May 21, 2009

The collapse of oil standard

The economy today is based on oil, oil revenues flood the markets and represents the backbone and blood of the global economy; oil supplies provide fuel to to the global production engine.
When the amount of reserves and barrels of oil start decreasing due to peak oil the confidence in the future of the market and the flood of petrodollars supporting it disappears quickly.
This event has an historical precedent with gold in the 20th Century.
A century ago almost all the world’s currencies were linked to gold and most of the rest to silver. Currencies were readily interchangeable, gold anchored exchange rates and the physical supply of gold stabilized the money supply over the long term.
The gold standard collapsed in the wake of World War I. Wartime financing with un-backed paper currency led to widespread inflation. European nations tried to resume the gold standard in the 1920s, but the gold supply was insufficient and inelastic. A ferocious monetary squeeze and competition across countries for limited gold reserves followed and contributed to the Great Depression. After World War II, nations adopted the dollar-exchange standard. The U.S. dollar was backed by gold at $35 per ounce, while the rest of the world’s currencies were backed by dollars. The global money stock could expand through dollar reserves.
President Richard Nixon de-linked the dollar from gold in 1971 (to offset the U.S.’s expansionary monetary policies in the Vietnam era), and major currencies began to float against one another in value. But most global trade and financial transactions remained dollar-denominated, as did most foreign exchange reserves held by the world’s central banks. The exchange rates of many currencies also remained tightly tied to the dollar. The rest is history.
Today we are going on the same road, this time not gold but oil will be the final prize for competing countries try to make a living with the last available resources.
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