Running on Empty, Part II
How the Petrodollar Poisoned Foreign Policy with Financial Profiteering
Welcome to Part II of Running on Empty, my three-part analysis of the Petrodollar system. Part I of this series explained what the petrodollar system is, how it came to be, and what its financial effects have been on the United States. In Part II, I’ll explain the petrodollar’s implications for foreign policy. In Part III, I’ll show how those implications paved the way for the Russo-Ukraine War, and why that’s causing the system to break down.
America’s Chief Export is the US Dollar
As explained in the previous installment, the petrodollar system is based on an agreement between the US and Saudi Arabia. Under the terms of the deal, the US guarantees the security of Saudi Arabia and in exchange, Saudi Arabia guarantees that all petroleum is sold by OPEC for US dollars, with the US dollars re-invested into America via petrodollar recycling. The result: Since everyone needs petroleum, everyone needs US dollars. Oil replaces gold as the hard backing for the dollar. 1
Since the petrodollar system was put in place, the US has enjoyed a comparative advantage in manufacturing currency that no other nation enjoys. Under conditions of free trade, a country produces and exports more of a good for which it a comparative advantage, and produces less and imports more of the goods for which it doesn’t. And that’s what has happened: Since the petrodollar system was put in place in 1973, America has produced more and more dollars and produced less and less of everything else. The dollar is today our nation’s #1 export.
How large is the circulation of US dollars? As of April 2022, the American money supply, which economists call M2, stands at $21,728 Billion Dollars. M2 includes three types of money:
metallic fiat money (U.S. Mint coins);
central bank fiat paper money (Federal Reserve notes, AKA “dollar bills”); and
bank deposits (including checking deposits, demand deposits, savings deposits, and money market fund deposits).
The U.S. Mint coins and Federal Reserve notes are collectively called the monetary base (MB). The monetary presently stands at $5,885 Billion Dollars. Therefore the remaining $15,843 Billion Dollars — 72% of the money supply — exists within bank deposits.
That’s a lot of money. Where did it actually come from? And cui bono — who benefited?
But the Dollar is Created by Private Banks For Profit
Most Americans believe that the Federal Government creates and controls our money supply. This belief is false. Now, it is true that the U.S. Treasury, acting through the Bureau of Engraving and Printing and the U.S. Mint, prints our paper money and coins our metallic money. However, the U.S. Treasury does not decide how much money gets printed. The Federal Reserve actually makes that decision, submitting an order to the BEP each year stating how much money to print.
Despite its name, the Federal Reserve isn’t actually run by the Federal Government. It’s just chartered by it. As the official website of the St. Louis Federal Reserve states, “The Federal Reserve Banks are not a part of the federal government, but they exist because of an act of Congress.” The Federal Reserve Banks are actually private corporations owned by the nation’s commercial banks, such as JP Morgan Chase, Bank of America, Wells Fargo, and Citigroup. The commercial banks are paid dividends (profits) from the Federal Reserve’s operations and get to elect six of the nine members of each Bank's board of directors. The dollar printing press is actually, albeit indirectly, controlled by Wall Street.
Even if the U.S. Treasury were in charge of the printing press, however, it would still not create or control the money supply, because most of the money isn’t in bills or coins. As I said above, 72% of the money supply consists of commercial bank deposits.
And who creates bank deposits? Banks! According to the credit creation theory of banking, money is created whenever banks loan funds. They create this money out of thin air.
