Petrodollars drive American political indulgence and provoke war and terrorism. But few living today remember how petrodollars started.
Petrodollars are US dollars that one person, group or country pays another for oil. The word dates back to 1973, the year of the Yom Kippur War—and the likely year in which America and Saudi Arabia struck a Faustian bargain.
On August 15, 1971, then-President Richard M. Nixon refused to redeem US dollars for gold, after he and others realized that the USA no longer had enough gold to buy back every dollar that foreign governments were handing in. The Bretton Woods Agreements of 1944 was now dead. The United States had just gone bankrupt, like any person or company that cannot pay his/her/its bills.
So in 1973, Nixon and his new Secretary of State, Henry Kissinger, invented another system to let it continue spending money and not pay it back. They asked King Faisal of Saudi Arabia to accept only the US dollar in payment for oil, and to buy US Treasury bonds, notes and bills with their excess profits. In return, the USA pledged to protect Saudi Arabian oil fields from seizure by any enemy of the kingdom. The likely enemy that Faisal feared was the Soviet Union.
The Yom Kippur War upset this agreement, and the Great Oil Embargo of 1974 was the result. What made Saudi Arabia lift that embargo is still not clear, because the Arabs never wrung from Israel any of the concessions they said they were demanding. More likely, the Saudis realized that if they didn’t come to terms, the USA would get along without them. Nixon had cut all arguments short on the Alaska Pipeline; who knew what other oil reserves the USA had?
By 1975 the Embargo was over and all members of OPEC accepted dollars for oil. The dollar now became the reserve currency of the world. Everyone needed it to buy oil. Everyone would take as many dollars as the Federal Reserve cared to print. The USA could now print more money to buy oil (or anything else), and expect the oil producers to hold the debt that such printing incurred—and never ask for their money back.
This petrodollar system might explain why President Jimmy Carter could force Israel to give up Sinai and agree to buy Sinai oil—and pay in dollars—forever. It also explains why Carter would do this. Israel would never join OPEC and never sell the oil from Sinai oil wells for anything other than gold, other commodities, or maybe in shekels. (Even today, Israeli merchants eagerly take US dollars from American tourists, though these shrewd people ought to know that a tourist dollar is not worth the paper it’s printed on. The country needs dollars to buy oil. End of story.)
The system has never been stable. It nearly broke down during the Carter years, as the money inflated by double digits. President Ronald Reagan restored stability, and calmed the public, by removing all controls on oil and fuel prices and all restrictions on oil drilling. Oil flooded the market, prices fell, and petrodollars became more valuable (or seemed to). These were some of the most prosperous years that America had. But the danger remained, because America continued to spend more than it earned.
Petrodollars also led to the First Persian Gulf War of 1990. The objective was not to seize Saddam Hussein’s oil fields directly, but to satisfy American obligations, under the secret agreement of the Nixon era, to protect the Saudi oil fields from an unscrupulous dictator who hoped to be the master of the Peninsula. Once Saddam Hussein sued for peace, George H. W. Bush graciously granted him that peace. (And while this was happening, the people of Israel had to build sealed rooms in their homes, and bolt to them often when Hussein launched missiles at them, allegedly laden with chemical warheads. The Israeli Air Force could have taken out any of Hussein’s missile batteries at any time, but the USA wouldn’t let them.)
Petrodollars would stay in place so long as no one had an alternative to the dollar. The 1990s would produce such an alternative, and a latter-day Muhammad with a motive, opportunity, and means for war.