Mises Institute: On January 17, the Saudi minister of finance, Mohammed Al-Jadaan, announced that the Saudi state is open to selling oil in currencies other than the dollar. “There are no issues with discussing how we settle our trade arrangements, whether it is in the US dollar, whether it is the euro, whether it is the Saudi riyal,” Al-Jadaan told Bloomberg TV.
If the Saudi regime does indeed embrace substantial trade in currencies other than the dollar as part of its oil-export business, this would signal a shift away from the dollar as the dominant currency in global oil payments. Or measured another way, this would signal the end of the so-called petrodollar.
But how large of a shift is this? With the increasingly frequent Saudi comments about trading in nondollar currencies, we’ve also seen an increasing number of pundits announcing the “collapse” of the dollar or the imminent implosion of the dollar’s currently outsized global power.
Will a shift away from the dollar in the global oil trade really lead to a big relative decline in the dollar? Probably and eventually. But a number of other dominoes would need to fall first, most especially the domino we call “Eurodollars.”
“Then the sixth angel poured out his bowl on the great river Euphrates, and its water was dried up, so that the way of the kings from the east might be prepared.” Rev. 16:12
On the other hand, it would be foolish to simply dismiss the potential end of the Saudi preference for the dollar with hand-waving. The end of the petrodollar would indeed weaken the dollar, even if this would not be a mortal blow in itself. Moreover, it is especially foolhardy to ignore the status of the petrodollar because that status also has geopolitical implications. Saudi comments on the dollar signal that the Saudis no longer consider its alliance with the United States to be as important as it has been since the 1970s. What’s not an immediate economic problem for the US regime or the dollar may nonetheless be an immediate geopolitical problem.
In context, probably the best way to look at the potential end of the petrodollar is to see it as one piece of the dollar-based portion of the global economy. Since the 1950s, the dollar has experienced an immense amount of support in terms of global trade and investment and in terms of dollar reserves held by foreigners. This has greatly propped up demand for US debt and for dollars, and this has had enormous disinflationary effects in the domestic US economy. That is, newly created dollars are soaked up by foreigners who both want and need dollars to pay off dollar-denominated debt and to pad bank reserves. But if global dollar dominance truly is in decline, we could potentially expect both higher domestic price inflation and higher interest rates than what Americans have become accustomed to over the past thirty years. In other words, as the dollar declines, the US regime will no longer be able to monetize debt and heap up immense new deficits without fear of high price inflation or falling Treasury prices. The end of the petrodollar is not a reason to panic right now, but it is the latest sign that the US regime’s power via the dollar is being reined in.
What Is the Petrodollar?
The petrodollar is the result of US efforts to secure access to Middle Eastern oil while also lessening the slide of the dollar in the early 1970s.
By 1974, the US dollar was in a precarious position. In 1971, thanks to profligate spending on both war and domestic welfare programs, the United States could no longer maintain a set global price for gold in line with the Bretton Woods system established in 1944. The value of the dollar in relation to gold fell as the supply of dollars increased as a byproduct of growing deficit spending. Foreign governments and investors began to lose faith in the dollar.
In response to these developments, Richard Nixon announced that the US would abandon the Bretton Woods system. The dollar began to float against other currencies. Not surprisingly, this devaluation did not restore confidence in the dollar. Moreover, the US had made no effort to rein in deficit spending. So the US needed to continue to find ways to sell government debt without driving up interest rates. That is, the US needed more buyers for its debt. Motivation for a fix grew even more after 1973, when the first oil shock further exacerbated the deficit-fueled price inflation Americans were enduring.
But by 1974, the enormous flood of dollars from the US into Saudi Arabia, the top oil exporter, suggested a solution. Nixon secured an agreement in which the US would buy oil from Saudi Arabia and provide the kingdom military aid and equipment as well. In return, the Saudis would use their dollars to purchase US Treasurys and help finance US budget deficits.
From a public finance point of view, this appeared to be a win-win. The Saudis would receive protection from geopolitical enemies, and the US would get a new place to unload large amounts of government debt. Moreover, the Saudis could park their dollars in relatively safe and reliable investments in the United States. This became known as “petrodollar recycling.” By spending on oil, the US was creating new demand for US debt and US dollars.
As time went on, thanks to Saudi Arabia’s dominance in the Organization of the Petroleum Exporting Countries (OPEC), the dollar’s dominance was extended to OPEC overall, which meant that the dollar became the preferred currency for oil purchases worldwide.
This petrodollar arrangement proved to be especially important in the 1970s and 1980s, when Saudi Arabia and the OPEC countries controlled more of the oil trade than they do now. It also closely tied US interests to Saudi interests, ensuring US enmity toward the kingdom’s traditional rivals, such as Iran.
The Petrodollar Is a Type of Eurodollar
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