Inside today’s Daily Journal…

Editor’s note: Although Erez Kalir ordinarily focuses on technology, blockchain, and biotech issues in Porter & Co.’s Tech Frontiers, Porter turned over the Journal to him today so Erez could tell the story of the single most important thing in the entire economic landscape. And while the war in Iran brings this topic into focus – the slow collapse of this trend that kicked off more than 50 years ago is starting to get real…

In 1974, U.S. Secretary of State Henry Kissinger quietly closed what is arguably the most consequential deal in modern financial history. There was no signing ceremony, no front-page Wall Street Journal story, almost no paper trail. But the deal would fundamentally shape the global economic order for the next half century.

To understand the deal’s significance, we have to begin in 1971 – when President Richard Nixon shocked the world and abruptly closed the “gold window.” Nixon’s surprise announcement that U.S. dollars would no longer be redeemable for gold at a fixed price shattered the Bretton Woods agreement, which had governed international currency exchange since 1944. And it left global economic leaders facing an uncomfortable question: What, exactly, backed the dollar?

The implicit answer was “trust”… but Kissinger knew America needed a better answer. In the early 1970s, the U.S. economy found itself reeling from the OPEC oil embargo and its aftereffects – a quadrupling of oil prices, stagflation, and a cratering stock market. Asking the world to “trust” the durability of the U.S. economy and the dollar wasn’t going to cut it.

So Kissinger and then-Treasury Secretary William E. Simon devised an elegant, ruthless solution. In the summer of 1974, they traveled to Jeddah to finalize an understanding between Saudi Arabia and the United States that transformed the two countries into long-term strategic partners. The terms of the deal were simple: the U.S. would guarantee Saudi Arabia’s security with military protection and advanced equipment for Saudi oil fields. In exchange, Saudi Arabia would price its oil exports exclusively in U.S. dollars and reinvest a significant part of the revenue into U.S. Treasuries.

The Kingdom of Saudi Arabia was the undisputed leader of OPEC – so when it priced oil exclusively in dollars, other OPEC nations followed.

And just like that, a new global monetary order was born.

To understand the central role the petrodollar agreement has played in America’s economic dominance over the past half century, we have to understand how the system worked.