The Coming Collapse of the Petrodollar

Energy and money make the world go round. Just as the Spanish discovery of Aztec gold mines increased the value of the Spanish gold dollar, the agreements between the United States and Middle East countries has increased the value of the United States petrodollar. Industrial output, consumer transportation and international trade all benefit from stable energy prices.

When gasoline prices change dramatically, it can be difficult for individuals, businesses and governments to manage their budgets. The petrodollar was meant to stabilize energy prices. Unfortunately, since 2008, petroleum prices have experienced a violent roller coaster ride. How do volatile oil prices influence the petrodollar and payday loans?

Why Must Paper Currencies Be Backed by Real Assets?

A paper (fiat) currency is really just a receipt or IOU representing goods and services produced by a nation. The bearer of said IOU has earned the denomination value by his work or trade. Paper financial notes can also represent wealth, assets or income streams. Fiat currencies must be backed by real assets to qualify as a monetary store of wealth.

The Petrodollar Is an Important Linkage Between Real Assets and Currencies

When the United States won World War II, it inherited control over international trade from Great Britain. The British had adhered to the gold standard, which allowed for the British Pound and gold to be used as international reserve currencies. In 1948, the Bretton Woods agreement established the United States Dollar as international reserve currency while permitting nations to purchase from the American gold window.

Unfortunately, the United States started running out of gold and closed the gold window on August 15, 1971. International trade needed a new reserve currency foundation.

During the 1973-1974 Yom Kippur War between Arab nations and Israel, the Organization of Petroleum Exporting Countries (OPEC) instituted an oil embargo against the United States. In 1974, the petrodollar was created to resolve three major problems: 1. Replace Gold Standard, 2. Middle East Oil and 3. Israel. Georgetown University Faculty explained the importance of this creation: ” … petrodollar surpluses do not represent ‘real wealth’ but rather are a vehicle by which the latter can be acquired.”

The petrodollar created an economic bridge where oil prices could be quoted in dollars and sold to the West. In exchange, oil-producing countries would be paid with petrodollars, which could be recycled into United States Treasury Bonds.

Why Are Oil Prices Falling So Dramatically?

Since the US Dollar’s price is partially dependent upon petroleum, dramatic oil price changes could threaten the dollar. In 2008, the high price for the Brent Crude Oil was $143.95 per barrel on July 20. This was great for oil producing nations but bad for consumers.

During the 2008 Credit Crunch, oil fell to a low of $33.73 per barrel on December 26. Oil recovered a bit when the Federal Reserve intervened. In 2011, the oil price was starting to fall. After January 2015, the oil price started a precipitous decline, falling below $30 in January 2016. Oil exporting nations, such as Iraq, have become very worried because their budgets are oil-dependent.

This unraveling of the petrodollar agreement threatens to sever the relationship between OPEC and the United States. Oil producers may seek a better price on the open market and start to price their contracts in other currencies. Also, lower oil prices could reduce demand for United States Treasury Bonds and Dollars.

Economists disagree over the exact cause of the oil price declines. Zerohedge analysts have pointed out that the “Baltic Dry Index reaching a record low” suggests that international trade is weakening.

Lower Gas Prices Means Lower Transportation Costs

Gasoline prices may see more volatility if the petrodollar collapses, and this could affect transportation options. Individuals might want to upgrade their automobiles to take advantage of the new petroleum prices. Lower gasoline prices can impact transportation budget. More information can be found about these financial topics and more at the Personal Money Store finance blog.

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