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GEW Assessment Report

The World Has Changed

Is this the end of an Era? The short answer may be: yes, it seems to be so. Why? The short answer may be formulated into a single sentence:

The expiration of the 50-year petrodollar agreement between Saudi Arabia and the United States on June 9, 2024, marks a pivotal shift in the global financial order, potentially heralding the end of U.S. economic hegemony.

Historical Context of the Petrodollar

The petrodollar system emerged in the 1970s following the collapse of the Bretton Woods system, which had tied currencies to gold through the U.S. dollar. As the dollar stepped in to fill the void left by gold, growing U.S. imports of increasingly costly crude oil led to the rise of the petrodollar as a significant economic and political force. In 1974, the U.S. and Saudi Arabia struck a deal to channel Saudi petrodollars into U.S. Treasuries, followed by subsequent arrangements for the U.S. to finance development projects and weapons sales in Saudi Arabia using oil export proceeds. The mutual dependence between the U.S. and oil exporters allowed business to continue as usual, with foreign exporters receiving payment in the most useful currency while the U.S. maintained its economic, financial, technological, and military dominance. However, this power-sharing manifested in development projects, cross-border investment flows, and a Mideast arms race fueled by U.S. weapons exports.

Saudi Arabia’s Role in the Petrodollar System

Saudi Arabia played a pivotal role in establishing and maintaining the petrodollar system. In 1974, Secretary of State Henry Kissinger and Saudi Prince Fand Ibn Abdel Aziz formalized the petrodollar agreement, ensuring that oil sales by OPEC members would be priced in U.S. dollars in exchange for U.S. military protection and economic incentives. As one of the top OPEC members and a leading oil producer under King Abdulaziz Ibn Saud, Saudi Arabia’s compliance meant other OPEC nations followed suit, guaranteeing the continued pricing of oil in dollars.

The 1945 Quincy Agreement between President Roosevelt and King Abdulaziz laid the groundwork for this cooperation, with Saudi Arabia’s vast oil reserves and strategic location making it an essential U.S. partner. Saudi Arabia’s commitment to the petrodollar system ensured a steady flow of oil to world markets, stabilizing global oil prices and reinforcing the U.S. dollar’s dominance. At the heart of the petrodollar system lies this crucial relationship between the U.S. and Saudi Arabia, the leading OPEC member state.

The potential impacts of ending the petrodollar agreement could be far-reaching, affecting global financial markets, geopolitical dynamics, and the U.S. economy. If Saudi Arabia and other oil exporters begin pricing oil in currencies other than the U.S. dollar, such as euros, yuan, or a basket of currencies, it could reduce global demand for dollars. This may lead to a decline in the dollar’s value, higher U.S. inflation, rising interest rates, and increased volatility in U.S. bond markets. Geopolitically, the end of the petrodollar system could prompt a reconfiguration of global power dynamics as countries diversify economic ties and reduce reliance on the U.S., fostering closer relationships with emerging powers like China. The U.S. may see its influence in the Middle East diminish as Saudi Arabia and other nations chart a more independent course in foreign policy. For the U.S. economy, lower demand for dollars could make it more expensive to finance budget and trade deficits. With China, Russia, and other nations selling U.S. Treasuries, the U.S. may increasingly have to monetize its own debt, potentially spurring even higher inflation. The transition away from a dollar-centric system may necessitate major adjustments in currency markets, international trade, and how the U.S. engages with the world financially and diplomatically.

Impact on U.S. Treasury Bonds

The petrodollar system’s decline is likely to have a significant impact on the U.S. Treasury bond market. Historically, petrodollar recycling has been a major source of demand for U.S. Treasuries, as oil-exporting nations invested their dollar surpluses into these securities. However, with the shift away from the petrodollar system, this key source of demand may diminish, potentially leading to higher yields and lower prices for U.S. Treasuries.

Moreover, recent research suggests that U.S. Treasury market conditions can amplify the impact of U.S. monetary policy shocks on bond markets, both domestically and globally.[Ibid] During periods of low liquidity or when leveraged funds hold large net short positions in Treasury futures, the effect of U.S. monetary policy changes on bond yields tends to be more pronounced.[Ibid] As the petrodollar system unwinds and global dollar liquidity potentially declines, U.S. Treasuries could become more sensitive to shifts in monetary policy.

