From Gold to the Petrodollar: Exploring the history of the Bretton Woods system

As society continues to experience a gradual transformation of its definition of money, from gold-backed currencies to highly traded paper notes and the rise of digital currency, questions are being raised as to when an official transition period will occur to mark an official move from physical to digital money. 

When referring to examples of comparable turning points from the past, one, in particular, continues to be discussed – the Bretton Woods system and its various forms over the years that marked the move from gold to the petrodollar. But what is the Bretton Woods System? And are we on the verge of another iteration?

Bretton Woods and the gold standard

The origins of the Bretton Woods system can be traced back to the 1930s, when the United States government made gold ownership illegal, forcing people to sell any they owned back to the government. This allowed the government to effectively build a huge stockpile of gold reserves in addition to serving as its custodian for a number of other countries as World War II unfolded.

As the US was one of the nations least affected in the ensuing conflict, it quickly became one of the world’s largest creditors. As a result of this dominance, the system now referred to as Bretton Woods I was created. The name came from the meeting that took place at the Mount Washington Hotel in Bretton Woods, New Hampshire which was attended by 730 delegates from all 44 Allied nations in 1944. Its aim was to establish how economies would be ordered in the wake of the war.

This system marked the first example of a fully negotiated monetary order, intended to govern monetary relations among independent states. It was decided that the United States would back its dollar currency with gold, with others following suit, pegging their currencies to the dollar in turn. The US also began laying the groundwork for its alliance with Saudi Arabia, which would later feed into the next iteration of the Bretton Woods system.

Despite its initial success, solidifying the nation’s influence over the international monetary system and leading to the creation of the eurodollar market outside of the US, the gold backing slowly began to crumble as the costs of the Vietnam War in the 1960s escalated.

As the number of dollars multiplied and the amount of available gold did not, President Nixon took the decision in 1971 to remove the dollar from the gold standard. Other countries had already begun to doubt the backing of the dollar and were choosing instead to redeem their dollars for gold. However, despite this period of uncertainty, this new US-dominated monetary order had only just begun. Enter Bretton Woods II and the rise of the petrodollar.

Bretton Woods and the rise of the petrodollar

Since the demise of the gold-backed dollar in the 1970s, virtually all countries in the world focused on their own fiat currency system (a government-issued currency that is not backed by a commodity such as gold). However, the Bretton Woods system was not dead and buried yet. It would make a return in the form of the petrodollar system. 

This came about from a deal the US made with Saudi Arabia and other OPEC countries to only sell their oil in dollars, regardless of which country was buying. In return, the US granted these countries military protection and trade deals and solidified its dominance in the global order, restoring trust in the dollar as a reserve currency and a continued global demand for it. 

Thanks to this deal, the term inside money is often used to refer to the US dollar as a currency that is trustworthy due to its source – in this case, the large reserve that they could use to actively maintain the strength of their currency. This period of global fiat currency continues today and is considered normal by the majority of us. But if you take a moment and consider the implications of such a global network, making a single system work across the world, despite the various intricacies of each country, is an incredible achievement.

For example, even if Germany wants to buy oil from Saudi Arabia, they do so in dollars, not euros. Any country that wants oil needs to be able to get dollars to pay for it, either by earning them or exchanging their currency for them. And, all of these countries store excess dollars as foreign-exchange reserves, which they mostly put into US Treasuries to earn some interest. While this may seem fairly normal, it essentially means that a large portion of US federal deficits is financed by foreign governments, which marks an unusually beneficial situation for a country to be in compared to others around the world.

So, are we on course to remain with the petrodollar system? Recent news would suggest the opposite. As times have progressed, various political events have begun to undermine this global order. Previously, countries that didn’t like how the global monetary system was structured didn’t have much recourse to do anything about it. The conflict in Ukraine has resulted in actions that have raised questions about what a possible third iteration of the Bretton Woods system might look like, however.

But where do Bitcoin and its fellow cryptocurrencies fit into all this? You could argue that while Bretton Woods remains a system of the past, today we find ourselves in a similar position as the allied nations did back then. Rising inflation, continued conflict and sustained currency devaluations have left the world in need of an alternative solution. While Bitcoin may still be a ways off mainstream adoption, many nations are looking into a central bank digital currencies (CBDC)  as an alternative with reduced risk and fully endorsed by the government.

Achieving a Bretton Woods-style agreement for the digital age may require a lot more coordination, however. Many countries such as India and China have taken action pushing miners and other crypto enthusiasts out which will put a strain on a global coordinated effort. While many hoped the pandemic would have been the fuel needed to light the fires of adoption, there is still hope that the recent moves toward Bitcoin as a store of value in countries in flux could provide the push needed for serious action. Only time will tell. 

Bretton Woods III and the future global order

In early March, Zoltan Pozsar, an investment strategist at Credit Suisse and a former senior adviser to the U.S. Department of the Treasury wrote an economic paper called ‘Bretton Woods III’, which outlined the possible arrival of a new world monetary order that is centered around commodity-based currencies in the East. 

In his example, the commodity – a raw material or primary agricultural product that can be bought and sold – is oil coming out of Russia and its inability to be sold due to the many sanctions being raised against it by the G7, an inter-governmental political forum consisting of Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States. 

As a result, while Russian-backed oil fell in price, oil being sold outside Russia experienced a huge price increase and this divergence may have potentially damaging implications in the future should another country not step in to address the gap. However, for Zoltan, that might not mean Western countries.

For the investment strategist, one bank may be up to the task: the People’s Bank of China (PBOC). He goes on to add that China may not be as concerned with towing the US-Europe line when it comes to Russian sanctions. 

While shipping companies are not willing to take Russian crude oil anywhere based on sanctions regardless of discounts, China has been presented with the option to gain even more independence from that US-led system by using its own currency to step in and purchase these commodities. By doing so, Zoltan argued that this could lead to greater control over inflation in China while the West would continue to suffer commodities shortages and further recessions. 

Zoltan concludes his paper by comparing the crisis to the period we described earlier when President Nixon took the US dollar off gold in 1971, arguing that Bretton Woods III will come to represent the period in which outside money will create a new monetary system backed once again by gold and other commodities. 

While an intriguing premise to think about, one thing is certain, these political and global challenges have ensured that Bitcoin and other cryptocurrencies will have a beneficial part to play in the future of money. What that might look like however, is still to be seen.

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