The petrodollar system’s demise appears to be imminent. It has enormous geopolitical and financial consequences that most investors don’t understand.
BY Nick Giambruno for International Man
It’s been rightly said that “he who holds the gold makes the rules.”
After World War 2, the US had the largest gold reserves in the world, by far. Along with winning the war, this let the US reconstruct the global monetary system around the dollar.
The new system, created at the Bretton Woods Conference in 1944, tied the currencies of virtually every country in the world to the US dollar through a fixed exchange rate. It also tied the US dollar to gold at a fixed rate of $35 per ounce.
The dollar was said to be “as good as gold.”
The Bretton Woods system made the US dollar the world’s premier reserve currency. It forced other countries to store dollars for international trade or to exchange with the US government for gold.
However, it was doomed to fail.
Runaway spending on warfare and welfare caused the US government to print more dollars than it could back with gold at the promised price.
By the late 1960s, the number of dollars circulating had drastically increased relative to the amount of gold backing them. This encouraged foreign countries to exchange their dollars for gold, draining the US gold supply at an alarming rate.
To plug the drain, President Nixon “temporarily” suspended the dollar’s convertibility into gold in 1971. This ended the Bretton Woods system and severed the dollar’s last tie to gold.
The “temporary” suspension is still in effect today. And it’s had profound geopolitical consequences.
Most critically, it eliminated the main reason foreign countries stored large amounts of US dollars and used the US dollar for international trade. As a result, oil-producing countries began to demand payment in gold instead of rapidly depreciating dollars.
It was clear the US would have to create a new monetary system to stabilize the dollar. So it concocted a new scheme… and chose Saudi Arabia as its ally. This agreement came to be known as the “petrodollar system.”
The US handpicked Saudi Arabia because of the kingdom’s vast petroleum reserves and its dominant position in the global oil market.
In essence, the petrodollar system was an agreement that the US would guarantee the House of Saud’s survival. In exchange, Saudi Arabia would do three things.
First, it would use its dominant position in OPEC to ensure that all oil transactions would only happen in US dollars.
Second, it would recycle hundreds of billions of US dollars from annual oil revenue into US Treasuries. This lets the US issue more debt and finance previously unimaginable budget deficits.
Third, it would guarantee the price of oil within limits acceptable to the US and prevent another oil embargo.
The petrodollar system gave foreign countries another compelling reason to hold and use the dollar. And it preserved the dollar’s unique status as the world’s top reserve currency.
But… why oil?
Unmatched Geopolitical Power
Oil is the largest and most strategic commodity market in the world.
As you can see in the chart below, it dwarfs all other major commodity markets combined. The annual production value of the oil market is ten times bigger than the gold market for example.
Global Commodity Markets (Billions)
Every country needs oil. And if foreign countries need US dollars to buy oil, they have a compelling reason to hold US dollars.
Think about it… If Italy wants to buy oil from Kuwait, it must purchase US dollars on the foreign exchange market to pay for the oil first.
This creates a huge artificial market for US dollars.
This is what differentiates the US dollar from a purely local currency, like the Mexican peso.
The dollar is just a middleman. It’s used in countless transactions, amounting to trillions of dollars that have nothing to do with US products or services.
Since the oil market is enormous, it acts as a benchmark for international trade. If foreign countries are already using dollars for oil, it’s just easier to use the dollar for other international trade.
In addition to nearly all oil sales, the US dollar is used for about 80% of all international transactions.
This gives the US unmatched geopolitical power.
The US can sanction or exclude virtually any country from the US dollar-based financial system at the flip of a switch.
By extension, it can also cut off any country from most international trade. And that would be a financial kiss of death. This creates a powerful incentive for governments to stay in Washington’s good graces.
The petrodollar system is why people and businesses worldwide take US dollars. They have had little choice but to accept this.
Today, the biggest US exports are dollars and government debt. The US government can create unlimited quantities of both… from nothing.
It requires no effort to create US dollars, which can then be exchanged for real things like French wine, Italian cars, electronics from Korea, or Chinese manufactured goods.
Ultimately, the petrodollar boosts the US dollar’s purchasing power. This is because it entices foreigners to soak up many of the new currency units the Fed creates.
The system has helped create a deeper, more liquid market for the dollar and US Treasuries. It also helps the US keep interest rates artificially low. This allows the US government to finance enormous deficits it otherwise would be unable to.
This kind of spending would otherwise be impossible without destroying the currency through money printing.
It’s hard to overstate how much the petrodollar system benefits the US. It’s the bedrock of the US financial system.
