Several readers have been in touch in recent months to share their concerns about the U.S. dollar.

They are worried about the possibility of the U.S. dollar losing its reserve currency status to other currencies… most notably, the Chinese yuan.

Last month, I showed you why the U.S. dollar remains the strongest world currency.

It draws its strength from being the primary reserve currency worldwide.

About 60% of the world’s foreign exchange trading involves the dollar. Roughly about as much of the world’s debt is also issued in dollars.

That’s not to say the dollar is without its challengers…

I recently sent you an excerpt of my 2018 book, Collusion, in which I told the story of China’s earlier efforts to undermine the U.S. dollar. (If you missed it, you can catch up here.)

Now, while I see no danger of it supplanting the U.S. dollar in our lifetimes, there’s no denying that China is pushing its currency, the yuan, forward on the world stage.

At the center of these efforts is the emergence of a so-called petroyuan. This refers to oil futures contracts priced in yuan.

This is a direct challenge to the U.S. dollar’s exclusive role in oil markets. Currently over 90% of all oil traded globally is priced in U.S. dollars. This is why the dollar is often referred to as the “petrodollar.”

So today, in the first of a two-part series, I’ll show you how the petrodollar came into existence. And how it underpins the U.S. dollar’s status as the world’s top reserve currency.

And tomorrow, I’ll tell you all about China’s challenge to undermine the U.S. dollar.

America Closes the “Gold Window”…

The U.S. promised to convert any dollars brought to it by other countries into gold at a rate of $35 per ounce.

In essence, the entire Western financial system was pegged to gold, via the U.S. dollar.

But in 1971, the Bretton Woods System effectively came to an end.

At the time, the U.S.’ gold stock was dwindling. It was reaching the point where it didn’t have enough gold reserves to cover the amount of foreign-held dollars. President Nixon feared a run on our gold stock.

So on August 15, 1971, he closed the international gold window.

This stopped countries converting their U.S. dollars to gold. And it brought an end to the postwar system of international exchange rate stability.

…And Opens the “Black Gold Window”

This move also put the U.S. dollar’s position as the world’s reserve currency in danger…

But Nixon had a trick up his sleeve…

In 1974, along with his Secretary of State, Henry Kissinger, Nixon struck a deal with the Saudi Royal Family. Saudi Arabia agreed to price all international oil sales exclusively in U.S. dollars.

At the time, Saudi Arabia was the third-largest oil producer in the world, behind the Soviet Union and the United States.

This marked the opening of what some like to call the “black gold window.”

Oil is often referred to as “black gold” because of its color and its high economic value.

By 1975, all OPEC nations agreed to settle oil trades exclusively in dollars.

The Organization of the Petroleum Exporting Countries (OPEC) is an international alliance of oil producers, including Saudi Arabia, the United Arab Emirates, Kuwait, and Venezuela. Set up in 1960, it has a major influence over oil supply and prices.

The upshot was that all countries still needed U.S. dollars to purchase oil. And this helped the dollar to maintain its status as the world’s primary reserve currency.

Petrodollar Recycling Benefits U.S. Dollar

Now, all those dollars received by Saudi Arabia and other oil exporters needed to make a rate of return to be useful. Remember, they could no longer be exchanged for gold…

Enter petrodollar recycling.

The basic framework of this was strikingly simple. The U.S. would buy oil from Saudi Arabia and provide it with military protection and weapons.

In return, the Saudis would plow billions of their petrodollar revenue back into U.S. Treasuries.

Both parties benefited from this relationship immensely.

By 1977, Saudi Arabia had accumulated about 20% of all the U.S. Treasuries held abroad.

And in the U.S., the increased demand for government securities reduced interest rates. This essentially financed America’s spending because it made capital cheaper and boosted investment.

These are the factors that have cemented America’s status as the world’s economic superpower.

And again, other oil-producing countries followed Saudi Arabia’s lead.

By 1975, all members of OPEC were recycling their U.S. dollar surpluses through U.S. financial markets.

To this day, many oil-producing countries continue to invest their petrodollars in U.S. stocks, bonds, and other financial instruments.

Where the U.S. Dollar Stands Today

Taking the U.S. dollar off the gold standard could well have undermined U.S. financial authority. But the U.S.-Saudi agreement to price oil purchases exclusively in U.S. dollars saved the day.

The deal effectively kept the U.S. dollar as the world’s reserve currency (even after the breakdown of the Bretton Woods System).

This was critically important. Had the dollar lost its reserve status, the consequences would have been dire for Americans.

At best, it would have pushed up interest rates for American consumers and businesses, making everything from buying a house to building a factory more expensive.

At worst, it could have caused a run on the U.S. dollar as international creditors rushed for the exits. This may well have triggered a global financial calamity and hyperinflation.

Today, the petrodollar continues to serve as a crucial support for the U.S. dollar. As I said above, over 90% of global oil sales are priced in dollars.

This incentivizes other countries to hold dollars. And it encourages petrodollar recycling, further propping up the U.S. dollar as the world reserve currency.

This is where we stand today.

But the U.S. dollar has competition… from China. And while I don’t think the dollar is in immediate danger, it’s worth keeping an eye on any significant developments.

So tomorrow, I’ll show you what China is doing to challenge the U.S. dollar’s dominance in the oil market… and on the global stage.

Stay tuned…



Nomi Prins
Editor, Inside Wall Street with Nomi Prins

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