The connection between the United States Dollar and gold are well documented, both here and across the web.
Once upon a time, U.S. currency was physical gold bullion itself. Even though paper money became more common in the twentieth century, currency remained tied to gold in some way through 1971.
However, things changed early on in the age of disco. The watershed moment was August 15 when President Richard Nixon announced the closing of the gold window. This event is seen by many economists and market observers as the day the “fiat” dollar was born.
What has happened in the 40+ years since? Did the dollar collapse? If not, what kept it from collapsing? What does this mean for gold and silver?
This important (but often overlooked) issue is perhaps one of the biggest concerns facing the future of the U.S. economy — and gold bullion investments.
How the Dollar Became World Currency
To understand the Petrodollar, we need to go back nearly 30 years before its creation — to 1944 and the Bretton Woods Agreement.
Made at the end of World War II, the agreement established the dollar as the world’s reserve currency. The British Pound filled the role before.
Investopedia defines reserve currency as “…a foreign currency held by central banks and other major financial institutions as a means to pay off international debt obligations, or to influence their domestic exchange rate.”
World nations agreed to the system since the dollar was overall solid. The U.S. had immense gold reserves and a strong economy.
At the end of World War II, this country was one of the only economic powerhouses not directly touched by the war. Also, foreign holders of dollars could trade their holdings for gold at a rate of $35 per ounce.
For many years, there were relatively few “withdrawals.” As the ‘60s came to a close, confidence in the dollar grew shaky, thanks to government spending on the Vietnam War and new entitlement programs like Medicare.
By 1971, confidence was so low that many wondered if the dollar would survive. On August 15, President Nixon officially closed the gold window, ending foreign holders’ ability to convert dollars into gold.
To prevent a complete collapse of the dollar — and to restore confidence — something had to replace gold.
Enter the Petrodollar
Between 1971 and 1974, several agreements with oil-rich nations, principally Saudi Arabia, were implemented.
These agreements, which eventually became known as the Petrodollar, established the requirement that foreign countries use dollars to buy oil. By 1975, all member-nations of Oil Producing and Exporting Countries (OPEC) adopted the Petrodollar.
Explained in the video below, the way it worked was pretty simple. If Italy wanted to buy oil from Kuwait, it had to purchase dollars on the foreign exchange markets. Of course, to buy dollars for every transaction was a headache, so naturally, many countries opted to buy dollars and hold them in reserve.
Using dollars to buy oil on the global market creates an artificial demand for U.S. currency and bonds. Of course, this allows the U.S. Government to export much of its debt since other countries really have no choice if they want to buy oil outside their borders.
Although the system has worked at keeping the U.S. dollar afloat for several decades, its day may be coming to an end.
Watch for Part II in our Petrodollar series, and learn more about troubles facing the system, and the effects any potential collapse could have on gold, silver and the U.S. economy.