Guest Post: The Coming Collapse Of The Petrodollar System

Tyler Durden's picture

Authored by Andrew McKillop,

PETRODOLLAR WAR

The theory of Petrodollar Warfare can be attributed to US analyst and author William R Clarke, and his 2005 book of that title which interpreted the US-UK decision to invade Iraq in 2003. He called this an "oil currency war", but the concept of the petrodollar system and petrodollar recyling dates back to the eve of the first Oil Shock in 1973-1974. The role of the petrodollar system as a driving force of US foreign policy is explained by analysts and historians as basic to maintaining the dollar's status as the world's dominant reserve currency - and the currency in which oil is priced.

The term "petrodollar warfare" as used by William R. Clark says that major international war, legal or not, was seen as justified to protect the petrodollar system. Over and above the loss of human life, the combined costs of the Afghan and Iraq wars for the US are controversial like the interpretation of these wars as "oil wars", but analysts like Joseph Stiglitz and Linda Bilmes put the total combined war cost at above $4 trillion. This can be compared with - and totally dwarfs - the annual cost of US oil imports, which are now sharply declining on a year-in year-out basis as domestic shale oil output ramps up, and US oil demand stagnates.

Clarke's theory, like the explanation of the role and power of the "petrodollar system" depends on two basic drivers. Most major developed countries rely on oil imports, which are purchased using dollars, so they are forced to hold large stockpiles of dollars in order to continue importing oil. In turn this also creates consistent demand for dollars, and prevents the dollar from losing its relative international monetary value, regardless of what happens to the US economy.

 

Variants of the Petrodollar War concept include the role of oil currency conflicts and rivalry, notably concerning US relations with Iran, Venezuela and Russia, and possibly with Europe concerning the gradual replacement of US dollars with the euro, for oil transactions. More important, the entire petromoney system and the potential for Petrodollar War hinges on global oil import demand and the oil price. Both of these have to hold up. When or if they do not, foreign oil importer nations who formerly found it beneficial to hold dollars to pay for oil, would have to find some other (unexplained) reason for huge holdings of dollars, when their oil imports decline and-or oil prices also decline.

The "currency war" variant of the petrodollar system theory, holding that a shift to notably euros or gold for oil payments would undermine the system, is unrealistic when given any serious analysis, because all world moneys are interchangeable or convertible, and gold is priced in US dollars.

 

THE THREE PHASES OF THE SYSTEM

These are easy to define.

1974-1986 The first phase. The 1972 start of "petrodollar recycling" initiated by Nixon and Kissinger  just before the fivefold rise in oil prices of 1973-74, set the process of US-Saudi Arabian cooperation for the near-exclusive benefit of these two players. The US dollar was "backstopped" by the transfer of Saudi liquidities to the US Federal Reserve system banks, especially the Federal Reserve Bank of New York.  A small number of other chosen central banks, especially the Bank of England, and the central banks of Germany, France, Italy and Japan also benefitted.

1986-1999 The second phase. This also featured US and Saudi control, but under Clinton's two mandates the focus radically changed to the controlled deflation or reduction of both oil prices and the world value of the US dollar. While the US continued to benefit from "petrodollar recycling", Saudi Arabia was the major loser, undoubtedly changing its perceptions of the system's utility to KSA.

2000-2013 The third and last phase. This period featured a major longterm rise in oil prices and the entry not in force, but progressively of the euro currency into the now enlarged "petromoney recycling" process. Euros now cover about 25% of global oil transactions, for an annual value of around €700 billion, with about the same amount of back-to-back additional lquidities. The massive growth of QE and central bank "easing", from 2008, has heavily reduced the role of "petromoney recycling".

Among the major changes of the petromoney system during these 3 phases, the first phase set the basic political concept among US deciders that "petrodollar recycling" could at one and the same time enable the US to run huge trade and budget deficits, low or very low interest rates, and prevent the collapse of the dollar's value due to the forced need of all world buyers of oil to hold US dollars to make purchases of oil. By the second phase, this underlying concept shaded to including non-oil assets as the focus of value manipulation, controlled inflation and controlled deflation of value. In the third phase, massive increases of the oil price to 2008 played a major role in enabling the continued depreciation of the dollar's world value as US sovereign debt also massively increased, but since 2008 and the start of central bank QE the need for, and role of the petrodollar system have heavily contracted.

 

THE SYSTEM IS NOW MENACED

Estimates of the exact size and role of petrodollars and petroeuros in the international money system, finance system, and economic system are varied. Many analysts however say the minimum role of the petrodollar system is to create, back-to-back, liquidities at least equivalent to the transaction value of the world oil trade, which for crude and products is about $3.4 trillion-a-year. Combined, the approximate minimum total $6.8 trillion annual value of oil trade plus the petromoney system is about 10% of world annual GNP, equivalent to about 45% of US annual GDP. This may appear as still large and important but has to be compared with, for example, the exposure of national private banks only in Europe in relation to national GDPs, which is often 300% - 400%.

Only QE can "plaster over" these liabilities.

Petromoney recycling is still treated by "the elites" as a critical prop to monetary system integrity, and explains why the USA is far from the only country depending on the system holding up. All oil producers, even smaller-sized, are beneficiaries the same way as all major developed nations' central banks, but the US is still the prime beneficiary. However, the basic supports for the system's operation - continuing high oil demand, high oil prices, and oil priced in dollars -  have all weakened or are threatened, today. In particular when global oil demand declines or stagnates, and when oil prices decline, the dollars that will no longer be needed for global purchases of oil will return in massive amounts back to their country of origin, the USA. The consequences can only be dramatic, and threaten the start of a process completely unlike the Clinton-era controlled devaluation of the dollar's value along with the decline of oil prices consented by Saudi Arabia.

The now-menaced "petrodollar system" is also weakened because of worldwide change in the perception of oil and oil energy. From the dawn of the petroleum age to its accelerating twilight, today, geopolitical strategies concocted by developed nations featured the maintenance of secured access to world oil supplies. This was believed to be a win-win strategy for developed nation policy makers, and especially for US policy makers. From the 1970s and the first Oil Shock of 1973-1974, the only "morph' in this policy and strategy was to substitute expensive oil, for cheap oil.

For the USA's ability to run deficits and the petrodollar system, much higher oil prices were a major gain, not a loss, and this is almost surely still the perception of the Obama administration today.

In its first phase and last phase, the economic and political incentives for ensuring national access to oil supplies, and the existence of the petrodollar system as a monetary and finance tool - unrelated to the economy - worked better with higher oil prices. Today however, with the major and massive changes of oil resource availability revealed by the shale energy revolution, rising global oil production capabilities, stagnating oil demand, and rising renewable energy supplies in all major developed countries, and the constantly declining role of oil in the economy, the Petrodollar System's days are surely numbered, like the notion that $100-oil prices are "normal".

The impact of this will be massive.