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Gold Standard and the PetrodollarIn 1971 the US abandoned the Gold Standard and created...

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enotechris | College Teacher | (Level 2) Senior Educator

Posted January 18, 2009 at 7:30 AM via web

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Gold Standard and the Petrodollar

In 1971 the US abandoned the Gold Standard and created the Petrodollar. Is oil therefore what has backed US Currency for the last 38 years?

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kromlic | Student, Undergraduate | eNotes Newbie

Posted February 17, 2009 at 9:30 PM (Answer #2)

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When the US abandoned the Gold Standard, it did not "create" the petrodollar. The petrodollar refers to the process where a nation sells oil in a price of US dollars, then deposits that money in Western banks. This term was coined by Dr. Ibrahim Oweiss, a professor of economics at Georgetown University.

Since the US has abandoned the gold standard, the currency has become a fiat currency. The money is no longer "worth something" except the promise to be paid for the dollar itself(Fiat currencies are still useful for debt and the exchange of goods and services, but they are no longer directly redeemable for gold or silver). As such, the money system relies on debt as a key component. The governing body which regulates the US currency is called the Federal(not a government institution) Reserve. The "Fed", as it's known, is a private bank which regulates the USD through various means. Also, Fiat Currency only functions if the people using it agree on it as a common means of transaction.

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santari | eNotes Employee

Posted February 17, 2009 at 9:42 PM (Answer #3)

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When the US abandoned the Gold Standard, it did not "create" the petrodollar. The petrodollar refers to the process where a nation sells oil in a price of US dollars, then deposits that money in Western banks. This term was coined by Dr. Ibrahim Oweiss, a professor of economics at Georgetown University.

Since the US has abandoned the gold standard, the currency has become a fiat currency. The money is no longer "worth something" except the promise to be paid for the dollar itself(Fiat currencies are still useful for debt and the exchange of goods and services, but they are no longer directly redeemable for gold or silver). As such, the money system relies on debt as a key component. The governing body which regulates the US currency is called the Federal(not a government institution) Reserve. The "Fed", as it's known, is a private bank which regulates the USD through various means. Also, Fiat Currency only functions if the people using it agree on it as a common means of transaction.

That's an excellent explanation.

I would add that one of the only reasons the US Dollar remains a viable fiat currency is because it is also the world's reserve currency. Countries around the world hold their reserves in dollars, hence they have a huge stake in making sure the dollar remains viable. But you are exactly right -- it is backed by nothing other than the government's promise that is legal tender to pay debt, and everyone accepts that promise.

One form in which countries hold their reserves is in U.S. Treasury bonds, especially China, but including many countries in the Middle East who use petrodollars to buy these bonds.

The United States finances its huge debts by selling the bonds, which for the most part the rest of the world has continued to buy. Thus, the huge advantage of the U.S. economy. Because it prints the reserve currency, it can finance massive debt.

Is it possible that people might lose faith in the fiat currency and want to hold their wealth in something other than paper dollars? Absolutely. This is something that gives the Federal Reserve and the U.S. Treasury nightmares. A likely candidate is gold. Gold is virtually the only asset in today's market demonstrating a substantial primary bull trend, largely unnoticed for many years, but now gaining more attention. As I noted in a previous post, the closing price of gold annually for the last 8 years is illustrative.

 

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jillyfish | Student, Undergraduate | (Level 1) Valedictorian

Posted February 18, 2009 at 3:02 AM (Answer #4)

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The thing to remember is that a dollar is just a piece of paper. It's worth nothing. The paper dollar is a symbol of value. It represents bartering power. Money, actually, doesn't exist in the physical world. It is just an abstract concept of mutual understanding. It is a convenient 'holding position' in the bartered exchange of goods.

3000 years ago, before money, I swapped my lovely olives for your plump chicken. Goods were bartered. It was very inefficient. But now, I swap things for CASH! Cash is the middle position in a bartered exchange.

So, currently, we all agree to believe a dollar swaps for 'A Coke' or 'A newspaper' or '36 seconds talking to a psychiatrist'! But, 100 years ago, people agreed the dollar had the value of '50 cokes' or '50 newspapers' or '45 minutes with Molly and a bottle of whiskey' etc.  The value moves about!?! How?

Well, the vital, tricky concept to understand is... the dollar is in our heads, not in our wallets. The value of money isn't real. Gold has no value. Dollars have no value. Nothing has any genuine monetary value.

I have a house in Manchester which I could exchange for £180,000 today. If President Putin dropped a nuclear bomb on London tonight, the same house will be worth nothing tomorrow. What changed?... People's feelings of trust.

Money doesn't exist. It is only an indication of our trust in the stability of 'The Market', (where you barter olives for chickens (or houses))

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jillyfish | Student, Undergraduate | (Level 1) Valedictorian

Posted February 18, 2009 at 3:30 AM (Answer #5)

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cont... so, to answer your question...

Economists realised that The Gold Standard wasn't supporting the dollar. Peoples' faith in The Gold Standard was supporting the dollar. So they dropped it. Now, people have direct faith in The Dollar itself. The Dollar represents your feelings towards 'The American Market' in its widest sense. When you are paid in dollars, you are paid in 'faith-in-the-system' vouchers. For the last 38 years, The Dollar has been supported by people's faith in The American Market's stability and growth.

