International Action Organization

How Money Works

 By Lila Schow
June, 2005

World War II created a unique situation for the United States.  With most of the world in literal and economic ruin, the US became the only developed nation to end 1945 with booming industries and production.  As an additional bonus, the US found itself in possession of 80% of the world’s mined gold, worth $30 billion.[1]

That gold was used to back the dollar, leading the dollar to become the international reserve currency. But the 1964-1975 Vietnam War cost the US government over $500 billion, far exceeding the amount of gold held in the Treasury.[2] 

So on August 15, 1971, President Nixon suspended the dollar’s conversion to gold. The US dollar became “fiat,” a currency whose value is based on the government’s “financial means and creditworthiness.”[3]

Enter Iraq.  The Baghdad Conference, held September 10-14, 1960, resulted in the creation of the Organization of the Petroleum Exporting Countries (OPEC).  A cartel of oil-rich nations, OPEC came together to battle the power of large refinery companies.  The countries of OPEC knew American and European oil companies were planning to hold down petroleum prices.  The oil companies would reap huge benefits, but oil producing nations would see little of that profit.

The five Founding Members (Iran, Iraq, Kuwait, Saudi Arabia and Venezuela) were later joined by eight others: Qatar (1961); Indonesia (1962); Libya (1962); United Arab Emirates (1967); Algeria (1969); Nigeria (1971); Ecuador (1973–1992) and Gabon (1975–1994).[4]

Thirteen years after OPEC’s creation, the 1973 October War provided Middle Eastern nations the opportunity to flex their power.  On Yom Kipper October 6, 1973, the holiest Jewish holiday, Egypt and Syria attacked Israel. The countries wanted to regain territories held under Israeli occupation since 1967. The US provided Israel with military assistance, leading Egypt’s President Anwar Sadat to pressure Saudi Arabia’s King Faisal to retaliate. 

On October 16 1973, five Gulf States (Iran, Iraq, Abu Dhabi, Kuwait, Saudi Arabia and Qatar[5]) announced a 70% increase in oil prices.[6] 

At a meeting held in Kuwait City, Iraq called on Saudi Arabia, Iran, Abu Dhabi, Kuwait and Qatar[7] to nationalize American businesses and impose a total oil embargo.  In addition, Iraq demanded the withdrawal of all Arab funds from US banks hoping it would result in a panic similar to the crash of 1929. 

Instead of going with Iraq’s scheme, on October 17 1973 OPEC started a limited embargo.  They planned a 5% cut in production that would decrease an additional 5% each month until Israel pulled out from the 1967 territories and the US amended its foreign policy.  

On October 19 1973, Nixon asked Congress for $2.2 billion in aid for Israel.  The next day, Saudi Arabia led OPEC’s embargo.[8]  The US faced a total embargo.  For voicing support for Israel and allowing Americans to use Dutch airfields for supply runs to Israel, the Netherlands were also slapped with a complete embargo.

West Germany, Belgium, Italy and Luxemburg faced partial restrictions.  The “United Kingdom and France received almost uninterrupted supplies (having refused to allow America to use their airfields and embargoed arms and supplies to both the Arabs and the Israelis).”[9]

The results to the US were devastating. The price of a gallon of gasoline rose from 38.5 cents to 55.1 cents in less than one year.  Worse, the New York Stock Exchange lost $97 billion in six weeks. Imported oil from Arab countries dropped from 1.2 million barrels a day to a mere 19,000 barrels.[10]

Perhaps some of the US’s greatest losses during the embargo came in the form of Japan’s emerging dominance in the global market.  Unlike the other oil-importing nations, Japan adapted their industry to take advantage of the embargo.  Japanese automakers led the way in manufacturing smaller and more fuel efficient cars.  The embargo also forced the shift in Japan’s economy away from oil-intensive industries, resulting in huge investments in the electronics arena.[11]

Although the October War did not end until 1977, all hostilities ended by October 26, 1973.[12]  The embargo lasted until March 18, 1974, when Nixon sent Henry Kissinger to the Washington Energy Conference, with a seven-point "Project Independence" plan to make the US energy independent. Key Middle Eastern countries (Algeria, Egypt, Syria, and Saudi Arabia) accepted the plan in view of the progress in Arab-Israeli disengagement, and oil shipments to the US resumed.[13]  

Saudi Arabia played a crucial part in the oil embargo and watched the price of their oil leap from $1.39 to $8.32 a barrel.  This money filled Saudi Arabia’s national coffers with billions and undermined some of the strict religious beliefs of the country. 

