The Petro-Dollar Cycle

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I read an article on the BBC today on the recent OPEC meeting and the closing statement of the Iranian president attacking the cartels ongoing policy to sell oil exports in US dollars, a currency that has steadily weakened over the last twelve months. This reminded me of some reading I started on the petro-dollar cycle, an economic cycle that is in place as a result of OPEC selling oil in dollars, and forms the basis of the US economy. I thought the consequences of such a statement could be profound, and so took to writing an article spread across two posts on The Shelf explaining the back ground of the petro-dollar cycle in order to better understand the effects its collapse would have.

In the 1940’s the US were somewhere near the largest exporter of world oil, which as such was exported in US dollars. As things changed with the development of extraction techniques the Middle Eastern became a key player in oil exports. Now Saudi Arabia is currently the largest producer and exporter of oil, and along with other countries who uncovered huge oil deposits at this time founded OPEC. The original intention was to limit production for consistent market so that overproduction didn’t devalue oil as an export product.

Upon the creation of OPEC the cartel first suggested selling OPEC oil globally in one of their domestic currencies, not the dollar. Around this time America’s support for Saudi Arabia in the Middle East began to grow. Saudi Arabia then agreed to sell OPEC oil in US dollars at the same time the Americans started to supply the countries arms. :| The economists will realise the significance of this move, as with Saudi support OPEC now decided to sell oil in US dollars. This decision was the foundation stone of America latter emerging as the world’s first superpower.

This is the case four decades latter today, and as the globes leading super power, America has been founded on two things; the dollar and its military.

It is important to point out that these two factors are inexplicably linked. Without the dominance of the dollar over other world currencies, Americans would have completely different spending trends, (unable to sustain huge credit deficits for one) and therefore the amount of money the US government had to invest in the military would have no doubt been reduced.

As a result of OPEC oil being sold in US dollars, Saudi Arabia stores all its export revenue from its oil in dollars in the federal reserve bank of New York. Around 70% of Saudi Arabia’s fortune is in that one American bank. As each country is responsible for printing its own currency the US Federal Reserve is the only place that the dollar can be printed. Any country therefore wishing to purchase oil as an import needs to store US dollars. As a result the likes of Japan will obtain US dollars buy selling Hondas to America, as one crude example. Those US dollars will then come back to America in the form of Saudi oil accounts. This fortune being held in US dollars therefore means America now in essence has an unlimited credit card at its disposal.

In terms of imports and other buying, it means the US can spend as much as it wants on the back of the Saudi Fortune, including military expenditure, and sustain a substantial national debt. This cycle has led to the US developing a distinct consumer culture. The birth of the ‘buy now pay later’ trend was all founded on this principle, know as the ‘petro-dollar cycle’.

The effects of this petro-dollar cycling collapsing will be contined in tomorrows post.


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