Now, many influential economists, as well as the unbiased and trustworthy philanthropists at the World Economic Forum, reject this theory, arguing that banks are merely financial intermediaries. I disagree with them, vehemently, but it’s a complex debate. For a comprehensive review, I refer you to the 2014 paper “Can Banks Individually Create Money Out of Nothing?” The paper’s findings are summarized below, and mirror my own assessment:
This paper presents the first empirical evidence in the history of banking on the question of whether banks can create money out of nothing… Three hypotheses are recognized in the literature. According to the financial intermediation theory of banking, banks are merely intermediaries like other non-bank financial institutions, collecting deposits that are then lent out. According to the fractional reserve theory of banking, individual banks are mere financial intermediaries that cannot create money, but collectively they end up creating money through systemic interaction. A third theory maintains that each individual bank has the power to create money ‘out of nothing’ and does so when it extends credit (the credit creation theory of banking). The question which of the theories is correct has far-reaching implications for research and policy. Surprisingly, despite the longstanding controversy, until now no empirical study has tested the theories. This is the contribution of the present paper. An empirical test is conducted, whereby money is borrowed from a cooperating bank, while its internal records are being monitored, to establish whether in the process of making the loan available to the borrower, the bank transfers these funds from other accounts within or outside the bank, or whether they are newly created. This study establishes for the first time empirically that banks individually create money out of nothing. The money supply is created as ‘fairy dust’ produced by the banks individually, "out of thin air".
If you accept the credit creation theory of banking, then the method by which banks create money is actually easy to understand: Whenever they make a loan, they magically make the money they lend. When Citibank issues a college student his first credit card, extending a $1,000 credit line, Citibank has created $1,000. When a homeowner, noticing that his house has appreciated on Zillow.com, secures a home equity loan for $100,000 from Bank of America, Bank of America has created $100,000. The money didn’t exist before then.
Now, when a loan is created, it carries interest; and that interest must be paid back to the lender. The repayment of interest constitutes the bank’s profit. Since 72% of America’s money supply is created by commercial banks via lending, there’s a lot of profit to be had. (The other 28% of the money supply is created by the Federal Bank, indirectly for the profit of the commercial banks which own it, too.) Banking is big business - the biggest business in the world.
The Petrodollar Monopoly is Maintained by Military Might
At this point we’ve established that the petrodollar system gives the US a worldwide monopoly over creating the currency needed to buy oil, and that said currency is created by our commercial banks when they lend money for profit. This is a remarkably advantageous monopoly for any industry.
Economists hold that monopolies can occur because of a number of factors. For instance, the monopolist might be protected by barriers to entry created by high fixed costs, low volume-based pricing, or network effects. The monopolist might have physical control over real property. Or the monopolist might have legally-enforced control over intellectual property.
How is the petrodollar monopoly maintained? Within the United States, US banks have a legally-enforced monopoly over creation of money. But US law does not apply overseas and there are hundreds of currencies in circulation. What prevents an oil-producing country from selling its oil for euros or yuan? What prevents a country from disrupting oil sales in dollars through embargos, sanctions, or military force?
The petrodollar monopoly is maintained by maintained by military might. Any country that threatens the system, whether by destabilizing the Middle East or by selling oil for any other currency, is punished by the U.S. First it endures sanctions, then it faces air strikes and covert actions, and finally - if sufficiently recalcitrant — it suffers invasion.
The necessity of using force is logically entailed by the security deal we struck with Saudi Arabia and the actions taken to sustain the arrangement are evident in the historical record.
After World War Two, but prior to the petrodollar regime, the US followed a policy of non-involvement in the Middle East. There were 36 notable conflicts in the Middle East between 1945 and 1980 — approximately one notable conflict each year.2 The United States participated in none of them.
But that changed as soon as the petrodollar system faced its first threat. That came in the form of the 1979 Iranian Revolution. US President Carter immediately announced a new policy:
"An attempt by any outside force to gain control of the Persian Gulf region will be regarded as an assault on the vital interests of the United States of America, and such an assault will be repelled by any means necessary, including military force."
In the 42 years since Carter announced this policy, there were another 39 notable conflicts in the Middle East — again, approximately one notable conflict began each year. But the US has taken part in 11 of these, with active fighting in every year since 2003.
