OPEC had a problem. They were selling their oil and getting dollars in return. However, the dollar was losing value quickly. They worried that, in the future, the dollar might not be worth very much at all. They would have sold their irreplaceable natural resources for a paper promise from a country that didn’t keep its promises.
The year was 1971. On August 15 of that year, president Richard Nixon officially ended the dollar’s link to gold, which had been the policy of the U.S. government since 1789. At the time, the dollar was worth 1/35th of an ounce of gold, as it had been for the previous 38 years. When OPEC sold its oil, it was, in a sense, receiving gold in return. That was the idea, anyway.
In September of 1971, only a month after Nixon pulled the rug from under them, OPEC gathered to decide what to do about the dollar’s declining real value. In Resolution XXV.140, they decided that: “[OPEC] Member Countries shall take necessary action … to offset any adverse effects on the per barrel real income of Member Countries resulting from the international monetary developments of 15 August 1971.” Eventually, this took the form of higher prices, as it took more and more depreciating dollars to buy a barrel of oil.
Today, OPEC is faced with a similar problem. They take dollars for their oil, and these dollars often end up buying Treasury bonds. Also, their own domestic currencies are linked to the dollar, which is causing domestic inflation.
OPEC should go back to its original plan. Sell oil, and take gold in return – or a hard currency linked to gold. In practice, taking payment in metal is impractical, so a gold-linked currency — like the dollar was — is a more appropriate choice for today’s financial world.
Gold-linked currency? There aren’t any more of those. So why not make one? Today, there are discussions about depegging regional currencies like the United Arab Emirates’ dirham from the unreliable dollar, and perhaps repegging to a currency basket. But is a currency basket, of many fiat currencies, much better than a single fiat currency? “Some [OPEC members] said producing countries should designate a single hard currency aside from the U.S. dollar … to form the basis of our oil trade,” Iranian president Mahmoud Ahmadinejad said recently.
Ah, there’s the rub. There are no hard currencies. Only varying degrees of softness. No central bank today wants its currency to rise further against the dollar. During the 1970s, all the fiat currencies in the world got dragged down with the dollar, because of the trade implications of allowing the dollar to fall too far against their currencies. The pound, deutschemark and yen were no escape. Inflation roared throughout the world.
Instead of pegging to the euro or yen, both just as unreliable as the dollar in the long run, the UAE could peg the dirham to gold – even if the government owns no gold at all. The important thing is not to stockpile bullion, but to properly adjust the supply of dirhams to meet demand, the exact same process now used by the existing currency board. The UAE would have, in effect, a currency board linked to gold.
This would not be anything new for the dirham. The dirham coin used to be worth 3.207 grams of gold, and circulated alongside another popular Islamic currency, the dinar, which was worth 4.25 grams of gold. The gold dinar coin was reintroduced in 2006 by the Malaysian state of Kelantan.
Middle East oil – traded on the Dubai Mercantile Exchange for example — could then be priced in gold-linked dirhams. The world would finally have a hard currency again, as the dollar was before 1971. The dirham would immediately become an international currency, because everyone would need it to buy Middle East oil. The UAE would get into the currency business, which can be very lucrative. The Federal Reserve makes a profit of about $40 billion a year on its roughly $800 billion of U.S. Treasury bond holdings.
Eventually, if people wanted access to Middle East capital, they could issue bonds denominated in dirhams. No more dollar bonds. This would be very attractive, because the interest rate on dirham bonds would sink to very low levels. When the British pound was pegged to gold from 1823 to 1914, a ninety-one year stretch, the average interest rate on Consols – government bonds of infinite maturity – was 3.14%. It never rose above 4.0%. In the past century, no central bank has ever managed such a record of success. After four decades of experimentation with floating currencies, nothing has ever come close to the performance of a gold standard in action.
The world is transitioning to a new monetary order. Ideally, it will be better than what preceded. The dollar-centric monetary order arose in the 1930s and 1940s because the dollar remained a hard currency – pegged to gold – while all the currencies of Europe and Japan were devalued during the Depression and two world wars.
Perhaps it is time for the oil-exporting countries to stop playing by the rules of the oil importers, and start setting their own rules. The first rule is that they get paid for their oil in a “hard currency,” which, over six thousand years, has only meant one thing: a currency linked to gold.
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