The dollar as the currency of valuation for oil silently died last week, ushering in a new era in the global monetary status quo. On June 9, the US agreement with Saudi Arabia expired – What will be the consequences.
Although it did not grab the headlines of the economic press, for obvious reasons the death of the dollar as the currency of valuation of oil could create huge financial problems for the US government that depends on the dominance of the dollar to support borrowing and massive public its spending – but also the geopolitical power of the country itself. “Petrodollar” refers to the role of the dollar in crude oil trading.
In the wake of the 1973 oil crisis, Saudi Arabia agreed to conduct all oil transactions in dollars and invest its oil surpluses in US bonds in exchange for US military support.
The agreement produced a boon for the dollar and was instrumental in stabilizing it as the world’s reserve currency. Because of Saudi Arabia’s prominent role in global oil trade, the deal had far-reaching implications.
As a result, almost all global oil transactions were priced in dollars. This ensured a constant demand for the US currency. Every country needed dollars to buy oil.
This demand for dollars supported the fiscal policies of the US government so that it could maintain its huge deficits. To the extent that the world needed dollars to buy oil, it ensured the demand for the dollar. This meant that the Federal Reserve could print more dollars and issue more bonds than it could otherwise. The deal created a “captive market” for US government debt.
How the “captive market” of US debt worked
One of the key features in the global economy of the past 50 years has been a global financial system based on the petrodollar – an economic regime where oil producers would sell their goods to the US denominated in dollars, with which they would then buy assets denominated in dollars and invested in them by supporting the dollar as the world’s reserve currency and in the process established the position of the US as the world’s undisputed economic superpower.”
On June 9, the agreement expired and there appears to be no desire on the part of Saudi Arabia to renew it. This enables the Saudis to sell oil in currencies other than the dollar.
The end of the deal does not mean Saudi Arabia will stop accepting dollars to sell oil, and there are many other major players in the mix who will likely continue to rely on the dollar. But the deal’s expiration opens the door for oil sales in other currencies, including the Chinese yuan. And if the Saudis move away from the dollar, other countries will likely follow.
Almost 80% of global oil sales are conducted in dollars. However, Russia, Iran, Saudi Arabia, China and others are increasingly turning to local currencies in energy trade.
In 2023, 20% of global oil was priced in other currencies. China has been pushing Saudi Arabia to accept yuan for trading in energy products, and the Saudi government has reportedly expressed open support for the idea.
Saudi Arabia’s accession to the BRICS bloc this year will likely strengthen economic ties between the two countries. BRICS is an economic cooperation bloc that originally consisted of Brazil, Russia, India, China and South Africa.
As of January 1, 2024, the bloc has expanded to include Saudi Arabia, Egypt, the United Arab Emirates, Iran, and Ethiopia. More than 40 other nations have expressed interest in joining BRICS. The enlarged BRICS have a combined population of about 3.5 billion people. The economies of the BRICS countries are worth over $28.5 trillion and represent about 28% of the global economy.
The countries of the group also account for about 42% of the world’s crude oil production.
Under constant pressure
The petrodollar was under pressure ahead of the expiration of the Saudi-US deal. Late last summer, the United Arab Emirates did not convert local currencies into dollars for the first time when India’s top refiner paid for crude in rupees.
India also bought oil from Russia without using dollars. India ranks as the world’s third largest oil importer. This move by Saudi Arabia marks the beginning of a major shift in global economic dynamics, although its full implications for international trade and finance remain to be seen.
Possible consequences of the decline of the petrodollar
The end of the petrodollar could accelerate global de-dollarization and that would be a disaster for the US economy. While the current de-dollarization trend does not directly threaten the dollar’s role as the world’s reserve currency – it does, however – could portend bigger problems down the road, especially if it accelerates.
The dollar is already on slippery ground Many countries are looking for ways to minimize dependence on the dollar due to growing concerns about America’s use of the dollar as a foreign policy weapon. After Russia’s military invasion of Ukraine, IMF managing director Gita Gopinath warned that sanctions on Russia could erode the dollar’s dominance by encouraging smaller trading blocs that use other currencies.
This is exactly what we see happening. Without the petrodollar it would be possible to accelerate the de-dollarization of the global monetary system. Even those who willfully overlook any threat to the dollar’s status as the world’s reserve currency admit that the end of the petrodollar deal could weaken the dollar in the long run. This would carry over into the US financial markets, particularly the bond market.
It would also lead to more inflation for American consumers. If investors worldwide reduce their use of dollars significantly, the ability of the US to issue dollar debt and run trade deficits will shrink.
In fact, if other states no longer need dollars to conduct transactions, the demand for dollars could be significantly reduced. This would create an oversupply of the dollar and a rapid depreciation of the US currency. US Treasury yields will skyrocket.
This would be a disastrous situation for a government that must service a massive debt of over $34.5 trillion. The Federal Reserve’s staggered interest rate hikes have already sent debt servicing costs skyrocketing, adding to the fiscal pressure on whichever new president is elected in next November’s election. The US government now spends more on debt service than on national defense or Medicare.
In short, the replacement of the petrodollar will cause a significant blow to the US economy which is expected to collapse slowly and steadily.
