How the Dollar Got and Retained its Status

Until the end of World War II, a country’s currency was tied to its gold reserves, i.e., a country printed money would stay in sync with how much gold it had. This acted as a check against a country “just printing” away money endlessly. At the end of World War II, Europe (winners and losers) was in shambles with all its infrastructure and industries bombed away. The US, thanks to its geographical separating from all the war zones, came away intact on those fronts.

 

Thus, the US came to dictate the new rules at the end of World War II, writes Dharshini David in The Almighty Dollar:

“It named the dollar as the international reserve currency. That meant it was the official reserve currency of global commerce, the one in which international trade would be settled.”

Inevitably then, the dollar became coveted. If all inter-country was to be settled in dollars, well then, every country needed to have dollars in hand. To “simplify” matter, only the US dollar would be tied to gold, all other currencies would be tied to the US dollar, not directly to gold.

 

The system worked until the 1970’s when the Israel-Arab war called Yom Kippur War happened:

“In 1973, Arab oil producers boycotted America and punished the West in response to its support for Israel in the Yom Kippur War.”

Suddenly, oil prices spiked by 4 times. Since every part of every country’s economy is tied to oil, suddenly, there wasn’t enough gold to back the dollar. If the dollar collapsed, the effect would be everywhere: remember, all global trade was in dollars. If the dollar was suddenly worthless (i.e., not backed by gold), then why would anyone trade in it?

 

Therefore:

“To help re-establish the dollar’s global credibility, the USA made a deal with Saudi Arabia in 1973.”

Petroleum would be priced and traded in dollars only. That was the agreement between the Saudis and the US. Since Saudi Arabia was the world’s largest oil producer, Saudi Arabia could push the same decision through OPEC as well. Since every country needs oil, this effectively restored the dollar as the global reserve currency. This time, not because the Americans said so, but because that’s what the Saudis and OPEC would accept.

 

What did the Saudis get in return? America’s backing, in many matters including security. It effectively ensured the Iraqis and the Iranians would never attack Saudi Arabia. One can’t prove it but it could certainly explain why the Americans never go hard at the Saudis when it comes to terrorism: If the Saudis switched to the Euro or a combo of Euros, Yen, and Pounds as the currency for petroleum, it would hurt the dollar and thus the US severely…

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