In the previous article, “Petrodollar: The American Hegemony,” we explored how the US emerged from World War II as the trusted nation to lead the new monetary system with other currencies pegged against the dollar. After President Richard Nixon abandoned the gold standard in 1971, America moved to a new system of using dollars as the median of exchange for oil to maintain global dominance. Today over 60% of reserves in foreign central banks consist of US dollars, meaning that in effect the currency still remains the world reserve currency.
What would happen if the petrodollar system collapsed?
- An unwanted influx of US$ from foreign nations back to the US in exchange for a new currency for oil.
- The Federal Reserve would lose their ability to print money at will to solve US economic problems.
- Potential hyperinflation could ensue and interest rates would increase to combat the high money supply.
This outlines the fact that it must be ranked high on the Federal Reserve’s, and subsequently, the US government’s agenda to ensure that the system is maintained for the future.
In modern day, the attempts of various countries to move against the dollar have become widespread, and speculation as to whether we have entered a new Cold War period built out of currency manipulation has emerged from speculation.
The Emerging Economies vs The Dollar
Previous moves against the petrodollar have included Iraq’s conversion to the Euro as a means for trade of oil in 2000 – which has sparked widespread questioning about the true nature of US invasion of the country in 2003.
In more recent times, one of the biggest moves against the dollar came in July 2014, when the BRICS signed an agreement to form the New Development Bank. The multilateral bank had initial capital equivalent to US$50 billion, as well as a reserve pool of over US$100 billion, to provide funding for infrastructure and development projects within the BRICS. This measure was taken to break the dominance of the US dollar in global trade, as well as the dollar-backed institutions of the IMF and World Bank.
Following the formation of the Bank, the Russian President claimed:
“This mechanism creates the foundation for an effective protection of our national economies from a crisis in financial markets.”
However, since this move, falling oil prices (with the Brent crude oil reaching a six-year low of less than US$50 per barrel) have crippled the Russian economy – with oil exports constituting over 40% of their GDP.
Additionally, sanctions imposed on Russia following their involvement in the Ukraine crisis of 2014 have invoked capital flight, a virtual freeze on foreign direct investment, left the rouble at an all-time low against the dollar (over 60 roubles purchased 1 US$ as of December 2014) and saw Russian bonds downgraded to junk (BB+) by Standard & Poor’s; all of which are synonymous with a country on the brink of collapse.
Putin, while perturbed by the magnitude of the sanctions imposed on his mother nation, has merely used the opportunity to improve relations with countries outside the EU and combat the United States’ global hegemony.
Russia and Iran have agreed to move away from mutual settlements in dollars, and instead are on the verge of a new joint banking system where payments are made in roubles and rivals. The Eurasian Economic Union – including Russia, Belarus, Kazakhstan and Armenia; are aiming to create a single market for financial services by 2025. The overall goal is to simplify the switch to non-dollar trading, and thus weaken the Western influence over member states.
For Russia, this bilateral trade agreement with Iran follows the US$25 billion currency swap/forward agreement with China in December 2014; a significant move for China with US$4 trillion (32%) of its foreign exchange reserves being held in US bonds.
While making agreements outside of its own borders, Russia must also combat its own financial difficulties at home, and has been doing so by accumulating gold in substantial amounts. (Please see graph illustrated, all figures are in tonnes)
This can be considered a move to hedge against the collapse of the rouble and towards the establishment of a new gold-exchange standard, a move which would allow the country to be viewed as a more trustworthy trading partner. Should China and other emerging economies follow suit, it could eventually lead to a sudden flow of unwanted dollars back into the US, which would have the knock-on effects explained earlier.
The End of the Dollar Reign?
The period of American global hegemony could be coming to an end, but the US government and the Federal Reserve remain strong in their economic and overseas policy – and with Obama’s presidential reign soon coming to a close, it is unlikely that the next era of government will submit to competing nations and seek to explore measures to maintain America’s position as the world superpower.
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