The downturn of the pandemic economy has hit many groups hard. But for many millennials — those born between 1981 and 1996 — and Generation Z, who follow them, that pain — plus a number of other factors — are creating questions about who is responsible. Over the next few nights, economics correspondent Paul Solman is going to examine this. He begins tonight from the perspective of some millennials.
The vast majority of Americans – 71% – think the economy is rigged against them. Guess what – they’re right. How do you rig an economy? You start with the U.S. tax code.
We held a conversation about the nation’s tax code with Erica Payne, founder and President of the Patriotic Millionaires, a group of high-net worth Americans, business leaders, and investors who are united in their concern about the destabilizing concentration of wealth and power in America, and Morris Pearl, Chair of the Patriotic Millionaires and former managing director at BlackRock, Inc. They’ll discuss exactly how “the rich”—and the politicians they control—manipulate the U.S. tax code to ensure the rich get richer, and what reforms are needed to ensure our tax code reduces, rather than increases, economic inequality.
Morris Pearl, Chair, Patriotic Millionaires; former managing director, BlackRock, Inc.
Erica Payne, founder and President, Patriotic Millionaires
Good Government would make Bitcoin unnecessary.
- Confidence in governments and financial institutions is at an all time low.
- It was within the context of this alienation, that Bitcoin was created
- Bitcoin is designed to be an alternative or parallel system.
Many Elites take Bitcoin as an Insult
It is hard for a man/institution that is part of the political/economic establishment to understand the value of a project whose very existence was motivated by dissatisfaction with their work.
Many elites stand to lose power
Many elites benefit from federal reserve policy. A company like AT&T can borrow money from the Federal Reserve by issuing bonds that the Fed buys. Rather than use the money from that debt to invest, producing useful things, the executives at AT&T take the money and use it to buy back AT&T stock.
Stock buybacks increase a company’s stock price, allowing executives to collect their bonuses and profit from stock appreciation. Stock buybacks also inflate the stock market, tricking some Americans into thinking stock market gains are sign of a healthy economy.
Banks get special access to lower interest rates. They then charge a higher rate to the public and pocket the difference.
Goal: Ending the Cantillion Effect
The 18th century French banker Richard Cantillion observed that those closest to the printing press benefit more than those further away.
In Cantillion’s day, the money creation was done via gold mining. In our day the Federal Reserve’s “plumbing” requires it to act through the financial system of banks and other institutions, rather than interacting with citizens directly.
The result of the financial system’s structure is that hedge funds, private equity, and bankers have benefitted most from the money printing. It’s structural “trickle-down“.
Bitcoin has the potential to put everyone on a more level playing field because money would not be issued through institutions which have special privileges due to the nature of the financial plumbing.
How Bitcoin Started:
Bitcoin was not started as a get rich quick scheme. Rather it began with the:
- publication of an academic-style White Paper
- feedback from the community
- publication of the source code for Bitcoin
- feedback from the community
An Alternative to Printing Money
Bitcoin’s first transaction recorded a snapshot of a newspaper article titled: Chancellor on Brink of Second Bailout for Banks.
- Bitcoin’s decentralized governance and 21 million coin limit are designed to prevent further such bailouts
An Alternative to Government Digital Currencies
Many people are skeptical of the power that Government-issued digital currencies could provide governments.
If digital currencies are inevitable, which would you rather have:
- digital currencies designed and issued by governments like China and the US
- digital currencies designed and created by the private sector, including libertarian-spirited programmers and business people competing to be the choice of citizens
Distributed in the most fair way possible
While some later cryptocurrency creators have designated some of the first coins for themselves, the creator of Bitcoin was concerned about distributing the initial coins in the most fair way.
So rather than distributing newly issued coin to people they knew, Satoshi (the Bitcoin author’s pen name) decided to distribute Bitcoin only to those who perform work for the project. This means that Bitcoin is distributed only to those people who run servers that verify transactions. These “miners” can then chose to sell the coin they earn on the open market.
As time progresses, the strength of the encryption Bitcoin uses gets stronger and stronger, so that today it is strong enough to encrypt billion dollar transactions.
Creator of Bitcoin does not “Cash In”
The creator of Bitcoin chose not to patent their solution to the Byzantine General’s Problem and collected no payment for their work. The Byzantine General Problem is a mathematical problem that encapsulated the challenges present in a decentralized system of coming up with a common agreement when some parties may fail to return results and others may present fraudulent information. The solution to this problem allows systems to function without a trusted centralized system.
Contracts without Trusted Escrow
An example of the type of transaction that Bitcoin enables is a real estate purchase without an escrow agent.
Normally, the buyer of the house has to provide money to an escrow in advance so that the seller can trust the the buyer will make good on the purchase. With Bitcoin, a seller can verify that the buyer is using legitimate Bitcoin and within 10 minutes verify that the transaction has settled.
Bitcoin was considered virtually worthless
When Bitcoin was started, there was no price conversion between Bitcoins and dollars.
Many people who first got Bitcoin misplaced it because they didn’t think it was valuable.
In fact, people so underestimated the potential value of Bitcoin that the first real-world transaction was 2 pizzas for 10,000 bitcoin. Today, 10,000 bitcoin would be worth $350 million!
Can Bitcoin do what VISA does: 40,000 transactions per second?
VISA can handle 40,000 transactions per second, while Bitcoin can only handle about 7 transactions per second.
But VISA transactions depend upon the the rest of the banking system to settle its transactions. This involves both individual banks and the Federal Reserve
VISA has advertised that it would like to continue to operate as a payment network, but using Crpto as a means of funding, in addition to traditional bank accounts using dollars.
Bitcoin’s technology is superior to the Federal Reserve
Although some people still think of Bitcoin as a currency used for payments, the Bitcoin community chose in 2017 to make Bitcoin a high-performance settlement layer, akin to the Federal Reserve’s Fed Wire.
When VISA payments are processed then are not sent in real time. Rather the banks aggregate transactions and “net out” the totals. They then transfer a single total value to the member bank. These totals are much larger and fewer in number.
While Fedwire transfers can be completed in a day, Bitcoin transactions can settle a billion dollars in 10 minutes!
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
- 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.
- They agreed to take to profits from those dollars and secretly purchase US Treasury bonds, thereby financing US debt.
- 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.
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.
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.
Electronic copy available at: http://ssrn.com/abstract=2621599
USAEE Working Paper Series
Has the Petrodollar Had Its Day?
Dr Mamdouh G. Salameh
International Oil Economist
World Bank Consultant
UNIDO Technical Expert
Visiting Professor of Energy Economics at ESCP
Europe University, London
Oil Market Consultancy Service
Surrey GU27 3SJ
Tel: (01428) – 644137
Electronic copy available at: http://ssrn.com/abstract=2621599
Has the Petrodollar Had Its Day?
Dr Mamdouh G Salameh*
The petrodollar came into existence in 1973 in the wake of the collapse of the
international gold standard which was created in the aftermath of World War II under
the Bretton Woods agreements. These agreements also established the US dollar as
the reserve currency of the world. The Nixon Administration understood that the
collapse of the gold standard system would cause a decline in the global demand for
the US dollar. Maintaining demand for the US dollar was vital for the United States’
economy. So the United States under Nixon struck a deal in 1973 with Saudi Arabia.
Under the terms of the deal, the Saudis would agree to price all of their oil exports in
US dollars exclusively and be open to investing their surplus oil proceeds in US debt
securities. In return, the United States offered weapons and protection of Saudi
oilfields from neighbouring countries including Israel. For the Americans, the
petrodollar increases demand for the dollar and also for US debt securities and
allows the US to buy oil with a currency it can print at will. In 1975, all of the OPEC
nations agreed to follow suit. Maintaining the petrodollar is America’s primary goal.
Everything else is secondary. However, as the US dollar continued to lose
purchasing power, several oil-producing nations began to question the wisdom of
accepting increasingly devalued petrodollar for their oil exports. Several countries
have attempted to move away from the petrodollar, or already moved away.
Examples include Iraq under Saddam Hussein, Iran, Syria and Venezuela.
Additionally, other nations are choosing to use their own currencies for oil like China,
Russia and India. This paper will deal with the actions, incentives, and related
consequences that the United States has created through its attempts to maintain
global hegemony through the petrodollar. It will examine the latest challenges facing
the petrodollar and how the petrodollar system influences the United States’ foreign
policy. The paper will conclude that the petrodollar has had its day and that it will be
a matter of time before it becomes redundant with huge repercussions for the US
economy and the global economy.
Key Words: Petrodollar, Yuan, Reserve Currency, Inflation, Federal Reserve.
The petrodollar came into existence in 1973 in the wake of the collapse of the
international gold standard which was created in the aftermath of World War II under
the Bretton Woods agreements. These agreements also established the US dollar as
the reserve currency of the world. Former president Richard Nixon and his then
foreign secretary Henry Kissinger understood that the collapse of the gold standard
system would cause a decline in the global demand for the US dollar.
Electronic copy available at: http://ssrn.com/abstract=2621599
Maintaining that “artificial dollar demand” was vital for the United States’ economy.
So the United States under Nixon struck a deal in 1973 with Saudi Arabia under
which every barrel of oil purchased from the Saudis would be denominated in US
dollars only. Any country that sought to purchase oil from Saudi Arabia would be
required to first exchange its own national currency for dollars. Under the terms of
the deal, the Saudis would agree to price all of their oil exports in US dollars
exclusively and be open to investing their surplus oil proceeds in US debt securities.
In exchange, the United States offered weapons and protection of Saudi oilfields
from neighbouring countries including Israel.
For the Americans, the petrodollar increases demand for the dollar and also for US
debt securities and allows the US to buy oil with a currency it can print at will.
Maintaining the petrodollar is America’s primary goal. Everything else is secondary.
Without it, the US dollar would collapse. 1
In 1975, all of the OPEC nations agreed to follow suit. However, as the US dollar
continued to lose purchasing power, several oil-producing nations began to question
the wisdom of accepting increasingly worthless paper currency for their own oil
exports. Today, several countries have attempted to move away from the petrodollar,
or already moved away. Examples include Iraq under Saddam Hussein, Iran, Syria
and Venezuela. Additionally, other nations are choosing to use their own currencies
for oil like China, Russia and India. The petrodollar created an immediate demand
for US dollar around the globe thus enhancing its artificial value. And of course, as
global oil demand increased, so did the demand for the dollar. As more countries
continue to move away from the petrodollar, massive inflationary pressures could be
expected to strike the US economy. 2
What is Petrodollar?
The Petrodollar is the money that oil-exporting nations receive from selling their oil in
US dollar-denominated currency which is deposited into Western banks. The term
was first coined by Egyptian-born American economist, Professor Ibrahim M Oweiss
of Georgetown University in a pioneering work on petrodollar surpluses in 1974. 3
Under the Bretton Woods agreements, the US Dollar was pegged at a fixed rate to
gold. This made the US dollar completely convertible into gold at a fixed rate of $35
per ounce within the global economic community. This international convertibility into
gold allayed concerns about the fixed rate regime and created a sense of financial
security among nations in pegging their currencies’ value to the dollar. After all, the
Bretton Woods arrangements provided an escape hatch: if a particular nation no
longer felt comfortable with the dollar, they could easily convert their dollars holdings
into gold. This arrangement helped restore a much-needed stability in the financial
system. But it also created a strong global demand for US dollars as the preferred
medium of exchange (see Figure 1).
