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Petrodollar extraction in progress.

The Myth of the Petrodollar

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Let’s get a few facts straight about the so called petrodollar. There is no such thing as some official agreement anywhere that stipulates anything about petrodollar. It’s a mere name given to the phenomenon of oil being mainly traded in US dollars.

Saudi Arabia has thus not ended the petro dollar. It has not decided to not renew some petro dollar contract. Nothing has happened there. I don’t know where this idea that the Saudis ended the petrodollar comes from as it never happened. What the Saudis are doing is to open up for the purchasing of Saudi crude and petroleum products using other currencies, having before preferred to only sell in US dollars.

Okay so what does this mean? Not much. It means that the Saudis have decided to consider selling for other currencies to some customers, like for example China. The problem for them is twofold. China is notorious for not wanting anyone to take Chinese currency out of China. Also Chinese currency only has any value in China or maybe as payment to another entity that trades with China.

China mostly produces shit and low quality stuff. Limiting the usability of the Chinese currency. Which is why the dollar still reigns supreme. Almost all crude is will sold on the global markets in dollars regardless of what the Saudis decide. If the market offers dollars they’ll take dollars.

Buyers are ok with holding into dollars as it’s the most usable currency out there. You can buy with dollars everywhere. No other currencies come even close. They will not risk the FOREX fluctuations and sit on billions or millions of random currencies just to buy from the Saudis. They’ll buy from whomever sells in dollars.

Saudi Arabia stands for roughly 20% of the world’s crude. That means that there’s 80% of the market still out there of whom the vast majority don’t want to sell on anything but the dollar. Maybe the euro.

The high acceptance of US dollars as a payment method creates what we in economics call a huge moat for them, meaning it’s extremely hard for anyone to break into the American currency market. Just like Visa and MasterCard have moats around their businesses across the globe. Their cards are accepted everywhere when your local banks credit card issued by them isn’t.

There’s also a geopolitical component to this. The US is a fortress in that it sits as the only superpower on a separate continent. Meaning anyone wanting to invade them have to come by sea or somehow convince Canada or Mexico to help them do it. This is not happening any time soon. Combine this with the US being an economic power house and it’s clear why it’s a safe haven for money. Every time there’s increased tensions anywhere else in the world countries and businesses park money in US dollars, as the US is seen as safe and has the military power to protect its interest.

The competing currency is the Euro. The EU has no military and borders Asia. No sea there to stop a land force. Just look at Ukraine.

The day that the US dollar loses its position in the world will come sometime. Every empire comes to that day, just like Rome and the British empire. But in the case of the US it’s not happening any time soon. And some Arabs selling oil in Chinese currency isn’t going to change that.

The myth of the petrodollar rests on a wrong assumption about the nature of American power. The real source of American economic power is not the petrodollar but the fact that the dollar serves as the global reserve currency. The US dollar is not the first one to hold this status. There have been many. Like I mentioned earlier, the Roman Empire is the oldest one that comes close to what we today see as a foreign reserve currency. The British pound sterling was the primary reserve currency of the world for most of the 19th century.

Today there are in fact many global reserve currencies but the USD is the biggest, making up just shy of 60% of foreign exchange reserves according to the IMF. In second place we find the Euro at just shy of 20%. The British pound and the Japanese yen have a place there with roughly 5% each.

So why is good for a country to have its currency become the world reserve currency?

The most obvious one is that it allows a country, to some extent, to export its inflation. Meaning, in a fiat system or when the Romans reduced the precious metal content of their coin, to offload some of the excess liquidity on foreign demand for the currency. But as we see in the US now, it doesn’t mean one can print as much as one wants. Inflation will still kick in. The limit is laxer, but it’s still there.

The biggest benefit isn’t as sexy as many would like to make it sound. It’s not a magic wand, and not something one has to be that worried about. One benefit is that it reduces transaction costs for all businesses in the country that commands the reserve currency, giving them a small business edge. Transaction costs are all cost derived form any transaction, be it time spent on forming contracts etc. but in essence, if your businesses can enter trade agreements using their own currency they have less forex risk and thus lower transaction costs.

The big benefit is that there’s always demand for the currency, so the state issuing it can borrow at reduced interest rates compared to other countries. Therefore it is possible for the US, as a reserve currency country to rack up debt to levels that aren’t sustainable for anyone else. In the long term, this is bad for the people of that state if the government keeps spending like there’s no tomorrow and once they lose the reserve status they are screwed. The latter is the main reason why the US being the global reserve currency isn’t a real threat to anyone but a blessing and a curse for the US.

From a political perspective though the risk arises that when the US decides to ban someone or something from trading in US dollars it have big effect and makes life very difficult, which is why countries like Russia and commie China want to undermine it. But they don’t have anything to offer that could replace it.

Would it be great if the US dollar wasn’t the global reserve currency? Sure, as long as the currency taking over that role belonged to a good state. Unfortunately there aren’t many good options out there.

Originally published on Neo-Mike’s Corner. Republished and adapted with permission.

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