by Jim Rickards via Daily Reckoning
Investors have been speculating for years about the demise of the “petrodollar” deal struck by Henry Kissinger and Treasury Secretary William Simon in 1974.
It was first set up between the U.S. and Saudi princes to prop up the U.S. dollar. At the time, confidence in the dollar was on shaky ground because President Nixon had ended gold convertibility of dollars in 1971.
In 1974, the price of oil was skyrocketing, partly due to inflationary policies pursued by the Federal Reserve, and partly due to an Arab oil embargo in response to U.S. aid to Israel in the Arab-Israeli Yom Kippur War of 1973.
The world economy was under threat unless a way could be found to “recycle” the dollars the Arabs were receiving back into U.S. banks. President Nixon and Henry Kissinger asked Simon to negotiate with Saudi Arabia on this issue.
Kissinger and Simon worked out a plan. If the Saudis would price oil in dollars, U.S. banks would hold the dollar deposits for the Saudis.
The Saudis and other OPEC members agreed that oil would be priced in dollars (the “petrodollar”) and the dollars would be deposited with U.S. banks so they could be loaned to developing economies who could then buy U.S. manufactured goods and agricultural products.
This would help the global economy and help the U.S. maintain price stability. The Saudis would get more customers and a stable dollar, and the U.S. would force the world to accept dollars because everyone would need the dollars to buy oil.
Behind this “deal” was a not so subtle threat to invade Saudi Arabia and take the oil by force. I personally discussed these invasion plans in the White House with Kissinger’s deputy, Helmut Sonnenfeldt, at the time. But the petrodollar plan worked brilliantly and the invasion never happened.
Now, almost 50 years later, the entire arrangement is in jeopardy.
According to a recent Reuters article, the Saudis themselves are confirming that they may be getting ready to push the dollar to one side when it comes to setting the price for oil. Why?
The reason is that the U.S. Congress is considering legislation that would expose OPEC members to U.S. antitrust lawsuits. Saudi Arabia has said that if that pending legislation becomes law, they will end the petrodollar deal.
The result would be that oil could be priced in euros, yen, yuan or even gold. The result for the U.S. dollar and U.S. economy would be catastrophic. It may not happen, but the fact that such threats are being voiced in public should give you pause. The cracks in the dollar are already getting larger.
The best protection for investors is to allocate part of your assets to gold as insurance against a collapse in the dollar.