Have you ever wondered why the US is such a close ally of Saudi Arabia?

Why Saudi Arabia is an Ally

Have you ever wondered why the US is such a close ally of Saudi Arabia that American presidents bow to the king and hold the Saudi Crown Prince’s hand.  This isn’t just because the Saudi are the low-cast swing producer of oil, with the potential to influence oil prices.

It’s also because the Saudis have historically had the power to enable the US to remain the global reserve currency and finance the US debt, even when the state of US finances would suggest it is undeserving of such a position.

Breton Woods: Setting up a “Rigged” System

In 1944 at Breton Woods. The British advised the US to setup a neutral financial system (using a unit of account known as the “Bancor“) to be used for international trade.  Each of the major economies would have a share of the Bancor in proportion to the size of its economy.

The American’s rejected the British proposal, instead favoring a global reserve currency in which the US maintained a dominant and exclusive share.

The British Warning

The British advised the US that this would benefit the US in the short term but would later cause distortions in the market as American exports would become more expensive.

The British warning proved to be accurate.  Although the entrance of China into the WTO has also been a significant factor, the structure of the dollar as the sole reserve currency has led to the exporting of supply chains — one of Trump’s chief complaints.  The Council of Foreign Relations has cited one of its own articles arguing that the US should voluntarily relinquish the global reserve currency, but that is unlikely to happen as long as the policy benefits elites.

Breaking our own “Rigged” System

After a series of budget deficits forced the US to abandon the gold standard, the US risked losing its dominant status.

In 1971, after large deficits caused by the military industrial complex, wars in Korea and Vietnam, and LBJ’s “Great Society” spending , Nixon was forced to abandon the Gold Standard.

Nixon said this was a temporary measure to thwart speculators, but in reality, American’s allies had lost faith in the US’s fiscal discipline.

After rigging the financial system so that America benefited from exclusivity as the reserve currency, America’s allies thought the US was failing to live up to its commitments in its own rigged game.

France calls America’s Bluff

France decided to call the US bluff by converting the paper dollars to gold at the official rate of $35 per ounce.  They loaded up a naval vessel with the paper dollars that the US had paid them and sent it to New Jersey.  They they requested that the US convert their dollars to gold at the advertised rate.  Since the market was pricing gold at a significantly higher price than the US’s official rate, the French were signaling in a very visible way that the US was effectively bankrupt, based on the gold standard they themselves designed.  Because the British and Germans also intended to follow the French, on Aug 15, 1971 Nixon announced that he was going to thwart speculators by “temporarily” suspending the dollar’s backing with gold.

The Saudi Alliance: Avoiding Fiscal Discipline

The US then faced a challenge of maintaining its power without having to restore fiscal discipline.  They did this by devising the petrodollar system in which

  1. Saudi Arabia agreed to price oil exclusively in USD and convince their friends in OPEC to follow suit.  This generated demand for US dollars because every country that wanted oil had to obtain dollars to purchase it.  It also generated demand for US Treasury bills to hold as foreign reserves.
  2. They agreed to take to profits from those dollars and secretly purchase US Treasury bonds, thereby financing US debt.
  3. They also agreed to purchase US military equipment, thereby funding the military industrial complex and, at the time, purchasing surplus weapons manufactured for the Vietnam War.

 

Recently

Mark Carney has proposed reviving the concept of the Bancor.  Carney is formerly Governor of the Bank of Canada and later Governor of the Bank of England.

Zhou Xiaochuan, the governor of the People’s Bank of China has also endorsed Keyne’s Bancor approach.

Columbia University professor Jeffery Sachs calls for multiple reserve currencies.

The Council of Foreign Relations says that proposals for alternative global reserve currencies are unlikely as long as the US has a veto at the IMF.