The Amazing Petrodollar “Permission Slip”
As you can imagine, the petrodollar system has proven tremendously beneficial to the U.S. economy. In addition to creating a marketplace for affordable imported goods from countries needing dollars, the petrodollar system provides at least three other immediate benefits to the United States.
• It increases global demand for U.S. dollars
• It increases global demand for U.S. debt securities
• It gives the United States the ability to buy oil with a currency it can print at will
Let’s briefly examine each one of these benefits.
The Petrodollar System Increases Global Dollar Demand
In our previous chapter, I explained how global demand for the dollar is important to maintaining a rising levels of prosperity. In many ways, currencies are just like any other commodity: the more demand that exists for the currency, the better it is for the producer. Allow me to develop and refine this thought even further with the following illustration.
Hamburgers, permission slips, and the petrodollar
Let’s imagine that you decided to open a hamburger stand in a small town with a population of 50,000. Of course, not everyone likes hamburgers, so only a certain percentage of your town’s population will actually ever be potential customers. And since you are obviously not the only hamburger stand in town, your competitors will all be attempting to market to the same segment of your town’s population as you will.
Now, as an owner of a hamburger stand in a very small town, would you prefer to have demand for hamburgers from your own town only . . . or would you like to have hamburger demand from other nearby towns and communities, too? (My guess is that you would like to have more customers, as that potentially means more money in your pocket!)
Now, let’s take it a step further with another question. Would you rather have demand for your burgers from your own town and nearby communities only . . . or would you prefer to have all of the hamburger demand in your entire state?
Once again, the answer should be obvious. Every good business owner understands that increasing customer demand is a positive thing for their company’s bottom line.
To put it another way, if consumers all over your state are demanding your burgers, you have just been given a “permission slip” to hire more burger flippers so that you can produce more burgers. (This concept of a “permission slip” created by growing levels of demand is important. So keep it under your hat for a moment.)
Okay, now allow me to go even one ridiculous step further.Imagine that Oprah Winfrey is driving through your state and just so happens to stop in at your growing hamburger stand. (I know — this is getting ridiculous — just bear with me. I really do have a point here.) After Oprah tries your hamburger, she expresses utter amazement at your culinary skills. Oprah is now a raving fan of your burger joint and invites you onto her show to tell the whole world about your hamburgers. It doesn’t take an economist to figure out what is going to happen to the demand for your burgers — it is going to skyrocket.
Your hamburger demand is now global. Congratulations!
As the demand for your hamburgers increases dramatically, so too the supply must increase. Your newfound global hamburger demand has given you a “permission slip” to buy even more frozen patties and hire new fry cooks.
The important concept here is that a growing demand “permits” the producer to increase his supply.
Now, let’s conclude our hamburger illustration by imagining that an up-and-coming rival hamburger company becomes a major competitor with your hamburger restaurant chain. As many of your customers begin visiting your new competitor, the demand for your hamburgers begins to wane. As the demand for your burgers drops, you no longer have a “permission slip” to buy as many frozen patties as you had before. As demand for your burgers continues to fall, it makes little sense to hire more workers. Instead, to remain competitive, you must lay off workers and buy fewer frozen patties just to keep your company afloat. Furthermore, you may even need to sell your existing burgers at a discount before they spoil.
If you chose to ignore the warning signs and continue hiring new employees and buying more patties than were actually demanded by your customers, you would soon find your company nearing bankruptcy. At some point, logic would dictate that you must decrease your supply.
So how does this apply to our current discussion on the U.S. dollar?
Let us now apply the same economic logic that we used to explain the increasing and decreasing demand for your hamburgers to our discussion on the global demand for U.S. dollars.
If it is only Americans who “demand” U.S. dollars, then the supply of dollars that Washington and the Federal Reserve can “supply,” or create, is limited to our own country’s demand.
However, if Washington can somehow create a growing global demand for its paper dollars, then it has given itself a “permission slip” to continually increase the supply of dollars.
This is exactly the type of scenario that the petrodollar system created in the early 1970s. By creating direct incentives for all oil-exporting nations to denominate their oil sales in U.S. dollars, the Washington elites effectively assured an increasing global demand for their currency. And as the world became increasingly dependent on oil to run their economies, this system paid handsome dividends to the United States by creating a consistent global demand for dollars.
And, of course, the Federal Reserve’s printing presses stood ready to meet this growing dollar demand with freshly printed U.S. dollars. After all, what kind of central bank would the Federal Reserve be if they were not ready to keep our dollar supply at a level consistent with the growing global demand?
FACT: The artificial dollar demand created by the petrodollar system returned to Washington the “permission slip” to supply the global economy with freshly printed dollars that it lost after the demise of the Bretton Woods system.
The artificial dollar demand created by the petrodollar system has “permitted” Washington to go on multiple spending sprees to further create their “welfare and warfare” state. And with so many dollars floating around the globe, America’s asset prices (including houses, stocks, etc.) naturally rose. After all, as we have already demonstrated, asset prices are directly related to the available money supply.
With this in mind, it is easy to see why maintaining a global demand for dollars is vital to our national “illusion of prosperity” and our “national security.” (The lengths to which America has already gone to protect the petrodollar system will be explained in our next chapter.)
When, not if, the petrodollar system collapses, America will lose its “permission slip” to print excessive amounts of U.S. dollars. Just like the hamburger stand owner who loses customers to a rival company, the United States will no longer be able to print dollars as the demand for them will have decreased. When this occurs, the amount of dollars in existence will far exceed the actual demand. This is the classical definition of hyperinflation. Since 2006, I have been teaching that America’s bout with hyperinflation will be tied in some way with a breakdown of the petrodollar system and the artificial dollar demand that it has created.
When hyperinflation strikes America, it will be very difficult to stop without drastic measures. One possible measure will be a quick and massive reduction in the overall supply of U.S. dollars. However, with a reduction of the supply of dollars will come a massive reduction in the value of assets currently denominated in dollars. I will provide a potential scenario of a coming petrodollar collapse along with personal strategies that you can take.
The petrodollar system increases demand for U.S. debt securities.