Thursday, December 13, 2012

PETRODOLLAR

 


WHAT DOES THE TERM PETRODOLLAR MEAN?

 

Many people don’t know what a Petrodollar is, or what the term means. Well guys allow me to preach and your job is to read.
Preparing to rebuild the international economic system as World War II was still intense, 730 delegates from all 44 Allied nations gathered at the Mount Washington Hotel in Bretton Woods, New Hampshire, United States, for the United Nations Monetary and Financial Conference. There was an obligation for each country to adopt a monetary policy that maintained the exchange rate by tying its currency to the U.S. dollar (PEG) which was the only currency to meet the rising demands for international currency transactions, because every 1/35Th of an ounce of gold was based to each US dollar. Once the agreement was settled in July 21, 1944 the Bretton Wood system was created. This was the first system that was intended to govern monetary relations amongst independent nations. This system collapsed when Nixon cut the Bretton Woods tie to gold in 1971 and did the oil for US dollars deal with Saudi Arabia in 1973.  
Because of the massive printing of the US dollar to cover the Vietnam War and welfare reform costs, Nixon worried about the strength of the United States currency. He knew that the United States, and the rest of the world was going to need and use more oil, and that Saudi Arabia wanted to sell the world’s largest economy (by far the US) more oil, Nixon and Saudi Arabia came to an agreement whereby Saudi oil could only be purchased in US dollars. This caused an immediate and strong global demand for US dollars. 

In 1973, Nixon struck a deal with Saudi Arabia, (without consulting with the members of the Bretton Wood agreement, nor his own state department) that every barrel of oil purchased from the Saudis would be in U.S. dollars. Under this new arrangement, any country that wanted to purchase oil from Saudi Arabia would be required to first exchange their own national currency for U.S. dollars. In exchange for Saudi Arabia's cooperation to change their oil sales exclusively in U.S. dollars, the United States offered weapons and protection of their oil fields from neighboring nations, including Israel. In 1975 every GCC (Golf Cooperation Council) member- Bahrain, Kuwait, Oman, Qatar, the United Arab Emirates (UAE) and Saudi Arabia supported oil pricing in dollars assuring the strength of the United States dollar post Bretton-Wood  era              
The term Petrodollar was created in 1973 by a Georgetown University economics professor, Ibrahim Oweiss, who established the need for a term that can describe the use of the dollar by Petroleum Exporting Countries (OPEC) in exchange for oil. Most oil sales throughout the world are conducted in United States Dollar (USD).  Because oil is the most demanded good in the world, most countries are forced to keep large stockpiles of dollars in order to continue to import oil.

When a country does not have a surplus of dollars it must creates a strategy in order to obtain them to buy oil. The easiest way to obtain US dollars is the exchange market, but this is not a long-term solution, so instead they export goods and products to the United States in exchange of  its dollar to purchase oil. For example Japan manufactures a Honda to the United States and immediately receives payments in dollars


The petrodollar system provides at least three immediate benefits to the United States.
· It increases global demand for U.S. dollars
· It increases global demand for U.S. debt securities
· It gives the United States the ability to buy oil with a currency it can print at will

 