The end of the petrodollar era may also coincide with a period of rising inflation and interest rates, further pressuring Treasury prices. As of April 2024, the 30-year Treasury bond yielded approximately 4.25%, while inflation stood at around 3.5%. If inflation continues to outpace Treasury yields, investors may seek alternative assets that offer better protection against purchasing power erosion.

In summary, the petrodollar system’s demise could lead to reduced demand for U.S. Treasuries, increased sensitivity to monetary policy shocks, and potential challenges in managing inflation and interest rate risks. These factors may contribute to a more volatile and uncertain environment for the U.S. Treasury market in the post-petrodollar era.

Rise of Digital Currencies and CBDCs

The rise of central bank digital currencies (CBDCs) is reshaping the global monetary landscape as countries explore the potential benefits and challenges of digital fiat. As of March 2024, there are four live retail CBDCs globally – in The Bahamas, the Eastern Caribbean, Nigeria, and Jamaica – with pilots underway in 24 jurisdictions and wholesale CBDC pilots in 23 jurisdictions. The motivations for CBDC issuance vary across countries, with retail CBDC work more advanced in economies with larger informal sectors. Most central banks are considering “hybrid” or “intermediated” CBDC architectures, where the CBDC is a direct cash-like claim on the central bank but the private sector handles customer-facing activities.[Ibid] CBDCs offer potential benefits such as more efficient transactions, improved economic data for policymakers, and tools to combat financial crimes. However, the rise of CBDCs also raises questions about their implications for financial stability, monetary policy transmission, and the role of the private sector in the monetary system. As the petrodollar system unwinds and countries explore alternative payment systems, the growing prominence of CBDCs and other digital currencies may accelerate the shift away from the U.S. dollar’s dominance in global trade and finance.

Petrodollar Collapse: Economic Ramifications

The petrodollar system’s demise could have far-reaching implications for the U.S. economy. As demand for the U.S. dollar potentially declines, the nation’s ability to issue dollar debt and earn dollars for exports may diminish, leading to a shrinking economy. This could manifest in higher inflation, as the government might need to print more money to stabilize the economy, eroding purchasing power and increasing the cost of living for households.[Ibid]

Public spending may also be impacted, with taxpayer money potentially redirected to stabilize the economy rather than fund new developments or social programs. Infrastructure, healthcare, and education spending could face cuts, leading to longer wait times for medical care and fewer resources for schools.[Ibid]

The U.S. Treasury market, which has historically benefited from petrodollar recycling, may experience reduced demand, higher yields, and increased sensitivity to monetary policy shocks in the post-petrodollar era. This could contribute to a more volatile and uncertain environment for U.S. Treasuries.

Furthermore, the end of the petrodollar system could accelerate de-dollarization trends, with more countries settling energy trades in currencies other than the U.S. dollar. This shift could weaken the dollar over the long term, spilling over into U.S. financial markets and leading to more price inflation for American consumers.

In summary, the potential implications of the petrodollar’s demise for the U.S. economy include higher inflation, decreased purchasing power, cuts to public spending, challenges in the Treasury market, and an accelerated shift away from the U.S. dollar’s global dominance. Navigating this new economic landscape may require significant adjustments and policy responses from the U.S. government and central bank.

GCC Economic Diversification Imperative

The end of the petrodollar system is likely to have significant implications for Saudi Arabia and other Gulf Cooperation Council (GCC) countries. Saudi Arabia, as the largest economy in the GCC, has been a key player in the petrodollar system since its inception in the 1970s. However, as the global energy landscape shifts and geopolitical dynamics evolve, Saudi Arabia and its GCC partners are adapting to the post-petrodollar era.

One potential consequence of the petrodollar’s demise is a reduction in demand for Saudi Arabian oil exports denominated in U.S. dollars. This could lead to a decline in the kingdom’s foreign exchange reserves and potentially impact its ability to maintain its currency peg to the U.S. dollar. However, Saudi Arabia has been diversifying its economy away from oil dependence through initiatives such as Vision 2030, which aims to increase non-oil revenue and attract foreign investment.

