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1944 was a crucial year in one of history’s most devastating topics of all times. But this is not all! It holds an even greater significance for the global economic system. Since 1944, with the ratification of the Bretton Woods Accords, the US Dollar has served as the world’s major reserve currency, held in monumental stores by Central Banks across the globe. When it comes to economic development, the most influential and indispensable commodity on earth is oil. What interrelates the two is the petrodollar.

The petrodollar is any US Dollar paid to oil-exporting countries in exchange for oil. Petrodollars earned by oil-exporting nations depend on the selling price of oil and the volume being sold abroad, which in turn depend upon the oil production. Petrodollars are the primary source of government revenue in many Middle Eastern countries that are net exporters of oil. Simply put, petrodollars are oil revenues denominated in U.S. dollars. Since petrodollars are denominated in U.S. dollars, the true purchasing powering of them are reliant on both the core rate of U.S. inflation and the value of the U.S. dollar.

The Origin: From Bretton Woods To Petrodollar The petrodollar system originated in the early 1970s in the wake of the Bretton Woods collapse. President Richard M. Nixon and his globalist sidekick, Secretary of State, Henry Kissinger, knew that the destruction of the international gold standard under the Bretton Woods arrangement would cause a decline in the artificial global demand of the U.S. dollar. Maintaining this “artificial dollar demand” was vital if the United States were to continue expanding its “welfare and warfare” spending.

Two years later, in an effort to maintain global demand for U.S. dollars, another system was created called the ‘petrodollar system’. In 1973, a deal was struck between Saudi Arabia and the United States in which every barrel of oil purchased from the Saudis would be denominated in U.S. dollars. Under this new arrangement, any country that sought to purchase oil from Saudi Arabia would be required to first exchange their own national currency for U.S. dollars. In exchange for Saudi Arabia’s willingness to denominate their oil sales exclusively in U.S. dollars, the United States offered weapons and protection of their oil fields from neighbouring nations, including Israel.

By 1975, all of the OPEC nations agreed to price their own oil supplies exclusively in the greenback in exchange for weapons and military protection.

Petrodollar surplus Petrodollar surpluses are defined as the net U.S. dollars earned from the sale of oil that is in excess of internal development needs. Petrodollar surpluses, accrued in the process of converting subsoil wealth into internal income-generating capital stock, refer to oil production that exceeds such needs but are transformed into monetary units.

Since petrodollars and petrodollar surpluses are by definition denominated in U.S. dollars, their purchasing power is dependent on the U.S. rate of inflation and the rate at which the U.S. dollar is exchanged by other currencies in international money markets. The link, therefore, between the U.S. dollar and petrodollar surpluses, in particular, has significant economic, political, and other implications. Petrodollar surpluses do not represent real wealth but rather are a vehicle by which the latter can be acquired! These funds represent a massive amount of investment capital and are often traded on the eurocurrency market, a money market which currency held in banks outside of the country where it is legal tenderis borrowed and lent by banks, and is utilized by banks, multinational corporations, mutual funds and hedge funds that wish to circumvent regulatory requirements, tax laws and interest rate caps often present in domestic banking, particularly in the United States. It is worth mentioning that the eurocurrency market has no direct relation with ‘euro currency’.

According to the U.S. Treasury information, petrodollar surpluses turned into deficits since 1982 primarily because of three reasons: increase in imports by oil-exporting nations; reduction in the demand for oil, particularly from OPEC; and the oil glut, which led to a reduction in its price. However, it saw a boom again in the 2000s.


One of the most brilliant aspects of the petrodollar system was requesting that oil-producing nations take their excess oil profits and place them into U.S. debt securities in Western banks. This process, referred to as “petrodollar recycling,” is a win-win for all involved: oil-rich states enjoy a safe place to store their petro-profits, and the United States gains a key source of financing for its deficit spending. However, OPEC countries gradually began to diversify their investment portfolios. Oil profits were instead invested in foreign banks and sovereign wealth funds.

These foreign banks then lent money to countries who could not actually afford to make further oil purchases. Because these countries must essentially buy their oil from OPEC nations, the funds essentially return to OPEC hands. This cycle then repeats itself when OPEC nations once again invest their funds into the aforementioned foreign banks. This is how the petrodollar recycling system in the world works. While this system ensures that there is a flow of money in the global economy, it also highlights a grim reality — that borrower countries will perpetuate a debt that they will never be able to repay.

As per the US Treasury Report of 2006, increased oil prices generated an extra $1.3 trillion in revenue for OPEC countries since 1998. Conventionally, oil revenues are spent on increased imports, higher wage rates, increasing reserves and retiring debts. However, a large chunk of the investable petrodollar funds could not be accounted for, leading to scepticism that the unaccounted-for funds were invested in construction loans, regional stock markets, private equity funds, and hedge funds. An unknown amount of funds could have been invested in U.S. assets through foreign intermediaries, which are untraceable.

These hidden petrodollars increase global volatility. That’s due to their sheer size of $400 billion. If it is in U.S. Treasuries, withdrawal of that size could trigger both a decline in the dollar and higher interest rates, something Saudi Arabia has been threatening to do for a long time!