And along with this growing demand for US Dollars came the need for a
larger supply of dollars. This begs the question: Are there any obvious benefits from
creating more dollars? And if so, who benefits?
The United States government benefits from a global demand for US dollars. How?
It’s because a global demand for dollars gives the Federal government a
“permission” to print more. Is it a coincidence that printing dollars is the US
government’s preferred method of dealing with its economic problems?
Source: Courtesy of Jerry Robinson, FTM Daily.com.
One has to remember that Washington only has four basic ways to solve its
economic problems: (1) Increase revenue by raising taxes; (2) Cut spending by
reducing benefits; (3) Borrow money through the issuance of government bonds and
(4) Print money.
Raising taxes and making meaningful spending cuts can be political suicide.
Borrowing money is a politically convenient option, but you can only borrow so much.
That leaves the final option of printing money. Printing money requires no immediate
sacrifice and no spending cuts. However, printing more money than is needed can
lead to inflation. Therefore, if a country can somehow generate a global demand for
its currency, it will have a “permission” to print more money. Understanding this
“permission” concept will be important as we continue.
Finally, the primary beneficiary of an increased global demand for the US Dollar is
America’s central bank, the Federal Reserve.
The U.S. Dollar is issued and loaned to the United States government by the Federal
Reserve. Because the dollars are loaned to the US government by the Federal
Reserve, which is a private central banking cartel, the dollars must be paid back.
And not only must the dollars be paid back to the Federal Reserve. They must be
paid back with interest. And who sets the interest rate targets on the loaned dollars?
It’s the Federal Reserve, of course.
To put it simply, the Federal Reserve has a clear vested interest in maintaining a
stable and growing global demand for US Dollars because they create them and
then earn profit from them with interest rates which they set themselves.
In summary, the American consumer, the Federal government, and the Federal
Reserve all benefit to varying degrees from a global demand for US Dollars. There is
an old saying that goes, “He who holds the gold makes the rules.” This statement
has never been truer than in the case of America in the post–World War II era. By
the end of the war, nearly 80% of the world’s gold was sitting in US vaults, and the
U.S. Dollar had officially become the world’s undisputed reserve currency. 4
As a result of the Bretton Woods arrangements, the dollar was considered to be “as
safe as gold.”
A study of the United States economy in the post-World War II era demonstrates that
this was a time of dramatic economic growth and expansion. By the late 1960’s,
however, the American economy was under major pressure. Deficit spending in
Washington was uncontrollable as former US President Lyndon B. Johnson began to
realize his dream of the “Great Society.” Meanwhile, an expensive and unpopular
war in Vietnam funded by record deficit spending led some nations to question the
economic underpinnings of America. Vietnam, the Great Society, and deficit
Spending undermined the gold standard.
After all, the entire global economic order had become dependent upon a sound US
economy. Countries like Japan, Germany, and France, while fully on the mend from
the devastation of World War II, were still largely dependent upon a financially stable
American economy to maintain their economic growth.
By 1971, as America’s trade deficits increased and its domestic spending soared, the
perceived economic stability of the United States was being publicly challenged by
many nations around the globe. Foreign nations could sense the severe economic
difficulties mounting in Washington as the United States was under financial
pressure at home and abroad. According to most estimates, the Vietnam War had a
price tag in excess of $200 billion. This mounting debt, plus other debts incurred
through a series of poor fiscal and monetary policies, was highly problematic given
America’s global monetary role. 5
But it was not America’s financial issues that most concerned the international
economic community. Instead, it was the growing imbalance of US gold reserves to
debt levels that was most alarming.
The United States had accumulated large amounts of new debts but did not have the
money to pay for them. Making matters worse, US gold reserves were at all-time
lows as nation after nation began requesting gold in exchange for their dollar
holdings. It was almost as if foreign nations could see the writing on the wall for the
end of the Bretton Woods arrangements.
As 1971 progressed, so did foreign demand for US gold. Foreign central banks
began cashing in their excess dollars in exchange for the safety of gold. As nations
lined up to exchange their dollar holdings for Washington’s gold, the United States
realized that the game was over. Clearly, America had never intended to be the
globe’s gold warehouse. Instead, the convertibility of the dollar into gold was meant
to generate a global trust in US paper money. Simply knowing that the US dollar
could be converted into gold if necessary was good enough for some — but not for
everyone. The nations which began to doubt America’s ability to manage their own
finances decided to opt for the recognized safety of gold.
One would have expected that the large and growing demand by foreign nations for
gold instead of dollars would have given a strong signal to the United States to get
its fiscal house in order. Instead, America did exactly the opposite. As Washington
continued racking up enormous debts, foreign nations sped up their demand for
more US gold and fewer U.S. dollars. Washington was caught in its own trap and
was required to supply real money (gold) in return for the inflows of their paper
money (US dollars).
Soon the United States was bleeding gold. Washington knew that the system was no
longer viable, and certainly not sustainable. But what could they do to stem the
crisis? There were only two options. The first option would require that Washington
immediately reduce its massive spending and dramatically reduce its existing debts.
This option could possibly restore confidence in the long-term viability of the US
economy. The second option would be to increase the dollar price of gold to
accurately reflect the new economic realities. There was an inherent difficulty in both
of these options that made them unacceptable to the United States at the time. They
both required fiscal restraint and economic responsibility. Then, as now, there was
very little appetite for reducing consumption or changing the American way of life for
the sake of “sacrifice” or “responsibility.”
The Bretton Woods agreements created an international gold standard with the US
dollar as the ultimate beneficiary. But in an ironic twist of fate, the system that was
designed to bring stability to a war-torn global economy was threatening to plunge
world back into financial chaos.
On August 15, 1971, under the leadership of former President Nixon, Washington
chose to maintain its reckless consumption and debt patterns by detaching the US
Dollar from its convertibility into gold. By “closing the gold window,” Nixon destroyed
the final vestiges of the international gold standard. Nixon’s decision effectively
ended the practice of exchanging dollars for gold as directed under the Bretton
Woods agreements. It was in the year 1971, that the US dollar officially abandoned
the gold standard and was declared a purely “fiat” currency, a currency which
derives its value from its sponsoring government and is issued and accepted by
By “closing the gold window,” Washington had not only affected American economic
policy but also global economic policy. Under the international gold standard of
Bretton Woods, all currencies derived their value from the value of the dollar. And
the dollar derived its value from the fixed price of its gold reserves. But when the
dollar’s value was detached from gold, it became what economists call a “floating”
currency”. Put simply, a “floating” currency is a currency that is not fixed in value.
Like any commodity, the dollar could be affected by the market forces of supply and
demand. When the dollar became a “floating” currency, the rest of the world’s
currencies, which had been previously fixed to the dollar, suddenly became “floating”
currencies as well.
In this new era of floating currencies, the US Federal Reserve had finally freed itself
from the constraint of a gold standard. Now, the US dollar could be printed at will —
without the worry of not having enough gold reserves to back up new currency
production. And while this new-found monetary freedom would alleviate pressure on
America’s gold reserves, there were other concerns. One major concern that
Washington had was regarding a potential shift in global demand for the US
dollar. With the dollar no longer convertible into gold, would demand for the dollar by
foreign nations remain the same, or would it fall?
The second concern had to do with America’s extravagant spending habits. Under
the international gold standard of Bretton Woods, foreign nations gladly held US debt
securities, as they were denominated in gold-backed US dollars. Would foreign
nations still be eager to hold America’s debts despite the fact that these debts were
denominated by a heavily indebted paper currency? Once one understands this
“dollars for oil” arrangement, it becomes easier to get a better understanding of what
motivates America’s foreign policy.
Dollars for Oil Replace Dollars for Gold
Despite pressure from foreign nations to protect the dollar’s value by reining in
excessive government spending, Washington displayed little fiscal constraint and
continued to live far beyond its means. It had become obvious to all that America
lacked the basic fiscal discipline which could prevent the destruction of its own
Like previous governments before it, America had figured out how to “game” the
global reserve currency system for its own benefit, leaving foreign nations in an
economically vulnerable position. After America and its citizens have tasted the
sweet fruit of excessive living at the expense of other nations, they are not going to
change their way of life.
It is unfair, however, to say that the decision-makers in Washington were blind to the
deep economic issues confronting their country in the late 1960’s and early
1970’s.They were aware that the “dollars for gold” arrangement had become
completely unsustainable. But instead of seeking solutions to the global economic
imbalances that had been created by America’s excessive deficits, Washington’s
primary concern was how to gain an even greater stranglehold on the global
In order to ensure their economic hegemony, and thereby preserve an increasing
demand for the dollar, the Washington elites needed a plan. And in order for this
plan to succeed, it would require that the artificial dollar demand that had been lost in
the wake of the gold standard collapse be replaced through some other mechanism.
That plan came in the form of the petrodollar system.
Saudi Arabia to the Rescue
Saudi Arabia has a very long history of collaborating with the United States in
economic and geopolitical matters. The deal struck in 1973 between the United
States and Saudi Arabia to denominate all Saudi oil exports exclusively in US dollars
is but one case among many with the Saudis doing America’s bidding.
The most recent example of this collaboration is the steep decline in crude oil prices
since July 2014 with Saudi Arabia not only refusing to cut its production to bolster the
oil price but also exerting strong pressure on OPEC not to do so. Circumstantial
evidence suggests some political collusion between Saudi Arabia and the United
States behind the steep decline in the oil price since July 2014. 7
Saudi Arabia took advantage of the low oil prices to inflict damage on Iran’s
economy and weaken its influence in the Middle East in its proxy war with Iran over
its nuclear programme whilst the United States is taking advantage of the low oil
prices to weaken Russia’s economy and tighten the sanctions against Russia over
History repeats itself. Early in the 1980s, Sheikh Ahmad Zaki Yamani, the veteran,
former oil minister of Saudi Arabia, suddenly awoke to Saudi Arabia’s need for
market Share. He flooded the market with oil causing the oil price to collapse to
$10/barrel. It later transpired that the Saudi need for a market share was just a cover
for a CIA-Saudi conspiracy to hasten the demise of the former Soviet Union.
And now the Saudi oil minister Ali Al-Naimi is waking up to the same need. Al-Naimi
has followed in the exact footsteps of Yamani. He suddenly remembered at the
166th Meeting of the Conference of OPEC on the 27th of November 2014 the need
for Saudi market share. This is probably a cover for a new collusion between the
United States and Saudi Arabia to lower the oil prices in a new conspiracy against
Russia and Iran.
Whilst the key players have changed, the strategic objectives have remained the
The Primary Benefits of the Petrodollar for the United States
The petrodollar system has proven tremendously beneficial to the US economy. In
addition to creating a marketplace for affordable imported goods from countries who
need US dollars, there are more specific benefits. In essence, America receives a
double loan out of every global oil transaction.
