HO Chi-Ping Patrick



The marriage of oil and the dollar—the petrodollar—goes back to a 1975 agreement between the Nixon administration and the House of Saud, an agreement that proved to be one of the most consequential in modern history.


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During the late 1960s and early 1970s, the United States was running substantial deficits caused by the Vietnam War and the Johnson administration’s Great Society-related spending. These deficits grew even bigger thanks to the oil price hike resulting from the 1973 Oil Embargo.

Three years before the agreement with the Saudis, the Nixon administration was already in the middle of a process of decoupling the dollar from the international gold standard, which governed world finance since Bretton Woods in 1944. To justify his controversial August 1971 order to suspend the dollar’s convertibility into gold, Nixon pegged the blame on the “attacks of international money speculators.”


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These nefarious “speculators” were none other than the French, who earlier that month had sent a warship to New York Harbor with instructions to bring back $200 million worth of French gold reserves stored at the New York Federal Reserve Bank, as well as the governments of United Kingdom, Belgium and the Netherlands who demanded the U.S. buy back hundreds of billions of dollars of foreign exchange.

Just like today’s dollar insurgents, those of the 1970s were quite fed up with America’s exorbitant privilege and with what they viewed as the unfair advantage Americans enjoy due to the privilege of holding the world’s reserve currency at the expense of other nations.

In any event, Nixon’s decision to decouple the dollar from gold, which is known today as the “Nixon shock,” deeply troubled the oil exporters who had until then backed their oil trading with gold. Under the agreement reached in 1975 between then Secretary of State Henry Kissinger and the Saudis, any country that sought to purchase oil from the Oil Kingdom would be required to do so in dollars and in dollars alone.


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In exchange for Saudi Arabia’s willingness to denominate its oil sales exclusively in dollars, the United States offered the vulnerable Saudis long-term security guarantees which includes protection of their oil fields.

This commitment to shield the House of Saud from foreign and internal adversaries has been put to the test many times over the years – from the 1979 attack on the Grand Mosque in Mecca, through Saddam Hussein’s 1990 invasion of Kuwait, to the recent rise of Iran as an existential nuclear threat to Saudi Arabia.bauteonzlf

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Until 2003, tens of thousands of U.S. combat troops equipped with top-of-the-line missiles and aircraft were actually stationed in Saudi Arabia. Thanks to Saudi loyalty to what could be described as the buck-barrel-bomber nexus, by 1975 all the other members of the Organization of Petroleum Exporting Countries (OPEC) also agreed to trade their oil in dollars. This arrangement allowed OPEC members to plough their surplus dollars back into the U.S. economy through investments and the purchase of U.S. Treasuries which, in turn, allowed the U.S. government, then facing declining GNP and soaring unemployment, to finance its deficit and bolster its military.

The buck-barrel-bomber nexus was an ingenious scheme. It essentially ensured that the demand for dollars would always grow in sync with the growth of the world economy, which is powered by oil. The perpetual demand for its currency allowed the U.S. government to continue to run loose fiscal policies, increase military spending, win the Cold War and engage in an interventionist foreign policy for the nearly half century that followed. Even better, the hegemony of the dollar over oil trading spread into other commodity markets, determining the pricing of all metals, energy and agricultural commodities—from nickel to sugar.


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But after four decades of relative harmony, cracks are beginning to appear in the buck-barrel-bomber arrangement. One reason for this is that the umbrella organization with which the scheme was concocted, OPEC, is no longer unified in its views about the United States. In fact, some of its fourteen members, including Iran, Venezuela, Libya and Qatar (the latter decided in 2018 to leave the cartel) are under U.S. sanctions and/or deeply resentful of the United States for a variety of reasons.

Additionally, America’s relations with Saudi Arabia, the country that de facto runs OPEC, are not as amicable as they used to be. Many Americans cringe in the face of their government’s deference to Saudi Arabia, which under normal circumstances would be treated as a pariah state, just as US President Biden referred it. Indeed, Saudi Arabia has been given a sort of implicit blanket immunity by the U.S. government. Despite 15 of the 19 hijackers who attacked the United States on September 11 being Saudis, despite blatant Saudi efforts over decades to proliferate radical Sunni Islam globally and the sponsorship of terrorism worldwide by key Saudi royals, the Axis of Evil described by President George W. Bush in January 2002 included two of Saudi Arabia’s challengers, but not Saudi Arabia itself. The kingdom’s clandestine financial and logistical support for ISIS and other radical groups, its human rights violations, the arrest of hundreds of businessmen at the Ritz Carlton hotel in Riyadh where $100 billion was robbed by the regime without any due process, the brutal war in Yemen which brought millions to starvation, and the state-sponsored execution of Saudi journalist Jamal Khashoggi are widely reported by the western and American press.


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But while Saudi Arabia’s image in the eyes of the American public is in free-fall, the U.S. government and to some degree Congress are still unprepared to change the policy toward its strange “ally.” To be sure, Saudi Arabia’s sway over Washington is rooted in its role as a swing oil producer, which can inject additional barrels into the market to arrest prices when supply disruptions occur, as they sometimes do.