PETRODOLLAR ILLUSTRATION

The petrodollar system has proven beneficial to the U.S. economy. In addition to creating a marketplace for affordable imported goods from countries that need U.S. dollars, there are more specific benefits. America receives a double loan out of every global oil transaction. First, oil consumers are required to purchase oil in U.S. dollars. Second, the excess profits of the oil-producing nations are then placed into U.S. government debt securities held in Western banks.
To help illustrate this point, let's imagine that you decided to open a hot dog stand in a small town with a population of 20,000. Of course, not everyone eats hot dogs, so only a certain percentage of your town's population will actually ever be a potential customer. And since you're obviously not the only hot dog stand in town, your competitors will all be attempting to reach the same portion of your town's population as you are.
Now, as an owner of a hot dog stand in a very small town, would you prefer to have demand for hot dogs from your own town only… or would you like to have hot dog demand from other nearby towns and communities too? (My guess is that you would like to have more customers, as that potentially means more money in your pocket.)
Now, let's take it a step further with another question…
Would you rather have demand for your hot dogs from your own town and nearby communities only or would you prefer to have all of the hot dog demand in your entire state?
Once again, the answer should be obvious.  To put it another way, if consumers all over your state are demanding your hot dogs, you have just been given a permission slip to hire more cooks so that you can produce more hot dogs.
Okay, now allow me to go even one ridiculous step further…
Imagine that Oprah Winfrey is driving through your state and just so happens to stop in at your growing hot dog stand. After Oprah tries your hot dog, she expresses excitement for your culinary skills. Oprah is now a raving fan of your hot dog joint and invites you onto her show to tell the whole world about your hot dogs.
It doesn't take an economist to figure out what is going to happen to the demand for your hotdogs… it is going to skyrocket.
As the demand for your hot dogs is increasing dramatically, so will the supply. Your new found global hot dog demand has given you a "permission slip" to buy even more frozen hot dogs and hire new fry cooks.
The important concept here is that a growing demand "permits" the producer to increase his supply.
Now, let's conclude our hot dog illustration by imagining that an up and coming rival hot dog company becomes a major competitor with your hot dog restaurant chain. As many of your customers begin visiting your new competitor, the demand for your hot dog begins to decrease. As the demand for your hot dogs drop, you no longer have a "permission slip" to buy as many hot dogs as you had before. As demand for your hot dog continues to fall, it makes little sense to hire more workers. Instead, to remain competitive, you must lay off workers and buy fewer hot dogs just to keep your company from closing down. Furthermore, you may even need to sell your existing hot dogs at a discount before they spoil.
If you decided to ignore the warning signs and continue hiring new employees and buying more hot dogs than were actually demanded by your customers, you would soon find your company nearing bankruptcy.
At some point, logic would dictate that you must decrease your supply.
How it all applies to the U.S. Dollar: Now, let's apply the same economic logic that I used to explain the increasing and decreasing demand for your hot dog to the global demand for U.S. dollars.
If it's only Americans who "demand" U.S. dollars, then the supply of dollars that Washington and the Federal Reserve can "supply", or create, is limited to our own country's demand.
However, if Washington can somehow create a growing global demand for its paper dollars, then it has given itself a "permission slip" to continually increase the supply of dollars.
This is exactly the type of scenario that the petrodollar system created in the early 1970's. By creating incentives for all oil-exporting nations to denominate their oil sales in U.S. dollars, the Washington elites effectively assured an increasing global demand for their currency. As the world became increasingly dependent on oil, this system paid handsome dividends to the U.S. by creating a consistent global demand for U.S. dollars.
And, of course, the Federal Reserves printing presses stood ready to meet this growing dollar demand with freshly printed U.S. dollars.
FACT: The artificial dollar demand created by the petrodollar system returned to Washington the "permission slip" to supply the global economy with freshly printed dollars that it lost after the fall of the Bretton Woods agreement.
The artificial dollar demand created by the petrodollar system has "permitted" Washington to go on multiple spending sprees to  create their "welfare and warfare" state.
And with so many dollars floating around the globe, America's asset prices (including houses, stocks, etc.) naturally rose. With this in mind, it is easy to see why maintaining a global demand for dollars is vital to our national "illusion of prosperity" and our "national security." When, not if, the petrodollar system collapses, America will lose its "permission slip" to print excessive amounts of U.S. dollars


POLITICAL WARS

         
Since the petrodollar existed there have been many nations that tried to oppose this system and create their own. In November 2000, Saddam Hussein became one of the first OPEC members to invoice oil sales in Euros under the United Nations (UN) Oil for Food Program. The Iraqi government used this as a political shot against the United States which at the time the was enforcing the UN sanctions against Iraq. 10 billion dollars was held by the French bank BNP Paribas to deny the UN Oil for Food Program, for Iraq. After the USA occupied Iraq, the new Iraqi government quickly returned the sale of oil to dollars. The United States to protrect their financial interests enforces that any country or regime that tries to change the invoice of oil trade will be dealt with.
Muammar Gaddafi harbored the Lockerbie Bombers and allowed many terrorist organizations establish training camps in Libya. He tried to buy a nuke from China in 1972. He baught nerve gas from Thailand.  In spite of well over fifty failed assassination attempts on Gaddafi by Israel, the US and the UK. Seeking nukes and harboring terrorists is one thing, but threatening the petrodollar is quite another.  Gaddafi made a fatal mistake when he decided to move away from the petrodollar in favor of other currencies. This was not tolerated by the US. Having already played the world police card in Iraq, the US made some phone calls and within a year, ‘rebels” rose up in rebellion against Gaddafi and now he is dead.     
The Iran situation is a little trickier. The US has tried to dissemble Iran’s government ever since the 1979 Iranian Revolution. So why, after thirty years of hostility, has the U.S. come up with this new story? As Obama stated in his recent State of the Union address, "When it comes to Iran and the insistence they dismantle their nuclear program, no options are off the table”. By stating ‘no options’ this would include “nuclear deployment”. The answer of course is that Iran is now seeking to disengage itself from the petrodollar. In 2005, Iran sought to create an Iranian Oil Exchange, bypassing the US controlled petrodollar. The US has created sanctions and has frozen Iranian accounts in Europe. But that is not stopping Iran. Iran sought other ways to get around the petrodollar lasso. There are rumors that India, which imports 12% of their oil from Iran, has agreed to purchase oil for gold. Energy trade with China, importing 15% of its oil and natural gas from Iran may be settled in gold, Yuan, and Rial. South Korea plans to buy 10% of their oil from Iran in 2012, and unless Seoul sides with American and European sanctions, it is likely to use gold or their sovereign currency to pay for it. Also, Iran is already dumping the dollar in its trade with Russia in favor of Rials and Rubles. So if the US doesn’t do it’s “World Police Work” a loaf of bread will cost $500.00 dollar instead of $1.00 dollar.

CONCLUSION


People talk about how we are in war for Oil, and how the petrodollar is bad. Think of the consequence that can happen if the US allows a different currency to be used and how it will affect your dollar. Check this article about attempts from other nations to change the way they do business 11 international agreements

Since 2000, US-Saudi (the strongest GCC member) relations have been deteriorating causing US dollar to loose in value overtime. Many GCC members have been trying to change the way they trade oil, but while changing currencies can be easy, changing the US military umbrella is not. (Always stick with the bug guys, with big guns). Let’s see how the Obama administration handles the financial interests of the United States.

 

 

 





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