Is U.S. Petrodollar Dominance Over?

In 1974, President Nixon struck a deal with Saudi Arabia.

It went something like this…

“We’ll provide muscle to help protect the Saudis in exchange for ensuring all their black gold is traded in U.S. dollars.”

A brilliant move on the part of the Nixon administration to ensure petrodollar dominance, and a sweetheart deal for the Saudis as it essentially gave them carte blanche to bully other oil-producing nations in the Middle East while avoiding the typical U.S. condemnation for human rights abuses.

From violations of religious freedom to unlawful airstrikes on Yemeni civilians to providing funding for the terrorists who attacked the U.S. on 9/11, Saudi Arabia has literally gotten away with murder because petrodollar dominance is thought to be that important to the security and stability of the U.S. economy. 

Many have actually pointed to Saddam Hussein’s decision in 2000 to transition away from using U.S. dollars for oil exports as the primary reason the U.S. invaded Iraq. It should be noted that Saddam also converted the country’s $10 billion reserve fund from U.S. dollars to euros.

That didn’t really have any effect on the U.S. economy, but it was a sent message that the U.S. did not take lightly. After all, around 80% of global oil sales are done in U.S. dollars.

So the question is, if the U.S. did lose petrodollar dominance, would it crater our economy?

Not really.

In 2009, analyst Dean Baker challenged the assumption that the loss of U.S. petrodollar dominance would collapse the U.S. economy, writing…

Any market — a stock market, a wheat market, or the oil market — requires a unit of measure. The importance of the U.S. economy made the dollar the obvious choice for most markets. But there would be no real difference if the euro, the yen, or even bushels of wheat were selected as the unit of account for the oil market. It’s simply an accounting issue.

Suppose that prices in the oil market were quoted in yen or bushels of wheat. Currently, oil is priced at about $70 a barrel. A dollar today is worth about 90 yen. A bushel of wheat sells for about $3.50. If oil were priced in yen, then the current price of a barrel of oil in yen would be 6,300 yen. If oil were priced in wheat, then the price of a barrel of oil would be 20 bushels. If oil were priced in either yen or wheat it would have no direct consequence for the dollar. If the dollar were still the preferred asset among oil sellers, then they would ask for the dollar equivalents of the yen or wheat price of oil. The calculation would take a billionth of a second on modern computers, and business would proceed exactly as it does today.

If this is true, then it begs the question, does it even matter if the U.S. loses its petrodollar dominance?

Perhaps we may find out sooner than later.

The Long Game Matters

A couple days ago, we learned that Saudi Arabia has expedited its conversations with China to price some of its oil sales in yuan. 

Word is, the Saudis aren’t happy with recent U.S. policy decisions that take some of the wind out of Saudi Arabia’s bully sails. These include lack of support for Saudi Arabia’s attacks on Yemen, a revitalization of nuclear talks between Iran and the U.S., and the recent U.S. withdrawal from Afghanistan. 

While all three of these policy decisions are in the best interests of U.S. blood and treasure, they also make Saudi Arabia’s bodyguard less reliable. 

But no worries, because China is more than happy to step in and provide its own muscle in exchange for the opportunity to strengthen its own currency. After all, 25% of Saudi-exported oil goes to China.

Of course, the question remains, would such a move hurt the U.S. economy?

Being that the U.S. dollar remains the world’s reserve currency, I don’t see how 25% of Saudi oil being traded in yuan is going to send us into an economic tailspin.

I would also note that the importance of petrodollars will become less integral to the strength of any economy in about 20 years.

As reported by Bloomberg New Energy Finance, by 2040, about 70% of global passenger vehicle sales will come from electric vehicles. And fuel for internal combustion vehicles is set to peak in 2027 (just five years from now), plateau for about 10 years, then drastically plummet. 

Truth is, the long game does not favor oil production, and that makes the potential loss of petrodollar dominance less of an issue, although I maintain that the U.S. will still ensure petrodollar dominance for the foreseeable future.

Of course, if the Saudis do strike a deal with China, the markets will react, and this should give a very nice boost to cryptocurrencies. So I would encourage you to get at least a little exposure to the best-in-breed cryptocurrencies before that happens.

I should note that I’m not an expert in cryptocurrencies, but my colleague Christian DeHaemer is, and in light of recent situations regarding petrodollar uncertainty, Christian put together this brief investor note detailing which cryptocurrencies will likely benefit the most from a potential deal between China and Saudi Arabia. You can check that out here.

To a new way of life and a new generation of wealth…

Jeff Siegel