On January 17, 2023, the Saudi minister of finance announced that the Kingdom was ending the petrodollar. “There are no issues with discussing how we settle our trade arrangements, whether it is in the US dollar, whether it is the euro, whether it is the Saudi riyal”. Yikes!
Background
In 1971, the U.S. ended its policy of maintaining a set global U.S. dollar price for gold in line with the Bretton Woods system established in 1944. This was driven by an increase in deficit spending which lowered the value of the U.S. dollar in relation to gold, causing a crisis of confidence in the greenback. This situation was aggravated by the 1973 oil shock which further fueled inflationary pressures.
Resultantly, in 1974 President Nixon reached an agreement in which the U.S. committed to buy oil & provide military support to Saudi Arabia in exchange for their commitment to using their dollars to help finance U.S. deficits by purchasing Treasuries. Further, Saudi Arabia would require oil buyers from other nations to settle in U.S. dollars, further strengthening the greenback. Other OPEC producers followed Saudi’s lead.
This practice of “petrodollar recycling” helped mitigate U.S. inflation and interest rates as excessive U.S. dollar printing to fund domestic deficit spending was absorbed directly into U.S. treasuries held by oil-rich OPEC nations.
Implications
Our country’s very poor fiscal management is currently driving less international support for the U.S. dollar. This is vividly portrayed by Saudi Arabia’s recent decision to end its long-standing requirement for all trading partners to settle oil export sales in the U.S. dollar. This development helps explains the Fed’s current mandate to hike interest rates as it seeks to defend against declining confidence in the U.S. dollar. Better to cut government spending as discussed in this post.