China, the Saudis, and a Paradigm Shift
For nearly 50 years, the Saudis had always insisted anyone wanting their oil would need to pay with US dollars, upholding their end of the petrodollar system.
But that could all change soon…
China is the world’s largest importer of oil and Saudi Arabia’s top customer. Beijing buys over 25% of Saudi oil exports.
The Wall Street Journal recently reported that the Chinese and the Saudis had entered into serious discussions to price Saudi oil exports to China in yuan instead of dollars.
The WSJ article claims the Saudis are angry at the US for not supporting it enough in its war against Yemen. They were further dismayed by the US withdrawal from Afghanistan and the nuclear negotiations with Iran.
In short, the Saudis don’t think the US is holding up its end of the deal. So they don’t feel like they should hold up their part. In this context, the Saudis have entered serious talks with China to sell oil in yuan.
Even the WSJ admits such a move would be disastrous for the US dollar.
“The Saudi move could chip away at the supremacy of the US dollar in the international financial system, which Washington has relied on for decades to print Treasury bills it uses to finance its budget deficit.”
Here’s the bottom line.
Saudi Arabia is flirting in the open with China about pricing oil in yuan. It signals an imminent and enormous change for anyone holding US dollars. It would be incredibly foolish to ignore this giant red warning sign.
We are likely on the cusp of a historic financial earthquake…
One that could alter that direction of the US forever and mark the biggest economic event of our lifetimes.
Yet few people are aware of what is happening.
Oil for Gold (and Bitcoin)… the End of the Petrodollar and What It Means for You
The US government reaps an unfathomable amount of power from its racket of printing fake money out of thin air and forcing it on the world.
The petrodollar system is a big reason it has gotten away with this scam for so long.
Oil is by far the largest and most strategic commodity market. For the last 50 years, virtually anyone who wanted to import oil needed US dollars to pay for it.
Every country needs oil. And if foreign countries need US dollars to buy oil, they have a compelling reason to hold large dollar reserves.
This creates a huge artificial market for US dollars and forces foreigners to soak up many of the new currency units the Fed creates. Naturally, this gives a tremendous boost to the value of the dollar.
The system has helped create a deeper, more liquid market for the dollar and US Treasuries. It also allows the US government to keep interest rates artificially low, thereby financing enormous deficits it otherwise would be unable to.
In short, the petrodollar system is the bedrock of the US financial system.
That’s why the US government protects it so fiercely. It needs the system to survive.
World leaders who have challenged the petrodollar have ended up dead…
Take Saddam Hussein and Muammar Gaddafi, for example. Each led a large oil-producing country—Iraq, and Libya, respectively. And both tried to sell their oil for something other than US dollars before US military interventions led to their deaths.
Of course, there were other reasons the US toppled Saddam and Gaddafi. But protecting the petrodollar was a serious consideration, at the very least.
When countries like Iraq and Libya challenge the petrodollar system, it’s one thing. The US military can dispatch them with ease.
However, it’s a whole other dynamic when Russia and China undermine the petrodollar system… which is happening in a big way right now.
Russia and China are the only countries with sophisticated enough nuclear arsenals to go toe-to-toe with the US up to the top of the military escalation ladder.
In other words, the US military can’t attack Russia and China with impunity because they can match each move up to all-out nuclear war—the very top of the military escalation ladder.
For this reason, the US is deterred from entering into a direct military conflict with Russia and China—even though they are about to strike a fatal blow to the petrodollar system.
The top Russian energy official recently made it explicit. He said Russia would accept gold or Bitcoin in return for its oil.
“If they want to buy, let them pay either in hard currency—and this is gold for us… you can also trade Bitcoins.”
Here’s the bottom line.
The petrodollar system’s demise appears to be imminent. It has enormous geopolitical and financial consequences that most investors don’t understand.
The Real Reason for China and Russia’s Massive Gold Stash
It’s no secret that China and Russia have been stashing away as much gold as they can for many years.
China is the world’s largest producer and buyer of gold. Russia is number two.
Today it’s clear why China and Russia have had an insatiable demand for gold.
They’ve been waiting for the right moment to pull the rug from beneath the petrodollar system. And now is that moment…
After it invaded Ukraine, the US government kicked Russia out of the dollar system and seized hundreds of billions in dollar reserves of the Russian central bank.
Washington has threatened to do the same to China for years. These threats helped ensure that China cracked down on North Korea, didn’t invade Taiwan, and did other things the US wanted.
