Oil in Us Economy

The reality is that the "safe harbor" status of the U.S. dollar since 1945 rests on it being the international reserve currency. Thus it has assumed the role of sole currency for global oil transactions (ie. 'petrodollar'). The U.S. prints hundreds of billions of fiat dollars, which U.S. consumers provide to other nations via the purchase of imported goods. These dollars become "petro-dollars" when are then used by those nation states to purchase oil/energy from OPEC producers (except Iraq, to some degree Venezuela, and perhaps Iran in the near future). Approximately $600 to $800 billion 'petrodollars' are annually from OPEC and invested back into the U.S. via Treasury Bills or other dollar-denominated assets such as U.S. stocks, bonds, real estate, etc. This recycling bolsters the dollar's international liquidity value.

In 1974 the Nixon administration negotiated assurances from Saudi Arabia to price oil in dollars only, and invest their surplus oil proceeds in U.S. Treasury Bills. In return the U.S. would protect the Saudi regime. These agreements created the phenomenon known as "petrodollar recycling." In effect, global oil consumption via OPEC provides a healthy subsidy to the U.S. economy. Hence, the Europeans created the euro to compete with the dollar as an alternative international reserve currency. Obviously the E.U. would also like oil priced in euros as well, as this would reduce or eliminate their currency risk for oil purchases.

The 'old rules' for valuation of the U.S. dollar currency and economic power were based on its flexible market, free flow of trade goods, high per worker productivity, manufacturing output/ trade surpluses, government oversight of accounting methodologies (ie. SEC), developed infrastructure, education system, and of course total cash flow and profitability. It’s superior military power afforded some additional confidence in the dollar. While many of these factors remain present, over the last two decades U.S has diluted some of the 'safe harbor' economic fundamentals. Despite vast imbalances and structural problems that are escalating within the U.S. economy, since 1974 the dollar as the monopoly oil currency created 'new rules'. The following excerpts from an Asia Times article discusses the virtues of the petrodollar hegemony (or vices from the perspective of developing nations, whose debt is denominated in dollars).

"Ever since 1971, when US president Richard Nixon took the dollar off the gold standard (at $35 per ounce) that had been agreed to at the Bretton Woods Conference at the end of World War II, the dollar has been a global monetary instrument that the United States, and only the United States, can produce by fiat. The dollar, now a fiat currency, is at a 16-year trade-weighted high despite record US current-account deficits and the status of the US as the leading debtor nation. The US national debt as of April 4 , 2003 was $6.021 trillion against a gross domestic product (GDP) of $9 trillion.

"World trade is now a game in which the US produces dollars and the rest of the world produces things that dollars can buy. The world's interlinked economies no longer trade to capture a comparative advantage; they compete in exports to capture needed dollars to service dollar-denominated foreign debts and to accumulate dollar reserves to sustain the exchange value of their domestic currencies. To prevent speculative and manipulative attacks on their currencies, the world's central banks must acquire and hold dollar reserves in corresponding amounts to their currencies in circulation. The higher the market pressure to devalue a particular currency, the more dollar reserves its central bank must hold. This creates a built-in support for a strong dollar that in turn forces the world's central banks to acquire and hold more dollar reserves, making it stronger. This phenomenon is known as dollar hegemony, which is created by the geopolitically constructed peculiarity that critical commodities, most notably oil, are denominated in dollars. Everyone accepts dollars because dollars can buy oil. The recycling of petro-dollars is the price the US has extracted from oil-producing countries for US tolerance of the oil-exporting cartel since 1973.

"By definition, dollar reserves must be invested in US assets, creating a capital-accounts surplus for the US economy. Even after a year of sharp correction, US stock valuation is still at a 25-year high and trading at a 56 percent premium compared with emerging markets.

". . . The US capital-account surplus in turn finances the US trade deficit. Moreover, any asset, regardless of location, that is denominated in dollars is a US asset in essence. When oil is denominated in dollars through US state action and the dollar is a fiat currency, the US essentially