DID YOU KNOW?
After the collapse of the Bretton Woods gold standard in the early 1970s, the United States struck a deal with Saudi Arabia to standardize oil prices in dollar terms.
Through this deal, the petrodollar system was born, along with a shift away from pegged exchanged rates and gold-backed currencies to non-backed, floating rate regimes (Fiat).
The effect of steering to the petrodollar is what maintained the USD as the global currency reserve.
By “agreeing” to have its currency used as a reserve currency, a country can pin its hands behind its back. To keep the global economy chugging along, it may have to inject large amounts of currency into circulation, driving up inflation at home.
The more popular the reserve currency is relative to other currencies, the higher its exchange rate and the less competitive domestic exporting industries become. This causes a trade deficit for the currency-issuing country (U.S.) but makes the world happy.
If the reserve currency country instead decides to focus on domestic monetary policy by not issuing more currency, then the world becomes unhappy. So a country that issues a reserve currency must balance its interests with the responsibility to make monetary decisions that benefit other countries. Issuing a reserve currency means that monetary policy is no longer a domestic-only issue, it’s international.
The U.S. Government has to balance the desire to keep unemployment low and economic growth steady with its responsibility to make monetary decisions that will benefit other countries. If another currency were to become the world’s reserve currency of choice the dollar would likely depreciate relative to other currencies, which could boost exports and lower the trade deficit.
The bigger issue would be an increase in borrowing costs as demand for a constant flow of dollars tapered off, which could have a severe impact on the ability of the U.S. to repay its debt or fund domestic programs.
The U.S. kind of fell into its reserve currency role from the aftermath of a war torn world. The U.S. had a stable political climate, did not experience the ravages of world wars like Europe had, and had a steadily growing economy that was large enough to absorb shocks.
As it stands today what used to be a beneficial allure to being a reserve currency has lost its appeal to other nations, such as China, who have become content with the U.S. holding the status.
Thus, it allows their sovereign currency to depreciate relative to other currencies while boosting and maintaining their exports and keeping trade deficits balanced. (Trade deficit, simply put, means you have more product going out then you have coming in or more coming in then you have going out).
The more balanced the trade cycles, the better an economy can stabilize. When that balance is drastically different, one way or the other, importing countries find themselves reliant on the goods from exporting countries and the exporting countries, in order to maintain their manufacturing base, find themselves reliant on the importing nations. Oil being the most traded commodity.
So again we are faced with another strange coincidence. The oil wars began March 8, 2020 and a week or so later the WHO declared the pandemic. So imagine that phone call to Saudi Arabia. “ Look guys, we are going to announce a global pandemic prohibiting air travel and ordering everybody to stay home, Just a thought, but you might want to dump as much of your oil as you can, cause ain’t nobody going to be buying it”.
Coincidence? Yeah right!
How does basic commodity production work? Since the topic is “oil”, we’ll dissect it. The oil is pumped from wells-it then is shipped and stored in holding tanks via pipelines trucks and trains .From the holding tanks, it is moved to shipping tankers and the ships then deliver it to other destination holding tanks.
From those holding tanks, it is sent to refineries who process the oil into all fossil based products, gas, diesel, asphalt, kerosene, plastics and a slew of other byproducts. All of which are then sold to the retail markets.
When people quit buying the products, (no demand) the whole thing goes back down the supply chain all the way to the oil wells who then need to shut down. The wells shut down (holding tanks are full, and no place to send the freshly pumped oil, the revenues cease, and the petrodollar (supporting the USD as the currency reserve) takes a haircut and the global economy is turned upside-down.
All other commodities follow the same scenario. Grow it or mine it, store it, ship it to be processed (packaged or smelted) deliver for retail consumption.
Business 101, if you want to get something done, create a demand. Doesn’t really matter what it is, if there is a demand for it, it will get done.
In a good ole capitalistic society we call it a “sale”.
We can only guess at the future of the petrodollar and in turn the future of the USD as a global currency reserve and the ramifications to the economies if it doesn’t work itself out. But one can’t help but assume there is an alternative plan in play for global economics.