Saudi Arabia has been in the news lately. “Crown Prince Mohammed bin Salman is leading a sweeping crackdown against what he has labeled ‘corruption’” among family members in the House of Saud. The net has ensnared at least 11 princes and maybe as many as 500 people, according to a November 8, 2017 New York Times article.
Saudi Arabia’s oil deposits are believed to be second only to Venezuela in size. According to Ron Chernow in The House of Morgan, Saudi Arabia’s link to the United States and to US oil companies goes back at least to 1933, when Standard Oil of California (SoCal) negotiated the first oil concession with the Saudi finance minister. At that time gold was the only Saudi currency, so they agreed to an initial 30,000 British pound gold loan, plus 5000 British pounds for the first year’s rent. The deal was nearly scuttled, because President Franklin D. Roosevelt had embargoed gold exports, and the Treasury denied SoCal—an American company—permission to ship gold from the US. To bypass the injunction, SoCal bought 35,000 gold sovereigns from a Guaranty Trust branch in London to seal the deal. By the 1940s, SoCal had brought Texaco, Standard Oil of New Jersey (later Exxon), and Socony Vacuum (later Mobil) into a partnership christened the Arabian-American Oil Company, or Aramco.
Saudi Arabia started buying shares in the company, and in 1980 took full control, renaming the company the Saudi Arabian Oil Company, or Saudi Aramco. Now, the crown prince Mohammed bin Salman has indicated he wants to sell five percent of the company on the stock market, and President Donald Trump is encouraging him to offer the first IPO on the NYSE. Saudi Aramco is the largest company in the world, with estimated value between two and ten trillion dollars.
Flashback to the events of July, 1944. As World War II was coming to an end, a financial conference was held at Bretton Woods, New Hampshire. Seven hundred thirty delegates from 44 allied nations attended, to plan for the reconstruction of a war-torn Europe. At that famous meeting, The International Bank of Reconstruction and Development (IBRD)--also known as the World Bank--and the International Monetary Fund (IMF) were established. The conference also designated the US dollar as the international reserve currency. At that time, the US held 80% of the world’s gold. By agreement, other currencies would be pegged to the dollar, which was pegged to gold at $35/ounce.
However, the US ramped up deficit spending after World War II, including spending $200-500 billion on the Vietnam war, instituting Lyndon B. Johnson’s “Great Society” programs in the 1960s (including Medicare/Medicaid, among others), and generally creating a “warfare state” and “welfare state.” The growing imbalance of US gold reserves to debt worried other nations. Britain, France, Germany, and others began cashing in their dollars for gold.
This depleted US gold reserves, so on August 15, 1971, US President Richard M. Nixon unilaterally ended the international convertibility from US dollars to gold, effectively breaking the Bretton Woods agreement. Nixon and Secretary of State Henry Kissinger knew going off the gold standard would reduce the international artificial demand for the dollar and would antagonize oil exporting nations, which suddenly were receiving less valuable dollars for their oil.
On October 17, 1973, Arab members of the OPEC imposed an embargo against the United States, partly in retaliation for the US decision to re-supply the Israeli military during the Arab-Israeli war (the Yom Kippur war). That same year, in 1973, the Nixon administration negotiated a deal with Saudi Arabia to ameliorate the situation by creating the “petrodollar.” Under this arrangement, every barrel of oil purchased by anyone from Saudi Arabia would be denominated in US dollars. In return, the US offered weapons and protection of oil fields from the neighboring nations, including Israel, according to Jerry Robinson, an economist at ftmdaily.com.. In addition, the Saudis were encouraged to deposit oil profits in Western banks, and to buy US Treasuries. This is called “petrodollar recycling,” as much of the money is returned to the US.
The oil embargo ended in March, 1974.
By 1975, all OPEC nations agreed to price oil only in US dollars, in exchange for weapons and military protection. Most also invested profits in US Treasuries. This created an immediate artificial demand for dollars worldwide, as any country wanting to buy OPEC oil had to procure US dollars to do so. This increased the incentive for foreign countries to export products to the United States, in order to receive dollars to buy Mid-East oil.
The US remains a major military presence in the Persian Gulf, in Bahrain, Iraq, Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates, Egypt, Israel, Jordan, and Yemen.
Robinson suggests that President George W. Bush’s insistence on invading Iraq in 2003 was the result of Iraq’s trying to denominate its oil price in euros in 2002. The result of the Iraq war was to re-establish the petrodollar system there. Robinson also notes that while the US claims to be a friend of Israel, its sworn enemies get eight times more US foreign aid than Israel does.
However, the petrodollar system is shaky. As of October, 2017, Venezuela and Iran have refused to accept US dollars for oil. China, which has now surpassed the US as Saudi oil purchaser, is pressuring Saudi Arabia to accept yuan for oil. Both Russia and China are backing at least part of their currencies with gold.
Iran has also refused to trade in US dollars. Economic sanctions—especially from Europe—have been lifted, and Iran is increasingly influential in Iraq, Syria, and Lebanon. According to Federico Pieraccini of globalresearch.ca, the continued presence of the US in Afghanistan is a move to interfere with Eurasian integration by China, Russia, and Iran. As soon as Vladimir Putin took power in Russia, he started moving to de-dollarize oil trade. Pieraccini says the Russo-Sino-Iranian strategy is to render the US irrelevant and to rein in the uncontrolled Federal Reserve spending.
These events raise several questions. First, if countries like Russia and China are moving back toward a gold standard, what will that do to the dollar, which is now merely fiat money? If major countries trade in other currencies—like a currency “basket” including yuan, ruples, and euros, such as Venezuelan president Nicolas Maduro has suggested—it will drastically reduce the artificial demand for the dollar. What if foreign investors start cashing in their US Treasuries? What currency will the Fed pay them in, if the dollar is worthless?
Even a superficial understanding of how the petrodollar system works may do more to explain US military involvement in the Mideast than all the chest-thumping about terrorism.