The Petrodollar System: A Persisting Strife Since the inception, petrodollars have been a hotly debated issue, with analysts holding different stakes having different views. Some view it as being unfair to producing nations, while others contend it is necessary to bring structure to the global oil trade.

Proponents of the system consider stability and security as the primary advantages of the petrodollar system. Also, the view that receipts in dollar provide more liquidity, given the fact that USD accounts for over 70% of world’s reserve currency, and thus can be reinvested directly into the world economy through the process of ‘recycling’.

Detractors believe that dependence on the USD is inherently risky to oil-producing nations. Oil products are bought and sold universally in terms of dollars, so the real value of the revenues generated from trade is precisely dependent on the value of the USD. So in case of inflationary pressures devaluing the USD, the producers tend to lose market share. In order to reduce this risk, many oil-rich nations have pegged the value of their domestic currency to that of the USD.

Petrodollar Warfares: Iran & Iraq US petrodollars have become the de facto currency for global oil transactions, leaving all producers with their profit in dollars. This system has been opposed by many till date. Petrodollar warfare refers to the alleged motivation of US military offensives as preserving by force the status of the United States dollar as the world’s dominant reserve currency and as the currency in which oil is priced. In 2000, not too happy perhaps with the petrodollar regime, Saddam changed the Iraqi oil transaction currency to the euro, a decision ultimately approved by the UN. At the time this move cost Iraq $270 million, but it paid off in the long run; the US dollar depreciated steadily against the Euro, making Saddam a fortune in the process. The 2003 invasion of Iraq, of course, put an end to his regime, and with it, his subversive petro-political gamble. Sanctions on Iraq were stopped once the war began, and, in 2003, Iraqi oil transactions were once again denominated in US dollars.

US has been imposing sanctions on Iran in the wake of violation of the Nuclear Non-Proliferation Treaty (NPT). Setting the doubtful nuclear threat aside for a moment, it might be useful to consider if more is at stake in this brewing conflict. In this regard, the petrodollar warfare theory has a lot of explanatory potential. In November 2007, Ahmadinejad called for a “credible and good currency to take over the US dollar’s role and to serve oil trades” during the third summit of OPEC. By December 2007, Iran had stopped selling its oil in US dollars. And in February 2008, the country established the Iranian Oil Bourse (IOB) on Kish Island. The establishment of the IOB allowed exchanges of oil, petrochemicals, and gas between industrialized and developing countries in a basket of currencies other than the US dollar. All these instances very well signify that the Iran sanctions have much to do with the petrodollar system and are not just because of mere violations of NPT.

The Nearing Collapse: An End Of The Era? Artificial demand for dollars has long sustained the world’s petrodollar ecosystem. This system is now proving unsustainable — and the ever-growing US trade deficit is creating even more pressure. The U.S. Federal government also currently runs a budget deficit ranging from $600bn to $1tn a year. This is scheduled to get worse over the coming years and decades as a much higher proportion of its population reaches retirement age and there are fewer workers per retiree to pay their pensions, their medical costs and the higher interest costs on the exponentially increasing National Debt, which is currently at $20tn.

Since its outset, the future viability of the petrodollar has always been a much apprehended and anticipated area for economic and geopolitical analysts. Over the course of its existence, there have been many high-profile challenges to its status as the standard for the global oil trade, for instance, in 2016, Iran sought payments for signed oil contracts in euros instead of dollars. Ongoing commitments from Vladimir Putin to sell more of Russia’s oil output in rubles (RUB) and yuan (CNY) threaten to reduce the dominance of the U.S. dollar in the oil trade. Russia is also considering to trade oil in cryptocurrency. Venezuela and Iran also signed oil contracts in their currencies instead of petrodollars. China’s launch of an oil futures contract denominated in CNY marks an attempt to bring a new valuation model to the oil markets of the Far East. The recent negotiations on the Rupee-Rial mechanism for trade settlements between India and Iran signify to the global forces eroding the power of petrodollars. Also, the geopolitical sands of the middle east have been rapidly shifting.

These threats hold a great potential to erode the petrodollar regime, however, these ventures will take time to materialise. Given the fact that Euro and Yuan are the greatest contenders of USD, it is worth noticing that Euro is in itself a phase of turmoil, thanks to the Eurozone crisis! The strongest alternative to the petrodollars, as of now, is Yuan, with China growing as a world power and its ever-increasing share in the global trade volume!

The Future Since Bretton Woods to the Nixon Shock to the present day, one can’t deny the fact that Dollar has been the de facto currency for the world, so has been the petrodollar. The coming years are likely to pose new and unique challenges to the petrodollar system. As the oil-producing countries look forward to avoiding US hegemony and insulate against the volatile market associated risks, alternate forms of valuations will take root. A paradigm shift in the global monetary system also seems inevitable. But owing to the volume of petrodollars in circulation and trade currently and the fact that the potential alternatives will take time to mature, the petrodollar system is definitely not going to collapse in the near future! Ultimately, only time will tell if the petrodollar mechanism will be viable in the future or not.

By Sakshi Agrawal


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