There has been increasing talk of global trade, especially oil, moving away from being priced in US dollars thereby ending the American monetary hegemony. This piece gives a bit of historical context to why ‘petrodollars’ exist in the first place and why it isn’t going away anytime soon.
“Although “petrodollars” refers simply to oil priced in dollars, the term sometimes takes on a broader significance, because surplus oil exporters who are paid in dollars will recycle them through US Treasury bond purchases, thus helping to finance US trade deficits. Whether this arrangement originated as a quid pro quo (in exchange for US security guarantees) is a source of much controversy. The debate was recently reignited by speculation that the petrodollar system had formally expired on June 9, the 50th anniversary of a military and economic pact that US Secretary of State Henry Kissinger and Saudi Prince Fahd bin Abdulaziz Al Saud signed in 1974.”
Whilst that agreement doesn’t specifically allude to any petrodollar pricing or quid pro quo, the article quotes an interesting Wall Street influence on the whole situation:
“US Treasury Secretary William Simon and his deputy, Gerry Parsky, undertook a mission to the Kingdom under the guise of a broader diplomatic tour that had been launched in response to the Arab oil embargo that followed the 1973 Arab-Israeli War. Before entering public service, Simon had served as a senior executive at Salomon Brothers, where he was instrumental in developing the firm’s government bond trading department.
Salomon Brothers established a dominant position in the trade of US Treasury securities and reshaped the landscape of Wall Street finance in the process. Teaming up with legendary figures such as William “Billy” Salomon and John Gutfreund, Simon began issuing bonds by pooling risk. By his own account, the institution became “a scrappy, bare-knuckled, risk-taking firm.”
He then brought the same bold style (and experience managing complex financial instruments) to the Department of the Treasury. During a four-day layover in Jeddah, his team brokered a confidential agreement with Saudi officials to mitigate the use of crude oil as an economic weapon. The US would purchase oil from Saudi Arabia and furnish it with American military aid and equipment, and the Saudis would invest their oil proceeds in US Treasury bonds. Bloomberg reported the secret diplomatic cable, obtained from the National Archives database, in 2016.”
There have been other reasons than just the 50th anniversary of the pact leading to speculation of the end of the petrodollar regime. First, the rise of Chinese influence on the global economy and geopolitics creating a need for Saudi’s diversification away from the dependence on the US. Second, Saudi’s own current account surplus turning into deficit as it invests in diversifying its economy away from just oil, thereby eliminating the need to invest the surplus in US treasuries. And above all this is the US’ increasing self-sufficiency in oil thanks to the discovery of vast shale reserves.
“In 2014, the world witnessed a dramatic drop in oil prices, owing primarily to an oil glut caused by the boom in US shale energy. The shift toward greater US production disrupted global oil-price stability and posed challenges to Saudi Arabia and other traditional oil-exporting economies.
In response to these economic pressures – and as part of a broader strategy to mitigate the impact of volatile oil prices – Saudi Arabia launched Vision 2030. Again, the plan was to diversify the Saudi economy away from oil dependence by investing heavily in sectors such as health, education, infrastructure, and tourism, as well as in new industries.”
Yet, the author reckons it is unlikely that we will move away from the petrodollar system anytime soon:
“Despite the decline and periodic reversal of Saudi Arabia’s external surplus since 2014, the cumulative current account is close to $1.5 trillion (see Chart 1), suggesting sizable dollar-denominated holdings. Even if the Kingdom has diversified into eurodollars, rather than predominantly holding US Treasuries, secondary sanctions could oblige foreign custodians of dollars outside the US to block or otherwise restrict the use of those assets. It is thus impossible for the Saudis to dismiss the risk of US dollar coercion entirely.”
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