The petrodollar system is a complex and essential system on which the world economy is deeply based. The system dates back to the late 19th century, when the British Empire dominated all trade and commerce. At the time, the British pound sterling was called the “reference currency”. This currency had to be used to purchase any merchandise on the international market. Furthermore, it was in the hands of any nation that sold these products. Throughout the 1800s and early 1900s, Britain happily controlled this currency, primarily due to its military capabilities and international presence.

After World War II, an important meeting was held in Bretton Woods, New Hampshire. The meeting determined that the US would become the new anchor currency of the Bretton Woods system. In the deal, the US would allow other nations to sell their dollars for gold. As time passed, the realities of Triffin’s dilemma became reality.

In 1971, West Germany, Switzerland, and France decided to sell their dollars for gold; they later left the Bretton Woods system that same year. Ultimately, the United States was slowly running out of gold to back its dollars. How could the United States preserve this system? In 1971, the Nixon Shock occurred, ending the convertibility of the US dollar into gold and ultimately ending the Bretton Woods system. In addition, this established a new system, which was called the petrodollar system.

What exactly is a petrodollar? It is a US dollar that the Organization of the Petroleum Exporting Countries (OPEC) earns, when it sells oil to another nation. The term was first used by Ibrahim Oweiss in 1973.

In the 1970s, many geologists knew that the Middle East had huge oil reserves. Later, US foreign policy pundits decided to maintain a military presence in the Middle East, primarily in nations like Saudi Arabia, Lebanon, Kuwait, Qatar, and Bahrain. This policy would ensure that these nations sold oil in US dollars and the US would protect them from potential threats like the Soviet Union.

So how would this petrodollar system benefit the United States? In the 1970s and 1980s, many OPEC nations ran petrodollar surpluses. Their economies were not sophisticated enough to reinvest in their own economy. Where did these petrodollars end up? The OPEC nations invested the petrodollars in the US and European economies, which were run by commercial banks. Furthermore, these banks allowed OPEC nations to invest in US government securities. The entire process became known as petrodollar recycling, a remarkably efficient and lucrative system for both OPEC and the US.

As the 1990s approached, the US made sure that its foreign policy focused on the Middle East. This would ensure that the petrodollar system would remain intact and would not be challenged by any OPEC nation. In 1991, Saddam Hussein invaded Kuwait. At the same time, Hussein posed a serious threat to Saudi Arabia (remember, Iraq eventually captured the city of Khafji, Saudi Arabia). The United States felt that Saudi Arabia could not be left vulnerable to the Iraqi army. The first strategy the United States tried was to punish Hussein financially. The United States urged OPEC to significantly increase oil production. Saudi Arabia, Bahrain, Qatar and the United Arab Emirates increased oil production. Hypothetically, this would lower the price of oil, which it did, forcing Iraq’s revenues to plummet. This strategy worked only for a short period of time, eventually the US had to intercede militarily. The United States and the coalition liberated Khafji and later all of Kuwait. What would have happened if Saudi Arabia had been completely invaded by Iraq? Could Hussein be left with gigantic oil reserves? Once again, it must be remembered that Hussein could have been in control of the oil fields in Iraq, Saudi Arabia and Kuwait. Also, what if Hussein sold oil in another currency besides the US dollar?

For the next decade, the United States would maintain a robust military presence in Saudi Arabia and other Middle Eastern nations. This strategy ensured that the petrodollar system remained dominant and that all oil was only sold in US dollars. The main side effect of the strategy was terrorism against the US.

In the year 2000, the petrodollar system faced an unprecedented challenge. Iraq’s Oil-for-Food program, which conducted all oil transactions in US dollars, was moved to the euro by Hussein. Washington became exceptionally apprehensive about the Baghdad move. What if other OPEC nations followed Iraq’s plan? In 2003, Hussein finally realized the deadly mistake he had made. Hussein found himself in a dangerous situation when the United States invaded his nation. In the following years, Muammar Gaddafi would exchange Libya’s currency for the gold dinar. Many OPEC nations are in Africa, so these nations would be tempted to dump the US dollar. Gold is another option to sell oil; like the euro. In 2011, Gaddafi would also realize that he threatened the supremacy of the petrodollar system.

There is yet another nation that wants to see the death of the petrodollar system, it is Iran. The Iranians are selling all their oil in yen and euros and they no longer accept US dollars. On the other hand, they are believed to be building a nuclear weapons program, just as Iraq did. Some believe that Iran has the right to use civilian nuclear energy, and they do. The problem is that Iran does not fully comply with the standards of the International Atomic Energy Agency (IAEA).

Iran is playing an exceptionally dangerous game with Washington. If they continue to discontinue the US dollar, further economic sanctions will be imposed on them. Some wonder; Why isn’t Iran still using US dollars? Others ask; Why doesn’t Iran try to become an ally of the US and submit to the petrodollar system? These are relevant questions. The reality is that many anti-American nations like Iran want to see the death of the petrodollar system. Furthermore, they believe that the US system of neo-colonialism should end now.

So what would really happen if the petrodollar system ended tomorrow? Would the United States allow this system to stop? The United States would not allow the system to end because it would hurt not just the US economy, but the world economy. If the petrodollar system ended tomorrow, we would be in deep trouble. First, colossal amounts of US dollars would be pumped back into the US economy, causing massive inflation. Second, oil prices would skyrocket to unprecedented levels. Third, the Federal Reserve would raise interest rates to reduce the overall US money supply. Lastly, people with adjustable-rate debt would be buried and huge layoffs would occur as businesses suffer from high interest rates .

Proponents of the petrodollar system would argue that the system greatly benefits the United States. It allows the US to borrow massive amounts of money at extremely low interest rates. In addition, it allows the recycling of petrodollars to continue. Proponents also claim that the US/OPEC relationship has improved due to the recycling of petrodollars. They state that the US and Saudi Arabia, Bahrain, Qatar and Kuwait have excellent relations for the implementation of the system.

Critics of this system believe that a gold standard should be implemented immediately, they may be right. Although many economists call for a basket of fiat currencies, which can be used to trade oil, this is stubbornly opposed by supporters of the gold standard. They believe that the petrodollar system is a nuisance and invites terrorism against the United States and its interests abroad.

Historically, nations like Iraq and Libya threatened the economic superiority of a world superpower and faced the consequences. Some believe that Iran needs to take this into account and may want to rethink its foreign policy towards the US.

The petrodollar system accurately shows how complex the economy is and how it works for both OPEC and the US The petrodollar system is what shaped and will continue to shape US foreign policy. It is a system that will be tested in the future by possible US adversaries. Many economic and energy experts do not understand it; Why don’t OPEC nations just submit to the petrodollar system? It would be a simple way to avoid a confrontation with the US The future will bring new challenges to the system and we have to hope that nations choose to play by US rules or unfortunately there will be a lot of military conflicts in the future.