The petrodollar system provides at least three immediate benefits to the United
States. It increases global demand for US dollars. It also increases global demand
for US debt securities and it gives the United States the ability to buy oil with a
currency it can print at will. Let’s briefly examine each one of these benefits.
One of the most brilliant
aspects of the petrodollar system was requesting that oil producing nations take their
excess oil profits and place them into US debt securities. This system would later
become known as “petrodollar recycling” as coined by Henry Kissinger. Through
their exclusive use of dollars for oil transactions, and then depositing their excess
profits into American debt securities, the petrodollar system is a “dream come true”
for a spendthrift government like the United States.
This has enabled the United States to maintain artificially low interest rates. The US
economy has become dependent upon these artificially low interest rates and,
therefore, has a vested interest in maintaining them through any means necessary.
The massive economic distortions and imbalances generated by the petrodollar
system will eventually self-correct when the artificial dollar and US debt demand is
removed. That day is coming.
Another major benefit of the petrodollar system has to do with the actual purchase of
oil itself. With oil priced in US dollars, America can literally print money to buy oil and
then have the oil producers hold the debt that was created by printing the money in
the first place. What other nation, besides America, can print money to buy oil?
Petrodollars & Petrodollar Surpluses
Since petrodollars and petrodollar surpluses are by definition denominated in US
dollars, then purchasing power is dependent on the US rate of inflation and the rate
at which the U.S. dollar is exchanged (whenever there is need for convertibility) by
other currencies in international money markets. It follows that whenever economic
or other factors affect the US dollar, petrodollars will be affected to the same
magnitude. The link, therefore, between the US dollar and petrodollar surpluses, in
particular, has significant economic, political, and other implications.
First, the placement of petrodollar surpluses of the Arab oil exporting nations in the
United States may be regarded politically as hostage capital. 8 In the event of a
major political conflict between the United States and an Arab oil-exporting nation,
the former with all its military might can confiscate or freeze these assets or
otherwise limit their use. It can impose special regulations or at least use regulations
for a time, in order to attain certain political, economic, or other goals. The US
government resorted to such weapons twice in the l980s against Iranian and Libyan
assets. It follows, therefore, that governments placing their petrodollar surpluses in
the United States may lose part of their economic and political independence.
Consequently, the more petrodollar surpluses are placed in the United States by a
certain oil-exporting nation, the less independent such a nation becomes.
Second, an oil-exporting country can have petrodollar surpluses only if its absorptive
capacity is less than its earnings from the sale of’ oil for any particular period of time.
It follows, therefore, that petrodollar surpluses depend on oil prices, volumes
exported, and the nation’s absorptive capacity.
Third, petrodollar surpluses do not represent real wealth but rather are a vehicle by
which the latter can be acquired. If kept in liquid form such as paper dollars, their
purchasing power will gradually be eroded by inflation and adverse foreign exchange
rates. Both are affected in the United States by a host of variables such money
supply, interest rates, marginal productivity and balance-of-payments deficit. Another
factor is US monetary and fiscal policy which in turn affects some of’ these variables.
Therefore, the purchasing power of petrodollar surpluses belonging, for example, to
Arab oil-exporting nations is determined by factors that are not in the control of these
Fourth, efficient allocation of petrodollars for internal investments could increase the
productive capacity of an oil-exporting nation and may work to its relative advantage.
However, dependency on imported consumer goods promotes the export of limited
oil resources that could have been otherwise used for internal capital development.
Fifth, the economic development of an oil-exporting nation is based on the
conversion of its oil resources into other assets such as wealth-creating projects,
diversification, education, technology, infrastructure, and other forms of real wealth,
that is, real capital stock. Obviously the conversion process can be carried on at
different rates. An optimum rate is achieved when oil is pumped at a level that can
maximize the conversion process. By pumping oil in excess of an optimum
production rate, the Arab Gulf oil-producing countries accumulated petrodollar
surpluses until 1981. After that the petrodollar surpluses have turned into deficits.
That was the time when Sheikh Ahmad Zaki Yamani flooded the global oil market
with oil causing the oil price to collapse to around $10/barrel. It is worth noting that
the difference between the volume of oil actually supplied and the volume that
should have been supplied in observance of standard microeconomic theory is in
fact a subsidy granted, in real terms, to oil-importing nations such as the United
States, Germany, France, and Japan. 10
Allocation of Petrodollar Surpluses
The bulk of petrodollar surpluses is held either in US treasury bills and other shortterm instruments or in American and Western European banks. Petrodollar
surpluses have also been used to increase the official reserves of the oil-exporting
countries at both the International Monetary Fund and the International Bank for
Reconstruction and Development.
Petrodollar surpluses have been recycled by commercial banks in the United States
and other industrialized nations as well as by international institutions. By drawing
against petrodollar surpluses as deposits or certificates of deposits, banks were able
to expand their volume of lending. For bankers the most obvious clients were the
developing countries, mainly in Latin America, such as Mexico, Brazil, and
According to US Treasury information, petrodollar surpluses have turned into deficits
since 1982. There are three main reasons for this turn of events: increase in imports
by oil-exporting nations; reduction in the demand for oil, particularly from OPEC; and
the oil glut which led to a reduction in its price.
The Petrodollar Wars: Iraq & Libya
The world currently consumes 92 million barrels of oil per day (mbd) and this is
projected to rise to 97 mbd by 2020. And thanks to the petrodollar system, growing
global demand for oil leads to an increase in US dollar demand. This artificial
demand for US dollars has provided remarkable benefits for the US economy. It has
also required the Federal Reserve to keep the dollar in plentiful supply (see Figure
By perpetually expanding the US money supply, America’s standard of living
increases as well. The problem with this situation is that the only way that it can be
sustained is if the demand for the dollar and for US debt securities remains
On September 11, 2001, America’s relations with the Middle East would be altered
forever. The tragic events of that day still live on in the memory of the world.
Interestingly, just five hours after American Airlines Flight 77 crashed into the
Pentagon, former US Secretary of Defence Donald Rumsfeld began ordering his
staff to develop plans for a strike on Iraq despite the fact that there was absolutely no
evidence linking the country, or its leader Saddam Hussein, to the 9/11 attacks. 11
Source: Courtesy of FTMdaily.com
On September 12, 2001, despite zero evidence against Iraq, Defence Secretary
Rumsfeld proposed to former president George W. Bush that Iraq should be “a
principal target of the first round in the war against terrorism.” Bush, along with his
other advisors, including Deputy Secretary of Defence Paul Wolfowitz, strongly
supported the idea that Iraq should be included in their attack plans.
In fact, Washington had already been preparing for an invasion of Iraq. The Los
Angeles Times reported that one year prior to the attacks of 9/11, the US began in
April 2000 constructing Al Adid, a billion-dollar military base in Qatar with a 15,000-
foot long runway. What was Washington’s stated justification for the new Al Adid
base, and other similar ones in the Gulf region? Preparedness for renewed action
It would later be revealed that an invasion of Iraq was at the top of the Bush
administration’s agenda only 10 days after his inauguration, which was a full eight
months before 9/11. 13
So why Iraq? Why the rush to war with a country that so obviously had no
connection with the events of 9/11? Did the U.S. have some other motivation for
seeking international support to invade Iraq?
On September 24, 2000, Saddam Hussein allegedly emerged from a meeting of his
cabinet and proclaimed that Iraq would soon switch its oil export transactions from
the petrodollar to the euro. By 2002, Saddam had fully converted to a petroeuro – in
essence, dumping the dollar. On March 19, 2003, George W. Bush announced the
commencement of a full scale invasion of Iraq.
Saddam’s bold threat to the petrodollar system had invited the full force and fury of
the US military onto his country. Or was America’s stated purpose to “liberate” the
Iraqi people from a brutal regime actually a clever guise for making an example of a
nation which dared threaten the existing petrodollar system? However, it would be
naïve to assume that this was the real reason for the invasion of Iraq in 2003. The
real reason was oil. 14 Even Alan Greenspan the former chairman of the Federal
Reserve Board for 17 years, concurs. 15
It should be noted that Iraq’s proven oil reserves are considered to be among the
largest in the world. Some experts believe that Iraq’s oilfields, many of which have
yet to be exploited, will catapult Iraq above Saudi Arabia in total proven oil reserves
in the coming years.
It is a matter of conjecture that the Middle East could have had a different shape
today had the petrodollar not come into existence. Being established on a
geopolitical infrastructure, the petrodollar has developed dimensions of security,
economics and development for the US and the major oil exporters in the Middle
The petrodollar has caused much ire for many nations due to the power it gave the
US. Interestingly, anyone who challenged the petrodollar did not fair well.
In Libya, US-backed rebels toppled Muammar Gaddafi who proposed a gold-backed
African currency that would be traded for African oil. Moreover, Russian president
Putin is under scrutiny for his push towards a Yuan-Ruble oil trading system. 16
Defending the Petrodollar System
Since the dawn of the oil age, the geopolitical strategies concocted by developed
nations have increasingly been centred on maintaining easy access to the world’s oil
supplies. Only the truly naive could deny the obvious powerful economic and political
incentives that are derived from access to cheap oil supplies. And while most nations
have a clear motivation to maintain easy access to the world’s cheapest oil supplies
out of sheer economic necessity, this is certainly not the sole concern for the United
States. The United States has an additional unique incentive regarding the world’s
oil, namely, ensuring that all oil around the globe, both current supplies and future
discoveries, remain priced in US dollars.
A simple examination of America’s foreign policy efforts in the wake of the ‘oil shock’
of 1973 and in the ensuing foundation of the petrodollar system in the mid-1970s,
makes it painstakingly clear to any casual political observer that a central goal of
Washington has been to control global oil supplies, specifically in the Middle East.
After the 1973 ‘oil shock’, former president Nixon warned US citizens “that American
military intervention to protect vital oil supplies” in the region, was a strong possibility.
This speech marked the first official and formal commitment to deploy US troops to
the Middle East for the explicit reason of protecting America’s oil interests.
