The Petrodollar Dusk: The Biggest Threats For The U.S. Dollar To Overcome In Order To Maintain Its Global Hegemony

The USD has an uphill battle to fight.

Is it possible to trade oil without the United States dollar? The answer to the question will ultimately determine whether or not the dollar is capable of maintaining its global reserve status.

If it wasn’t for the energy crisis of the early 1970s, a petrodollar may have never emerged. The United States and the Saudi Arabia successfully managed to strike a deal that was extremely beneficial to both sides. In addition to pricing oil in American dollars, the middle eastern country agreed to hold its reserves partially in United States Treasury bonds and to link its currency exchange rate to the dollar. In return, the United States built an airfield in Dhahran, Saudi Arabia and offered its military protection to the Saudis.

As the result, the Saudi Arabia got richer while the United States became its biggest exporter of oil. However, the true winner was the United States as its dollar became exponentially stronger. The arrangement made it easy for the U.S. to finance its growing budget deficits. The country started to outsource more and more of its production and manufacturing to foreign countries, primarily China, as a strong dollar made U.S. produced goods relatively expensive and therefore, less competitive on the market.

The Saudi Arabia undeniably benefited from the constant inflow of the most stable currency in the world. It became cash-rich and accumulated considerable reserves held in the U.S. dollars.

Over the years, the United States dollar slowly morphed into a tool that could be portrayed as both a carrot and a stick. Think about the privilege to sanction foreign countries - for example, freezing $300 billion in Russian financial assets, or blocking oil sales to Venezuela and Iran. Using the dollar as a method to manipulate governments forced leaders around the world to start moving away from the dollar’s dominance. Unless foreign governments see that their U.S. dollar denominated national reserves are fully protected, which is unlikely to happen, they will continue their search for safer assets that they can actually control. It’s no wonder that foreign central banks have been stockpiling gold and silver at unprecedented rates since 2018. After moving downward for four decades, central bank gold holdings have risen since the Global Financial Crisis. The International Monetary Fund notes that multilateral sanctions are to blame for the increase in gold reserve holdings and a decline in United States dollar reserves held by central banks. Not only are precious metals the ultimate store of value, but they are the assets that businesses and individuals have been historically defaulting to during uncertain times.

Today, central banks hold about 60% of their foreign exchange reserves in dollars. However, the International Monetary Fund is reporting that the dollar-denominated reserves have declined to a 25-year low and are expected to decline even further. After the Western sanctions exposed the dollar’s role and possible weaknesses (from foreign governments’ perspective); a dual oil pricing system emerged when Russia stopped accepting the dollar in return for its oil and natural gas shipments. Sales of oil by Russia, Iran and Venezuela to China, India, Turkey and a few other countries are now priced in Chinese yuan, Russian rubles, importing country currencies and even barter. This trend has already weakened the demand for the United States dollar as is evident from the loss of its value since the beginning of 2023.

Yet another reason why developing nations see considerable benefits to purchasing oil without using the U.S. dollar is the fact that non-dollar denominated sales of oil tend to be discounted. In some cases, discounts may be as high as 30% or more. Foreign buyers are paying less for all or part of their oil purchases compared to those made by Europe or the United States. It goes without saying that there are hardly any reasons to revert back to the U.S. dollar.

In the past two years the U.S. - Saudi relationship has taken an unexpected turn. Not only does the agreement of 1974 that effectively created the petrodollar seems to be falling apart, but also the Saudi Arabia has found common ground with China. China’s goal is to open the doors to Saudi’s oil to be fully exchanged for the Chinese Yuan. So far, the Saudi Arabia finds the idea appealing; especially after President Xi offered mutually beneficial terms, including a partnership to explore the South China Sea and direct investments into the Saudi’s economy.

The current United States foreign policy and long term economic interests are hardly aligned. In addition to the negative effects of economic sanctions discussed above, a bill titled No Oil Producing and Exporting Cartels (Nopec) has been introduced in Congress to effectively challenge the role of OPEC+. Yes, technically OPEC+ is a cartel but why challenge it now when the stability of the U.S. economy is questionable and global markets are extremely volatile? Whether the bill will pass or not is unknown at this time, but the fact remains that it is yet another incentive for the Saudi Arabia and China to pursue a partnership that does not include any cross border trade denominated in the United States dollar. Without these two powerful market players, the United States dollar’s outlook is far from promising. Simply put, the “Nopec” bill might just be another obstacle for the American currency to overcome as it attempts to re-gain its global hegemony.

Besides the clearly detrimental effects of foreign economic sanctions and policies, yet another quite significant challenge to the value of the dollar is the new digital currency that BRICS nations plan to create. It has not been announced whether it will be the Chinese yuan, Russian rubles or Indian rupees, but the Russian State Duma indicated it will be a central bank digital currency, a CBDC. Additionally, unrelated to the BRICS new currency plans, Russia and Iran are in talks to create a stable coin backed by gold that has the potential to further destabilize the trade currently executed in the U.S. dollar.

Any country whose money gained the status of a global reserve currency has too much to lose. In fact, the impact to an average citizen might be life changing. It goes far beyond savings, 401Ks and investments. The loss of its global reserve currency status by the United States dollar can potentially impact every aspect of the American economy: the US would not be able to easily finance its own debt; small business closures as banks view them too risky for lending; inability to take out mortgage and car loans, etc.

The dollar is a fiat currency and there is absolutely nothing that it can be converted to. No tangible asset of value backs the dollar other than its issuer, i.e. the government. The challenges and risks discussed above represent a strong force that, if ignored, would undoubtedly pull the future of the current global currency under water.