The story began in 1944. World War II was at its height in Europe. Amid such insecurities, 44 allied nations came together in New Hampshire to establish the Bretton Woods system. According to the system’s stipulations, all countries adjusted their currencies to the US dollar while pegging the dollar to gold. They assumed that setting a gold standard would reduce volatility in the global economy. Ideally, this agreement also established American hegemony over world trade. However, in the early 1970s, this system collapsed when the United States encountered a gold crisis.
The United States faced a balance of payments crisis. The Federal Reserve did not have enough gold reserves to support the dollar. The infamous Nixon Shock ended the convertibility of the US dollar into gold.
Growth and decline of the petrodollar
Now the US dollar has fallen as countries rapidly lost confidence in the greenback. This is the pivotal point in today’s reality. In the mid-1970s, President Richard Nixon entered into an agreement with the Organization of the Petroleum Exporting Countries (OPEC) to trade oil exclusively in dollars in return for US military assistance. Consequently, the petrodollar emerged, oil prices quadrupled, and the rest is history.
Since then, the US dollar has been the undisputed foreign exchange reserve currency in the world. Agreements with Saudi Arabia and the rest of the Middle East have bolstered global oil trade in the greenback currency. Trading in oil and gas futures contracts, denominated in dollars, cemented the position of the United States as a global superpower. As the euro emerged as a strong competitor in the 1990s, dollar-based finance continued to flourish. Developing economies like China and Russia have had no choice but to hold US Treasuries and accumulate massive reserves of dollars to hedge currency risk. And, while rebel elements like Iraq’s Saddam Hussein and Muammar Gaddafi relentlessly tried to derail the petrodollar, those efforts led to invasion, assassination and decimation.
Can the dollar continue to dominate in a changing world?
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Today, multiple geopolitical and economic factors are once again turning the tide against the supremacy of the US dollar. Rapid globalization was already a ticking time bomb situation for the greenback. Today, the rise of China as the next potential economic powerhouse, Russia’s exclusion from the dollar-focused SWIFT system, and a global economic slowdown are challenging the dominance of the US dollar.
The dedollarization trend is not exactly a new phenomenon. Latin America tried to move away from the dollar in the 1990s. In response to US sanctions, Venezuela instead sought to pay oil payments in Chinese yuan. Chile de-dollarized in the 1980s and generally avoided dollarization. In the early 2000s, Iraq attempted to sell oil in euros while Libya actively lobbied for years to forge a pan-African gold standard.
However, the global financial crisis of 2007-2008 reversed this dedollarization trend. Over the past decade, no significant developments have emerged to lessen the dominance of the US dollar. With the emergence of a rift between the United States and Saudi Arabia, the dollar faces a new challenge.
United States and Saudi Arabia separate
With 17.2% of world exports, Saudi Arabia is the world’s leading exporter of crude oil. In the past, it was the largest supplier in the United States. It is thanks to oil that Saudi Arabia has become a key ally of the United States in the Middle East. Saudi Arabia leads OPEC. In the past, this gave the United States indirect influence over world oil prices, which are denominated in dollars. This has allowed successive US governments to run huge trade deficits and run up debt on the cheap. Since 1979, the Saudi Kingdom has been a US proxy against Iran.
In recent years, the United States has boosted shale oil production and built up its Strategic Petroleum Reserve (SPR). In the 1990s, the United States imported about 2 million barrels per day. By 2021, that figure has fallen to just 500,000 barrels per day, a drop of 75%.
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Recently, Saudi royalty has been particularly unhappy with US President Joe Biden’s policies in the Middle East. Biden’s decision to withdraw support for Saudi Arabia’s military intervention in Yemen has annoyed Riyadh. Houthi attacks on Saudi oil facilities and Biden’s attempt to revive the nuclear deal with Iran have heightened Saudi insecurity. Riyadh believes the United States is backtracking on historic security guarantees given to the House of Saud.
Biden’s recent tour of the Middle East was a dismal failure. He failed to achieve his main objective: to get Saudi Arabia to increase its oil production. More recently, the White House accused OPEC+ of siding with Russia after this group of oil producers agreed to drastically cut oil production. In turn, OPEC+ accused the West of “arrogance of wealth” and hypocrisy.
China and others appear as an alternative to the United States
Over the years, China has become the top importer of Saudi oil. In 2020, Saudi Arabia exported $95.7 billion worth of oil. China accounted for $24.7 billion of that figure, while US imports were just $6.59 billion. China’s Belt and Road Initiative has invested in Saudi Arabia, and Chinese investment is reported to have reached $43.47 billion in 2021.
Saudi Arabia plans to invest in Chinese companies. Aramco has signed a $10 billion deal with Chinese oil companies. Talks about petroyuan oil trading have hit the headlines. Right now, the $13.4 trillion Eurodollar market and the $25 trillion US Treasury market offer depth and liquidity that no one else can match. However, this could change in the future. Rising interest rates strengthened the dollar, causing poorer economies’ import bills to soar and triggering a global debt crisis. This could shake global confidence in the US dollar and at least China’s trading partner may become more willing to trade in yuan.
[EMBED: https://www.fairobserver.com/politics/china-will-decide-who-wins-the-fight-russia-or-the-west/]
Russian President Vladimir Putin recently addressed the summit of BRICS, a grouping of Brazil, Russia, India, China and South Africa. He talked about an alternative mechanism for international payments and an alternative to the International Monetary Fund’s Special Drawing Rights (SDRs). Instead of denominating against the dollar, countries could use a basket of their respective currencies instead.
Discussions about Iran and even Saudi Arabia joining the BRICS have emerged. If that happened, such a consolidation would represent more than a third of world GDP, more than 25% of world oil production, about 40% of world iron production and about half of world agricultural production. Even a weakened Russia wreaked havoc on global oil and commodity markets. An expanded BRICS with its own reserve currency could seriously challenge the dollar.
Russia and China already engage in ruble-yuan trading. Russian energy giant Gazprom recently announced that Beijing would start “making payments for Russian gas supplies in the countries’ national currencies – the ruble and the yuan”. Frozen by the West from SWIFT, Russia now uses China’s cross-border interbank payment system (CIPS). When the time comes, the CIPS could become the clear winner of the Russian-Ukrainian war. India openly defies US pressure by increasing its oil purchases from Russia. Today, Russian oil accounts for 21% of Indian oil imports, up from less than 1% before the war. India is buying Russian oil at a discount to curb inflation and this trade is no longer denominated in dollars. In addition to closer Russia-China ties, Indian imports of Russian oil are hampering dollar dominance. The same goes for Turkey, a member of NATO, which buys Russian oil at a discount. If these trends continue, the US dollar’s days could be numbered.
The opinions expressed in this article are those of the author and do not necessarily reflect the editorial policy of Fair Observer.
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