The petrodollar system is one of the most important indicators to watch in order to gauge the timing of the collapse of the US dollar.
This is naturally relevant to those considering diversifying their political risk through internationalization—what this site is all about.
Once the dollar loses its status as the world's premier currency, I believe your options to take preventative action will have significantly narrowed, if not disappeared altogether.
Hence the premium on taking action before that happens.
In order to better understand all of this and get a better idea of where we are right now and where we are headed, I got in touch with Jim Rickards.
Jim Rickards, as many of you know, is a best-selling author and an expert on the international monetary system and geopolitics.
I'm hard-pressed to think of anyone more qualified than him to comment on this critically important topic and am glad to bring this interview exclusively to International Man readers.
You won't want to miss this fascinating discussion, and you'll find it below.
Until next time,
Nick Giambruno: Jim, can you give us a summary of the health of the petrodollar in the past, what it looks like now, and what you think it will look like going forward? What is the significance of all this for the dollar's role as the world's premier reserve currency, the international monetary system in general, and the nominal price of gold?
Jim Rickards: The term "petrodollar" is shorthand for an understanding between Saudi Arabia and the United States that the US will guarantee the security of the House of Saud in return for the Saudis agreeing to price oil in dollars, to manage the dollar price of oil, and to redeposit those dollars in the banking system where they can be used to support international lending by major banks.
This lending, in turn, supports purchases of US and Western manufactured goods and agricultural exports by developing economies. From this deal, the US got cheap energy, exports, banking profits, and the ability to operate a fiat currency system. The Saudis got rich and survived. This system has existed implicitly since 1945 and explicitly since 1974 when it was negotiated by Henry Kissinger on behalf of the Nixon administration.
Now the petrodollar system is collapsing for two reasons. The US has abused its privileged reserve currency position by printing trillions of dollars in an effort to create inflation. More recently, President Obama has taken steps to anoint Iran as the regional hegemon of the Middle East, and to ease the way, in stages, toward Iran's possession of nuclear weapons capability. This is viewed as a stab-in-the-back by the Saudis and the Israelis and will lead quickly to Saudi Arabia obtaining nuclear weapons from Pakistan.
There is also a newly emerging alliance among Saudi Arabia, Israel, Egypt, and Russia. The new alignment will have no particular use for US dollars and no reason to support them. This turn of events marks the beginning of a significant diminution in the role of the dollar in the international monetary system. Since the price of gold is, in large part, simply the inverse of the value of a dollar, the decline of the dollar will presage a major increase in the dollar price of gold.
Nick Giambruno: Saudi Arabia is the lynchpin of the petrodollar system, and they feel the US is not holding up its end of the deal, i.e., keeping the region safe for the monarchy. It also appears that the Saudi regime is not militarily self-sufficient and needs an external protector of sort. That said, what actions can the Saudis realistically take to diversify away from the US, and what initial steps would signal they are not bluffing?
Jim Rickards: When the US withdraws from the rest of the world, as it has been doing since 2009, the world does not sit still but instead seeks regional alliances and other alignments to protect their respective security interests. With the US moving closer to Iran and away from Saudi Arabia, it can be expected that Saudi Arabia will react by creating new alliances. It will receive nuclear weapons from Pakistan, conventional weapons from Russia, intelligence cooperation from Israel, and troop strength, if needed, from Egypt. This is basically an alignment of powers that are all disaffected by the recent US tilt toward Iran.
Saudi Arabia will also expand it energy exports to China. Russia and China are two major powers who have expressed dissatisfaction with the dollar system in the recent past. With Saudi Arabia now aligning more closely with Russia and China, the pieces are in place to diminish the role of the dollar and replace it with either a system of regional reserve currencies or a new global currency based on the Special Drawing Right issued by the IMF. These developments will not be completed overnight, but they have begun and will assume greater prominence and visibility in the next several years.
Nick Giambruno: In gauging the sustainability of the petrodollar system, what other factors should we keep a lookout for: alternative economic/monetary/security arrangements from the BRICS countries, a GCC central bank, and the possibility of a yuan denominated oil futures contract on the Shanghai Futures Exchange?
Jim Rickards: All of the developments you mention, a GCC central bank, a BRICS multilateral bank, and the increasing use of the yuan are significant straws in the wind all pointing in the same direction—the decline of the dollar as the global reserve currency. Other similar developments could include a regional ruble zone on the Russian periphery and the creation of a true Eurobond backed by the full faith and credit of all members of the European Monetary System. While no one of these developments is decisive, each one of them represents an alternative to the dollar for a specified set of transactions. Cumulatively these developments could push the dollar past a tipping point, where it collapses suddenly and unexpectedly after an initially slow decline.
Nick Giambruno: Do you think the US has any aces up its sleeve or will otherwise be able to somehow pull a rabbit out of a hat and prevent the diminution of the dollar's role in the international monetary system?
Jim Rickards: There is a set of policy choices the US could make that would preserve and even strengthen the dollar's role as the leading global reserve currency. These include lower taxes, higher interest rates, breaking up big banks, reduced regulation, repeal of Dodd-Frank, reinstatement of Glass-Steagall, banning most derivatives transactions, improved educational outcomes, smart investment in infrastructure, reduced entitlements, and other structural adjustments. I see little prospect of any of these things happening, let alone all of them. As a result, one must conclude that the dollar is heading for collapse even thought that outcome is not inevitable. It is not too late to make structural adjustments, but it is extremely unlikely.
Nick Giambruno: Jim Rickards, thank for your time and insight into this critical issue. I'd like to encourage our readers to check out your upcoming book, The Death of Money: The Coming Collapse of the International Monetary System, which will no doubt be an international hit. I have already pre-ordered it, and our readers can do the same here.