The end of the petrodollar?

BarcelonaOn October 6, 1973, thousands of Israeli soldiers were forced to eat. That day, the country was celebrating Yom Kippur, one of Judaism's holiest holidays, characterized by fasting and prayer, when it was attacked militarily by Egypt and Syria. Many members of the army had to postpone their celebrations. This war, which lasted about three weeks, was another episode in the Arab-Israeli conflict. But at the same time, it marked a turning point for the global economy, as the Organization of the Petroleum Exporting Countries (OPEC, comprised mainly of Arab states) implemented a crude oil embargo on Western countries (the United States and some allies, primarily European), which caused prices to skyrocket and triggered the first of the oil crises of the 1970s and early 1980s.

One of the consequences of that embargo was that the US rushed to reach agreements with Middle Eastern oil-producing countries, especially Saudi Arabia, the largest, to prevent a new blockade of crude oil exports from affecting the US, which was experiencing fuel shortages. Although both governments had already negotiated before the Yom Kippur War, the definitive treaty was signed in 1974, when Washington and Riyadh reached an agreement whereby Saudi Arabia committed to selling all its oil only in dollars in exchange for military protection. This is the birth of the petrodollar.

The petrodollar essentially refers to "dollars originating from the fortunes of oil-producing countries, especially in the Middle East," explains Albert Carreras, professor of economic history at Pompeu Fabra University and director of the university's School of International Trade (ESCI-UPF). However, these dollars are recycled by returning them to the United States in the form of investment, primarily through the purchase of US Treasury bonds, which alleviates the US government's debt burden, and of US weaponry (at a good price). The other Gulf monarchies—Kuwait, Qatar, Bahrain, and the United Arab Emirates—adopted the same practice of receiving payment for crude oil only in dollars, thus making the US currency... de facto The reference currency in global energy markets.

For the US, the fact that most of the world's hydrocarbon transactions were conducted in its currency further solidified its global economic dominance at a time when the Soviet Union still acted as a geopolitical counterweight. However, it wasn't exactly indispensable: "Since World War II, the dollar's hegemony has been indisputable" internationally, notes Carreras.

In this sense, since 1945, the only moment of relative "weakness" in the dollar's role as the world's main currency was in 1971, when US President Richard Nixon abandoned the dollar's parity with gold, thus transitioning to the current monetary system in which currencies are not backed by any precious metal, as had been the case for much of the previous century, the professor reminds us. The creation of the petrodollar partially mitigates this loss of the gold standard, maintaining the US at the center of international trade, even in transactions between third countries. It also compels states wishing to import oil to acquire dollars to pay for it, thereby strengthening the value of the US currency.

Loss of importance

However, the situation of the 1970s has changed over the years, and the concept of the petrodollar has lost importance. Firstly, because countries like Russia and Iran, at odds with the US, have significantly increased their exports of oil and natural gas. Furthermore, the United States has reduced its dependence on the Gulf petro-monarchies and extracts much of its own oil – since the 2000s, fracking played an important role—or they import it from Canada, which is another major exporter. In Europe, North Sea fields have gained importance, and a significant portion of natural gas comes from the US, Australia, or Azerbaijan.

With the current conflict in the Middle East, the energy situation has been further shaken. In practical terms, the Strait of Hormuz—the passage connecting the Persian Gulf to the Indian Ocean through which 25% of oil and 20% of liquefied natural gas and nitrogen fertilizers pass—is closed, but not for everyone: "The Strait of Hormuz is open; it is only closed to those who attack us and their allies." These were the words of Iranian Foreign Minister Abbas Araghchi a week ago.

A statement that shows that the problems Europe is having with oil prices may be less pronounced for other countries. In fact, China is buying Iranian crude and paying for it in yuan, its currency. Russia is also selling crude to China and India. Indeed, since the Russian invasion of Ukraine, Moscow, Beijing, and other countries (Brazilian President Lula da Silva has often criticized the dollar's dominance) have made "efforts to erode the position of the US" and its currency in the global economy, Carreras notes, but so far with little success.

It is Donald Trump's return to the US presidency that could accelerate events, although it is still too early to see it clearly. Trump's tariff policy seeks to reduce his country's trade deficit, which would diminish the importance of the dollar, as the US would buy less from abroad. Furthermore, the war in Iran is incentivizing the governments of the region's oil-producing states, traditionally US allies, and importing countries to seek alternative markets for their crude oil. This could involve abandoning the dollar in exchange for Iran guaranteeing safe passage for ships through the Strait of Hormuz. Adding to this the criticism and threats against traditional allies, these incentives gain traction in the capitals of the European Union and in countries like Canada, Japan, and South Korea.

"Trump has realized that it is very important for fundamental business to be conducted in dollars," says the professor. It remains to be seen whether it will now change course to maintain the dominance of its currency or whether it will remain true to its policies thus far.