On 23 January 1980, former US president Jimmy Carter proclaimed in his State of
the Union Address the “Carter Doctrine” which stated that the United States would
use military force if necessary to defend its national interests in the Persian Gulf. It
was a response to the Soviet Union’s intervention in Afghanistan in 1979 and was
intended to deter the Soviet Union from threatening oil supplies from the Middle
By January 1, 1983, the United States created the Central Command (CENTCOM)
with the stated mission of acting as a deterrent (primarily against the Soviets) and to
help maintain regional stability and the flow of oil from the Arab Gulf to the United
States and other western allies (see Figure 3). After all, maintaining a global order
dependent upon a “dollars for oil” system is no cheap task and requires careful
monitoring and oversight of the world’s oil supplies. Chief among the potential
concerns for the petrodollar
guardians are: threats of
restrictions on oil supplies
and, perhaps most importantly,
devising “permanent solutions” to
the problems presented
by nations who dare challenge
the current “dollars for oil”
Putin’s Revenge: Russia is Actually Abandoning the Petrodollar
Sanctions were imposed on Russia after its intrusion into the Ukraine in February
2014 and the ensuing annexation of the Crimea. Even before sanctions were
introduced, Russia was already in the process of reorienting its energy posture to
Asia in view of the growth in energy demand in that continent and the likely
stagnation or decline of demand in Europe over the next few decades. 17
Angered by the sanctions, the Russians began considering action against the United
States. They are actually making a move against the petrodollar. It appears that
they are quite serious about their de-dollarization strategy. The largest natural gas
producer on the planet, Gazprom, has signed agreements with some of their biggest
customers to switch payments for natural gas from US dollars to euros. And
Gazprom would have never done this without the full approval of the Russian
government which holds a majority stake in Gazprom. 18 When you are talking
about Gazprom, you are talking about a company that is absolutely massive. It is
one of the largest companies in the entire world and it makes up 8% of Russian GDP
all by itself. It holds 18% of the proven natural gas reserves of the entire world, and
it is also a very large oil producer. So for Gazprom to make a move like this is
extremely significant. 19
When Barack Obama decided to slap some meaningless economic sanctions on
Russia a while back, he probably figured that the world would forget about them
soon after. But the Russians do not forget, and they certainly do not forgive.
At this point the Russians are turning their back on the United States, and that
includes the US dollar. What Gazprom is now doing has the potential to really shake
up the global financial landscape.
Gazprom Neft had signed additional agreements with consumers on a possible
switch from dollars to euros for payments under contracts. Nine out of ten
consumers had agreed to switch to euros. 20
And Gazprom is not the only big company in Russia that is moving away from the
US dollar. According to Russia Today TV (RT), other large Russian corporations are
moving to other currencies as well.
Russia will start settling more contracts in Asian currencies, especially the Chinese
yuan in order to lessen its dependence on the dollar market, and because of
Western-led sanctions that could freeze funds at any moment. Diversifying trade
accounts from dollars to the Chinese yuan and other Asian currencies such as the
Hong Kong dollar and Singapore dollar has been a part of Russia’s pivot towards
Asian as tension with Europe and the US remain strained over Russia’s action in
And expanding the use of non-dollar currencies is one of the main things that major
Russian banks are working on right now. Russia’s large exposure to the dollar
subjects it to more market volatility in times of crisis. There is no reason why you
have to settle trade you do with Japan in dollars.
Meanwhile, Russians have been pulling money out of US banks at an
unprecedented pace. In March 2014, without waiting for the sanction spiral to kick in,
Russians yanked their money out of US banks. Deposits by Russians in US banks
suddenly plunged from $21.6 billion to $8.4 billion in one month. They’d learned their
lesson in Cyprus the hard way: get your money out while you still can before it gets
As Russia abandons the US dollar, that will hurt but if other nations start following
suit that could eventually cause a financial avalanche.
What we are witnessing right now is just a turning point. The effects won’t be felt
right away. But this is definitely another element in the “perfect storm” that is starting
to brew for the US economy.
Putin’s support of the BRICS Development Bank is significant. The New BRICS
Development Bank is up and running. It is backed by gold, silver and real
commodities unlike the US Federal Reserve System which is based on Fiat private
China and Russia are together moving to create a parallel financial system,
disentangled from the Western financial system. It includes creating entities such as
the Asian Development Bank. One of the principal tools in the hands of Washington
to control the global system has always been the International Monetary Fund (IMF).
Nations have to go to the IMF to ask for financial help when in difficulties, but
recently it was China – and not the IMF – which bailed out Venezuela and Argentina
and provided financial support to Russia when their currencies came under pressure.
The IMF and the World Bank were no longer at the centre of the global financial
order. They are being displaced by China. 22
European and American leaders thought that Russia would weaken because of
sanctions and the fall of the ruble against the US dollar, but China intervened and
stopped the collapse of the ruble. In short, China is operating as a backstop to a
financial system that is in the process of shifting dramatically away from Western
China Is Also Making A Move Against the US Dollar
There are indications that the Chinese are now accelerating their long-term plan to
dethrone the US dollar. The truth of the matter is that China does not plan to allow
the US financial system to dominate the world indefinitely. Right now, China is the
number one exporter on the globe and the largest crude oil importer in the world.
And soon it will have the largest economy in the world.
The Chinese would like to see global currency usage reflect this shift in global
economic power. At the moment, most global trade is conducted in US dollars and
more than 60% of all global foreign exchange reserves are held in US dollars. This
gives the United States an enormous built-in advantage but thanks to decades of
incredibly bad decisions, this advantage is starting to erode. And due to the recent
political infighting in Washington D.C., the Chinese sense vulnerability. China has
begun to publicly worry about the level of US debt. Chinese officials have publicly
threatened to stop buying any more US debt and have started to aggressively make
currency swap agreements with other major global powers and, furthermore, China
has been accumulating unprecedented amounts of gold. All of these moves are
setting up the moment in the future when China will completely pull the rug out from
under the US dollar.
Today, the US financial system is the core of the global financial system. Because
nearly everybody uses the US dollar to buy oil and to trade with one another, this
creates a tremendous demand for US dollars around the planet. So other nations
are generally happy to take US dollars in exchange for oil, cheap plastic gadgets and
other things that US consumers “need”.
Major exporting nations accumulate huge piles of dollars, but instead of just letting all
of that money sit there, they often invest large portions of their currency reserves into
US Treasury bonds which can easily be liquidated if needed.
So if the US financial system is the core of the global financial system, then US debt
is “the core of the core”. US Treasury bonds fuel the print-borrow-spend cycle that
the global economy depends upon. That is why a US debt default would be such a
big deal. A default would cause interest rates to skyrocket and the entire global
economic system to go haywire.
Unfortunately for the United States, the US debt spiral cannot go on indefinitely. US
debt is growing far more rapidly than GDP is, and therefore the debt is completely
and totally unsustainable.
The Chinese understand what is going on, and when the dust settles they plan to be
the last ones standing. In the aftermath of a US currency collapse, China anticipates
having the largest economy on the planet, more gold than anyone else, and a
respected international currency that the rest of the globe will be able to use to
conduct international trade.
And China is not just going to sit back and wait for all of this to happen. In fact, they
are already doing lots of things to get the ball moving. The following are signs that
China is making a move against the US dollar.
China has just entered into a very large currency swap agreement with the euro
zone that is considered a huge step toward establishing the yuan as a major world
currency. This agreement will result in a lot less US dollars being used in trade
between China and Europe.
China currently owns about 1.3 trillion dollars of US debt, and this enormous
exposure to US debt is starting to become a major political issue within China.
There have been media reports that China is looking to diversify its $3.66 trillion of
foreign exchange reserve into real estate investments in Europe.
Xinhua, the official news agency of China, called for a “de-Americanized world” ” and
also made the following statement about the political turmoil in Washington:
“Politicians in Washington have done nothing substantial but postponing once again
the final bankruptcy of global confidence in the US financial system“. The
commentary in the government-run media also declared that the debt deal “was no
more than prolonging the fuse of the US debt bomb one inch longer.”
China is the largest producer of gold in the world, and it has also been importing an
absolutely massive amount of gold from other nations. But instead of slowing down,
the Chinese appear to be accelerating their gold buying. In fact, China plans to buy
another 5,000 tons of gold. There are many who are convinced that China eventually
plans to back the yuan with gold and try to make it the number one alternative to the
US dollar. 23 This could have devastating effects on the US economy. Demand for
the US dollar and US debt would drop like a rock, and prices would soar. If the rest
of the world (led by China) starts to reject the US dollar, it would result in a massive
tsunami of currency coming back to the US and a very painful adjustment in US
standard of living. Today, most US currency is actually used outside of the United
Oil-rich Nations Are Selling off Their Petrodollar Assets
In the heady days of the commodity boom, oil-rich nations accumulated billions of
dollars which they invested in US debt and other securities. Now that oil prices have
dropped by half to just over $50 a barrel, Saudi Arabia and other oil-rich nations are
fast drawing down those “petrodollar” reserves.
If oil and other commodity prices remain depressed, the trend will cut demand for
everything from European government debt to US real estate as producing nations
seek to fill holes in their domestic budgets.
This is the first time in 20 years that OPEC nations will be sucking liquidity out of the
market rather than adding to it through investments. And for the first time, too, we
see the end of the petrodollar as a system for recirculating oil revenues to
Wall Street. It is sucking liquidity out from Wall Street, not putting it in. The fall in the
price of oil has suddenly created huge financial turbulence, which is endangering the
global financial system. 24
Saudi Arabia, the world’s largest oil producer, is a prime example of the swiftness
and magnitude of the selloff: its foreign exchange reserves fell by $20.2 billion in
February 2015 alone, the biggest monthly drop in at least 15 years according to data
from the Saudi Arabian Monetary Agency. That’s almost double the drop after the
financial crisis in early 2009 when oil prices plunged and Riyadh consumed $11.6
billion of its reserves in a single month. 25
The International Monetary Fund commodity index, a broad basket of natural
resources from iron ore and oil to bananas and copper, fell in January to its lowest
since mid-2009. Although the index has recovered a little since then, it still is down
more than 40% from a record high set in early 2011.
A concomitant drop in foreign reserves, revealed in data from national central banks
and the IMF, is affecting nations from oil producer Oman to copper-rich Chile.
Algeria, one of the world’s top natural gas exporters, saw its funds fall by $11.6
billion in January, the largest monthly drop in a quarter of century. At that rate, it will
empty the reserves in 15 months.26
OPEC members are expected to earn $380 billion selling their oil this year,
according to US estimates. That represents a $350 billion drop from 2014 — the
largest one-year decline in history.
“The shock for oil-rich countries is enormous,” Rabah Arezki, head of the
commodities research team at the IMF in Washington, said in an interview. Oil-rich
countries will sell more than $200 billion of assets this year to bridge the gap left
between high fiscal spending and low revenues.
The drawdown reverses a decade-long inflow into the coffers of commodity-rich
nations which helped to increase funds available for investment and boost asset
prices. Bond purchases have helped to keep interest rates low.
Are the Petrodollar’s Days Numbered?
Today, the geopolitical sands of the Middle East are rapidly shifting. The faltering
strategic regional position of Saudi Arabia, the rise of Iran (which is not part of the
petrodollar system), failed US interventions, Russia’s increasing power as an energy
giant and the emergence of the BRICS nations (which offer the potential of future
alternative economic/security arrangements) all affect the sustainability of the
One needs also to be aware of what Vladimir Putin is doing. Putin would like nothing
more than to sabotage the petrodollar, and he’s forging alliances across the world
that he hopes will help him achieve his goal. At the same time, one should also
watch the deteriorating relationship between the US and Saudi Arabia.
The Saudis are furious at what they perceive to be the US not holding up its end of
the petrodollar deal. They believe that as part of the US commitment to keep the
region safe for the Kingdom, the US should have attacked its regional rivals Syria
and Iran by now. And they may feel they are no longer obliged to uphold their part of
the deal, namely selling their oil only in US dollars. They’re already heavily involved
with China and could also tilt toward Russia. Oil traded in rubles or yuans could be
the future result.
