The longstanding pact that established the U.S. dollar as the global currency for crude oil transactions, known as the petrodollar system, has recently concluded. This system, which has been a cornerstone of international economic relations for half a century, was initiated in the 1970s following the United States’ departure from the gold standard. The deal struck between the United States and Saudi Arabia brought substantial advantages to the American economy, shaping the financial landscape significantly.
A Boon to U.S. Bonds
In the aftermath of the 1973 oil crisis, the petrodollar agreement was forged, requiring Saudi Arabia to conduct oil sales in U.S. dollars and to reinvest surplus oil income in U.S. government securities. The U.S., in exchange, offered military backing and security to the Saudi kingdom. This symbiotic relationship fostered a steady oil supply for the U.S. and a secure investment for its government debts, while Saudi Arabia benefitted from strengthened economic and defense assurances.
Status as the Reserve Currency
Denominating oil exclusively in U.S. dollars had ramifications that transcended the oil and finance sectors. It cemented the dollar’s position as the principal reserve currency globally, which has had lasting effects on the American economy. The constant global need for dollars to trade oil has supported a robust dollar, allowing the U.S. to import goods inexpensively. Moreover, the influx of capital into U.S. Treasury bonds has sustained low interest rates and a vibrant bond market.
In his recent publication, Bonfire of the Sanities (December 2023), the influential author and investor David Wright suggests that the dollar’s strength is integral to the high living standards in the U.S., ascribed to the economy’s credibility and the dollar’s critical role in energy trading.
Potential to Disrupt the Global Financial Order
Yet the dominance of the petrodollar is being tested by the expiry of the U.S.-Saudi oil agreement on June 9, 2024. This development could unsettle the established global financial system. Changes in the oil market, including the rise of alternative energy sources and the entry of new oil-producing countries, are reshaping the industry’s balance of power.
U.S. Dollar’s Future
With the petrodollar system’s cessation, the U.S. dollar’s stronghold could be undermined, potentially leading to decreased global demand for the currency. This might result in higher inflation, increased interest rates, and a faltering bond market in the United States.
Key Takeaway – A Significant Shift in Global Power Dynamics
The end of the petrodollar treaty marks a pivotal change in international power structures, underscoring the ascendant role of emerging markets and the evolving energy sector. While the long-term effects are yet to fully unfold, it is clear that the global financial order is transitioning into a novel phase, with the U.S. dollar’s supremacy no longer assured.