The Petro-Dollar Standard In Crisis


–Boy, it sure isn’t a good look for the land of the free and the home of the brave that American-made F-16s and M1 Abrams battle tanks are out in force across Egypt now. But cosmetics and theatrics aside, there’s a bigger story here: the entire geopolitical arrangement that has grown up around the U.S. dollar standard is unravelling. The modest task of today’s Daily Reckoning is to figure out what that means for your investments.

–First we should probably back-pedal on our statement above about Middle East tyrannies being supported by American policy and American weapons. Or wait, should we? Hmm. The fact the Egyptian Army is now in the streets of Cairo and NOT firing on people is an argument that the Army itself may force out Egyptian President Hosni Mubarak and end his 30-year U.S.-backed rule.

–Whatever happens in the next few days, it’s getting clearer by the day that as global food and fuel prices rise (Bernanke exports), so does political instability. Of course if you’re in Egypt and have been living under the heel of the State for 30 years, a little instability might be welcome. In fact, the desire for stability—to freeze things as they are so we can control them and manage them just the way we like—is often the motivator for more State control in private and public life.

–Viva instability!

–Financial markets continue to operate when geopolitical tensions rise. But they shift to risk aversion. For example, spot gold was up $23.50 in Friday trading. Short-sellers must have taken one look at the pictures coming from Cairo and decided to cover their bet on falling gold prices. Over in America the Dow fell 1.39%.

–It’s obvious that in the short-term, a crisis in Egypt is bearish for stocks and bullish for oil and precious metals. But you are not paying for the Daily Reckoning to read what is obvious to everyone. So what is the un-obvious point to take away from the last few days? Well we actually count four separate points.

–Watch out Europe.  Energy is capital. A U.S. dollar rally cannot be ruled out. Seek out public companies with many years of energy reserves.

–Why should Europe watch out? Popular protests can spread like a bad cold. Egypt may not be experiencing a revolution so much as a changing of the institutional guard. And it’s unlikely, in our view, that the wave of anger/resentment/optimism spreading through North Africa will reach, say, Saudi Arabia and its 263 billion barrels of light sweet crude oil. But like a psychic tsunami, that wave could travel across the Mediterranean and into Europe.

–There are large populations of North African immigrants in Europe’s major cities. Many of them arrived at the end of World War Two. They provided cheap labour for Europe’s rebuilding economies. Are those large immigrant populations now a potential source of even more unrest in Europe?

–Well, the art of organising protests to take down the authorities is refined each time one of these “revolutions” takes place. Facebook, Twitter, YouTube, flash mobs, it’s all getting pretty sophisticated…and very difficult to shut down (even when the State does the ham-fisted thing and turns out the lights on the Internet.)

— Popular uprisings happen at the margin. A small, well-organised cadre of individuals can set a whole process in motion that reaches a tipping point. And after that, all bets are off. You never quite know where your revolution/uprising will take you.

–What’s happening in Egypt is not just something to watch on Sky News over dinner. It’s a preview of what may happen in the developed world too in coming years. The reasons will be different. In the developed world it will happen because of the corrupt and debt-laden financial system continues to reward the elites at the top at the expense of the Middle Class.  But the results (a deposed or decapitated leadership) may be the same.

–So good luck Europe and good luck the Euro!

–The second point is energy itself (especially crude oil) is a kind of capital in a world where there’s a bear market in paper money. Energy is normally just a commodity. It’s an economic input that, along with labour, land, and capital combines to bring you goods and services.

— But the urbanisation and population of the modern world would not be possible without cheap energy. These days, access to cheap and abundant energy is as important as anything else if you want to ensure your economic competitiveness. If you don’t have energy,  or at least a boatload of money to bid for it, you have nothing.

–You could further argue that the U.S. dollar is the world’s reserve currency because of its relationship with energy. The Saudis agreed to price oil in U.S. dollars in exchange for a U.S. security umbrella. But as the dollar is sabotaged from within by Ben Bernanke and Tim Geithner, all the geopolitical arrangements that evolved around the dollar standard—including the pricing of oil in dollars and the security of oil producing regimes—is slowly crumbling like the crust of a three-day old homemade apple pie.

–The unravelling of this strategic arrangement for energy puts a geopolitical premium on the actual ownership of oil, gas, coal, and uranium. Australia scores pretty well in three out of those four categories. But you still have to be careful. If you own a company that has large energy reserves, are those reserves located in politically risky areas?

–Point three: watch out for a U.S. dollar rally. You may disagree with your editor that the Euro could be a surprising next victim of the events in North Africa. But when S&P downgraded Japan last week, it was definitely dollar bullish. Betting on a dollar rally to contain inflation while U.S. deficits show no sign of getting smaller is admittedly pretty contrarian. But you shouldn’t rule it out.

–And keep in mind that dollar strength against the Yen and the Euro is only relative.  You don’t have to be a dollar bull to see that it could go up against other paper currencies in the next few weeks. The important price to watch is gold. If gold goes up against all paper currencies even as the dollar clobbers the Euro and the Yen, you’ll know the primary trend of the last ten years is still firmly in place.

