How the Collapse of Saudi Arabia Will Eventually Cause Gold to Soar

July 11, 2017, 10:28 am ET, BY Joseph H.- Contributor| Editor: Thomas H. Kee Jr. (Follow on LinkedIn)

First a little background regarding why the KSA is so important to the U.S.

By the end of World War II, nearly 80% of the world’s gold reserves had fled to the U.S seeking a safe haven. In 1944, the “Bretton Woods” agreement was reached that made the U.S. Dollar the world’s primary reserve currency; globally convertible into Gold at a fixed rate of $35 per ounce. This immediately created a strong global demand for Dollars and soon set off an economic boom in America.

But by the 1970s, thanks to huge deficit spending on wars and domestic spending programs, Nations around the world began doubting U.S. fiscal prudence and began demanding gold in exchange for their Dollars and nearly depleted U.S. gold reserves. So in 1971, President Nixon closed the gold window and turned the Dollar into a “fiat” currency.

Needless to say, this drastically reduced global demand for Dollars and contributed to the deep recession of 1973-74.

But the Nixon administration came up with an ingenious way to solve this demand problem and to restore the “trust” in the Dollar that Gold had previously provided.

And that was the Petrodollar system.

Essentially what Nixon did was enter into an agreement with Saudi Arabia to provide military protection to them in exchange for the Saudis pricing all of their oil sales in U.S. Dollars. And soon other Middle Eastern oil producing countries followed suit, also in exchange for U.S. military protection.

In one move Nixon managed to create a de facto commodity backing for the Dollar in the form of oil to replace gold. It took several years but once this system took hold it restored global demand and pushed the value of the Dollar up to new highs in 1985.

It is this system that enabled the U.S. to use debt to build itself into the largest economic and military power the world has ever seen.

Now since 1985 the power of the Petrodollar system has diminished as several oil producing countries have opted to price their oil in currencies other than Dollars. And this is evidenced by the gradual series of lower highs and lower lows in the Dollar since that time. But the Petrodollar system still provides the Dollar with a de facto commodity backing that few other currencies possess. It is the backbone of the “trust” that the world still has in the U.S. Dollar.

But if the Saudi Kingdom should fall then that de facto commodity backing for the Dollar goes away.

So what would likely happen when such an event occurs?

1.       Foreign holders of Dollars would likely start dumping the currency which would lead to a collapse of U.S. Treasury debt markets and a massive global stock market crash.

2.       Hyperinflation would occur in the U.S. Prices of commodities like Gold SPDR Gold Trust (ETF) (NYSEARCA:GLD) , Oil iPath S&P GSCI Crude Oil Total Return (NYSEARCA:OIL)and Food PowerShares DB Agriculture Fund (NYSEARCA:DBA)would soar.

3.       This hyperinflation would be followed by a huge increase in interest rates to stabilize the plunging value of the Dollar. This would bring about deflation. Think the Volker era in the 80s, only worse.

4.       The U.S. would have to adjust to having a much smaller economy, and military, due to a drastically reduced money supply and lower global demand for U.S. Dollars.

This is why it is imperative for you to keep a close eye on unfolding events in the KSA and their affects on the prices of Gold, Oil, and commodities in general.

Support and Resistance Plot Chart for WMT

Real Time Updates for Repeat Institutional Readers:

Factset: Request User/Pass

Bloomberg, Reuters, Refinitiv, Zacks, or IB users: Access Here.