The US is really not importing much Arab oil anymore. If that were the case, it’s
really hard to see why the Arabs would continue to price their oil in dollars, especially
that their biggest customers would be China, Japan and other Asia-Pacific countries
that have no particular reason to deal in dollars.
The petrodollar system breaking down, where oil is no longer paid for in dollars
internationally, essentially would be the death knell to the US dollar as the global
reserve currency. It means the US may not be able to borrow with great ease
anymore, and it means that the US Treasury market is set for an out-of-control
interest rate spiral.
As it is, the Arab oil-producing nations have more dollars than they know what to do
with. By one expert estimate, some $8–10 trillion in currency balances lie in Middle
Eastern hands, much of it in dollars. How long will they want to keep all those dollars
lying around especially when the Asia-Pacific region now accounts for one-third of
global oil consumption and the US only 20%? 27
Meanwhile, the world’s leading oil importer –China- is doing its part to undermine the
petrodollar. In recent years, China has been striking agreements with many of its
trade partners to do business using each other’s currencies. China and Russia,
China and Brazil, China and Australia, even China and its old/new enemy Japan —
they all have currency swaps and other arrangements in place to bypass the dollar.
Last November brought word the Shanghai Futures Exchange was thinking about
pricing its new crude oil futures contract in both yuan and dollars, with the aim of
making that contract the new Asian benchmark.
But while the Arabs fret about the value of their dollars and the Chinese move
actively to diversify away from the dollar it might be the Russians who will deliver the
The chaos that one day will ensue from the United States’ 44-year experiment with
worldwide fiat money will require a return to money of real value. The US will know
that day is approaching when oil-producing countries demand gold, or its equivalent,
for their oil rather than dollars. 28
This is critically important, because once the dollar loses its coveted reserve status,
the consequences will be dire for Americans. At that moment, Washington will
become sufficiently desperate to enforce the radical measures that governments
throughout world history have always implemented when their currencies were under
Since 1980, America has devolved from being the world’s greatest creditor nation to
the world’s largest debtor nation. But thanks to the massive artificial demand for US
dollars and government debt made possible by the petrodollar system, America
could still continue its spending spree, reckless wars, and record deficits.
At one point in America’s history, the country’s largest export was a variety of
manufactured goods. Today, America’s largest export is the US dollar. And the dollar
costs the United States practically nothing to print. How long will it be before the
nations of the world figure out that the petrodollar game is over. This shift is being
accelerated by joint Chinese/Russian efforts to dethrone the US dollar as a reserve
currency and also as the currency for global trade and oil transactions. Even Saudi
Arabia now acknowledges the eventual end of the petrodollar probably by 2032.
They are planning to invest a total of $109 bn in solar energy with the aim of
becoming an exporter of solar electricity.
And while the US economy with its great power of innovation and inherent strengths,
could support a powerful currency, it certainly can’t support the very many trillions of
dollars circulating around the world.
It is probable that the Chinese yuan will emerge as the world’s reserve currency
within the next two decades backed by gold, currency swap agreements, real
purchasing power and Russian oil and natural gas reserves.
*Dr Mamdouh G. Salameh is an international oil economist, a consultant to the World
Bank in Washington DC on oil & energy and a technical expert of the United Nations
Industrial Development Organization (UNIDO) in Vienna. He is a member of both the
International Institute for Strategic Studies in London and the Royal Institute of
International Affairs. He is also a visiting professor of energy economics at the ESCP
Europe University in London.
1 James D Hamilton, “Historical Oil Shocks” Department of Economics.
University of California, San Diego. Revised: February 1, 2011.
2 “Petrodollar Profusion”, The Economist, April 26th, 2012.
3 Ibrahim M. Oweiss, “Petro-Money: Problems and Prospects,” in Inflation and
Monetary Crisis, ed. G. C. Wiegand (Washington, D.C.: Public Affairs Press,
1975), pp. 84-85.
4 Jerry Robinson, “Preparing for the Collapse of the Petrodollar System”, FTM
7 Mamdouh G Salameh, “Economic & Financial Crisis Management in the
Light of Dwindling Oil Prices” (a lecture given at the invitation of the National
Defence College in Muscat, Oman on the 21st of April, 2015).
8 Ibrahim M Oweiss, “Petrodollars: Problems & Prospects” (a paper given at
the Conference on ‘The World Monetary Crisis’, Colombia University, March 1-
11 Jerry Robinson, “The Petrodollar Wars : The Iraq Petrodollar Connection”,
14 Mamdouh G Salameh, “Over a Barrel”, Joseph D. Raidy Printing Press sal,
Beirut, Lebanon, June 2004, p. 191.
15 Alan Greenspan, “The Age of Turbulence”, published by Penguin Books, USA,
in 2007, p.463.
16 Nabegh Al Sabbagh, “Opinion: Oil and Economics at a Geopolitical
Crossroad”, posted in Breaking Energy on April 28, 2015.
17 Mamdouh G Salameh, “Turning the Gaze Towards Asia: Russia’s Grand
Strategy to Neutralize Western Sanction” (a USAEE Paper Series No: 14-
168, posted on 19 July 2014).
18 Michael Snyder ”Russia is Doing it – Russia is Actually Abandoning the
Dollar”, posted on 11 June, 2014 on Infowars.com.
19 Preston James & Mike Harris, “ Putin’s Opportunity to Bust the US Petrodollar,
VT Veterans Today, 7 January 2015
20 A report by the ITAR-Tass News Agency.
21 Michael Snyder ”Russia is Doing it – Russia is Actually Abandoning the
22 Alastir Crook, “Expert: Oil Price Wars Fatally Wounded the Petrodollar”
(Interview with Zaman Today’s Daily (Turkish English-language Daily) on 15
23 Addison Wiggin, “The US Energy Boom Will End the Dollar’s World
Reserve Status”, published in Daily Reckoning, was published in June 4, 2014.
24 Alastir Crook, “Expert: Oil Price Wars Fatally Wounded the Petrodollar”.
25 Javiar Blas, “Oil-Rich Nations Are Selling Off Their Petrodollar Assets at
Record Pace” Bloomberg, April 14, 2015.
27 Nick Giambruno, “Ron Paul Says: Watch the Petrodollar System” Casey
A Short Biography
Dr Mamdouh G. Salameh is an international oil economist, a consultant for the
World Bank in Washington D.C. on oil and energy and also a technical expert
with the United Nations Industrial Development Organization (UNIDO) in
Vienna. He holds a PhD in Economics specializing in the economics &
geopolitics of oil and energy. Dr Salameh is also a visiting professor of energy
economics at the ESCP Europe University in London.
Dr Salameh has presented papers to numerous international energy
conferences on the economics and geopolitics of oil and energy and has been
frequently invited to lecture on these topics at universities around the world. He
has written three books on oil: “Is a Third Oil Crisis Inevitable?” (published in
London in April 1990), “ Jordan’s Energy Prospects & Needs to the Year
2010: The Economic Viability of Extracting Oil from Shale” (published in
London in October 1998) and “ Over a Barrel” (Published in the UK in June
2004) as well as numerous research papers published in international Oil and
Energy Journals. Dr Salameh has undertaken research assignments for the US
Department of Energy, the World Bank, the Institute of Energy Economics in
Japan, the Indian Government, OPEC, the Canadian Energy Research Institute,
Boston University working on the Encyclopedia of Energy and also the
Handbook of Energy and the government of Jordan among others. He regularly
appears on TV to discuss oil prices and other developments in the global oil
Dr Salameh is a member of many International Institutes and Associations
including the International Association for Energy Economics (IAEE) in the US,
the British Institute of Energy Economics, the International Energy Foundation in
Canada, the International Institute for Strategic Studies (IISS) in London, and
the Royal Institute of International Affairs (RIIA) in London. He is also an advisor
to the Oil Depletion Analysis Centre (ODAC), London.
Saudi Arabia is threatening to sell its oil in currencies other than the dollar if Washington passes a bill exposing OPEC members to U.S. antitrust lawsuits, three sources familiar with Saudi energy policy said.
They said the option had been discussed internally by senior Saudi energy officials in recent months. Two of the sources said the plan had been discussed with OPEC members and one source briefed on Saudi oil policy said Riyadh had also communicated the threat to senior U.S. energy officials.
The chances of the U.S. bill known as NOPEC coming into force are slim and Saudi Arabia would be unlikely to follow through, but the fact Riyadh is considering such a drastic step is a sign of the kingdom’s annoyance about potential U.S. legal challenges to OPEC.
In the unlikely event Riyadh were to ditch the dollar, it would undermine the its status as the world’s main reserve currency, reduce Washington’s clout in global trade and weaken its ability to enforce sanctions on nation states.
“The Saudis know they have the dollar as the nuclear option,” one of the sources familiar with the matter said.
“The Saudis say: let the Americans pass NOPEC and it would be the U.S. economy that would fall apart,” another source said.
Saudi Arabia’s energy ministry did not respond to a request for comment.
A U.S. state department official said: “as a general matter, we don’t comment on pending legislation.”
The U.S. Energy Department did not respond to a request for comment. Energy Secretary Rick Perry has said that NOPEC could lead to unintended consequences.
NOPEC, or the No Oil Producing and Exporting Cartels Act, was first introduced in 2000 and aims to remove sovereign immunity from U.S. antitrust law, paving the way for OPEC states to be sued for curbing output in a bid to raise oil prices.
While the bill has never made it into law despite numerous attempts, the legislation has gained momentum since U.S. President Donald Trump came to office. Trump said he backed NOPEC in a book published in 2011 before he was elected, though he not has not voiced support for NOPEC as president.
Trump has instead stressed the importance of U.S-Saudi relations, including sales of U.S. military equipment, even after the killing of journalist Jamal Khashoggi last year.
A move by Saudi Arabia to ditch the dollar would resonate well with big non-OPEC oil producers such as Russia as well as major consumers China and the European Union, which have been calling for moves to diversify global trade away from the dollar to dilute U.S. influence over the world economy.
Russia, which is subject to U.S. sanctions, has tried to sell oil in euros and China’s yuan but the proportion of its sales in those currencies is not significant.
Venezuela and Iran, which are also under U.S. sanctions, sell most of their oil in other currencies but they have done little to challenge the dollar’s hegemony in the oil market.
However, if a long-standing U.S. ally such as Saudi Arabia joined the club of non-dollar oil sellers it would be a far more significant move likely to gain traction within the industry.
Saudi Arabia controls a 10th of global oil production, roughly on par with its main rivals – the United States and Russia. Its oil firm Saudi Aramco holds the crown of the world’s biggest oil exporter with sales of $356 billion last year.
Depending on prices, oil is estimated to represent 2 percent to 3 percent of global gross domestic product. At the current price of $70 per barrel, the annual value of global oil output is $2.5 trillion.
Not all of those oil volumes are traded in the U.S. currency but at least 60 percent is traded via tankers and international pipelines with the majority of those deals done in dollars.
