Is the End of the Petrodollar Near?
By Hung Tran, Nonresident Senior Fellow at the Atlantic Council GeoEconomics Center
June 20, 2024
Note to Readers: This article has been revised to correct a previous assertion. Saudi Arabia made no announcement on June 13 regarding oil trade in US dollars. There is no official agreement between the United States and Saudi Arabia mandating oil sales in US dollars.
As nations within the BRICS bloc and regions such as the Middle East and Asia increasingly utilize local currencies for cross-border payments, the dollar’s dominance in international finance, notably in global oil markets, appears to be waning.
The term "petrodollar" refers to Saudi Arabia’s commitment to use revenue from oil sales to the United States to purchase U.S. Treasuries. This alignment has deep historical roots.
America and Saudi Arabia in 1974
During the Nixon administration, the United States was grappling with high inflation and a significant current-account deficit amid the Vietnam War, causing a depreciation of the dollar and a potential run on U.S. gold reserves. In 1971, the United States ended the dollar’s convertibility to gold, which had underpinned the Bretton Woods system of fixed exchange rates. Major currencies began floating against each other in 1973, coinciding with the oil shock that fall when OPEC cut production and embargoed shipments to the U.S. during the Yom Kippur War.
Amidst economic and political uncertainty, the Nixon administration launched a diplomatic initiative that forged a critical economic partnership with Saudi Arabia. The agreement envisioned Riyadh using the dollar for oil sales, thereby funneling revenues back into U.S. Treasury markets to aid American fiscal deficits. In exchange, Washington pledged to provide military equipment and safeguard Saudi national security. This deal not only stabilized demand for the dollar but also enhanced its use in global oil and commodities trading, fortifying the dollar’s status as the world’s primary reserve currency.
A Brave New World
Half a century later, America’s global dominance has relatively weakened. Its share of the global GDP has decreased from 40% in 1960 to 25%. Meanwhile, China’s economy has surpassed the United States in purchasing power parity terms. As Washington competes with an increasingly assertive Beijing and contends with allied nations striving for financial and foreign policy autonomy, there is a concerted effort to establish alternative cross-border payment mechanisms to the dollar, mitigating susceptibility to U.S. economic sanctions.
Simultaneously, the United States’ dependence on Saudi oil has diminished significantly due to the shale revolution, making it the world’s largest oil producer and a net exporter. In contrast, China now stands as Saudi Arabia’s largest oil customer, buying more than 20% of its oil exports. This shift underscores Beijing’s growing influence in the Middle East, where U.S. clout has waned.
Saudi Arabia’s pursuit of diversified currency transactions for oil sales aligns with its broader strategy to expand international relations beyond the United States and Europe. The Kingdom’s enrollment in the BRICS group and its collaboration with China on the mBridge project, exploring central bank digital currencies (CBDCs) for cross-border payments, exemplify this shift.
The Dollar’s Global Dilemma
Saudi Arabia’s interest in currency diversification marks a symbolic move towards de-dollarization. Many countries are engaging in cross-border trade using local currencies, employing currency-swap lines and linking national payment systems, thus operating outside the sphere of any single major power. Although less efficient due to liquidity constraints in local forex and money markets, technological advancements, such as tokenization in digital payments, could reduce these costs.
The digital payment ecosystem has progressed significantly towards "tokenization" of units of exchange like CBDCs or stablecoins. These tokenized units can facilitate instant and direct exchanges without commercial bank intermediaries. While widespread adoption of tokenized currencies remains distant, their potential to lessen the need for reserve holdings could undermine the U.S. Treasury market’s foundational role, diluting the dollar’s predominance in international finance. Indeed, the dollar’s share in global reserves has already declined from 71% in 1999 to 58.4% currently.
In the near future, the dollar will likely maintain its dominance. However, the financial landscape may gradually democratize, enabling increased use of local currencies in international transactions. The dollar would remain significant but share its influence with other major currencies such as the Chinese renminbi, the euro, and the Japanese yen, reflecting their economic footprints. Thus, Saudi Arabia’s evolving stance on the petrodollar could foreshadow broader shifts in the global financial order, much as its inception 50 years ago did.
Hung Tran is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center, former executive managing director at the Institute of International Finance, and former deputy director at the International Monetary Fund.
Source: Atlantic Council – Is the end of the petrodollar near?