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santari | eNotes Employee

Posted February 18, 2009 at 9:18 AM (Answer #6)

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Gold has no value

Many people would disagree with that that; in fact, 5,000 years of history would disagree with that. Gold has been intrinsic money for thousands of years in virtually every culture that has existed.

The difference between fiat currency and gold is that gold doesn't need the backing of any government to tell you it's worth something; it doesn't need collective trust. The sight and possession of gold has been ingrained in the human psyche as being worth something since it was the time it was discovered.

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jillyfish | Student, Undergraduate | (Level 1) Valedictorian

Posted February 18, 2009 at 9:36 AM (Answer #7)

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I think you've quoted me a little out of context. I said

The value of money isn't real. Gold has no value. Dollars have no value. Nothing has any genuine monetary value.

Gold has no inherent monetary value in itself. It is only in the human mind that it is endowed with value. You say so yourself in your final sentence.

Money doesn't exist so how can gold have any real value.

 

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alexb2 | eNotes Employee

Posted February 18, 2009 at 9:54 AM (Answer #8)

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I think you've quoted me a little out of context. I said

The value of money isn't real. Gold has no value. Dollars have no value. Nothing has any genuine monetary value.

Gold has no inherent monetary value in itself. It is only in the human mind that it is endowed with value. You say so yourself in your final sentence.

Money doesn't exist so how can gold have any real value.

 

At this level, it becomes almost a philosophical debate about the meaning of the word "value". People have always "valued" gold for its many properties, including simply that it looks beautiful in jewelry. On an abstract level you could say nothing has any inherent value other then the bare necessities to survive. People have created metal jewlery since the dawn of the metal age, and gold has usually been considered the most desireable metal. Today, gold is valuable in many applications including gold, electronics, etc. As long as there is such thing as value, gold (along with, perhaps wood, iron, etc.) will have value. Given the many uses of gold, the difficulty in obtaining it, etc. I think it's safe to say that gold's value will remain for the foreseeable future.

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engtchr5 | High School Teacher | (Level 3) Associate Educator

Posted February 18, 2009 at 10:51 AM (Answer #9)

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All of the above raise an interesting question, though it's only vaguely related to petrodollars vs. Gold standard. With the economy in the dumper as it is, many people are reverting to gold and silver as a secure means of financial gain. However, will gold and silver remain as valuable in a more stable economy? What are the factors that influence such rises and falls? It is mainly in times of financial crisis that people begin to grow conscious of precious metals' worth, so, will that value be as high when things regulate themselves once more? Just a thought -- this is why I don't teach economics... 

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enotechris | College Teacher | (Level 2) Senior Educator

Posted February 18, 2009 at 11:31 AM (Answer #10)

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It's true that the assignation of value is completely subjective.  Many may value gold, but that's an agreement among interested parties, and in its absence, people bartered for trade, yet it's still much more convenient to carry a few pieces of metal rather than 5 or 6 chickens.  Historically, going on some kind of exchange standard was (is?) critical for trade.  Then it became even more convenient to substitute paper for metal.  There was a time in these United States you could walk into a bank, plunk down your federal notes, and walk out with its equivalent in gold or silver. Then, at least for the government, it became convenient to "promise" to uphold the currency, as it did in 1934 when the US went off the Gold Standard.  That process completed in the 1970's, but did oil became the new "gold standard" in 1971?  Certainly if the US didn't control oil supplies outright, creating the situation (or forcing?) the world to trade for oil in dollars seems to be the equivalent of backing the dollar with oil, despite what the government says about fiat "promises." Could the "Oil Standard"  (...and not Standard Oil :) be the real reason for the war? This is an exploration in both the economic and philosophical quandaries;  thank you for your responses -- More thoughts?

 

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jillyfish | Student, Undergraduate | (Level 1) Valedictorian

Posted February 19, 2009 at 3:15 AM (Answer #11)

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The dollar is not directly supported by oil. It suits the oil industry to trade in a single currency. So oil from Kazakhstan or Nigeria or wherever is sold in dollars. This stabilises oil trading and oil production. But the dollar is not backed by oil in the way it used to be by gold. Oil almost hit $200 dollars a barrel last year (an insaneprice) and it did not directly reflect on the value of the dollar. If they were directly linked, then dollars would have been 'pumping on steroids', but they stayed low.

I feel sure that the only thing which supports any currrency is peoples' faith in the economy in which it operates. The value of the dollar (or Euro or Yen or Outer Mongolian Weasel Teeth) cannot be shored up by bolting it to another traded good. There is no possible way to artificially prop it up.

OK, when times are rough the price of gold goes up. That's just because of human behaviour. It's not because gold is solid or special. It is a ''lemming'' reaction to bad times. Everyone ''knows'' that people put their cash into gold during recessions, so the smart money does too. It is a self-fulfilling prophecy.

