U.S.-Saudi
Petrodollar Pact Ends after 50 Years
June 11,
2024 — 11:01 am EDT
Written
by Paul Hoffman for TipRanks ->
The
50-year-old petrodollar agreement between the U.S. and Saudi Arabia was just
allowed to expire. The term “petrodollar” refers to the U.S. dollar’s role as
the currency used for crude oil transactions on the world market. This
arrangement has its roots in the 1970s when the United States and Saudi Arabia
struck a deal shortly after the U.S. went off the gold standard that would go
on to have far-reaching consequences for the global economy. In the
history of global finance, few agreements have wielded as many benefits as the
petrodollar pact did for the U.S. economy.
A Boon
to U.S. Bonds
The
petrodollar agreement, formalized after the 1973 oil crisis, stipulated that
Saudi Arabia would price its oil exports exclusively in U.S. dollars and invest
its surplus oil revenues in U.S. Treasury bonds. In return, the U.S. provided
military support and protection to the kingdom. This arrangement was a win-win
situation for both; the U.S. gained a stable source of oil and a captive market for its debt, while Saudi Arabia secured its
economic and overall security.
Status
as the Reserve Currency
Oil being
denominated in U.S. dollars alone has significance beyond the categories of oil
and finance. By mandating that oil be sold in U.S. dollars (DXY), the
agreement elevated the dollar’s status as the world’s reserve currency. This,
in turn, has profoundly impacted the U.S. economy. The global demand for
dollars to purchase oil has helped to keep the currency strong, making imports
relatively cheap for American consumers. Additionally, the influx of foreign
capital into U.S. Treasury bonds has supported low interest rates and a robust
bond market.
In his
recent book, Bonfire of the Sanities (December 2023),
bestselling author and investment manager David Wright argues the strength of
the dollar is a key factor behind America’s high standard of living. Wright
declares that the reason why people in the U.S. enjoy “as high of a standard of
living as we do is because the dollar is strong.” Wright then explains this
strength is partly because of faith in our economy “and because energy can’t be
bought without U.S. dollars.”
Potential
to Disrupt the Global Financial Order
However,
the petrodollar’s dominance may be facing its most significant challenge yet.
The agreement between the U.S. and Saudi Arabia expired on June 9, 2024. This
expiration has far-reaching implications, as it has the potential to disrupt
the global financial order.
The
shifting power dynamics in the oil market are a critical factor in this
development. The rise of alternative energy sources, such as renewables and
natural gas, has reduced the world’s reliance on oil. Furthermore, the
emergence of new oil-producing nations, such as Brazil and Canada, has
challenged the traditional dominance of the Middle East.
U.S. Dollar’s Future
The
petrodollar’s expiration could weaken the U.S. dollar and, by extension, the U.S.
financial markets. If oil were to be priced in a currency other than the dollar,
it could lead to a decline in global demand for the greenback. This, in turn,
could result in higher inflation, higher interest rates, and a weaker bond
market in the United States.
Key
Takeaway – A Significant Shift in Global Power Dynamics
The expiration
of the petrodollar agreement represents a significant shift in global power
dynamics. It highlights the growing influence of emerging economies and the
changing energy landscape. While the full implications of this shift remain to
be seen, investors should at least be aware that on a macro level, the global
financial order is entering a new era. The U.S. dollar’s dominance is no longer
guaranteed.
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