Petrodollar Paranoia

By: Dr. M. Ray Perryman
Published in syndication March 30, 2022

Recently, there has been much focus on the "petrodollar" and whether it will continue as the currency of choice in the oil market. China and Saudi Arabia have discussed shifting away from it, a move that some worry will end the dollar's dominance in world markets; others seem to think it would be the end of life as know it. Let me put your mind at ease.

Petrodollars are not a separate currency. Simply defined, they are crude oil export revenues denominated in US dollars. The universal use of petrodollars in oil sales began in the 1970s, when the United States and Saudi Arabia agreed to standardize oil prices in dollars as part of the overall transition away from gold. There were certainly political maneuverings, but the dollar was essentially chosen because it was (and remains) the most widely accepted currency for global transactions.

As to mechanics, oil-producing countries exchange crude for dollar-denominated assets which they then recycle into purchases on international markets. For the US, the demand for dollars increases, which is normally beneficial because it helps promote non-inflationary growth, liquidity, and lower interest rates. Conversely, it is not at all uncommon to have policies which deliberately weaken the dollar, which makes domestic goods more competitive.

If petrodollar transactions decline, the fear is that a chain reaction could ensue. India is reportedly considering buying oil from Russia at discounted prices using the Chinese yuan. Other countries are exploring alternatives to the dollar due to US sanctions on Russia, which caused significant economic disruption. Some advocate a basket of currencies; others want to go the crypto route.

Some fret that such a move could end the dollar's popularity and stability. However, it's likely much ado about nothing (or not much). While petrodollars are certainly not insignificant, the dollar remains the world's most desirable currency for multiple reasons.

The dollar is backed by the world's largest and most stable economy and independently managed by a highly competent monetary authority. In times of crisis and uncertainty, investors and nations alike flock to it. In addition to currency reserves, US treasury bills and notes provide the best vehicle to protect assets. In fact, the dollar comprises over half of all known central bank reserves and undergirds the entire world economy. Moreover, in millions of financial calculations that occur daily, US bonds are the definition of a "risk-free asset" for assured repayment.

The dominance of the dollar in global exchange is positive for the US economy, facilitating faster growth with less inflation. If that truly ended, there would certainly be notable fallout. However, even though petrodollars are substantial, the primary source of demand for the dollar remains its stability and security. Relax! Stay safe!!