An unlikely alliance forges a new economic order
Written and accurate as at: Nov 28, 2023 Current Stats & Facts
In the 1970s, the global economy underwent a significant transformation. This period was marked by the dissolution of the Bretton Woods system and escalating geopolitical tensions following the Yom Kippur War. At the centre of this era's narrative was the unlikely alliance between the United States, the dominant global economic power, and Saudi Arabia, known for its vast oil reserves.
The Collapse of the Gold Standard and Its Consequences
Post-World War II, the Bretton Woods system established the U.S. dollar to be backed by gold. This arrangement offered stability and fostered international trade. However, by the late 1960s, cracks began to appear as the U.S. economy weakened. In 1971, President Richard Nixon withdrew from the gold standard, disconnecting the dollar from gold. This led to a significant devaluation of the U.S. dollar and created instability in international trade and investment, highlighting the need for a new financial framework.
The Yom Kippur War's Economic Impact
The 1973 Yom Kippur War exacerbated this crisis. In retaliation against U.S. support for Israel, Arab oil-producing nations, led by Saudi Arabia, imposed an oil embargo on the U.S. and its allies. The resulting oil shortage quadrupled prices, giving oil producers unprecedented leverage and deepening economic turmoil in the U.S., already reeling from the gold standard's collapse. These events triggered the U.S.'s worst post-World War II recession, with the U.S. Government imposing fuel rationing and lowering speed limits to reduce consumption. The economic situation was so bleak that the U.S. seriously considered a military operation against Saudi Arabia to gain control of the oil fields.
William E. Simon's Diplomatic Strategy
U.S. Treasury Secretary William E. Simon played a crucial role during this period of economic instability. Appointed by President Nixon to restore economic balance, Simon's strategy aimed to prevent oil-rich nations from exploiting their resources as a geopolitical weapon and persuade Saudi Arabia to finance America's growing deficit with its petrodollar wealth.
In 1973, Simon's negotiations led to the creation of the petrodollar system, mandating oil be priced and transacted in U.S. dollars, a strategic move that overrode ideological divides. Initially viewed with scepticism, this system proved critical for global economic policy, aligning the Saudi monarchy with the U.S. despite cultural differences. This arrangement stabilised the American and international economies and ensured Saudi Arabia received American military protection and financial assistance, bolstering Middle East stability and deterring war.
A Forty-Year Secret
The details of this deal remained secret until Bloomberg reporter Andrea Wong uncovered them in 2016 through a Freedom of Information Act. Documents revealing Simon's plan involved the U.S. buying oil from Saudi Arabia and providing military aid in return for Saudi investment in U.S. Treasuries. This resulted in Saudi Arabia accumulating significant U.S. debt, making it one of America's largest foreign creditors. While this deal affirmed the U.S. dollar's dominance and extended its global influence, it has implications.
Enduring Legacy of the Petrodollar System
Establishing the petrodollar system was pivotal in economic history, underlining the power of strategic diplomacy and financial foresight. This system continues to influence global economic trends and international relations profoundly. It solidified the U.S. dollar's status as the primary reserve currency. It created a deep interdependency between the U.S. economy and global energy markets. Additionally, it has significantly influenced U.S. foreign policy, especially in the Middle East, where stability in oil-producing regions is vital for global economic equilibrium.