American presidents understand the political danger of high gasoline prices and they know there is only one country that can come to the rescue when oil prices need to be forced down. No less important, Saudi Arabia is the number one buyer of U.S. defense and aerospace products. In 2018, Riyadh arms purchases from Washington surpassed those of Australia, UAE, Japan, South Korea and Israel combined. Time and again, the country’s orders of military equipment bought it an insurance policy against America’s wrath.


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For example, its order of $110 billion worth of arms blunted America’s response to the Khashoggi murder. It was then that President Trump revealed what is really at the core of the U.S.-Saudi relations. “I don’t want to hurt jobs. I don’t want to lose an order like that,” he said. In April 2019, he vetoed a congressional bill to end U.S. support for the Saudi led war in Yemen. And a month later, he invoked a loophole in the Arms Control Export Act to circumvent the congressional ban of the sale of $8 billion worth of weapons to the Saudis and their Sunni allies.

Less known is the role of the petrodollar in the relations. The Saudis and the other major producers in the Gulf Cooperation Council (GCC)—Kuwait, Oman and UAE—are today the de facto guardians of the petrodollar system. As detailed earlier, many of the major players in the global oil market have jumped ship and are transacting growing portions of their oil in non-dollar currencies. The GCC, together responsible for one quarter of the world’s oil exports, is the linchpin that holds the petrodollar system together. Should Saudi Arabia and its Sunni allies decide to abandon the dollar in oil transactions, it could trigger a cascading set of events that could change the world economy forever. Every barrel that shifts from dollar to something else means fewer dollars demanded in global trade. This will not only have implications for the strength of the dollar but also for America’s borrowing ability.


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Collectively, the Saudis and their Gulf allies are the fifth largest holders of U.S. foreign debt after China, Japan, the UK and Brazil. Other than buying arms, the dollars the Saudis and their allies accumulate in exchange for their oil are partly used to buy U.S. Treasuries and equity in American corporations. In fact, in the first two years of the Trump presidency, the Saudis almost doubled their bond holdings. But if oil is no longer traded in dollars, the amount of dollars available for the oil exporters to recycle into the U.S. economy will shrink and with it their ability to rollover and beef up their purchases of U.S. debt, all this at a time the U.S. needs more underwriters for its ballooning liabilities.

How much of an impact the de-dollarization of oil trading might have on the demand for the dollar is hard to tell. At $70 a barrel, the global oil market is channeling roughly $2.5 trillion worth of transactions every year. This makes up something between 2 and 3 percent of the global economy. But the “oil “market is much bigger if one includes the trade in natural gas as well as oil products—gasoline, diesel, aviation fuel, etc. A barrel of oil can be shipped from Saudi Arabia to China at a price of $70. But this barrel then generates additional economic value, much of it denominated in dollars, when it is refined into various products that are then sold around the world. Trading in derivatives such as oil futures and options is mostly dollar denominated and the nominal value of this market alone was about $5 trillion in 2018. Draining the world economy of numerous dollar transactions could not bode well for the greenback. The Saudis are aware of that. Americans less so.


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Will the Saudis and their Sunni allies remain loyal to the buck -barrel-bomber system? Because of fracking, the United States needs to buy less oil from the Persian Gulf than previously, but China is increasingly dependent on the Sunni oil states. In fact, Saudi Arabia is already its number one oil supplier, and in 2017 China bought a stake in Abu Dhabi’s National Oil Company (ADNOC). Saudi Arabia has already accepted payments in yuan for some of the oil it sends to China. It also invests heavily in China’s refining and petrochemical sector in order to ensure that China’s refineries are technically well suited to process its high sulfur Arabian crude. While those steps are meant to appease Beijing and secure market share in China, they are also meant to send constant reminders to Washington about the importance of Saudi Arabia to America’s financial supremacy.

The Saudis have not been subtle about their willingness to use economic weapons against the United States. In 2016, for example, they threatened the Obama administration that they would dump U.S. Treasuries if Congress decided to pass a bill implicating the Kingdom in the September 11 attacks. Three years later, the Saudis indicated to the Trump administration their intention to ditch the petrodollar and to shift their oil trading away from the dollar over Congress’ attempt to pass a bill known as NOPEC, or the No Oil Producing and Exporting Cartels Act, which aimed to remove OPEC members’ sovereign immunity from U.S. antitrust law. If passed, the law could have allowed OPEC members to be sued for colluding in raising oil prices. For years these were only threats. The Persian Gulf countries were not likely to drop the dollar any time soon. They had good reasons not to challenge the system that had kept them safe for so long.


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Other than the growing regional insecurity, which necessitates America’s military umbrella, there is the sticky issue of the tight connection between the dollar and their own currencies. One Saudi riyal or one UAE dirham is always worth 27 cents; 1,000 Iraqi dinars are always worth 84 cents; and one Kuwaiti dinar is always equal to $3.30. Unlike in Russia, whose ruble is free-floating, the Gulf oil countries peg their currency to the dollar, and this protects them domestically from sharp drops in oil prices. In Saudi Arabia, where people do not pay income tax yet expect to receive cradle-to-grave social services from the government, low oil prices are a nightmare. Shifting their oil trade from the dollar to other currencies could have destabilizing implications for their domestic economies which are difficult to predict. In a region that requires economic stability to keep the masses from storming the palaces, the appetite for financial adventurism is never strong. But as usual, things again boil down to the US and China.

Edited by Fang Fang

Proofread by Wang Yan