Dollar Dominance and the Oil Conspiracy

A Brief Recap

• In my previous post, The US Dollar Still Rules, to the Apparent Dismay of the BIS, we reviewed a brief history of money, and how in the post-WWII era the US dollar came to be the dominant global reserve currency. The dollar took over from British sterling - after its nearly 200 year run of being the favored international currency - thanks to the Bretton Woods Agreement of 1944.
• The Agreement established a new international monetary system where US dollars were convertible into gold at a fixed price, and other currencies were pegged to the dollar.
• The economics behind the collapse of the Bretton Woods system are honestly beyond me - in that they are beyond my tolerance for boredom. You can read about them here. The final reckoning began in the late 60s, when the US no longer had enough gold reserves to back the amount of currency at home and abroad, meaning the Federal Reserve was de facto insolvent. The rest of the world was understandably chapped.
• In 1971, West Germany and Switzerland were the first two to exit the Bretton Woods system, and other nations were demanding gold and threatening to leave as well. 
• Nixon, acting on advice of Treasury Secretary John Connally, Federal Reserve Chairman Arthur Burns, and a then-undersecretary at Treasury Paul Volcker, unilaterally took the US - and effectively the rest of the world - off the modified gold standard in 1971. 
• Currencies began to float after an adjustment period, though some retained a deliberate soft or hard peg to the US dollar.  
• In the early 70s as the world converted to fiat currency and the US dollar devalued, economists, financial analysts, and politicians the world over predicted the demise of the dollar as the global reserve currency. It didn't happen.

There is an interesting theory about why it didn't happen then. This is worth discussing because some analysts make investment recommendations based on the supposed link between oil trading and the dollar's status as global reserve currency.

The Big Oil Conspiracy

The crux of the big oil conspiracy is that as the US was backing out of Bretton Woods in the early 70s, US leaders entered into secret deals with Saudi Arabia to have oil invoiced and settled exclusively in US dollars in exchange for military protection and supplies. These deals supposedly secured oil production for the US, put the US dollar on an oil basis instead of a fiat basis, and ensured that the dollar would remain the dominant global reserve currency by monopolizing the oil trade. The US dollars paid for oil - nicknamed "petrodollars" - would then be recycled into US dollar assets, effectively subsidizing US energy needs and economic growth at the expense of other oil importers. The conspiracy goes a little bit further, alleging that the dramatic oil shocks of the early 70s were not due to political disagreements over the Arab-Israeli conflict, but supposedly secretly planned for and encouraged by former Secretary of State Henry Kissinger (you know it's always Kissinger) to inaugurate the petrodollar recycling wave and save the US and UK oil companies.

There is more if you want to read about it, complete with modestly hysterical undertones, here.

The scaffolding of the oil conspiracy is accurate, in that many of those things occurred, some no doubt hammered out during negotiations about mutually beneficial relationships between the US and its allies in the Middle East. The real cloak-and-dagger bits seem to trace back to two relatively recent books, one written by David Spiro, The Hidden Hand of American Hegemony: Petrodollar Recycling and International Markets, published in 1999; and the other by William Engdahl, A Century of War: Anglo-American Oil Politics and the New World Order, published in 2004. I haven't read either one of them, but they variously use as primary sources for their allegations recently declassified documents recovered via the Freedom of Information Act (Spiro), interviews with high level attendees at the meetings, and - in Engdahl's case (footnoted on the Big Oil website, link above):

Engdahl was able to purchase the secret minutes of a May 1973 Bilderberg meeting from a Paris bookseller. His book contains actual photocopies of the cover page and related text discussed in chapter 1. The cover page is stamped: "SALSJOBADEN CONFERENCE 11-13 May 1973." Also stamped on the cover page are the words: "PERSONAL AND STRICTLY CONFIDENTIAL" and "NOT FOR PUBLICATION EITHER IN WHOLE OR IN PART"

In my very limited research I have not seen anyone challenge their allegations or their source materials, nor have I seen other authors offer different interpretations of the notes or state they have reviewed the original documents. Take both of these sources as you will.

Specious Market Analysis and Trade Recommendations

The problem with conspiracy theories in investment management is that they may over-emphasize or attribute causal relationships between asset classes based on specious reasoning. I'm not trying to call anyone out, as I've certainly made some lousy trade recommendations of my own over the years. Therefore I'm not going to provide links to the original sources of the trade ideas below.

Idea #1: Since the US dollar is fundamentally an oil-based currency, the price of oil and the value of the dollar are linked. The price of oil will rise and the value of the dollar will increase.

Idea #2, different version: The value of the US dollar is heavily dependent on its role in oil trading. If energy trading begins to diversify away from the dollar - perhaps due to the $400 billion Sino-Russian gas deal signed in 2014 which allows Chinese purchases to be settled in renminbi - then the US dollar's reserve status will be threatened. Foreign banks will diversify away from US dollar assets, interest rates will rise, the value of the dollar will plunge and gold will appreciate.