On 9th June 2024 one biggest economic deal of the century came to an end. Petro-dollar agreement between US and Saudi Arabia expired on June 9th 2024. This agreement which is been there for 75 years marks huge shift in global economics.
There are multiple commodity that are traded across globe like rice, grain, etc, but there is one commodity that rules them all, it is oil.
Petro-dollar system is at the core of this intricate web of global finance, that’s why most trade across globe happens in dollar and countries across globe see it as a safe reserved currency.
But it was not the case before Petro-dollar deal. Between 1720-1815 French livre dominated the world, because it was French currency that held status of world reserved currency between 1720-1815.
After French livre from 1815-1920 it was British pound that held status of world reserved currency.
But after World War 2 everything changed with the creation of Bretton woods agreement, because after that US dollar dominated the world and became world’s reserved currency and this happened because US was only standing global superpower after world war 2.
Being one currency to dominate world trade, gave that country two superpower one is economic stability and currency that benefits from rising asset prices.
Stablity: It allows for things like international trade, if you want countries to trade you need a common value and a common money that everyone agrees to.
Benefit from rising asset price: Rise of asset price like treasury bonds, gold benefits such currency. That makes currency more stable and give confidence to investors and govt across globe to invest in world reserved currency to keep their wealth safe from inflation.
That’s why most of the countries like Japan, China, UK are some of the biggest holders of US asset through foreign exchange reserve roughly worth 7-8 trillion dollars.
But then after discovery of oil in middle east and after oil became most important commodity across globe it gave US dollar another superpower and that’s to control world’s energy.
After the dollar got away from gold standard it became super Petro-Dollar, it replaces gold with black gold also known as oil.
How it happened?
The mastermind behind Petro-Dollar were President Nixon and henry Kiesinger. Nixon sent his NSA Henry Kiesinger to Saudi Arabia for secret meeting that took place on battleship USS Quincy. Very few records were kept of that meeting.
Saudi Arabia was offered US weapon and security in exchange for US to have the exclusive right to develop oil from Saudi Arabia using dollar.
Which means now if any country need oil from Saudi Arabia, they will have to pay in US dollar. And from that point oil will be priced in USD.
This agreement between US and Saudi Arabia helps US dominate global trade and helps preserve US dollar as world reserve currency. But after 75 years on_____ prince of Saudi arabia announced that he will not renew this contract and this decision is part of much bigger trend where countries are ditching dollars in international trade and oil transaction.
US is world biggest money exporter. How does it help US economy? Having a petrol-dollar system has created demand around the world for other countries to buy US dollars and treasury bonds, that’s how US fuels its growth.by issuing treasury bonds that other countries buy. It also created stable economy lower interest rate and liquidity in financial market.
Even if US govt prints more money it is able to control its inflation by exporting some US dollar to other countries who need dollar for global trade.
But if other countries start ditching dollar and finds alternative to dollar this can severely affect US economy, inflation will rise, dollar will weaken.
If inflation rises that means interest rate will rise, this make borrowing money costly, interest rate on home loan, auto and student loan will rise.
It may cause problem in banking system and put strain on national deficit and federal budget. It means US govt may have to raise taxes to pay higher interest.
Travelling to foreign countries will become expensive, importing items will become expensive for US citizens and it becomes harder to retire because those retirement accounts, those IRA and 401KS will be negatively affected.
Why Saudi Arabia doing this?
Some people blame US leadership in congress for creating this situation. Some say because Saudi Arabia wants to trade on its term, they want to choose in how and in what currency they trade.
But also their commitment to BRICS alliance, An alliance between Brazil, Russia, India, China, South Africa.
Countries like Russia and China are reducing their dependence on dollar for trade. Russia even trade with China in Chinese currency Yuan.
Recently China also dumped US treasury bonds. And that’s why dollar as a reserved currency has reached 14 years low.
So how can US tackle this situation? One thing US can do is increase its fund rate or interest rate to attract more money. But there is a limit to how much US can increase that interest rate.
But still world holds 59% of its exchange reserves in dollar, 20% in euro and 3% in Chinese yaun.
And dollar have 88% of share in foreign exchange transaction according to Atlantic council.
And the Yuan which many people consider a competitor to a dollar just had 73 central banks abandon it in favour of gold and US dollar. In fact in surve of global money manager, when they were asked what they wanted to do over the next one to two year with their currency here what they said 18% would be adding to their US dollar which is three times higher what it was last year.
And dollar is also backed by biggest, most advanced and powerful military in the entire world. But how long it will last can’t be tell.