Trading in derivatives such as oil futures and options is mainly dollar denominated. The top two global energy exchanges, ICE and CME, traded a billion lots of oil derivatives in 2018 with a nominal value of about $5 trillion.
Just the prospect of NOPEC has already had implications for the Organization of Petroleum Exporting Countries. Qatar, one of the core Gulf OPEC members, quit the group in December because of the risk NOPEC could harm its U.S. expansion plans.
Two sources said that despite raising the dollar threat, Saudi Arabia did not believe it would need to follow through.
“I don’t think the NOPEC bill will pass but the Saudis have ‘what if’ scenarios,” one of the sources said.
In the event of such a drastic Saudi move, the impact would take some time to play out given the industry’s decades-old practices built around the U.S. dollar – from lending to exchange clearing.
Other potential threats raised in Saudi discussions about retaliation against NOPEC included liquidating the kingdom’s holdings in the United States, the sources said.
The kingdom has nearly $1 trillion invested in the United States and holds some $160 billion in U.S. Treasuries.
If it did carry out its threat, Riyadh would also have to ditch the Saudi riyal’s peg to the dollar, which has been exchanged at a fixed rate since 1986, the sources said.
The United States, the world’s largest oil consumer, relied heavily on Saudi and OPEC supplies for decades – while supporting Riyadh militarily against its arch-foe Iran.
But soaring shale oil production at home has made Washington less dependant on OPEC, allowing it to be more forceful in the way it deals with Saudi Arabia and other Middle Eastern nations.
Over the past year, Trump has regularly called on OPEC to pump more oil to lower global oil prices, and linked his demands to political support for Riyadh – something previous U.S. administrations have refrained from doing, at least publicly.
Reporting by Dmitry Zhdannikov and Alex Lawler in London and Rania El Gamal in Dubai; additional reporting by Timothy Gardner in Washington; editing by David Clarke
Find more of Lyn’s work at lynalden.com
One of the concerns I’ve seen aimed at Bitcoin is the claim that it’s a Ponzi scheme. The argument suggests that because the Bitcoin network is continually reliant on new people buying in, that eventually it will collapse in price as new buyers are exhausted.
So, this article takes a serious look at the concern by comparing and contrasting Bitcoin to systems that have Ponzi-like characteristics, to see if the claim holds up.
The short version is that Bitcoin does not meet the definition of a Ponzi scheme in either narrow or broad scope, but let’s dive in to see why that’s the case.
Defining a Ponzi Scheme
To start with tackling the topic of Bitcoin as a Ponzi scheme, we need a definition.
Here is how the US Securities and Exchange Commission defines one:
“A Ponzi scheme is an investment fraud that pays existing investors with funds collected from new investors. Ponzi scheme organizers often promise to invest your money and generate high returns with little or no risk. But in many Ponzi schemes, the fraudsters do not invest the money. Instead, they use it to pay those who invested earlier and may keep some for themselves.
With little or no legitimate earnings, Ponzi schemes require a constant flow of new money to survive. When it becomes hard to recruit new investors, or when large numbers of existing investors cash out, these schemes tend to collapse.
Ponzi schemes are named after Charles Ponzi, who duped investors in the 1920s with a postage stamp speculation scheme.”
They further go on to list red flags to look out for:
“Many Ponzi schemes share common characteristics. Look for these warning signs:
High returns with little or no risk. Every investment carries some degree of risk, and investments yielding higher returns typically involve more risk. Be highly suspicious of any “guaranteed” investment opportunity.
Overly consistent returns. Investments tend to go up and down over time. Be skeptical about an investment that regularly generates positive returns regardless of overall market conditions.
Unregistered investments. Ponzi schemes typically involve investments that are not registered with the SEC or with state regulators. Registration is important because it provides investors with access to information about the company’s management, products, services, and finances.
Unlicensed sellers. Federal and state securities laws require investment professionals and firms to be licensed or registered. Most Ponzi schemes involve unlicensed individuals or unregistered firms.
Secretive, complex strategies. Avoid investments if you don’t understand them or can’t get complete information about them.
Issues with paperwork. Account statement errors may be a sign that funds are not being invested as promised.
Difficulty receiving payments. Be suspicious if you don’t receive a payment or have difficulty cashing out. Ponzi scheme promoters sometimes try to prevent participants from cashing out by offering even higher returns for staying put.”
I think that’s a great set of information to work with. We can see how many of those attributes, if any, Bitcoin has.
Bitcoin’s Launch Process
Before we get into comparing Bitcoin point-by-point to the above list, we can start with a recap of how Bitcoin was launched.
In August 2008, someone identifying himself as Satoshi Nakamoto created Bitcoin.org.
Two months later in October 2008, Satoshi released the Bitcoin white paper. This document explained how the technology would work, including the solution to the double-spending problem. As you can see from the link, it was written in the format and style of an academic research paper, since it was presenting a major technical breakthrough that provided a solution for well-known computer science challenges related to digital scarcity. It contained no promises of enrichment or returns.
Then, three months later in January 2009, Satoshi published the initial Bitcoin software. In the custom genesis block of the blockchain, which contains no spendable Bitcoin, he provided a time-stamped article headline about bank bailouts from The Times of London, likely to prove that there was no pre-mining and to set the tone for the project. From there, it took him six days to finish things and mine block 1, which contained the first 50 spendable bitcoins, and he released the Bitcoin source code that day on January 9th. By January 10th, Hal Finney publicly tweeted that he was running the Bitcoin software as well, and right from the beginning, Satoshi was testing the system by sending bitcoins to Hal.
Interestingly, since Satoshi showed how to do it with the white paper more than two months before launching the open source Bitcoin software himself, technically someone could have used the newfound knowledge to launch a version before him. It would have been unlikely, due to Satoshi’s big head start in figuring all of this out and understanding it at a deep level, but it was technically possible. He gave away the key technological breakthrough before he launched the first version of the project. Between the publication of the white paper and the launch of the software, he answered questions and explained his choices for his white paper to several other cryptographers on an email list in response to their critiques, almost like an academic thesis defense, and several of them could have been technical enough to “steal” the project from him, if they were less skeptical.
After launch, a set of equipment that is widely believed to belong to Satoshi remained a large Bitcoin miner throughout the first year. Mining is necessary to keep verifying transactions for the network, and bitcoins had no quoted dollar price at that time. He gradually reduced his mining over time, as mining became more distributed across the network. There are nearly 1 million bitcoins that are believed to belong to Satoshi that he mined through Bitcoin’s early period and that he has never moved from their initial address. He could have cashed out at any point with billions of dollars in profit, but so far has not, over a decade into the project’s life. It’s not known if he is still alive, but other than some early coins for test transactions, the bulk of his coins haven’t moved.
Not long after, he transferred ownership of his website domains to others, and ever since, Bitcoin has been self-sustaining among a revolving development community with no input from Satoshi.
Bitcoin is open source, and is distributed around the world. The blockchain is public, transparent, verifiable, auditable, and analyzable. Firms can do analytics of the entire blockchain and see which bitcoins are moving or remaining in place in various addresses. An open source full node can be run on a basic home computer, and can audit Bitcoin’s entire money supply and other metrics.
With that in mind, we can then compare Bitcoin to the red flags of being a Ponzi scheme.
Investment Returns: Not Promised
Satoshi never promised any investment returns, let alone high investment returns or consistent investment returns. In fact, Bitcoin was known for the first decade of its existence as being an extremely high-volatility speculation. For the first year and a half, Bitcoin had no quotable price, and after that it had a very volatile price.
The online writings from Satoshi still exist, and he barely ever talked about financial gain. He mostly wrote about technical aspects, about freedom, about the problems of the modern banking system, and so forth. Satoshi wrote mostly like a programmer, occasionally like an economist, and never like a salesman.
We have to search pretty deeply to find instances where he discussed Bitcoin potentially becoming valuable. When he did talk about the potential value or price of a bitcoin, he spoke very matter-of-factly in regards to how to categorize it, whether it would be inflationary or deflationary, and admitted a ton of variance for how the project could turn out. Digging around for Satoshi’s quotes on the price of value of a bitcoin, here’s what I found:
“The fact that new coins are produced means the money supply increases by a planned amount, but this does not necessarily result in inflation. If the supply of money increases at the same rate that the number of people using it increases, prices remain stable. If it does not increase as fast as demand, there will be deflation and early holders of money will see its value increase.”
“It might make sense just to get some in case it catches on. If enough people think the same way, that becomes a self fulfilling prophecy. Once it gets bootstrapped, there are so many applications if you could effortlessly pay a few cents to a website as easily as dropping coins in a vending machine.”
“In this sense, it’s more typical of a precious metal. Instead of the supply changing to keep the value the same, the supply is predetermined and the value changes. As the number of users grows, the value per coin increases. It has the potential for a positive feedback loop; as users increase, the value goes up, which could attract more users to take advantage of the increasing value.”
“Maybe it could get an initial value circularly as you’ve suggested, by people foreseeing its potential usefulness for exchange. (I would definitely want some) Maybe collectors, any random reason could spark it. I think the traditional qualifications for money were written with the assumption that there are so many competing objects in the world that are scarce, an object with the automatic bootstrap of intrinsic value will surely win out over those without intrinsic value. But if there were nothing in the world with intrinsic value that could be used as money, only scarce but no intrinsic value, I think people would still take up something. (I’m using the word scarce here to only mean limited potential supply)”
“A rational market price for something that is expected to increase in value will already reflect the present value of the expected future increases. In your head, you do a probability estimate balancing the odds that it keeps increasing.”
“I’m sure that in 20 years there will either be very large transaction volume or no volume.”
“Bitcoins have no dividend or potential future dividend, therefore not like a stock. More like a collectible or commodity.”
Promising unusually high or consistent investment returns is a common red flag for being a Ponzi scheme, and with Satoshi’s original Bitcoin, there was none of that.
Over time, Bitcoin investors have often predicted very high prices (and so far those predictions have been correct), but the project itself from inception did not have those attributes.
Open Source: The Opposite of Secrecy
Most Ponzi schemes rely on secrecy. If the investors understood that an investment they owned was actually a Ponzi scheme, they would try to pull their money out immediately. This secrecy prevents the market from appropriately pricing the investment until the secret gets found out.
For example, investors in Bernie Madoff’s scheme thought they owned a variety of assets. In reality, earlier investor outflows were just being paid back from new investor inflows, rather than money being made from actual investments. The investments listed on their statements were fake, and for any of those clients, it would be nearly impossible to verify that they are fake.
Bitcoin, however, works on precisely the opposite set of principles. As a distributed piece of open source software that requires majority consensus to change, every line of code is known, and no central authority can change it. A key tenet of Bitcoin is to verify rather than to trust. Software to run a full node can be freely downloaded and run on a normal PC, and can audit the entire blockchain and the entire money supply. It relies on no website, no critical data center, and no corporate structure.
For this reason, there are no “issues with paperwork” or “difficulty receiving payments”, referencing some of the SEC red flags of a Ponzi. The entire point of Bitcoin is to not rely on any third parties; it is immutable and self-verifiable. Bitcoin can only be moved with the private key associated with a certain address, and if you use your private key to move your bitcoins, there is nobody who can stop you from doing so.
