On June 9, 2024, the 50-year-old petrodollar agreement between Saudi Arabia and the United States quietly expired. For half a century, this pact had ensured that oil sales were conducted exclusively in US dollars, bolstering the dollar’s status as the world’s reserve currency and cementing its dominance in global trade. The potential end of this agreement marks a seismic shift in the global economic landscape, with far-reaching implications for the future of the US dollar and international financial stability.
The End of an Era
The petrodollar system, established in the 1970s, was a cornerstone of the global economic order. In exchange for pricing its oil exclusively in US dollars and investing surplus oil revenues in US Treasury bonds, Saudi Arabia received military support and protection from the United States. This arrangement not only stabilized the global oil market but also reinforced the dollar’s supremacy. Countries around the world needed dollars to buy oil, which in turn maintained a steady demand for the currency, kept it strong, and facilitated low interest rates and robust financial markets in the US.
However, as of June 9, this critical component of the dollar’s global hegemony is no longer in place. Saudi Arabia has announced that it will now sell oil in multiple currencies, including the Chinese yuan (RMB), euros, and yen. This strategic pivot is not just a logistical change; it signals a profound realignment in international trade and finance.
The Decline of Dollar Dominance
Gita Gopinath, First Deputy Managing Director at the International Monetary Fund (IMF), has highlighted that the dynamics of global economic ties are undergoing significant changes, unseen since the end of the Cold War. She emphasized that nations are reassessing their trading partners based on economic and national security considerations. This reassessment has led some countries to reconsider their heavy dependence on the dollar for international transactions and reserve holdings.
One clear sign of this shift is China’s increasing use of the yuan in trade with Russia. In 2022, China imported $88 billion worth of major commodities from Russia, a 52% increase from the previous year, with much of this trade conducted in yuan. This transition has been driven by sanctions and the complexities of using the dollar amid geopolitical tensions.
Moreover, Saudi Arabia’s Aramco, the world’s largest oil producer, is significantly expanding its presence in China, aligning with the broader move away from dollar dependence. Aramco has signed definitive agreements to acquire a 10% interest in Shenzhen-listed Rongsheng Petrochemical Co. Ltd., a deal that includes supplying 480,000 barrels per day of Arabian crude oil to Rongsheng affiliate Zhejiang Petroleum and Chemical Co. Ltd. Reports in 2022 indicated that Saudi Arabia is in active talks with Beijing about pricing some of its oil sales to China in yuan.
This strategic shift not only deepens Saudi-China economic ties but also exemplifies the broader trend of diversifying currency use in global oil trading. A shift towards the yuan in oil trading could enhance China’s economic power and influence, challenging the US’s preeminence in global affairs. Such a transformation would also lead to greater economic and geopolitical competition among nations, as they navigate a new landscape where the dollar is no longer the unchallenged standard.
Motivations Behind the Shift
Sanctions, particularly those related to Russia’s war in Ukraine, have played a crucial role in prompting countries to seek alternatives to the dollar. As Daniel McDowell, author of “Bucking the Buck: US Financial Sanctions and the International Backlash Against the Dollar,” argues, the more the U.S. uses the dollar as a weapon of foreign policy, the more its adversaries will move their economic activities into other currencies.
China and Russia have been moving away from the dollar for years, and their adoption of alternative systems has accelerated since the Ukraine war. In March 2023, the yuan surpassed the dollar as the most used currency for Chinese cross-border transactions, highlighting the growing momentum behind de-dollarization.
Middle Eastern nations are also wary of the U.S. attempting to rewrite the rules of the global oil market, which they perceive as a strategic threat. Saudi Arabia’s strong stance against any potential price caps on its oil exports underscores the Kingdom’s determination to protect its economic interests.
The Rise of Central Bank Digital Currencies
Adding another layer of complexity, Saudi Arabia has joined a China-dominated central bank digital currency (CBDC) cross-border trial. Announced by the Bank for International Settlements (BIS), this move sees Saudi Arabia’s central bank becoming a full participant in Project mBridge, a collaboration launched in 2021 between the central banks of China, Hong Kong, Thailand, and the United Arab Emirates.