–Finally, alluding to the point we made above, the big takeaway for investors is to look at your portfolio and find out if you have enough exposure to energy stocks. The oil price climbed over the weekend. It wasn’t because Egypt is a major exporter of oil (it’s not) or that the Suez Canal is critical to the flow of oil to Europe (it’s not, the canal was built in the 19th century and is not big enough to handle modern super tankers).

–But it’s the speculation that U.S.-backed authoritarian regimes in the Middle East may now be living on borrowed time…THAT’s what has oil speculators worried. As well they should be.


Dan Denning
for Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.


  1. Dan, this statement is not totally correct:

    “The Saudis agreed to price oil in U.S. dollars in exchange for a U.S. security umbrella.”

    The agreement was made between the house and the oil companies to settle in gold. This went on for about a decade before the companies had to visit the US gold window as the payments started getting too big. The US then made a deal to provide paper gold contracts for later delivery for a portion of the oil and to settle the balance in Dollars, giving the external apparency of a stable US dollar vs oil.

    This is how the US dollar moved from being gold backed to being ‘oil backed’, i.e. redeemable for oil. This is what underpinned the reserve status. At this point gold was unpegged from the dollar, and golds price suppression scheme was commenced, so that the true rate of debasement could not be observed. At this point, the US could then tax the world through deflating the value of their reserves. There was a bit of a hitch for a while in the early 70’s the US didn’t want to pay in gold, this was externally seen as a shortage.

    The reason the US could not be seen buying oil with gold was that gold was not a controllable reserve.

    This is the reason why there is so much controversy regarding the unaudited gold in knox. So many believe it;s not there any more.

    For a tad more history, this agreement continued being played until the early 90’s. Around that time some large gold buyers from asia started hoovering all the physical, threatening a comex default for all that unbacked paper gold. This threatened the goldoil agreement, as now the oil nations could see the physical being removed from the bullion banks. Once that agreement ended, bye, bye low oil prices. It’s been going up even since, if for no other reason than dollars paid in oil are now chasing floating physical gold showing the true rate of inflation. Oil is still buying gold at a discount though, with spot suppressed by bullion banks operating a fractional reserve, which apparently is near 100:1.

    “Betting on a dollar rally to contain inflation while U.S. deficits show no sign of getting smaller is admittedly pretty contrarian.”

    Agreed. It’s a risk off. While the oil rally and threat to stability exists, here will be more people sitting in dollars outside equities. Each dollar oil rises however destroys 100billion in US business, business that generates tax receipts the USD is backed by. Ignoring the debt woes, clearly the rally is short term and will be eaten away as business is destroyed, and the US slumps even more.

    ” If gold goes up against all paper currencies even as the dollar clobbers the Euro and the Yen, you’ll know the primary trend of the last ten years is still firmly in place.”

    Guys, be very careful reading gold and silver charts. There is large scale manipulation in these markets that aims to depict and paint the chart in VERY methodical ways. I would advise AGAINST buying gold if you are looking at the chart and think ‘its going up’. If you have other reasons from reading FOFOA, Jsmineset, Harvey Organ, etc to buy gold, then ignore this. But whatever you do, don’t confuse the orderly retreat against gold as ‘gains’. The pullbacks are staged. Cyclical, sometimes having pullbacks at -exactly- the same scale.

    Chris in IT
    February 1, 2011
  2. “The oil price climbed over the weekend. It wasn’t because Egypt is a major exporter of oil (it’s not) or that the Suez Canal is critical to the flow of oil to Europe (it’s not, the canal was built in the 19th century and is not big enough to handle modern super tankers).”

    Excellent comment. I didn’t know the Suez could not move oil in modern scales.

