Episode 3: The rise (and potential fall) of the USD as global reserve currency.
26 Apr 2022
We roll on with our country drive down History Lane today and we move onto the next crisis that was about to hit the globe.
The USA was busy making “peace’ with the Vietnamese. In truth they had been handed a beating and retreated with tails between legs.
The world’s major currencies were now floating against each other, and the cold war was being fought in far flung destinations of Africa, South America, Asia, and significantly the middle East.
Egypt was aligned with the Soviet union, Saudi Arabia was firmly anti – communist, but also firmly anti – Zionist, and therefore paradoxically allied with Egypt, who was continuously engaged in wars with Israel. And this was the source of the next global crisis.
In October of 1973 Egypt And Syria launched a simultaneous attack against Israel. Syria attacked in the Golan heights (east) and Egypt in the west in the Sinai Peninsula. Initially Israel was caught off guard and defeat was a serious consideration. The Soviet union supplied weapons on a large scale to Egypt and Syria, and thus the USA was forced into a decision to Support Israel. This was initially more of and anti Soviet measure, rather than support for Israel. The USA announced that they would be resupplying Israel with weapons to the tune of 2.2 billion USD (1973 USD), and began flying in weapons and supplies to the beleaguered Israelis.
Note throughout this series how the quantum’s of the numbers keeps rising exponentially. Today 2.2 billion USD would buy you a few third generation jets. Back then it was a very large shipment. This is what inflation does, it erodes purchasing power.
As an aside ….in the week I took my car in for a service. I spent a few minutes in the showroom and was mortified at the prices of new cars. I remember the cost of my first new car……the equivalent vehicle today is around 50 TIMES what is what then. (and queue the ageists in my office who will no doubt say this is because my first new car was a Ford Model A)
Anyway , The Saudis interpreted this move as support for the “Zionists” and despite their “anti communism” stance, decided to weaponise their predominant export, and announced an oil embargo against Israeli allies, which included most of the Western powers.
Anecdotally this included South Africa who was at this time very friendly with the Israelis because the South Africans needed weapons and support as a growing Pariah state due to its own appalling apartheid policies. Fourty years later we now find ourselves on the other side of the divide in Russia’s war with Ukraine. Politics is a nasty smelly business and allegiances are fickle.
Back to the oil embargo ……Of course as a result of all of this oil prices rose rather alarmingly and queues at filling stations were seen across the globe as supplies were curtailed. Governments across the world were forced to ration fuel and inflation began to rise again.
As an aside again – I remember this period from my childhood. Discussions were had around the dinner table as to how to circumvent this rationing as South Africans were only allowed so much fuel per trip to the filling station. Long trips were a real problem because if you ran out of gas on the road you were very unlikely to be able to replenish. If you carried extra fuel cans you were fined heavily and in extreme cases may even face criminal charges. Of course the economic impact was also felt heavily as gas prices rose leading to a decline in discretionary spend.
Back in the middle east the Israelis managed to turn the tide of the war, eventually handing the Egyptians and Syrians a heavy defeat, leaving the Israleis as the superior military power in the region.
This left the Saudis with a dilemma. Because oil was their major export, and a large part of their market was now embargoed, they needed some solution to the problem. They also felt they needed to rearm the nation as they were now vulnerable to Israel’s military might. Weapons cost money. The other consequence of the embargo was to raise inflation, and inflation as we know erodes value. As the USD weakened so did the store of wealth held in USD by the Saudis.
Arguably this ushered in the next phase of the global economic establishment. The rise of the petro – dollar.
The US needed oil, the Saudis needed weapons. The USD was the mechanism that allowed that transaction to take place.
Negotiations were held, the upshot of which was that the Saudis would resume oil exports to the US, and the US would export weapons to the Saudis. Thus was born an unholy alliance that would impact global politics and economics for decades to come.
There were further oil shocks to come in later years – much like we are experiencing today.
But the lesson from these 3 episodes is that politics and economics are intertwined. Cause and effect. Decisions and consequences.
History teaches us important lessons. The decisions of the previous decades after world war one, would lead to WW2. The decisions after that conflict would lead to the cold war. The impact of which are still with us.
Next episode we pick up the story of the second oil shock in 1979, and a man called Paul Volcker. Inflation was about to become a very real issue for the USA and the world.