The mBridge platform, now at the “minimum viable product” stage, aims to facilitate cross-border transactions using digital currencies, potentially bypassing traditional dollar-based systems. This initiative represents a significant step towards diversifying the mechanisms of global trade and reducing dependency on the US dollar.
Historical Context and Future Projections
The petrodollar system has been integral to the US economy since its inception. Established after the 1973 oil crisis, it created a symbiotic relationship between the US and Saudi Arabia. This agreement ensured a stable source of oil for the US and a guaranteed market for its debt, reinforcing the dollar’s status as the global reserve currency.
In his recent book, “Bonfire of the Sanities,” investment manager David Wright highlights the significance of the dollar’s strength in maintaining America’s high standard of living. According to Wright, the dollar’s strength is crucial because it is underpinned by global trust in the US economy and the necessity of using dollars for energy purchases.
However, the expiration of the petrodollar agreement introduces uncertainties. The global energy landscape is changing, with a growing focus on renewable sources and the emergence of new oil-producing nations. These shifts, coupled with the end of the petrodollar pact, could weaken the dollar and disrupt US financial markets.
Broader Implications
The expiration of the petrodollar agreement underscores the shifting power dynamics in the global economy. It signals the increasing influence of emerging economies and a changing energy landscape. While the full implications of this shift remain to be seen, the global financial order is entering a new era, where the US dollar’s dominance is no longer guaranteed.
Middle Eastern nations are exploring alternatives to the dollar. For instance, Iraq has announced a ban on personal or business deals in US dollars, driven partly by a shortage of dollars and the volatility of the Iraqi dinar. Earlier this year, Saudi Arabia’s finance minister indicated that the kingdom is open to selling oil using different currencies, including the euro and the Chinese yuan. Additionally, several Middle Eastern nations have expressed interest in joining BRICS, a geopolitical bloc of emerging economies.
The Impact on Investors
Nigel Green, CEO and founder of the deVere Group, one of the world’s largest independent financial advisory and asset management companies, has warned that the shift in how global oil trading is conducted will have significant consequences for investors worldwide. Oil is one of the most traded commodities globally, and its pricing in US dollars has given the currency a dominant role in financial markets. If oil trading were to shift away from the dollar, it would reduce demand for the currency, potentially leading to a depreciation of its value. This could trigger a series of economic challenges for the United States, including increased inflation and destabilization of financial markets.
Investors worldwide must be alert to these shifts, as they will affect portfolios and investment strategies. “If oil were priced and traded in a different currency, investors would be exposed to currency risk as the value of the currency could impact the value of their investments,” Green explained. This necessitates a reassessment of holdings and a strategic adjustment to account for potential currency fluctuations. Companies with significant revenue from oil production or related services would also be impacted by changes in the currency used for trading. Investors with exposure to these companies need to evaluate the potential consequences of a shift away from the dollar on their investments.
The Challenge of Transition
Despite these developments, the transition away from the dollar will not be swift or easy. Many Middle Eastern countries still have currencies pegged to the US dollar, and de-pegging these currencies would be a significant indicator of a serious shift away from the dollar. However, as of now, such a move has not occurred.
Moreover, the existing infrastructure for global trade and finance is deeply entrenched in the dollar system. Creating alternative settlement mechanisms involves substantial legal and governance challenges. Even if countries desire to bypass the dollar, replacing the settlement infrastructure provided by the dollar-driven system is a complex and lengthy process.
End Note
The expiration of the petrodollar agreement between the US and Saudi Arabia marks a pivotal moment in global economic history. As Saudi Arabia moves to trade oil in multiple currencies, the implications for the US dollar and the global financial system are profound. Investors, policymakers, and economies worldwide must brace for a new era where the dollar’s dominance is increasingly challenged.
While the transition away from the dollar will be gradual and fraught with challenges, the signals are clear: the global financial order is evolving. As emerging economies and alternative currencies gain prominence, the landscape of international trade and finance will undergo significant transformation. The future of the US dollar, once the unassailable cornerstone of global commerce, now hangs in the balance, as the world prepares for a more multipolar economic era.