War, Clausewitz taught us, is a continuation of policy by other means; and US policy is to sustain the dollar as the reserve currency by enforcing the petrodollar system. American war is therefore the perpetuation of the petrodollar by other means. The US military has been transformed into the enforcement arm of the US banking industry.3
The US Invasion of Iraq (1991) was for the Petrodollar
Syria and Egypt had invaded Israel in 1973. Turkey had invaded Cyprus in 1974. Iraq had invaded Iran in 1980. The US never committed forces to intervene. But when Iraq invaded Kuwait in 1991, the United States led the largest military alliance since WWII into war, deploying a million-man army to liberate a country smaller than Massachusetts. Why? Because Kuwait was adjacent to Saudi Arabia, and Saudi Arabia was terrified that Saddam would advance against it. As the Encyclopedia Britannica explains:
Saudi political leadership was challenged when Iraq, after having rejected attempted Saudi mediation, reasserted its earlier claims and invaded neighboring Kuwait on August 2, 1990, precipitating the Persian Gulf War (1990–91). The Kuwaiti government fled to Saudi Arabia, and King Fahd denounced the Iraqi invaders. Fearing that Pres. Saddam Hussein of Iraq might invade Saudi Arabia next (despite Saudi assistance to Iraq during the Iran-Iraq War), the Saudis, breaking with tradition, invited the United States and other countries to send troops to protect the kingdom.
Since the petrodollar system was founded on America’s guarantee that it would offer military aid to Saudi Arabia in time of need, we had to repel Saddam. And we did.
The US Invasion of Iraq (2003) was also for the Petrodollar
When President Bush ordered the invasion of Iraq in 2003, the war was justified as the necessary disarmament of a destructive supporter of Islamic terrorism and the heroic liberation of a long-suffering people.
At the time, I staunchly supported the war, and even consulted to the Department of Defense for a project during the War on Terror. Unfortunately, I now know that the US invasion of Iraq was more about the petrodollar than about weapons of mass destruction. The evidence was there back then for those with eyes to see. (I didn’t).
On 1 November 2000, America’s Radio Free Europe reported that Iraq was actively attempting to destroy the petrodollar system:
“Iraq is going ahead with its plans to stop using the U.S. dollar in its oil business in spite of warnings the move makes no financial sense… Iraq is dusting off a strategy which another state hit by U.S. sanctions — Iran — discussed as recently as last year… [T]he idea of switching to the euro has appeal to Iran and Iraq because they feel if several major oil producers did it they could create a stampede from the dollar which would weaken Washington.”
Radio Free Europe is run by the Federal Government and reflects the foreign policy of our country. If RFE declared that Iraq was seeking to end the petrodollar, it’s because… the US thought that Iraq was seeking to end the petrodollar.
And the United States moved swiftly to respond. On January 23, 2001 — eight months before 9/11 — the US Department of State began circulating an Iraq regime change policy. By November 27, 2001 Secretary of Defense Donald Rumsfeld had drafted a top secret memo outlining the plan for the Iraq War.
The patriotic impetus provided by the atrocities of 9/11 made it easy for the Bush Administration to get public support to invade Iraq. The American elite, with a few notable exceptions, supported the invasion.
The elite in Europe were more circumspect. In January 2003, the Foundation for the Economics of Sustainability published a paper by Cóilín Nunan warning that America was going to invade Iraq in order to maintain dollar hegemony:
Europe, like most of the rest of the world, wishes to see a peaceful resolution of the current US-Iraqi tensions and a gradual lifting of the sanctions - this would certainly serve its interests best. But as Iraqi oil is denominated in euros, allowing it to become more widely available at present could loosen the dollar stranglehold and possibly do more damage than good to US economic health. All of this is bad news for the US economy and the dollar. The fear for Washington will be that not only will the future price of oil not be right, but the currency might not be right either. Which perhaps helps explain why the US is increasingly turning to its second major tool for dominating world affairs: military force.
