How the US Dollar Traded Gold for Oil—and Conquered the Global Economy

How the US Dollar Traded Gold for "Black Gold"—and Conquered the World

Imagine going to a bank with a piece of paper that says you can trade it for a block of gold. For years people believed in that promise and never questioned it. Then one day the bank says the paper is no longer worth anything but still says it is valuable. Most people would stop believing in it away.

This is exactly what happened to the global financial system in 1971.

For years the US Dollar was seen as the most trusted money in the world because every dollar was backed by gold. When that promise ended many experts thought the dollar would no longer be important.. More than fifty years later the US Dollar is still the most important money in the world. It continues to be the money used in global trade, international finance and the money that central banks hold.

How did a money survive after losing the thing that made it trusted?

The answer is one of the most interesting economic changes in recent history. This story is about world wars, politics, oil and one of the important agreements made between countries.

The World Needed a Strong Financial System

After the Second World War a lot of the economy around the world was broken. Countries needed an reliable way to handle money. This would help them trade with each other. Feel confident about sending money across borders. To make this happen leaders from countries met in a place called Bretton Woods in 1944.

This meeting led to an agreement called the Bretton Woods Agreement.

Under this agreement most of the money in the world was connected to the US Dollar. The United States promised that other countries could trade dollars for gold at a price of $35 for each ounce. This made the dollar as valuable, as gold.

You can think of it like a deposit box. Imagine putting something in a locker and getting a ticket that says you can get it back. The ticket has value because everyone believes the item is there and can be picked up anytime. In the way countries accepted the US Dollar because they believed they could always trade it for real gold.

For years this system made things stable and made the dollar the base of international trade.

When Many Dollars Entered the System

The Bretton Woods system was successful because the United States made sure that the number of dollars circulating around the world was roughly the same as the amount of gold available. This was important for people to have confidence in the system.

In the 1960s it became harder to keep this balance. The Vietnam War required a lot of government spending and the United States also had domestic programs that cost a lot of money. As a result more dollars entered the economy.

Foreign governments started to ask a question. They wondered if there were dollars in circulation than there was gold to support the Bretton Woods system. If many countries asked for gold at the time could the United States really deliver?

The foundation of the Bretton Woods system, which's confidence started to weaken. The Bretton Woods system depended on confidence and now confidence in the Bretton Woods system was weakening.

The Crisis That Changed Global Finance

As time went on the uncertainty turned into action. Some countries, including France wanted to exchange their dollars for gold. If many countries did this the United States would lose a lot of its gold reserves.

President Richard Nixon had to make a decision. In 1971 he decided that the United States would no longer exchange dollars for gold. This meant the end of the Bretton Woods system. The Nixon Shock, as it is called meant that the dollar was no longer backed by gold.

For a time the dollar had been linked to gold. Now for the time in decades the worlds main currency was not connected to precious metals like gold.

A big question came up. If the dollar was not backed by gold why would other countries still use it? The dollar was no longer backed by gold so why would countries still want to use the dollar?

Finding a New Foundation: Oil

If the dollar was not backed by gold it could have lost a lot of value.. The United States found another way to make sure people wanted to use the dollar. The answer was oil.

Oil was very important to the economy. It powered cars, factories and airplanes. Every country that was growing needed a lot of oil.

The United States made a deal, with Saudi Arabia, which had a lot of oil. Saudi Arabia agreed to sell its oil in dollars. The United States agreed to help protect Saudi Arabia.

This deal changed the way money worked around the world. If every country needed oil and oil was sold in dollars then every country needed dollars. The dollar was still important because oil was sold in dollars.

The Rise of the Petrodollar Essay

This new system was later referred to as the Petrodollar System.

Unlike the previous regime, the dollar was no longer tied to gold (or rather, the gold reserves in the vaults of the central bank). Rather, its role as the world’s reserve currency was now firmly tied to energy.

In order to engage in trade, purchase oil, develop their industries, transportation, and economies, the nations of the world had to acquire US dollars.

As a result, central banks continued to hold their reserves in dollars, international settlements were made in dollars, and investors continued to buy and sell securities in dollars, confident in the stability of the currency.

The dollar is the worlds currency and it has stayed that way. It used to be that gold was very important. Now oil is the new important thing.

More Than Economics

The US Dollar is the worlds main currency and it is not just because of money things.

The American economy is very strong. The American money markets are very good. The US government is seen as a partner. People who invest money trust the dollar. The United States has a lot of power, in world matters. All these things together make the dollar a respected currency. The US Dollar is still the currency because of these things. The US Dollar has a lot of prestige. That is why it is still the worlds main currency.

The Foundation of Dollar Dominance

The history of the US Dollar is one of the most fascinating episodes in the history of finance. It is a story about gold, oil, and the international prestige of the United States as the world’s leading economy. When the link between the dollar and gold was severed in 1971, few people believed that the dollar would retain its status as the world’s reserve currency. Yet, instead of vanishing, the dollar took over the role of the central currency in international trade and finance. The US Dollar today is much more than a piece of paper or metal. It is a symbol of the US economic, financial and political might.