• The Kingdom of Saudi Arabia has decided to not renew its 50-year long petrodollar deal with the United States, which expired on the 9th of June.
• The impact in the short run may be minimal, but if other OPEC countries follow suit the long run effect may be significant.
Where did the petrodollar come from?
In 1971, President Nixon ended the Gold Standard to prevent foreign nations from redeeming too many dollars for gold, causing a significant slump in the dollar and fear of weakening the international gold standard. This period, known as the Nixon Shock, coincided with increased interest in the Middle East’s oil reserves.
In 1961, OPEC was formed by Saudi Arabia, Iraq, Kuwait, Iran, and Venezuela to protect their natural resources, later expanding to include several other countries. The 1973 oil crisis, triggered by the US’s support for Israel in the fourth Arab-Israeli War, led Saudi Arabia to impose an oil embargo on the US. This pressured the US to reconsider its strategy in controlling oil production.
By 1975, Saudi Arabia and the US signed military contracts worth about $2 billion, establishing a deal where the US provided military protection in exchange for oil sales exclusively in dollars. Saudi Arabia also convinced OPEC to price oil in dollars. By the end of 1975, all OPEC nations had agreed to trade oil in dollars and reinvest surplus petrodollars in US government debt securities, securing military and economic protection.
Benefits to the US of having a dominant currency
The US dollar had already been the reserve currency before this deal however, this simply strengthened the currencies dominance. Having the Dollar as the reserve currency has many benefits to the United States. The high demand for dollars globally allows the United States to run persistent trade deficits (US national debt is nearly $35 Trillion) without facing immediate negative economic repercussions. Other countries need dollars to buy oil and conduct international trade, so they are willing to hold onto US dollars. This demand for the currency means the US can import more than it exports without devaluing its currency significantly.
Another benefit to the known as “petrodollar recycling”, this is where countries that export oil receive payments in dollars, resulting in large reserves of US currency. These countries often reinvest these dollars back into the US economy, primarily through purchasing US Treasury securities and other dollar-denominated assets as they are seen as stable and safe investments. This process is known as petrodollar recycling,and it ensures a continuous inflow of foreign capital into the United States. This reinvestment helps to finance the US federal budget deficit and supports domestic investments. It also strengthens financial ties between the US and oil-exporting countries, creating a mutually beneficial economic relationship.
The dollar’s dominant position also gives the United States significant influence over global economic markets. As the primary currency for international trade, especially in critical commodities like oil, the US can exert considerable power over global financial systems. The US can also use its currency’s dominance to impose economic sanctions effectively, as seen with the sanctions against Russia. Almost all international trade conducted in dollars falls under US jurisdiction, allowing the US to use financial sanctions to achieve geopolitical objectives.
Why did Saudi Arabia not renew the deal?
The big question on peoples’ mind will be, is this for Palestine? While we can’t comment on Saudi Arabia’s exact motives, the fact that this move will not have an immense impact in the short run, we can assume that this move is not directly correlated with the situation in Palestine.
This move could simply be part of a global trend of many countries gradually moving away from the dollar and Saudi Arabia is just the next country to do so. Or it could be due to Saudi Arabia’s commitment to the BRICS (Brazil, Russia, India, China, and South Africa) organisation and this may explain Saudi Arabia’s desire to trade oil in the Chinese Yuan.
This move may put pressure on US president Joe Biden, aiding the Republicans and Donald Trump, especially if this move leads to the depreciation of the dollar and therefore inflation, around election time.
Is the world dropping the petrodollar?
The world is witnessing a gradual lessening of significance of the petrodollar however, the US dollar still remains verydominant in global markets. One of the significant indicators of this gradual shift away from the dollar is the growing sentiment amongst the BRICS nations to move away from the dollar. These countries are increasingly exploring alternatives to the US dollar for their trade transactions. China, in particular, has been actively promoting the use of its currency, the yuan, in international trade and has established various currency swap agreements to facilitate this transition. Additionally, Russia and other countries within this bloc are seeking ways to reduce their dependence on the dollar, reflecting a broader trend towards diversification in global trade currencies.
Saudi Arabia’s decision not to renew its long-standing 50-year deal with the United States, which had been central to the petrodollar could potentially be significant if the other OPEC countries follow suit. But in the short term this may simply lead to higher interest rates in the US if this reduction in demand is significant enough to devalue the US dollar.
The world is definitely gradually moving away from the dollar however, we are far from seeing the dollar collapse or even lose its role as the global reserve currency.
