate a deal with the Saudis.
As per the agreement US would buy oil from Saudi Arabia and provide the kingdom with military aid/hardware. In return, the Saudis would use their oil wealth (which had gone up a lot especially given the price rise) to buy US Treasuries (i.e.US debt). This mechanism (of pricing oil in just US dollars) was soon adopted by other OPEC countries. This once again confirmed the hegemony of the US dollar as the mechanism for global trade (for e.g., oil purchases in the British pound fell from 20 per cent to 6 per cent in just a couple of years post this event).
This was referred as to the “Petrodollar” system, where oil was exclusively priced in US dollars and the oil producing nations, in return, ploughed their oil revenue money back in the United States. The purchase of US Treasuries with the oil revenue helped to keep the US dollar strong and the US debt cheap.
The US government, due to these foreign purchases of US debt, was able to keep borrowing costs lower and was unencumbered to generate even more larger sums of debt which it used to finance wars, social welfare programs etc., over the next few decades. For the OPEC nations, it allowed them to park their excess money in US Treasuries which was considered as one of the safest investment products around given the long-term stability of the dollar system and the US government creditworthiness (i.e., implicit understanding of not defaulting on their debt obligations). Read More at https://swarajyamag.com/world/weaponisation-of-the-dollar-and-the-end-of-its-role-as-the-global-reserve-currency
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