Wall Street and Washington decided they could not let another embargo affect the US.  Several options were discussed to ensure oil stability.  According to documents released in January 2004, the US pushed for the invasion of Saudi Arabia and Kuwait to seize their oil fields. The US also considered replacing Arab rulers with "more amenable" leaders, or using the military to intimidate OPEC nations into compliance.  Ultimately, these half-baked ideas were rejected for a more insidious plan.[14]

Forced to recognize the importance of Saudi Arabia to our economy, the US began an organized campaign designed to influence the distribution of petrodollars (Petrodollars may be defined as the US dollar earned from the sale of oil, or as oil revenues denominated in US dollars.).

Nixon offered the Saudi Arabia modernization, technical support, military hardware and training.  This entrance into the “twentieth century” came with two conditions. 

The first; Saudis had to guarantee to maintain oil at prices that, though they could fluctuate, always remained acceptable to the US.  This included a promise to never again engage in an oil embargo and to fill the void for any embargos by other oil-producing nations. 

The US-SA Joint Economic Commission (JECOR) was founded in 1975 and relied on Saudi money to hire American firms to build up Saudi Arabia.  Because of this, JECOR could work through the Department of Treasury with no Congressional oversight.  Their end objective was to maximize payouts to US firms while making Saudi Arabia increasingly dependent on us.  Besides literal dependence (for upgrades and maintenance), the modernization of Saudi Arabia caused a break in traditional Arab allies.  Threatened Middle Eastern nations created a huge defense industry which US corporations and government officials happily fed.[15]

The second, and most serious condition, stated that Saudi Arabia would only accept US dollars for their oil.  They then had to use these “petrodollars” to buy US government securities.  The interest on the securities would be spent by the US Treasury to help Saudi Arabia modernize and industrialize.  So, “interest compounding on billions of dollars of the kingdom’s oil income would be used to pay US companies,” at Saudi Arabia’s expense, to upgrade their society to one closer to ours through huge infrastructure projects and even the creation of entire cities.[16]

The House of Saud found themselves in no position to argue as they lacked a strong military and were surrounded by well-armed nations including Israel, Iraq, Iran, and Syria. In exchange for their cooperation, the US government would provide unwavering political and military support for the House of Saud. 

As both the largest oil producer and the country with the largest known oil reserves, Saudi Arabia does more than lead OPEC. They are the only member that do not have any production quota, meaning they can increase or decrease production bringing oil drought or glut to the world market.[17]

Because Saudi Arabia’s power allows them to determine OPEC prices, their acceptance of the dollar set the standard for other oil-producing nations.

 As oil could only be bought from OPEC with American dollars, countries world-wide suddenly needed the no longer gold-backed pieces of paper.  If impoverished nations could not sell enough goods to earn dollars, they had to borrow dollars from either the World Bank (WB) or International Monetary Fund (IMF), which had to be paid back, with interest, in dollars. 

“This requires them … to maintain dollar reserves to protect their own currency; and these reserves, when invested, help maintain the current high levels of the US securities markets.”[18]

 To prevent speculative and manipulative attacks on their currencies, the world's central banks must acquire and hold dollar reserves in corresponding amounts to their currencies in circulation. The higher the market pressure to devalue a particular currency, the more dollar reserves its central bank must hold. This creates a built-in support for a strong dollar that in turn forces the world's central banks to acquire and hold more dollar reserves, making it stronger. This phenomenon is known as dollar hegemony.[19]

And so the dollar became an oil-backed, not gold-backed, currency.