These threats against China may be a bluff, but if the US government carried them out—as it recently did against Russia—it would be like dropping a financial nuclear bomb on Beijing. Without access to dollars, China would struggle to import oil and engage in international trade. As a result, its economy would come to a grinding halt, an intolerable threat to the Chinese government.
China would rather not depend on an adversary like this. This is one of the main reasons it created an alternative to the petrodollar system.
This system will allow anyone in the world to trade oil for gold. It will bypass the US dollar, financial system, and sanctions.
Here’s how it works…
After years of preparation, the Shanghai International Energy Exchange (INE) launched a crude oil futures contract denominated in Chinese yuan in 2017. Since then, any oil producer can sell its oil for something besides US dollars… in this case, the Chinese yuan.
There’s one big issue, though. Most oil producers don’t want to accumulate a large reserve of yuan, and China knows this.
That’s why China has explicitly linked the crude futures contract with the ability to convert yuan into physical gold—without touching China’s official reserves—through gold exchanges in Shanghai (the world’s largest physical gold market) and Hong Kong.
PetroChina and Sinopec, two Chinese oil companies, provide liquidity to the yuan crude futures by being big buyers. So, if any oil producer wants to sell their oil in yuan (and gold indirectly), there will always be a bid.
After years of growth and working out the kinks, the INE yuan oil future contract is now ready for prime time.
It comes at the perfect moment.
Russia is the world’s largest energy producer.
China is the world’s largest energy importer, and Russia is Beijing’s largest oil supplier.
And now that the US has banned Russia from the dollar system, there is an urgent need for a credible system capable of handling hundreds of billions worth of oil sales outside of the US dollar and financial system.
The Shanghai International Energy Exchange is that system.
Other countries on Washington’s naughty list are enthusiastically signing up. For example, Iran—another major oil producer—accepts yuan as payment. So do Venezuela, Nigeria, and others.
Even Saudi Arabia—the linchpin of the petrodollar system—is flirting in the open with China about selling its oil in yuan. One way or another—and probably soon—the Chinese will find a way to compel the Saudis to accept the yuan.
China is already the world’s largest oil importer. Moreover, the amount of oil it imports continues to grow as it fuels an economy of over 1.4 billion people (more than 4x larger than the US).
The sheer size of the Chinese market makes it impossible for Saudi Arabia—and other oil exporters—to ignore China’s demands to pay in yuan indefinitely. The Shanghai International Energy Exchange further sweetens the deal for oil exporters.
Think about it…
An oil-producing country has two choices:
Option #1 – The Petrodollar
The dismal financial situation of the US guarantees the dollar will lose significant purchasing power.
Plus, there’s enormous political risk. Oil producers are exposed to the whims of the US government, which can confiscate their money whenever it wants, as it recently did to Russia.
Option #2 – Shanghai International Energy Exchange
Here, an oil producer can participate in the world’s largest market and try to capture more market share.
It can also easily convert and repatriate its proceeds into physical gold, an international form of money with no political risk.
From the perspective of an oil producer, the choice is a no-brainer.
Even though most people have not realized it yet, it marks the end of the petrodollar system and a new monetary era.
A lot of oil money—hundreds of billions of dollars and perhaps trillions—that would typically flow through banks in New York in US dollars into US Treasuries will instead flow through Shanghai into yuan and gold.
We could also see countries using Bitcoin to pay for oil, as the top Russian energy official recently suggested.
What Happens Next
Ron Paul knows more about the international monetary system than almost anyone alive.
He once gave a speech called “The End of Dollar Hegemony,” where he pointed out the one thing that would precipitate the US dollar’s collapse.
Here is the relevant part:
“The economic law that honest exchange demands only things of real value as currency cannot be repealed.
The chaos that one day will ensue from our experiment with worldwide fiat money will require a return to money of real value.
We will know that day is approaching when oil-producing countries demand gold, or its equivalent, for their oil rather than dollars or euros.
The sooner the better.”
Here’s the bottom line.
China, Russia, and other countries will ditch the dollar and use yuan, gold, and potentially Bitcoin to trade oil. It will be the end of the petrodollar system, and it is imminent.
For over 50 years, the petrodollar system has allowed the US government and many Americans to live way beyond their means.
The US takes this unique position for granted. But it will soon disappear.
There will be a lot of extra dollars floating around suddenly looking for a home now that they are not needed to purchase oil.
As a result, I expect inflation to skyrocket and a financial earthquake of historic proportions…
One that could alter that direction of the US forever and mark the biggest economic event of our lifetimes.
