Were you to ask most people on the street, even those who hold substantial investments, they would not be able to tell you what the Petro Dollar is, much less what it means to the U.S. economy. They would be overwhelmingly ignorant to the prosperity it has brought America and clueless to the consequences should it disappear.
So just what is the Petro Dollar? The short answer is it is the world’s reserve currency. A world reserve currency is the currency used to trade on a global scale. Have you notice how the price of oil is priced in U.S. dollars? That isn’t just for American traders, but for traders around the world. Hence the term “Petro Dollar” comes into play. However, it isn’t limited to oil, but for most transactions between nations. This is to make for a smoother, more uniform exchange of goods and monies, and also to provide stability against other inflationary currencies.
Since goods exchanged on the global market are bought and sold with U.S. dollars, any country doing business internationally cannot buy goods with their own currency. They first must exchange their currency into dollars, then make the transaction. Thus, it is in their country’s best interest to have a stable currency in relation to the dollar. Since they cannot print U.S. money, they are encouraged to keep a healthy value with the dollar. You can see this on any business channel on the ticker as it scrolls across the screen. It will show the value of the world’s major currencies in relationship to the U.S. dollar.
After World War II the dollar was declared the new reserve currency, mostly because of its stability backed with gold. What does this mean for the United States? For starters, this country does not have to buy another currency before making a transaction, so the cost of doing business is cheaper. Some estimates have us saving approximately $100 billion per year for this reason. We are also the only country that can print the dollar, and we have enjoyed low interest rates as we seek buyers for our bonds internationally as we have been allowed to live beyond our means.
What Keeps the World Faithful to a Reserve Currency Confidence. Other countries will observe and abide by the currency if they have faith in the stability of the currency. Several factors determine this like how much of the currency is backed by gold and other precious metals, how financially solvent and responsible the issuing country is, and the perceived status globally of the country, more precisely, does that country have good business relationships, and is that country engaging in antagonistic actions? It is essentially a feeling of goodwill toward the issuing country coupled with sound economic policies that keeps a reserve currency supreme.
What happens when that confidence and faith erodes? We really don’t have to speculate about this. The British Sterling was a reserve currency for the 19th and half of the 20th century for much of the world, but after being pummeled by two major wars and the emergence of the U.S. dollar as the global currency, it was quickly dethroned. Inflation ensued as a natural response, but the government compounded the problem by enacting more socialistic policies that continued to drain the treasury. As a result, by the 1970’s inflation had skyrocketed. Trash was piled in the streets because the government couldn’t afford to pay for services. It was not a good time to live in merry-old England.
The United States came out of World War II riding high. This is remarkable since we had been rocked by a depression for over a decade. Once the dollar was in place as the reserve currency, we began to enjoy a new prosperity, a prosperity that few nations could know, an economy allowing us to purchase cheaply, to borrow cheaply, to spend more, and to live beyond our means. There aren’t many people alive who remember life before this. It has been a way of life for so long, we do not know differently.
Our Friend Becomes Our Enemy
We are in trouble and don’t even know it. Ours has been the world reserve currency for about sixty years. Our economy has prospered because of it. We have been monetary royalty for decades. We have taken this status for granted, thus, have developed an attitude of invincibility, a complacency complex in which we tell ourselves nothing bad could really happen here. It is this view that will be our immediate enemy should things go awry.
Will things go awry? Will the United States ever lose its reserve status? The answer is almost an assured yes. No country remains at the top forever. Economies rise and fall, and we are no exception.
In today’s global market events happen at a greatly accelerated pace thanks primarily to the advent of the Internet and other forms of communication and transportation. As gigantic as it is, the world is much smaller today. In post World War II a rebuilt and revitalized Japan began to dominate the electronics market and soon after, the automotive market. The yen was strong and competing with the dollar for supremacy. There was a period in the 80’s where some economists were afraid the yen would win, and there was a negative view of our Japanese partners spreading through the populace.
We saw some fears that the European Union and its Euro would become stronger and replace us, as well. In the last decade we have seen a Chinese economy become dominate, and some economists see it surpassing our own in the near future. So far, we have been successful in remaining at the top of the world’s economy.
So what are we afraid of? The Japanese economy has been beaten up, and Europe is having crisis after crisis and not looking too stable at present. What about the Chinese? They have experienced phenomenal growth in almost every area, but we have recently seen that growth slow along with the rest of the world. And there is a consensus that their figures haven’t always been, shall we say, honest. They are trying a grand experiment that has been going on since they re-acquired Hong Kong, a jewel of capitalism. China is communist, the sworn enemy of capitalism, but the government is trying to fuse the two. It is not true capitalism and the people do not prosper as they would in a democratic society. They have no laws to protect the exploitation of its people. Thus, child labor and worker abuse is rampant. The usual party members and influential business leaders are the only winners in this experiment. While their economy is strong, some are beginning to believe we have seen their peak.
So, let’s ask again, what are we afraid of? The Japanese undermined their success by undertaking more social and deficit spending, an unwise move if yours is not the reserve currency. At some point the yen began to falter and Japan was removed as a potential threat economically.
The Europeans have been rushing towards socialist capitalism for decades, and as a result we have witnessed a decline in productivity while there’s been a dramatic increase is social spending and entitlements. Greece was the first to go belly-up and had to sell their collective soul to remain functional. More and more instability is spreading across the continent. Only Germany remains strong, but are they strong enough to carry the E.U? For now, we can scratch the E.U. as a credible economic threat.
China, as mentioned, will probably peak in the near future, if they haven’t already. While they presently flood the world with inexpensive goods, that is a bubble that will burst once the billion or so Chinese decide they want a larger piece of the pie. That would be tantamount to a revolution and chaos.
So let’s ask one more time, what are we afraid of?
Next: What Events Are Conspiring Against the Petro Dollar?