The sea is full of minute particles of gold. A vast vast supply, but nobody knows how to extract it efficiently. If I invented a machine tomorrow that could cheaply remove the gold from the oceans, the gold market would take a permanent sky-dive and gold would lose its magic lustre.

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santari | eNotes Employee

Posted February 19, 2009 at 2:18 PM (Answer #12)

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Everyone ''knows'' that people put their cash into gold during recessions, so the smart money does too.

That sort of begs the question, doesn't it? Are people really so mindless that they just buy gold during tough times because everyone else is? Might there be something else behind it?

Our government is attempting to deal with a vicious bear market -- one created by massive debts and inflation -- by printing ever more paper and pumping billions of dollars into the economy, creating ever more debt and inflation.  People will wonder if this will work; their confidence is being shaken and the market is showing that.  There is an underlying fear that the monetary system we've created, where we create limitless amount of fiat paper, cannot continue to function.

As one writer put it, the whole system is illogical and based on a contradiction:

The real contradiction is that we are forced to use a command money -- which can be produced in unlimited quantities by central bankers -- as the medium of exchange in a free market in which goods and services are scarce.

Before we left the gold standard the arguments against it were instructive. This, from 1892:

"If the Government can create money why should not it create all that everybody wants? Why should anybody work for a living?  Why should we have any limit put to the volume of our currency?"

Even if we did mine all the gold from the ocean, gold would still be scarce, and it would be the most likely candidate to replace or anchor fiat paper.  Sure, we could use any scarce good as the medium of exchange, whale teeth or diamonds or bear skins, but it's gold that has been used for thousand of years.

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jillyfish | Student, Undergraduate | (Level 1) Valedictorian

Posted February 20, 2009 at 2:00 AM (Answer #13)

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we could use any scarce good as the medium of exchange, whale teeth or diamonds or bear skins, but it's gold that has been used for thousand of years.

Forgive me, this will sound a little rude, but what you wrote seems a little mixed up. There is 'monetary value' and there is 'practical value'. Many things have great practical value. Quick example: If you had to spend a night in the open, in winter, in Alaska, would you rather have ten bear skins or 100 hundred-dollar bills? Many things have practical value and they are traded as goods. Bear skins are traded goods. You can swap goods (and services) for other goods (and services)...

"I'll wash your car, if you cook me dinner."

"If you fix my broken sink, I'll give you this guitar."

"Will you give me 'Psycho Killer' on PS3, for this pair of Allstars."

etc

But batering traded goods is really difficult. Finding perfect matches and people who want to swap etc. Very slow. So some genius in Lydia, 3000 years ago, invented an abstract concept called 'money'...

Imagine you have a car and I want it. Would you swap it for a slip of paper if I wrote "This slip is worth one car" on it? Probably not. Because nobody else will aknowledge its value. The slip is theoretically money, but it has no 'weight', no 'reassurance', no 'background'.

In the old days, money was real gold and silver because they were small valuable traded goods. With old, gold money you are basically still bartering.

cont...

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jillyfish | Student, Undergraduate | (Level 1) Valedictorian

Posted February 20, 2009 at 2:59 AM (Answer #14)

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Gold has a practical value. It is easy to shape and makes nice jewellery. People want nice jewellery, you can trade that. But it is no different from lead or magnesium or molybdenum. They are all bartered goods. But gold was chosen to make coins (because it's soft and shapeable, reasonably scarce and is found as a metal not an ore).

Old gold coins were produced in mints (money factories) and were ruthlessly controlled. People gradually began to believe 'gold' is 'money'. But this is a false association. Gold is only a traded good. There is no more 'monetary value' in a 10 dollar gold coin than a 10 dollar plastic one. They both represent the theoretical concept, '10 dollars'. I said it in my first post, I'll repeat it now... Gold has no inherent monetary value. It isn't money. Money doesn't exist. Money is a mental concept. There is no real physical thing that is 'a dollar'. You can't anchor it, prop it, support it or standardise it. Because it doesn't exist. The only thing you can do is have faith in it.

 

(((in the post above I said, 'Money was real gold'. That is lazy writing. I should have written, 'Coins were made from real gold')))

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enotechris | College Teacher | (Level 2) Senior Educator

Posted February 27, 2009 at 6:54 PM (Answer #15)

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I think we can agree that nothing has a value, until a value is placed upon it.  Gold has been a very good commodity upon which people throughout history and around the world have placed a value.  However, this is completely changeable, as the assignation of value may change.  Aluminum was once rarer than gold, so much so that none was available to be used as a medium of exchange. Now it's a container for soft drinks. Certainly, one would assign a huge value to 10 bear skins during an Alaskan winter night, trading $10,000 worth of Alaskan gold for their use.  But having the same 10 bear skins during a Manhattan summer day might be less than worthless, and might get you shot from some animal activist.  Value is relative; the assignation of value is arbitrary, and is best left between the two parties that wish to consummate a transaction.

But to get to the original intent of this post -- by having the world trade for oil in dollars, has that kept the value of a dollar higher than it would otherwise be?  Is the convertibility of the currency, the ability to exchange it from one medium to another, like used to be done in the US with dollars and gold, now done with dollars and oil?

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