Dollars are invested or deposited in US banks or the US Treasury by most non-oil producing, underdeveloped countries to protect their currencies and generate oil credit. Today foreigners hold 48% of the US Treasury bond market and own 24% of the US corporate bond market and 20% of all US corporations. In total, foreigners hold $8 trillion of US assets. Nevertheless, the foreign deposited dollars strengthen the US dollar and give the United States enormous power to manipulate the world economy, set rules, and prevail in the international market.[20]

With this currency scam, the US runs the world oil market for free, allowing the US government to build a debt based upon credit assets they don't physically own.[21] So what would happen if OPEC decided to trade in another currency?

Seventeen years ago the US economy's net foreign indebtedness was zero. In 1988, the United States was a creditor nation, investing and lending vast capital to others, always more than it borrowed. By 2002, before the start of a war that left us $160 billion in debt, our net foreign indebtedness reached nearly 25% of US GDP. As the deficit persisted at $400 billion a year, the total US indebtedness reached $3.5 trillion. Within a decade, it will total 50% of the GDP. [22]

In 2000, Iraq became the first OPEC country to trade in euros rather than dollars. Iraq also converted their $10 billion reserve fund at the UN to euros. It was predicted that Saddam's political act would cost Iraq millions.  Instead, Iraq profited from a 17% gain in the value of the euro against the dollar. (Note:  This gain was calculated when the euro was worth $1.08.[23] As of March 2005 the euro was valued at $1.3183 when compared to the dollar[24]).

The euro is the shared currency of 15 European nations.  Germany and France make up the bulk, but altogether the economies and populations of the euro countries are as large as that of the United States.  These nations share a closer relationship to the Middle East.[25]

Over half of OPEC crude oil is sold to the European Union (EU). The EU has a bigger share of global trade than the US and a more balanced economy. Today, OPEC member countries import more than 45% of their merchandise from the EU.

If OPEC oil switches to the euro, oil importing countries would have to drop the dollar and acquire the euro as their reserve.  The euro’s value would rise, dominating world trade. This will force the value of the dollar down, some speculate between 20%-40 %.[26]

In December 2003, the Pentagon announced that it had barred euro powerhouses France and Germany from bidding on Iraq's reconstruction.[27]

This move may not do what it takes to insulate the dollar’s value.  Japan’s unresolved deflationary crisis threatens the US.  Because oil prices have been stuck at more than $40 a barrel since July 2004,[28] it now seems likely that Japan will be required to bail out their failed banks.

There is only one place where the Japanese government can get enough money to bail out its banking system: The Japanese government owns about 15% of our US Treasury securities. And it would have to start selling them if it found itself facing a major banking crisis.

That would send the already ailing dollar down even further. And the initiation of a sale of our Treasury securities by Japan, of course, would immediately trigger a worldwide stampede to do the same before the securities become worth only a fraction of what they were purchased for. At the same time, interest rates in the US would immediately go through the roof. [29]

Each year the US borrows $665 billion from foreign lenders.  The equivalent of $5,500 per American household.  While the recent low interest rates have countered the effect of this debt, any rise of interest rates (such as Japan selling US securities) will have serious economic consequences.[30]

China holds more than $600 billion in Treasury securities and in 2004 the US trade deficit with China reached $124.9 billion[31] making them the biggest foreign lender to the US.  Rapidly rising trade surplus pours money into China, which should push up the value of the yuan, China's currency.  As a result, China's exports would become less competitive, shrinking this trade surplus.

Unwilling to let this happen, the Chinese government “has kept the yuan down by shipping the incoming funds right back out again, buying huge quantities of dollar assets - about $200 billion worth in 2004, and possibly as much as $300 billion worth this year. This is economically perverse: China, a poor country where capital is still scarce by Western standards, is lending vast sums at low interest rates to the United States.” [32]

This money keeps US interest rates low despite enormous government borrowing. Economist Paul Krugman predicts that though “a rise in the yuan and other Asian currencies will eventually make US manufacturing, which has lost three million jobs since 2000, more competitive,”[33] it will also result in a burst of the housing bubble, “construction employment and consumer spending will both fall; falling home prices may lead to a wave of bankruptcies. And we'll suddenly wonder why anyone thought financing the budget deficit was easy.”[34]

The US teeters at the edge of an economic precipice.  The invasion, occupation and return of Iraq to the dollar will not save us.  WE must force our government to get federal spending under control and relinquish our dependence on foreign creditors.

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