There are of course some bad actors in the surrounding ecosystem. People relying on others to hold their private keys (rather than doing so themselves) have sometimes lost their coins due to bad custodians, but not because the core Bitcoin software failed. Third-party exchanges can be fraudulent or can be hacked. Phishing schemes or other frauds can trick people into revealing their private keys or account information. But these are not associated with Bitcoin itself, and as people use Bitcoin, they must ensure they understand how the system works to avoid falling for scams in the ecosystem.
As previously mentioned, Satoshi mined virtually all of his coins at a time when the software was public and anybody else could mine them. He gave himself no unique advantage in acquiring coins faster or more easily than anyone else, and had to expend computational power and electricity to acquire them, which was critical in the early period for keeping the network up and running. And as previously mentioned, the white paper was released before any of it, which would be unusual or risky to do if the goal was mainly about personal monetary gain.
In contrast to this unusually open and fair way that Bitcoin was launched, many future cryptocurrencies didn’t follow those same principles. Specifically, many later tokens had a bunch of pre-mined conceptions, meaning that the developers would give themselves and their investors coins before the project becomes public.
Ethereum’s developers provided 72 million tokens to themselves and their investors prior to any being available to own by the broader public, which is more than half of the current token supply of Ethereum. It was a crowdsourced project.
Ripple Labs pre-mined 100 billion XRP tokens with the majority being owned by Ripple Labs, and gradually began selling the rest to the public, while still holding the majority, and is currently being accused by the SEC of selling unregistered securities.
Besides those two, countless other smaller tokens were pre-mined and sold to the public.
A case can be made in favor of pre-mining in certain instances, although some are very critical of the practice. In a similar way that a start-up company offers equity to its founders and early investors, a new protocol can offer tokens to its founders and early investors, and crowdsourced financing is a well-accepted practice at this point. I’ll leave that debate to others. Few would dispute that early developers can be compensated for work if their project takes off, and funds are helpful for early development. As long as it’s fully transparent, it comes down to what the market thinks is reasonable.
When defending against the notion of being a Ponzi scheme, however, Bitcoin is miles ahead of most other digital assets. Satoshi showed the world how to do it first with a white paper months in advance, and then put the project out there in an open source way on the first day of spendable coins being generated, with no pre-mine.
A situation where the founder gave himself virtually no mining advantage over other early adaptors, sure is the “cleanest” approach. Satoshi had to mine the first blocks of coins with his computer just like anyone else, and then never spent them other than by sending some of his initial batch out for early testing. This approach improved the odds of it becoming a viral movement, based on economic or philosophical principles, rather than strictly about riches. Unlike many other blockchains over the years, Bitcoin development occurred organically, by a revolving set of large stakeholders and voluntary user donations, rather than via a pre-mined or pre-funded pool of capital.
On the other hand, giving yourself and initial investors most of the initial tokens and then having later investors start from mining from scratch or buy into it, opens up more avenues for criticisms and skepticism and begins to look more like a Ponzi scheme, whether or not it actually is.
One thing that makes Bitcoin really interesting is that it’s the one big digital asset that flourished without centralized leadership. Satoshi created it as its anonymous inventor, worked with others to guide it through the first two years with continued development on open forums, and then disappeared. From there, other developers took the mantle in terms of continuing to develop and promote Bitcoin.
Some developers have been extremely important, but none of them are critical for its ongoing development or operation. In fact, even the second round of developers after Satoshi largely went in other directions. Hal Finney passed away in 2014. Some other super-early Bitcoiners became more interested in Bitcoin Cash or other projects at various stages.
As Bitcoin has developed over time, it has taken on a life of its own. The distributed development community and userbase, (and the market, when it comes to pricing various paths after hard forks) has determined what Bitcoin is, and what it is useful for. The narrative has changed and expanded as time went on, and market forces rewarded or punished various directions.
For years, debates centered around whether Bitcoin should optimize for storing value or optimize for frequent transactions on the base layer, and this is what led to multiple hard forks that all devalued compared to Bitcoin. The market clearly has preferred Bitcoin’s base layer to optimize for being a store of value and large transaction settlement network, to optimize for security and decentralization, with an allowance for frequent smaller transactions to be handled on secondary layers.
Every other blockchain-based token, including hard forks and those associated with totally new blockchain designs, comes on the coattails of Bitcoin, with Bitcoin being the most self-sustaining project of the industry. Most token projects are still founder-led, often with a big pre-mine, with an unclear future should the founder no longer be involved. Some of the sketchiest tokens have paid exchanges for being listed, to try to jump-start a network effect, whereas Bitcoin always had the most natural growth profile.
Unregistered Investments and Unlicensed Sellers
The only items on the red flag list that may apply to Bitcoin are the points that refer to investments that are unregulated. This doesn’t inherently mean that something is a Ponzi; it just means that a red flag is present and investors should be cautious. Especially in the early days of Bitcoin, buying some magical internet money would of course be a highly risky investment for most people to make.
Bitcoin is designed to be permission-less; to operate outside of the established financial system, with philosophical leanings towards libertarian cryptographic culture and sound money. For most of its life, it had a steeper learning curve than traditional investments, since it rests on the intersection of software, economics, and culture.
Some SEC officials have said that Bitcoin and Ethereum are not securities (and by logical extension, have not committed securities fraud). Many other cryptocurrencies or digital assets have, however, been classified as securities and some like Ripple Labs have been charged with selling unregistered securities. The IRS treats Bitcoin and many other digital assets like commodities for tax purposes.
So, in the early days, Bitcoin may have indeed been an unregistered investment, but at this point it has a place in tax law and regulatory frameworks around the world. Regulation changes over time, but the asset has reached the mainstream. It’s so mainstream that Fidelity and other custodians hold it for institutional clients and J.P. Morgan gives their price targets for it.
Many people who have not looked deeply into the industry lump all “cryptocurrencies” together. However, it’s important for prospective investors to look into the details and find important differences. Lumping “cryptocurrencies” together would be like lumping “stocks” together. Bitcoin is clearly not like the others in many attributes, and was launched and sustained in a way that looks more like a movement or a protocol than an investment, but that over time became an investment as well.
From there, folks can choose to look into the rabbit hole of thousands of other tokens that came in Bitcoin’s wake and make their own conclusions. There’s a big spectrum there from well-intentioned projects on one side, to outright scams on the other side. It’s important to realize, however, that even if real innovation is happening somewhere, doesn’t mean the tokens associated with that project will necessarily have durable value. If a token solves some novel problem, its solution could end up being re-adapted to a layer on a larger protocol with a bigger network effect. Likewise, any investment in those other tokens has an opportunity cost of being able to purchase more Bitcoin instead.
Section Summary: Clearly Not a Ponzi Scheme
Bitcoin was launched in the fairest way possible.
Satoshi first showed others how to do it with the white paper in an academic sense, and then did it himself months later, and anyone could begin mining alongside him within the first days as some early adopters did. Satoshi then distributed the development of the software to others and disappeared, rather than continue to promote it as a charismatic leader, and so far has never cashed out.
From the beginning, Bitcoin has remained an open source and fully transparent project, and has the most organic growth trajectory of the industry. Given available information, the market has priced it as it sees fit, out in the open.
The Broader Definition of a Ponzi
Because the narrow Ponzi scheme clearly doesn’t apply to Bitcoin, some folks have used a broader definition of a Ponzi scheme to assert that Bitcoin is one.
A bitcoin is like a commodity, in the sense that it’s a scarce digital “object” that provides no cash flow, but that does have utility. They are limited to 21 million divisible units, of which over 18.5 million have already mined according to the pre-programmed schedule. Every four years, the number of new bitcoins generated per ten minute block will be cut in half, and the total number of bitcoins in existence will asymptotically move towards 21 million.
Like any commodity, it produces no cash flows or dividends, and is only worth what someone else will pay you for it or trade you for it. And specifically, it is a monetary commodity; one whose utility is entirely about storing and transmitting value. This makes gold its closest comparison.
Bitcoin vs Gold Market
Some people assert that Bitcoin is a Ponzi scheme because it relies on an ever-larger pool of investors coming into the space to buy from earlier investors.
To some extent this reliance on new investors is correct; Bitcoin keeps growing its network effect, reaching more people and bigger pools of money, which keeps increasing its usefulness and value.
Bitcoin will only be successful in the long run if its market capitalization reaches and sustains a very high level, in part because its security (hash rate) is inherently connected to its price. If for some reason demand for it were to permanently flatline and turn down without reaching a high enough level, Bitcoin would remain a niche asset and its value, security, and network effect could deteriorate over time. This could begin a vicious cycle of attracting fewer developers to keep building out its secondary layers and surrounding hardware/software ecosystem, potentially resulting in quality stagnation, price stagnation, and security stagnation.
However, this doesn’t make it a Ponzi scheme, because by similar logic, gold is a 5,000 year old Ponzi scheme. The vast majority of gold’s usage is not for industry; it’s for storing and displaying wealth. It produces no cash flows, and is only worth what someone else will pay for it. If peoples’ jewelry tastes change, and if people no longer view gold as an optimal store of value, its network effect could diminish.
There are 60+ years of gold’s annual production supply estimated to be available in various forms around the world. And that’s more like 500 years worth of industrial-only supply, factoring out jewelry and store-of-value demand. Therefore, gold’s supply/demand balance to support a high price requires the ongoing perception of gold as an attractive way to store and display wealth, which is somewhat subjective. Based on the industrial-only demand, there is a ton of excess supply and prices would be way lower.
However, gold’s monetary network effect has remained robust for such a long period of time because the collection of unique properties it has is what made it continually regarded as being optimal for long-term wealth preservation and jewelry across generations: it’s scarce, pretty, malleable, fungible, divisible, and nearly chemically indestructible. As fiat currencies around the world come and go, and rapidly increase their per-unit number, gold’s supply remains relatively scarce, only growing by about 1.5% per year. According to industry estimates, there is about one ounce of above-ground gold per person in the world.
Similarly, Bitcoin relies on the network effect, meaning a sufficiently large number of people need to view it as a good holding for it to retain its value. But a network effect is not a Ponzi scheme in and of itself. Prospective investors can analyze the metrics of Bitcoin’s network effect, and determine for themselves the risk/reward of buying into it.
Bitcoin vs Fiat Banking System
By the broadest definition of a Ponzi scheme, the entire global banking system is a Ponzi scheme.
Firstly, fiat currency is an artificial commodity, in a certain sense. A dollar, in and of itself, is just an object made out of paper, or represented on a digital bank ledger. Same for the euro, the yen, and other currencies. It pays no cash flows on its own, although institutions that hold it for you might be willing to pay you a yield (or, in some cases, could charge you a negative yield). When we do work or sell something to acquire dollars, we do so only with the belief that its large network effect (including a legal/government network effect) will ensure that we can take these pieces of paper and give them to someone else for something of value.
