Authors: Sanjay Turi and Praveen Sothwal*
In the 1960s, there were various domestic social welfare programs in the US. Very high defense spending and the need to sustain its rivalry with the Union of Soviet Socialist Republics (USSR), particularly the proxy war in Vietnam, forced the US to print more dollars than it had gold to back them. The global market was soon flooded with dollars, resulting in inflationary pressure. Countries that held the dollar as forex began redeeming their gold, suspecting the US Federal Reserve, which actually caused a rapid outflow of gold from the US. As a result, the rapid outflow of gold and inflow of dollars led to the oversupply of dollars in the US economy, causing the overvaluation of dollars, which ultimately undermined the trust and capability of the US government to manage the world reserve currency. And this is what became the reason for the failure of the Bretton Woods system established in 1944. At last, to save the economy, the US had to temporarily suspend the convertibility of the dollar into gold in 1971, which later became a permanent provision for printing dollars, and countries around the world shifted from a fixed to a floating exchange rate system.
As the US economy was already struggling, it faced another setback within a few years: the oil embargo in West Asia. In the wake of the Yom Kippur War, the countries of the Organization of the Petroleum Exporting Countries (OPEC) came together, and in protest against Israel and its ally, the US, they slashed the export of crude oil, which led to the emergence of the famous Oil Shock of 1973. That incident completely destabilized the global energy market.
Keeping its crumbling economy and dollar hegemony in mind, the US had to come up with a way to enter into an agreement with King Faisal of the Saudi Kingdom, which was the largest producer and exporter of crude oil at that point in time. In 1974, the US signed an agreement with King Faisal, requesting that he settle all its oil trade in dollars. In return for this agreement, the US agreed to provide a security umbrella to the Saudi Kingdom and to make a large-scale investment in the country. The US also assured it would pay a relatively higher yield if it reinvested its revenues in US treasuries. That is how the petrodollar system began to take shape, and it gradually, under Saudi leadership, included all six members of the Gulf Cooperation Council (GCC). And that is also when the concept of the Gulf Sovereign Wealth Fund (SWF) came into prominence after the 1973 oil embargo. Hence, since then, the US has been printing dollars and managing demand and supply, keeping tight control over the prices of crude oil exported from the Gulf countries. And this is what has actually come under threat since Iran announced that it would grant passage through the Strait of Hormuz to those ships doing transactions in yuan only, while openly not allowing any ships of the US and Israel through this strait.
This announcement by Iran has actually challenged the 52-year-old petrodollar system through which the US exercises its power over controlling the oil trade while maintaining its dollar hegemony. As crude oil is the core driving force behind the development of any nation, exercising unilateral control over its prices matters a lot. It can be said that crude oil is actually the strength of the dollar. And that is how the US manages to have control over the global energy market. Hence, once this petrodollar system is broken or replaced by the petroyuan, the entire US economy will be under threat, but the US will likely never allow it to happen. Therefore, given the historical context of the US, one must not hesitate to say that the recent US-Iran war is less about geopolitics and more about geoeconomics. In this context, the US cannot afford to lose this war to prevent its economy from collapsing. In this regard, the consistent warning of President Trump to go for a ground operation into Iran is not merely a speculation; rather, it is likely a compulsion for the US to protect its economy. Given that China and rising multilateralism are gradually becoming a threat to the dollar, for its geoeconomic interests, the US can go to any extent to defend its economy.
Given that some central banks around the world have significantly reduced their US securities holdings, if Iran, with the help of China, Russia, and other significant players, succeeds in replacing the petrodollar with the petroyuan, a domino effect can be seen in the selling of US Treasuries globally, leading to the collapse of the dollar as the core global financial system.
Because bond yield and bond prices have an inverse relationship, dumping of US bonds and securities may also lead to significantly higher interest rates on US bonds. Hence, for the US, it can be said that the recent attack on Iran is more suited to phrases like ‘digging one’s own grave.’ However, it is also widely said that when America sneezes, the world catches a cold. This saying is not just an exaggeration. It is not to be forgotten that today, over 57% of global forex reserves and nearly 90% of all global foreign exchange transactions are conducted in US dollars. Now, the question arises: to what extent is the world ready to treat a cold, which is most likely to develop into a long-term, intractable disease?
In this context, it is not unreasonable to assume that the world is not very far from another global financial crisis. Now, another question arises: can the US really afford to exit the Iran war in the meantime? The answer is NO. Though President Trump consistently reiterates that he will end the war soon, the geo-economic compulsion of the US will not allow it to exit this war too early without achieving its objectives. The recent speculation of the US planning to go for a ground invasion plan into Iran is not just a prediction; rather, it is inevitable sooner or later. In fact, from an American economic and hegemonic perspective, it may have become necessary for the US, knowingly or unknowingly, to protect its own economy from collapsing.
*Praveen Sothwal, Doctoral candidate at the Centre for West Asian Studies (CWAS), School of International Studies (SIS), Jawaharlal Nehru University.