    Chris in IT
    February 1, 2011
  3. At the end of World War II, an agreement was reached at the Bretton Woods Conference which pegged the value of gold at US$35 per ounce and that became the international standard against which currency was measured. But in 1971, US President Richard Nixon took the US$ off the gold standard and ever since the US$ has been the most important global monetary instrument, and only the US can produce them. However, there were problems with this arrangement not least of all that the dollar was effectively worthless than before it reneged on the gold-standard. But more importantly because it was the world’s reserve currency, everybody was saving their surpluses in US$. To maintain the US$’s pre-eminence, the Richard Nixon administration impressed upon Saudi Arabia and therefore OPEC (Organisation of Petroleum Exporting Countries) to sell their oil only in US$. This did two things; it meant that oil sales supported the US$ and also allowed the USA access to exchange risk free oil. The USA propagates war to protect its oil supplies, but even more importantly, to safeguard the strength of the US$. The fear of the consequences of a weaker US$, particularly higher oil prices is seen as underlying and explaining many aspects of the US foreign policy, including the Iraq and Libyan War. The reality is that the value of the US$ is determined by the fact that oil is sold in US$. If the denomination changes to another currency, such as the euro, many countries would sell US$and cause the banks to shift their reserves, as they would no longer need US$ to buy oil. This would thus weaken the US$ relative to the euro. A leading motive of the US in the Iraq war — perhaps the fundamental underlying motive, even more than the control of the oil itself — is an attempt to preserve the US$ as the leading oil trading currency. Since it is the USA that prints the US$, they control the flow of oil. Period. When oil is denominated in US$ through US state action and the US$ is the only fiat currency for trading in oil, an argument can be made that the USA essentially owns the world’s oil for free.
    So long as almost three quarter of world trade is done in US$, the US$ is the currency which central banks accumulate as reserves. But central banks, whether China or Japan or Brazil or Russia, do not simply stack US$ in their vaults. Currencies have one advantage over gold. A central bank can use it to buy the state bonds of the issuer, the USA. Most countries around the world are forced to control trade deficits or face currency collapse. Not the USA. This is because of the US$ reserve currency role. And the underpinning of the reserve role is the petrodollar. Every nation needs to get US$ to import oil, some more than others. This means their trade targets US$ countries.
    Because oil is an essential commodity for every nation, the Petrodollar system, which exists to the present, demands the buildup of huge trade surpluses in order to accumulate US$ surpluses. This is the case for every country but one — the USA which controls the US$ and prints it at will or fiat. Because today the majority of all international trade is done in US$, countries must go abroad to get the means of payment they cannot themselves issue. The entire global trade structure today works around this dynamic, from Russia to China, from Brazil to South Korea and Japan. Everyone aims to maximize US$ surpluses from their export trade.
    Until November 2000, no OPEC country dared violate the dollar price rule. So long as the US$ was the strongest currency, there was little reason to as well. But November was when French and other Euroland members finally convinced Saddam Hussein to defy the USA by selling Iraq’s oil-for-food not in US$, ‘the enemy currency’ as Iraq named it, but only in euros. The euros were on deposit in a special UN account of the leading French bank, BNP Paribas. Radio Liberty of the US State Department ran a short wire on the news and the story was quickly hushed.
    This little-noted Iraq move to defy the US$ in favor of the euro, in itself, was insignificant. Yet, if it were to spread, especially at a point the US$ was already weakening, it could create a panic selloff of US$ by foreign central banks and OPEC oil producers. In the months before the latest Iraq war, hints in this direction were heard from Russia, Iran, Indonesia and even Venezuela. An Iranian OPEC official, Javad Yarjani, delivered a detailed analysis of how OPEC at some future point might sell its oil to the EU for euros not US$. He spoke in April, 2002 in Oviedo Spain at the invitation of the EU. All indications are that the Iraq war was seized on as the easiest way to deliver a deadly pre-emptive warning to OPEC and others, not to flirt with abandoning the Petro-dollar system in favor of one based on the euro.
    Informed banking circles in the City of London and elsewhere in Europe privately confirm the significance of that little-noted Iraq move from petro-dollar to petro-euro. ‘The Iraq move was a declaration of war against the US$’, one senior London banker told me recently. ‘As soon as it was clear that Britain and the US had taken Iraq, a great sigh of relief was heard in London City banks. They said privately, “now we don’t have to worry about that damn euro threat”.
    First Iraq and then Libya decided to challenge the petrodollar system and stop selling all their oil for US$, shortly before each country was attacked.The cost of war is not nearly as big as it is made out to be. The cost of not going to war would be horrendous for the US unless there were another way of protecting the US$’s world trade dominance.
    Guess how USA pays for the wars? By printing US$ it is going to war to protect.
    After considerable delay, Iran opened an oil bourse which does not accept US$. Many people fear that the move will give added reason for the USA to overthrow the Iranian regime as a means to close the bourse and revert Iran’s oil transaction currency to US$. In 2006 Venezuela indicated support of Iran’s decision to offer global oil trade in euro.
    6 months before the US moved into Iraq to take down Saddam Hussein, Iraq had made the move to accept Euros instead of US$ for oil, and this became a threat to the global dominance of the US$ as the reserve currency, and its dominion as the petrodollar.
    Muammar Qaddafi made a similarly bold move: he initiated a movement to refuse the US$ and the euro, and called on Arab and African nations to use a new currency instead, the gold dinar. Muammar Qaddafi suggested establishing a united African continent, with its 200 million people using this single currency. The initiative was viewed negatively by the USA and the European Union, with French president Nicolas Sarkozy calling Libya a threat to the financial security of mankind; but Muammar Qaddafi continued his push for the creation of a united Africa.
    Muammar Gaddafi’s recent proposal to introduce a gold dinar for Africa revives the notion of an Islamic gold dinar floated in 2003 by Malaysian Prime Minister Mahathir Mohamad, as well as by some Islamist movements. The notion, which contravenes IMF rules and is designed to bypass them, has had trouble getting started. But today Iran, China, Russia, and India are stocking more and more gold rather than US$.
    If Muammar Qaddafi were to succeed in creating an African Union backed by Libya’s currency and gold reserves, France, still the predominant economic power in most of its former Central African colonies, would be the chief loser. The plans to spark the Benghazi rebellion were initiated by French intelligence services in November 2010.
    – Nalliah Thayabharan

    Nalliah Thayabharan
    September 10, 2011

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