Secondly, when we organize these pieces of paper and their digital representations in a fractional-reserve banking system, we add another complicated layer. If about 20% of people were to try to pull their money out of their bank at the same time, the banking system would collapse. Or more realistically, the banks would just say “no” to your withdrawal, because they don’t have the cash. This happened to some US banks in early 2020 during the pandemic shutdown, and occurs regularly around the world. That’s actually one of the SEC’s red flags of a Ponzi scheme: difficulty receiving payments.
In the well-known musical chairs game, there is a set of chairs, someone plays music, and kids (of which there is one more than the number of chairs) start walking in circles around the chairs. When the music stops, all of the kids scramble to sit in one of the chairs. One slow or unlucky kid doesn’t get a seat, and therefore leaves the game. In the next round, one chair is removed, and the music resumes for the remaining kids. Eventually after many rounds, there are two kids and one seat, and then there is a winner when that round ends.
The banking system is a permanent round of musical chairs. There are more kids than chairs, so they can’t all get one. If the music were to stop, this would become clear. However, as long as the music keeps going (with occasional bailouts via printed money), it keeps moving along.
Banks collect depositor cash, and use their capital to make loans and buy securities. Only a small fraction of depositor cash is available for withdrawal. A bank’s assets consist of loans owed to them, securities such as Treasuries, and cash reserves. Their liabilities consist of of money owed to depositors, as well as any other liabilities they may have like bonds issued to creditors.
For the United States, banks collectively have about 20% of customer deposits held as cash reserves:
As the chart shows, this percentage reached below 5% prior to the global financial crisis (which is why the crisis was so bad, and marked the turning point in the long-term debt cycle), but with quantitative easing, new regulations, and more self-regulation, banks now have about 20% of deposit balances as reserves.
Similarly, the total amount of physical cash in circulation, which is exclusively printed by the US Treasury Department, is only about 13% as much as the amount of commercial bank deposits, and only a tiny fraction of that is actually held by banks as vault cash. There’s not nearly enough physical cash (by design), for a significant percentage of people to pull their capital out of banks at once. People run into “difficulty receiving payments” if enough of them do so around the same time.
As constructed in the current way, the banking system can never end. If a sufficiently large number of banks were to liquidate, the entire system would cease to function.
If a single bank were to liquidate without being acquired, it would hypothetically have to sell all of its loans and securities to other banks, convert it all to cash, and pay that cash out to depositors. However, if a sufficiently large number of banks were to do that at once, the market value of the assets they are selling would sharply decrease and the market would turn illiquid, because there are not enough available buyers.
Realistically, if enough banks were to liquidate at once, and the market froze up as debt/loan sellers overwhelmed buyers, the Federal Reserve would end up creating new dollars to buy assets to re-liquidity the market, which would radically increase the number of dollars in circulation. Otherwise, everything nominally collapses, because there aren’t enough currency units in the system to support an unwinding of the banking systems’ assets.
So, the monetary system functions as a permanent round of musical chairs on top of artificial government-issued commodities, where there are by far more claims on that money (kids) than money that is currently available to them (chairs) if they were to all scramble for it at once. The number of kids and chairs both keeps growing, but there are always way more kids than chairs. Whenever the system partially breaks, a couple more chairs are added to the round to keep it going.
We accept this as normal, because we assume it will never end. The fractional reserve banking system has functioned around the world for hundreds of years (first gold-backed, and then totally fiat-based), albeit with occasional inflationary events along the way to partially reset things.
Each individual unit of fiat currency has degraded about 99% in value or more over the multi-decade timeline. This means that investors either need to earn a rate of interest that exceeds the real inflation rate (which is not currently happening), or they need to buy investments instead, which inflates the value of stocks and real estate compared to their cash flows, and pushes up the prices of scarce objects like fine art.
Over the past century, T‑bills and bank cash just kept up with inflation, providing no real return. However, this tends to be very lumpy. There were decades such as the 1940s, 1970s, and 2010s, where holders of T‑bills and bank cash persistently failed to keep up with inflation. This chart shows the T‑bill rate minus the official inflation rate over nine decades:
Bitcoin is an emergent deflationary savings and payments technology that is mostly used in an unlevered way, meaning that most people just buy it, hold it, and occasionally trade it. There are some Bitcoin banks, and some folks that use leverage on exchanges, but overall debt in the system remains low relative to market value, and you can self-custody your own holdings.
Another variation of the broader Ponzi scheme claim asserts that because Bitcoin has frictional costs, it’s a Ponzi scheme. The system requires constant work to keep it functioning.
Again, however, Bitcoin is no different in this regard than any other system of commerce. A healthy transaction network inherently has frictional costs.
With Bitcoin, miners invest into customized hardware, electricity, and personnel to support Bitcoin mining, which means verifying transactions and earning bitcoins and transaction fees for doing so. Miners have plenty of risk, and plenty of reward, and they are necessary for the system to function. There are also market makers that supply liquidity between buyers and sellers, or convert fiat currency to Bitcoin, making it easier to buy or sell Bitcoin, and they necessarily extract transaction fees as well. And some institutions provide custody solutions: charging a small fee to hold Bitcoin.
Similarly, gold miners put plenty of money into personnel, exploration, equipment, and energy to extract gold from the ground. From there, various companies purify and mint it into bars and coins, secure and store it for investors, ship it to buyers, verify its purity, make it into jewelry, melt it back down for purification and re-minting, etc. Atoms of gold keep circulating in various forms, due to the work of folks in the gold industry ranging from the finest Swiss minters to the fancy jewelers to the bullion dealers to the “We Buy Gold!” pawn shops. Gold’s energy work is skewed towards creation rather than maintenance, but the industry has these ongoing frictional costs too.
Likewise, the global fiat monetary system has frictional costs as well. Banks and fintech firms extract over $100 billion per year in transaction fees associated with payments, serving as custodians and managers for client assets, and supplying liquidity as market makers between buyers and sellers.
I recently analyzed DBS Group Holdings, for example, which is the largest bank in Singapore. They generate about S$900 million in fees per quarter, or well over S$3 billion per year. Translated into US dollars, that’s over $2.5 billion per year USD in fees.
And that’s one bank with a $50 billion market capitalization. There are two other banks in Singapore of comparable size. J.P. Morgan Chase, the largest bank in the US, is more than 7x as big, and there are several banks in the US that are nearly as large as J.P. Morgan Chase. Just between Visa and Mastercard, they earn about $40 billion in annual revenue. The amount of fees generated by banks and fintech companies around the world per year is over $100 billion.
It requires work to verify transactions and store value, so any monetary system has frictional costs. It only becomes a problem if the transaction fees are too high of a percentage of payment volumes. Bitcoin’s frictional costs are fairly modest compared to the established monetary system, and secondary layers can continue to reduce fees further. For example, the Strike App aims to become arguably the cheapest global payments network, and it runs on the Bitcoin/Lightning network.
This extends to non-monetary commodities as well. Besides gold, wealthy investors store wealth in various items that do not produce cash flow, including fine art, fine wine, classic cars, and ultra-high-end beachfront property that they can’t realistically rent out. There are certain stretches of beaches in Florida or California, for example, with nothing but $30 million homes that are mostly vacant at any given time. I like to go to those beaches because they are usually empty.
These scarce items tend to appreciate in value over time, which is the key reason why people hold them. However, they have frictional costs when you buy them, sell them, and maintain them. As long as those frictional costs are lower than the average appreciation rate over time, they are decent investments compared to holding fiat, rather than being Ponzi schemes.
Section Summary: A Network Effect, Not a Ponzi
The broadest definition of a Ponzi scheme refers to any system that must continually keep operating to remain functional, or that has frictional costs.
Bitcoin doesn’t really meet this broader definition of a Ponzi scheme any more than the gold market, the global fiat banking system, or less liquid markets like fine art, fine wine, collectable cars, or beachfront property. In other words, if your definition of something is so broad that it includes every non-cashflow store of value, you need a better definition.
All of these scarce items have some sort of utility in addition to their store-of-value properties. Gold and art let you enjoy and display visual beauty. Wine lets you enjoy and display gustatory beauty. Collectable cars and beachfront homes let you enjoy and display visual and tactile beauty. Bitcoin lets you make domestic and international settlement payments with no direct mechanism to be blocked by any third party, giving the user unrivaled financial mobility.
Those scarce objects hold their value or increase over time, and investors are fine with paying small frictional costs as a percentage of their investment, as an alternative to holding fiat cash that degrades in value over time.
Yes, Bitcoin requires ongoing operation and must reach a significant market capitalization for the network to become sustainable, but I think that’s best viewed as technological disruption, and investors should price it based on their view of the probability of it succeeding or failing. It’s a network effect that competes with existing network effects; especially the global banking system. And ironically, the global banking system displays more Ponzi characteristics than the others on this list.
Any new technology comes with a time period of assessment, and either rejection or acceptance. The market can be irrational at first, either to the upside or downside, but over the fullness of time, assets are weighed and measured.
Bitcoin’s price has grown rapidly with each four-year supply halving cycle, as its network effect continues to compound while its supply remains limited.
Every investment has risks, and it of course remains to be seen what Bitcoin’s ultimate fate will be.
If the market continues to recognize it as a useful savings and payment settlement technology, available to most people in the world and backed up by decentralized consensus around an immutable public ledger, it can continue to take market share as a store of wealth and settlement network until it reaches some mature market capitalization of widespread adoption and lower volatility.
Detractors, on the other hand, often assert that Bitcoin has no intrinsic value and that one day everyone will realize for what it is, and it’ll go to zero. Rather than using this argument, however, the more sophisticated bear argument should be that Bitcoin will fail in its goal to take persistent market share from the global banking system for one reason or another, and to cite the reasons why they hold that view.
The year 2020 was a story about institutional acceptance, where Bitcoin seemingly transcended the boundary between retail investment and institutional allocations. MicroStrategy and Square become the first publicly-traded companies on major stock exchanges to allocate some or all of their reserves to Bitcoin instead of cash. MassMutual became the first large insurance company to put a fraction of its assets into Bitcoin. Paul Tudor Jones, Stanley Druckenmiller, Bill Miller, and other well-known investors expressed bullish views on it. Some institutions like Fidelity were onboard the Bitcoin train for years with an eye towards institutional custodian services, but 2020 saw a bunch more jump on, including the largest asset manager in the world, BlackRock, showing strong interest.
For utility, Bitcoin allows self-custody, mobility of funds, and permission-less settlements. Although there are other interesting blockchain projects, no other cryptocurrency offers a similar degree of security to prevent attacks against its ledger (both in terms of hash rate and node distribution), or has a wide enough network effect to have a high probability of continually being recognized by the market as a store of value in a persistent way.
And importantly, Bitcoin’s growth was the most organic of the industry, coming first and spreading quickly without centralized leadership and promotion, which is what made it more of a foundational protocol rather than a financial security or business project.This blog offers thoughts and opinions on Bitcoin from the Swan Bitcoin team and friends. Swan Bitcoin is the easiest way to buy Bitcoin using your bank account automatically every week or month, starting with as little as $10. Sign up or learn more here.