Start with a footnote that most petrodollar explainers skip. The Atlantic Council had to add an editors’ note to its own article on the subject: there is “no official agreement” between the United States and Saudi Arabia to sell oil in dollars. The system exists. The paper trail, as ever, is thinner than the legend.
How it came about
The setting was the early 1970s. The United States was dealing with high inflation, big current-account deficits and the Vietnam War, all of which pushed the dollar down and threatened a run on its gold reserves. In 1971 it ended the dollar’s convertibility to gold, the linchpin of the Bretton Woods system of fixed exchange rates. Major currencies began to float against each other in 1973. That autumn came the oil shock: OPEC cut production and embargoed shipments to the United States during the Yom Kippur war.
The next step, in 1974, is usually described as a deal. According to the Independent Institute, Saudi oil would be priced and sold in dollars, and Washington would offer security guarantees and access to American financial markets. The Atlantic Council puts the logic in plain terms. Riyadh was encouraged to use the dollar for its oil sales, and so to channel those dollars back into the Treasury bond market and help finance US deficits. In exchange, Washington promised military equipment and protection. Other OPEC members largely followed.
The technical reality
Under the hood, the mechanics are simple. Oil is the world’s most traded commodity, so buyers needed dollars to pay for it. Exporters then put the proceeds into Treasury bonds and other American assets, a loop known as “petrodollar recycling”. The effect was steady demand for the currency and for US debt.
It rests on convention rather than law. No formal treaty binds OPEC countries to the dollar, the Independent Institute noted, and Saudi Arabia and Russia have both taken yuan, euros or other currencies in some bilateral deals. Even so, roughly 80% of global oil transactions are still denominated in dollars. The writer put the staying power down to habit, liquidity, switching costs and the depth of US financial markets, and added the SWIFT payments network as a reinforcing factor.
Where the pressure is
The edges are fraying slowly. The United States is now the world’s largest oil producer and a net exporter, thanks to the shale revolution, while China is Saudi Arabia’s biggest customer, taking more than 20 percent of the kingdom’s oil exports. The dollar’s share of global reserves fell from 71 percent in 1999 to 58.4 percent, according to the Atlantic Council.
A popular theory holds that Washington fights wars to protect the arrangement, pointing to Saddam Hussein’s 2000 announcement that Iraq would sell oil in euros, followed by the 2003 invasion. Critics call that too neat. Afghanistan and Ukraine have no obvious currency angle, and oil is only one pillar of dollar dominance beside the size of the US economy, its bond markets and Federal Reserve policy.
The Atlantic Council’s own verdict was measured: in the foreseeable future, the dollar’s dominance will remain.
Sources
- Is the end of the petrodollar near? (Atlantic Council, Hung Tran)
- Unpacking The "Petrodollar War Theory" (Independent Institute, Scott Beyer)
