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The Hegemony of the Almighty Dollar -- PART 2|
01 August 2014.
Oil going to international markets has been priced in dollars, at least since the 1920s but, for decades, sterling was used at least as frequently as dollars in order to settle transnational oil purchases, even after the dollar had replaced sterling as the world's preeminent trade and reserve currency.
As long as sterling was pegged to the dollar and the dollar was "as good as gold", this was economically viable.
But, after Washington abandoned dollar-gold convertibility and the world transitioned from fixed to floating exchange rates, the currency regime for oil trading was up for grabs.
With the end of dollar-gold convertibility, America's major allies in the Persian Gulf, the Shah's Iran, Kuwait, and Saudi Arabia, came to favor shifting OPEC's pricing system, from denominating prices in dollars, to denominating them in a basket of currencies.
In this environment, several of America's European allies revived the idea (first broached by Keynes at Bretton Woods) of providing international liquidity in the form of an IMF-issued, multilaterally-governed currency, so-called, Special Drawing Rights (SDRs).
After rising oil prices engorged their current accounts, Saudi Arabia and other Gulf Arab allies of the United States, pushed for OPEC to begin invoicing in SDRs.
They also endorsed European proposals to recycle petrodollar surpluses through the IMF, in order to encourage its emergence as the main post-Bretton Woods provider of international liquidity.
That would have meant Washington could not continue to print as many dollars, as it wanted to support rising consumption, mushrooming welfare expenditures, and sustained global power projection.
To avert this, American policymakers had to find new ways to incentivize foreigners to continue holding ever-larger surpluses of what were now fiat dollars.
To this end, U.S. administrations from the mid-1970s devised two strategies.
One was to maximize demand for dollars as a transactional currency.
The other was to reverse Bretton Woods restrictions on transnational capital flows; with financial liberalization, America could leverage the breadth and depth of its capital markets, and it could cover its chronic current account and fiscal deficits by attracting foreign capital at relatively low cost.
Forging strong links between hydrocarbon sales and the dollar proved critical on both fronts.
To forge such links, Washington effectively extorted its Gulf Arab allies, quietly conditioning U.S. guarantees of their security to their willingness to financially help the United States.
Reneging on pledges to its European and Japanese partners, the Ford administration clandestinely pushed Saudi Arabia and other Gulf Arab producers to recycle substantial parts of their petrodollar surpluses into the U.S. economy through private (largely U.S.) intermediaries, rather than through the IMF.
The Ford administration also elicited Gulf Arab support for Washington's strained finances, reaching secret deals with Saudi Arabia and the United Arab Emirates for their central banks to buy large volumes of U.S. Treasury securities outside normal auction processes.
These commitments helped Washington prevent the IMF from supplanting the United States as the main provider of international liquidity; they also gave a crucial early boost to Washington's ambitions to finance U.S. deficits by recycling foreign dollar surpluses via private capital markets and purchases of U.S. government securities.
A few years later, the Carter administration struck another secret deal with the Saudis, whereby Riyadh committed to exert its influence to ensure that OPEC continued pricing oil in dollars.
OPEC's commitment to the dollar as the invoice currency for international oil sales was key to broader embrace of the dollar as the oil market's reigning transactional currency.
As OPEC's administered price system collapsed in the mid-1980s, the Reagan administration encouraged universalized dollar invoicing for cross-border oil sales on new oil exchanges in London and New York.
Nearly universal pricing of oil and, later on, gas, in dollars, has bolstered the likelihood that hydrocarbon sales will not just be denominated in dollars, but settled in them as well, generating ongoing support for worldwide dollar demand.
In short, these bargains were instrumental in creating "dollar hegemony 2.0.".
And they have largely held up, despite periodic Gulf Arab dissatisfaction with America's Middle East policy, more fundamental U.S. estrangement from other major Gulf producers (Saddam Hussein's Iraq and the Islamic Republic of Iran), and a flurry of interest in the "petroEuro" in the early 2000s.
The Saudis, especially, have vigorously defended exclusive pricing of oil in dollars.
While Saudi Arabia and other major energy producers now accept payment for their oil exports in other major currencies, the larger share of the world's hydrocarbon sales continue to be settled in dollars, perpetuating the greenback's status as the world's top transactional currency.
Saudi Arabia and other Gulf Arab producers have supplemented their support for the oil-dollar nexus with ample purchases of advanced U.S. weapons.
Most have also pegged their currencies to the dollar, a commitment which senior Saudi officials describe as "strategic".
While the dollar's share of global reserves has dropped, Gulf Arab petrodollar recycling helps keep it the world's leading reserve currency.