Written By Basilio Chen

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The short version is that a 1970 deal negotiated by President Nixon cemented the US dollar as the only currency to buy and sell crude oil, and from that monopoly on the all-important oil trade the US dollar slowly but surely became the reserve currency for global trades in most commodities and goods. Massive demand for US dollars ensued, pushing the dollar’s value up, up, and away. In addition, countries stored their excess US dollars savings in US Treasuries, giving the US government a vast pool of credit from which to draw.

The Petrodollar System

To explain this situation properly, start in 1973. President Nixon asked King Faisal of Saudi Arabia to accept only US dollars as payment for oil and to invest any excess profits in US Treasury bonds, notes, and bills. In exchange, Nixon pledged to protect Saudi Arabian oil fields from the Soviet Union and other interested nations, such as Iran and Iraq.

It was the start of something great for the US and constitutes the foundation for the monopoly of the US dollar and for it to become the reserve currency in the world.

By 1975 all of the members of OPEC agreed to sell their oil only in US dollars. Every oil-importing nation in the world started saving their surplus in US dollars so as to be able to buy oil; with such high demand for dollars the currency strengthened. On top of that, many oil-exporting nations like Saudi Arabia spent their US dollar surpluses on Treasury securities, providing a new, deep pool of lenders to support US government spending.

The “petrodollar” system was a brilliant political and economic move. With oil being the most necessary commodity aside from water. No country in the world can do without oil.  And any powerful country can lose it’s power because of lack of oil. 

The Petrodollar system forced the world’s oil money to flow through the US Federal Reserve, creating ever-growing international demand for both US dollars and US debt, while essentially letting the US pretty much own the world’s oil for free, since oil’s value is denominated in a currency that America controls and prints.

The result of the petrodollar system spread beyond oil: with every country dependent on oil, and all oil purchases requiring US Dollar, the US Dollar solidify by pure need and demand its position as the reserve currency of the world – the majority of international trade is done in US dollars, as long as oil is purchased only in US Dollar.

That means that from Russia to China, Brazil to South Korea, every country aims to maximize the US-dollar surplus garnered from its export trade to buy oil.