As with any groundbreaking innovation, whether it be the Internet or the cell phone, its ultimate success or failure is often not evident during its infancy. While advocates and early adopters envision unlimited potential, critics see only flaws that will limit its usefulness, legitimacy or sustainability. It may take months, years or even decades for an idea or technology to gain traction and prove its long-term value, or lack thereof. Bitcoin, the upstart digital currency, is no different.
Recently, the Bitcoin infrastructure (uppercase B) and its associated bitcoin currency (lowercase b) have garnered both positive and negative attention. This decentralized, peer-to-peer digital money and payment network uses cryptography, rather than a central authority, to enable transactions. Bitcoin has grown from being an unproven concept into a global multi-billion dollar upstart currency in just a few short years. But can, and why, would the bitcoin ever replace the U.S. dollar as the global trading currency?
For decades, the U.S. dollar has been the world’s primary reserve currency, and the standard currency for the vast majority of trade, including oil. In a landmark 1973 agreement, the U.S. promised to provide military protection for Saudi Arabia’s oil fields. In return, Saudi Arabia began accepting only U.S. dollars for its oil sales, while simultaneously investing much of its oil proceeds directly into U.S. debt securities. Within a few years, all OPEC member nations also began pricing oil exclusively in the U.S. dollar.
Commonly known as the petrodollar system, this arrangement increased the demand for both the U.S. dollar and its debt securities. The flow of oil-related money through the country’s Federal Reserve system strengthened the dollar and made it the primary currency for most international trading. Therefore, the U.S. would likely have the most to lose if the petrodollar system ended.
Although most oil transactions still use the U.S. dollar, there has been a growing movement against it. When the U.S. abandoned the gold standard in 1971, its dollar was no longer convertible to a fixed rate of gold. This made the dollar a floating currency susceptible to fluctuations in value. As a result, the price of oil often rises when the dollar weakens. The theory is that the purchasing power of oil-producing countries and companies decreases when the dollar weakens compared to other currencies. To meet profit margins, they then make investment or production decisions that cause oil prices to rise.