The GCC countries have also been strengthening their regional integration efforts, with Saudi Arabia playing a central role. Recent developments include the signing of memoranda of understanding between Saudi Arabia, Bahrain, and Oman to promote tourism and joint economic projects. The GCC is also considering a unified visa for tourists and businesspeople, which could further facilitate regional cooperation and diversification efforts.[Ibid]

Moreover, Saudi Arabia and other GCC countries have been expanding their global economic and financial ties beyond the U.S. Saudi Arabia’s recent membership in the BRICS bloc and its participation in the Bank of International Settlements’ bridge payment system indicate a shift towards alternative economic partnerships and payment mechanisms.

In summary, while the end of the petrodollar system may present challenges for Saudi Arabia and the GCC countries, it also offers opportunities for economic diversification, regional integration, and the forging of new global alliances. As these countries adapt to the post-petrodollar era, their economic and geopolitical influence is likely to continue to rise, with Saudi Arabia playing a pivotal role in shaping the region’s future.

Geopolitical Beneficiaries of Petrodollar Collapse

The demise of the petrodollar system could benefit several rival nations that have long sought to challenge U.S. economic dominance. China, in particular, stands to gain from the shift away from the U.S. dollar in global oil transactions. As the world’s largest oil importer, China has been actively promoting the use of its currency, the yuan, in international trade. The country has already established yuan-denominated oil futures contracts and has been encouraging its trading partners, including Russia and Iran, to settle oil transactions in yuan.

Russia, another major oil exporter, has also been working to reduce its dependence on the U.S. dollar. In recent years, Russia has significantly decreased its holdings of U.S. Treasuries and has been increasing its gold reserves. The country has also been collaborating with China to develop alternative payment systems, such as the System for Transfer of Financial Messages (SPFS), which could serve as a substitute for the U.S.-dominated SWIFT system.

Other nations, such as Iran and Venezuela, which have faced U.S. sanctions and have been largely excluded from the petrodollar system, may also benefit from its decline. These countries have been exploring alternative payment mechanisms and have been strengthening their ties with China and Russia to circumvent U.S. economic pressure.

The rise of digital currencies and central bank digital currencies (CBDCs) could further accelerate the shift away from the U.S. dollar’s dominance. As more countries develop their own CBDCs and explore alternative payment systems, the petrodollar’s influence may continue to wane, potentially benefiting nations that have long sought to challenge U.S. economic hegemony.

In summary, the demise of the petrodollar system could create opportunities for rival nations, such as China, Russia, Iran, and Venezuela, to assert their economic influence and challenge U.S. dominance in global trade and finance. As these countries promote alternative currencies, payment systems, and economic alliances, the post-petrodollar era may see a more multipolar global economic landscape.

Petrodollar Collapse: Geopolitical Rebalancing

The demise of the petrodollar system could indeed be seen as a form of “revenge” for nations that have long suffered under U.S. economic hegemony. The petrodollar agreement, which required oil transactions to be conducted in U.S. dollars, helped solidify the dollar’s status as the world’s reserve currency and enabled the U.S. to maintain its dominant position in the global financial system.

However, this arrangement also had negative consequences for many countries. Nations that challenged the petrodollar system often faced severe repercussions, such as economic sanctions or even military intervention. For example, when Iraq’s Saddam Hussein and Libya’s Muammar Gaddafi attempted to sell their oil for currencies other than the U.S. dollar, they both ended up being toppled by U.S.-led military campaigns.

Moreover, the petrodollar system allowed the U.S. to run large trade deficits and accumulate significant amounts of debt without facing the usual consequences, such as currency depreciation or higher interest rates. This “exorbitant privilege” came at the expense of other nations, which had to hold large amounts of U.S. dollars in their reserves to participate in the global oil trade.

As the petrodollar system unravels, countries that have long resented U.S. economic dominance may see an opportunity to assert their own influence and challenge the dollar’s supremacy. China, Russia, and other nations have been actively promoting their own currencies and payment systems as alternatives to the U.S.-led financial order.

The rise of digital currencies and central bank digital currencies (CBDCs) could further accelerate this shift, as countries explore new ways to conduct international trade and finance without relying on the U.S. dollar. For nations that have suffered under the petrodollar system, the emergence of a more multipolar global economic landscape could be seen as a form of long-awaited justice.

In summary, while the petrodollar system helped stabilize U.S. hegemony over the world, its demise could be interpreted as a “revenge” for nations that have long suffered under its dominance. As countries seek to assert their own economic influence and challenge the dollar’s supremacy, the post-petrodollar era may bring about a more balanced and equitable global financial order.