In the early 1970s, the US and Saudi Arabia developed an agreement whereby the US would provide military support to Saudi Arabia. In return, the Saudis agreed to only sell Crude Oil in US Dollars, and to plough billions of US dollars earned back into US Treasuries, significantly financing the US Government deficit.
This agreement grew to a point, via the OPEC Crude Oil Cartel, where in order to buy, oil traders globally had to first obtain US Dollars. Eventually, most other physical commodities could primarily only be purchased in US Dollars, in effect making the US Dollar the dominant global currency. Today, the US Dollar is used in almost 80% of international trade.
The US Treasury can create US Dollars at essentially zero cost, and use these dollars to buy hard assets from around the world, providing the US with a massive economic advantage. Other countries needed to earn US Dollars to conduct the majority of their trade and would naturally want to store these dollars in US assets such as US Treasuries, stocks and even property.
This global trade and bank transfer system became known as the “Petrodollar System”.
Daring to step outside the Petrodollar System commonly got a country an incoming US missile, destabilisation, a full war, or US attempts at regime change. Democracy was only ever a cover for US involvement in several Middle East wars. Most of the time, the US was acting to maintain the stature of the Petrodollar.
This was generally an easy task, as the US could afford to spend billions on its military and most opposing militaries were small in comparison.
Too big to fight?
This is now changing, as both China and Russia are starting to move away from trading in US Dollars. Both countries have huge nuclear weapons capability, China with approximately 300 warheads and Russia with around 6,000. These countries are being joined by the BRICS, an alliance which includes Brazil, Russia, India, China, and South Africa with a number of other countries working to enter the alliance recently.
“Weaponisation” of the US Dollar
While few countries have been happy with having to comply with the Petrodollar System, a combination of the US becoming particularly aggressive, pushed by neocons in the US Congress, and particularly the “Weaponisation” of the US Dollar, appears to have been the catalyst for an attempt to break the Petrodollar.
The US also controls the international US Dollar based payment system known as SWIFT (Society for Worldwide Interbank Financial Telecommunication). The system enables financial institutions to send and receive information about financial transactions in a secure, standardized environment. Given the US Dollar’s dominance, SWIFT facilitates the international dollar system. Being locked out of the system locks a country out of much international trade and bank currency transfers, a major economic risk for a country’s economy.
In 2014 and 2015, the US blocked several Russian banks from SWIFT as relations between the two countries deteriorated. More recently, the US threatened to lock China out of the system if it failed to follow United Nations sanctions on North Korea.
This “Weaponisation” of the Petrodollar and its SWIFT facilitation system has not gone unnoticed by many other countries who want to limit the risk of being bullied by the US.
A growing number of central banks have been buying gold recently to diversify holdings away from the Petrodollar and perhaps position for a future commodity backed currency. This trend is not just in countries traditionally anti US, but even traditional US allies have grown concerned over US bullying due to warmongering comments and actions with regards to Russia and China. Even the EU has been working on plans to bypass US sanctions on Iran so it can continue to trade with that country, in direct US defiance. Brazil and China recently developed a trade deal bypassing the US Dollar and using their own currencies (the new Brazilian President, Luiz Inacio Lula da Silva, is meeting with Chinese President Xi this week to expand this plan). Japan and India have been buying Russian oil in defiance of US sanctions and the Petrodollar system. Even Saudi Arabia recently developed a trade deal with China to trade oil in Chinese Yuan.
Ballooning Debt could make holding US Dollars a risky proposition
The US has government debt of US$31 trillion and unfunded liabilities of up to US$100 trillion, with the country unable to even audit its Defence spending. The Pentagon has never passed an audit, with poor accounting practices makes investors even more nervous.
Holding wealth in fiat US Dollars is beginning to look a lot less attractive, as is selling valuable commodities like crude oil in return for numbers representing US Dollar on a computer screen.
Hence, the trend to back away from the Petrodollar.
BRICS Commodity backed currency
Recently, Russian announced that the BRICS nations are working to develop a “new currency,” yet another sign that dollar dominance is on the way out. This new currency could potentially be a commodity backed currency with limited issuance, unlike US Dollar fiat-based currency, which has few limits on how much of it can be created. Like most products, currencies derive much of their value from their rarity.
History would suggest that all fiat currencies eventually fail. The longest lasting one has been the Sterling that has lasted approximately 300 years, but was backed by silver and gold for various periods so could be said to not have been purly fiat for some of that time period.
Ramifications could be huge for the US with the death of the Petrodollar
De-dollarisation of the world economy could perpetuate a currency crisis in the US, making it more difficult for the country to fund its ballooning deficit via the bond market. The US may need to increase interest rates and the yield on government bonds, to attract investors into the US Bond market. This would slow US economic growth, alternatively the US could start to monetise debt, by buying its own bonds with the US Dollars it creates. This however, would be inflationary. In effect, a stagflationary (low growth, high inflation and unemployment) recession could come about in the US as the US Dollar is less demanded internationally.
The value of the US dollar could start to reduce with dollar demand reduction, depending on how smooth a transition away from the US Dollar is and what replacement currency(s) are developed. This could add to US inflation as import costs would rise as the dollar devalues.
While the BRICS are trying to develop an alternative currency and transfer system, the US is starting to push a Central Bank Digital Currency, something the BRICS will see as no improvement over the current situation.
Finally, the probability of war increases as the US tries to hold onto its rapidly diminishing currency advantage.
The mainstream media is largely ignoring the ramifications of the decline in the Petrodollar and the negative consequences of the US backing Ukraine against Russia. They are in effect siding with the US and increasingly look likely they are backing the wrong horse.
Andrew Quin is a former Macroeconomic Strategist for Australia’s largest full service stockbroker, HNW fund manager, and published Author. He holds a Masters in Mineral Economics.
