In 1944, leaders of the 44 Allied nations gathered in a Breton Woods, New Hampshire hotel to agree on a new monetary and financial system post-World War II.
While British economist John Maynard Keynes presented the idea of a global unit of account managed by many nations, the U.S. pushed preferred the idea of the dollar at the center pegged to gold at $35/oz.
Using the leverage provided by its substantial control of the world's gold supply at a time when international trade deficits had to be settled in gold, the U.S. presented the Allied nations with a bargain they couldn't refuse - the Breton Woods system aka the American gold standard.
Breton Woods allowed the U.S. to administer monetary policy by holding on to Allied nations' gold holdings while pegging their sovereign currencies to adjustable dollar amounts backed by and redeemable for gold.
Combined with the Marshall Plan, America's initiative to issue a large amount of credit and distributed capital to help rebuild Europe after World War II, the United States became an economic powerhouse.
The Nixon shock
By the late 1960s, many nations started questioning America's ability to hold the gold peg at $35/oz. More importantly, they feared the U.S. would renege on its promise to keep their gold redeemable.
In 1971, the French government sent a battleship to New York City to collect their gold holdings from the Federal Reserve. Shortly thereafter, the British requested $3 Billion worth of gold for withdrawal.
On August 15, 1971, as a reaction to the world demanding its gold back, President Richard Nixon looked into the television cameras and told the American people (and the rest of the world) that the U.S. would no longer redeem dollars for gold.
This brought the Bretton Woods system to an end, caused the dollar to devalue by more than 10 percent, and called into question America's dominance in the world.
OPEC Crisis
As a response to the Nixon shock and the U.S.'s support for Israel in the Yom Kippur War in 1973, the Arab petroleum exporters of the Organization of the Petroleum Exporting Committee (OPEC) used oil as a political weapon by quadrupling its price, reducing its production by 5 percent a month until Israel withdrew from occupied territory, and embargoing the United States.
In just a few years, the barrel of oil rose by nearly 500 percent.
While this created a vast amount of wealth for Saudi Arabia and the OPEC nations, it also created a dilemma: they didn't know what to do with all the money.
Faced with double digit inflation, a declining global faith in the U.S. dollar, and the need for other nations to finance America's debt, President Nixon and Secretary of State Henry Kissinger came up with an idea that would change the world.
They cut a pact with the devil deal with the Saudis.
The petrodollar is born
The deal was simple. The Saudis would not only enforce the sale of world oil in U.S. dollars, they would take their huge profits and pour billions back in the U.S. treasury to finance America's spending and subsidize its citizenry's consumption.
In exchange, the U.S. would buy oil from Saudi Arabia and provide protection in the form of military aid and equipment.
This was the moment the U.S. dollar married Arab oil, giving birth to the petrodollar.
By 1975, all other OPEC nations joined. Any nation that wanted to buy oil from OPEC and their store of nearly 80 percent of the world's petroleum reserves had to pay in U.S. dollars.
The petrodollar's impact on manufacturing
The petrodollar system enabled the U.S.'s continuation as a global military and financial powerhouse.
However, its hidden costs have impacted the median American in a mostly negative way. The U.S.'s manufacturing sector, the bedrock of working class America, began structurally declining in the 1970's as a result of this imperfect system.
The system allowed the U.S. to run massive trade deficits in order to remain the world's reserve currency. This means America would engage in consumerism by importing goods from abroad while exporting dollars and little of its own goods.
While asset-holding elites on the coasts benefitted greatly from the petrodollar, blue-collar workers became its sacrificial lamb.
The median male income today is not enough to support a household. The ramifications of this on American society have been immense. Incarceration rates, drug abuse, mental illness, and domestic violence have risen steadily since 1971.
The petrodollar's impact on entrepreneurship
For over forty years, new startup businesses have consistently made up a shrinking portion of companies in the U.S. while generating a declining fraction of new jobs.
According to the Brookings Institution, the number of startup businesses launched each year fell by nearly half between 1978 and 2011. Between 1997 and 2012, the number of small construction firms declined by about 15,000, while the number of small manufacturers fell by more 70,000. Local retailers also saw their ranks diminish by about 108,000.
Is the coronavirus a tipping point for American entrepreneurship?
While American entrepreneurship has been consistently declining for decades, the coronavirus pandemic appears to have jump-started a wave of entrepreneurial activity.
According to a recent New York Times article, Americans filed paperwork to start 4.3 million businesses in 2020, a 24 percent increase from 2019 and the most in the last fifteen years. Applications are on place to be even higher this year.
Entrepreneurship is essential to broad prosperity and an expansive middle class. An economy where power and ownership are broadly distributed tends to distribute income more broadly.
The rain isn't clearly gone yet. There are still plenty of obstacles in our way. But this break in the clouds offers hope that tomorrow's gonna bring us brighter sunshiny days.
Stay alert. Stay educated. And most importantly, stay cool.
Have a great week!
Talk soon,
Old Man Winter