Mr. Nunan was, of course, correct. Two months later, the US invaded Iraq, where it continues to wage war, at varying degrees of intensity, almost two decades later.
The Foreign Policy Implications of the Petrodollar
The Iraq invasions are just two of the manifold policy outcomes driven by our petrodollar system. Two further examples wills suffice for this blog:
In April 2005, Iran announced that it would begin selling petroleum in alternative currencies in an oil exchange that would open in March 2006. In September 2006, the US enacted the Iran Freedom and Support Act, which empowered President Bush to aid “pro-democracy groups” in Iran. In January 2007, US forces raided the Iranian Consulate General located in Erbil, Iraq. In December 2007, Iran announced it would no longer sell oil for dollars. The two nations have continued to trade blows over oil and currency since.
In 2009, Libyan dictator Muammar Gaddafi suggested that Africa’s nations should switch to a pan-African currency based on gold. Libya was sitting on 150 tons of gold and announced that to support the currency its oil would be sold for gold-backed dinars. In March 2001, a NATO-led coalition intervened in Libya, leading to Gaddafi’s 41-year old regime (and life) coming to an end.
If you’d like to read more about the foreign policy implications of the petrodollar, I recommend two books:
Petrodollar Warfare: Oil, Iraq, and the Future of the Dollar by William R. Clark. Written in 2005, the book warned that the unsustainable macroeconomics and geostrategic tensions created by the petrodollar system would lead America into military overextension and subsequent economic decline.
Super Imperialism: The Economic Strategy of the American Empire by Michael Hudson. The 2021 edition is the most up-to-date explanation of how the dollar’s being forced off gold in 1971 led to the new international financial system which I call “the petrodollar regime” and Professor Hudson calls “super imperialism.”
In part III of this essay series, we’ll discuss how the petrodollar system is related to the the Russo-Ukraine War, and how we should understand the future of geopolitics in light of the petrodollar system’s imminent demise.
If you are wondering why you never heard much about the petrodollar treaty, it’s because it some of its key terms were deliberately kept secret. It stayed secret until 2016, when Bloomberg Business used a Freedom of Information Act request to discover what had transpired. Because the details of the petrodollar arrangement were kept secret for many years, many people have called it a conspiracy theory. Now that the existence of the arrangement is known, it’s harder to dismiss the theory.
However, some critics still argue that oil is of too little importance to explain America’s currency dominance, making the petrodollar effectively a myth. For a “steel man” presentation of this argument, check this Reddit post. I agree with the Redditor on the historical record but disagree on the economics. The Redditor’s napkin math hasn’t taken into account the fact that oil replaced gold in providing the “hard” backing of the US dollar. By similar napkin math, the prior gold standard also would have made no sense, because gold was such a small fraction of the US economy. I leave it to the reader to decide who is right.
Noam Chomsky found a clever way to exploit the yearly outbreaks of violence. Anytime he was called on to submit a speech proposal for a conference the following year, he always entitled it “The Current Crisis in the Middle East,” knowing that there’d always be a new crisis to talk about.
Many writers, especially on the political left, have claimed that the US wages war on behalf of oil companies. I believe this claim fails because it doesn’t actually track US policy. For instance, from 1973 to 1988, Saudi Arabia gradually nationalized ownership of all oil assets in the country, taking them from Exxon, Texaco, and Mobil. The US contemplated invading Saudi Arabia to take control of the oil fields and easily could have done so. Instead of doing that, we set up the petrodollar system.
We see a similar outcome in Iraq. When the US invaded Iraq, many leftists claimed that we’d done it for Halliburton. But many of Iraq’s oil contracts actually went to foreign firms, including Chinese and Russian oil companies. Why would the US allow this if the war was really fought for physical ownership of oil?
The truth is that the US foreign policymakers don’t actually care that much who ends up owning or operating the wells. They mostly care what currency the oil is bought and sold with. The war machine primarily serves Big Finance, not Big Oil.