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U.S.-Saudi Petrodollar Pact Ends after 50 Years
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.
The Canadian ETF Market, Retail and Institutional Usage of ETFs, Liquidity, Execution, and TradingThe Canadian ETF Market, Retail and Institutional Usage of ETFs, Liquidity, Execution, and Trading
Saudi Arabia ends 50-year petrodollar agreement with U.S.
Saudi Arabia ends 50-year petrodollar agreement with U.S.
Significant financial turmoil lies ahead in the financial world as Saudi Arabia has decided not to renew its 50-year petrodollar agreement with the United States. The deal, which expired on Sunday, June 9, was a cornerstone of American global economic dominance, The Business Standard commented.
Signed on June 8, 1974, the treaty included the creation of two joint commissions: one based on economic cooperation and the other on Saudi Arabia's military needs.
U.S. officials at the time expressed optimism that the deal would motivate Saudi Arabia to increase its oil production. They also saw the agreement as a plan to promote economic cooperation between Washington and other Arab countries.
The decision not to renew the contract allows Saudi Arabia to sell oil and other commodities in multiple currencies, including Chinese RMB, euros, yen and yuan, instead of just U.S. dollars.
This latest development marks a major departure from the petrodollar system established in 1972 when the U.S. decoupled its currency from gold, and is expected to accelerate the global move away from the U.S. dollar.
The dominance of the U.S. dollar is waning as Russia and Saudi Arabia consider using the Chinese yuan for oil deals and investors may need to start reconsidering their long-term investment strategies, said the CEO and founder of one of the world's largest independent financial advisory and asset management firms, DeVere Group.
Nigel Green's warning states that the change in the way global oil trade is conducted will have far-reaching consequences for economies and, therefore, for investors around the world.
"One of the most significant results of the three-day summit in April between Russian President Vladimir Putin and his Chinese counterpart Xi Jinping was that Putin announced that Russia now supports the use of the Chinese yuan for oil agreements," Green said. This suggests that the world's second-largest economy – China – and Russia are actively intent on reducing the dominance of the US dollar as the basis of the international financial system.
"Separately, Sudanese oil company Aramco plans to supply two Chinese companies with a total of 690,000 barrels per day of crude oil, reinforcing its position as China's largest supplier of crude," Green added. "It was reported that Saudi Arabia is also in talks with Beijing to pay in yuan instead of dollars."
Aramco is one of the largest oil producers in the world and is wholly owned and controlled by the Saudi government.
It seems that the rivals of the United States, led by China, are forming a new large economic bloc. If Saudi Arabia, which has vast oil reserves that are estimated to be the largest in the world, really switches to the yuan, it will bring about a huge change in the global economic system.
Cross-border CBDC transactions
Saudi Arabia has announced its participation in mBridge, a project that is exploring a central bank digital currency platform (CBDC) shared between central and commercial banks from different countries. The platform allows instant cross-border payments and foreign currency transactions.
The project involves more than 26 countries with observer status, including the South African Reserve Bank, which received the green light as a member this month.
The more prominent observers of mBridge are the Bank of Israel, the Bank of Namibia, the Bank of France, the Central Bank of Bahrain, the Central Bank of Egypt, the Central Bank of Jordan, the European Central Bank, the International Monetary Fund, the Federal Reserve, the Bank of New York, the Reserve Bank of Australia, and the World Bank.
The project's steering committee created a personalised governance and legal framework, including a rulebook, tailored to the decentralized nature of the platform.
Evolution of the mBridge project
The mBridge project is the result of an extensive collaboration that began in 2021 between the BIS Innovation Hub, the Bank of Thailand, the Central Bank of the United Arab Emirates, the Digital Currency Institute of the People's Bank of China, and the Monetary Authority of Hong Kong.
In 2022, a pilot project was carried out with transactions of real value. Since then, the mBridge project team has been exploring whether the prototype platform can evolve to become a minimum viable product (MVP) – a milestone that has already been reached.
mBridge is now inviting private sector companies to propose new solutions and use cases that could help develop the platform and show its full potential.
