WORDS: A. ALI
An interesting thing happened in June; social media was awash with a breaking news story that the Saudi-US 50-year petrodollar agreement had not been rolled over. The death of the Dollar as the global reserve currency seemed imminent. Stories like this crop up occasionally, yet the Dollar’s status remains unchanged. Why is this? What are these news stories and commentators missing, misunderstanding, or not telling you?
The Dollar’s Dominance
Discussions on the Dollar’s dominance and the political and economic leverage this gives the issuer, namely the USA, have become more frequent over the last year or two. This is partly due to the draconian sanctions imposed on Russia and its Dollar-denominated assets given the Ukraine war.
Further, we have all witnessed the atrocities in Gaza unfold over the last year. A genocide is being perpetrated in open sight, coupled with Orwellian double-speak from mainstream Western media and Western governments, justifying the actions and portraying Israel as the eternal victim.
Perhaps from a point of utter despair and hopelessness, the Muslim world and indeed the wider ‘Global South’ have started talking more about multi-polarity. They discuss standing up and unshackling themselves from status quo, the ineffectiveness of international bodies such as the UN, and the absurdity of the ‘rules-based order’. Amongst these torrents of emotion, the issue of economic power is also a hot topic; Dollar hegemony being one of them.
Petrodollar Emergence
I’ll state from the beginning, those news stories I referred to earlier are factually false. There is no written, time-bound agreement between Saudi Arabia and the USA on ‘Petrodollars’.
The use of the Dollar by Saudi Arabia for oil sales emerged out of the 1973 oil crisis when the Organization of Arab Petroleum Exporting Countries within OPEC decided to embargo oil sales to countries that supported Israel during the Yom Kippur War.
This resulted in oil prices quadrupling from $3 a barrel to almost $12 a barrel (yes, those were very different times economically). This, in turn, had major negative impacts on the global economy, causing widespread shocks given the importance of energy.
It was due to this weaponization of oil that the US and Saudi Arabia came to their agreement; namely that Saudi Arabia would sell oil in Dollars and use part of those revenues to invest back in US treasuries. In return, the US would provide military protection to the oil-rich Kingdom. This was done to ensure longer-term global stability.
Importantly, the Dollar was already the global reserve currency when this gentleman’s agreement was made. It didn’t become the reserve currency as a result, although we can say its status was further cemented.
Petrodollars Today
The oil-rich nations of the GCC have very similar economic realities. The abundance of oil reserves in the Gulf region has led to rentier economics; sell oil, receive vast income streams relative to population size, and fiscal (government) spending becomes and remains the driver of the economy as a result.
All of these countries have dollar pegs; this means they manage their own currencies in such a way that there is a permanent fixed exchange rate with the Dollar. Monetary policy is effectively outsourced to the US Federal Reserve.
Why is this?
Simply put, fiscal stability. When your primary revenue is exogenous due to fossil fuel export, and most other things are imported, what you can’t afford is exchange rate volatility. This can wreak havoc on your budgeting and fiscal planning.
Given c. 50% of global trade in goods and services is invoiced in Dollars, matching currencies on both sides of the trade balance makes sense, especially when oil is priced in the same currency.
In the absence of the private sector fueling economic growth and providing domestic revenues for the state, the sovereign nexus becomes all-encompassing.
So now we move onto the bigger question, why does the Dollar have the status it has? This goes beyond just invoicing. It isn’t really about what currency you use to buy and sell; that is just an emergent property of something far more structural.
Global Trade Imbalances
Even with globalization coming under intense scrutiny given the geopolitical states of play globally, there is vast interconnectedness in the global economy – everyone is buying and selling with everyone else.
Countries do not sell in equal amounts as they purchase from bilateral partners; there are imbalances in trade that exist everywhere.
Export-oriented economies generate current account surpluses; they make more than they spend. What do they do with this excess cash? Where they store it and why is at the heart of the Dollar’s status as the global reserve currency.
The US as a market is the only one large enough to absorb global trade surpluses en masse. It provides a robust and trusted legal framework and an open capital account allowing free flow in and out. It is incredibly deep, liquid, and has every type of asset class and accompanying risk profile to satisfy the world’s savings and investment needs. Given the openness of its economy, it is prepared to give near-limitless claims to just about everyone on its assets; be it securities, equities, real estate, land, businesses, etc. Countries with trade surpluses can’t hold those surpluses domestically; their domestic markets aren’t big enough and even if they were, they’d appreciate their currencies too much and destroy their export competitiveness. A major strengthening of their currencies would also increase domestic demand, resulting in usually higher wages and domestic purchasing power, resulting in increased imports. This, coupled with export contraction, could result in a reversal of their trade and current account balances from positive to negative. Countries, therefore, choose to export their surpluses to avoid the above, and in the US, they have a willing recipient.
Economic Implications for the US
Economically, being the global reserve currency market isn’t always great. Some theories suggest that the US has to run current account deficits to keep a supply of Dollars always available for everyone else (via debt).
Even if that isn’t true, the US ends up having an overly strong currency relative to everyone else given the world is constantly buying Dollars. This negatively impacts US exports and results in too many imports, causing chronic deficits which the US has run since the mid-70s.
US industry takes the hit; for the rest of the world US goods and services are expensive, for Americans themselves it can be cheaper to buy the world’s goods and services rather than their domestic equivalents. This is an ongoing issue at the heart of US political debate.
It also de-incentivizes domestic savings; things you need to finance get financed more from international capital inflows, and your population finds it too easy to spend their money in the global marketplace.
Suppressing domestic demand at home through surplus export to another country usually results in the receiving country experiencing their own domestic demand strengthening. This is also a trade; and there has to be net equilibrium eventually.
The political leverage and hegemony enjoyed by the US is immense; however, economically, it isn’t always a rosy picture.
The US’s own fiscal trajectory is alarming; their sovereign debt levels have reached close to $35 trillion (that’s 35 followed by 12 zeros). The Federal government continues to spend, somewhat negating the Federal Reserve’s monetary policy tightening and (perhaps) giving the illusion of a soft landing.
Because the demand for Dollars remains, the US can continue to do this through deficit spending – although it is unclear what the long-term effect on itself will be.
The UK tried to do an un-costed fiscal budget that would have relied on deficit spending too under Truss’s short-lived premiership; it blew the house up. Bidenomics does not work without the Dollar.
The trappings of having the world’s reserve currency can arguably give a false sense of economic invincibility.
What About China?
Given the above, now consider China and the commentary that exists on it being a viable alternative to the US in this regard.
China is an export-oriented economy. Absorbing trade surpluses into Yuan would likely destroy export competitiveness for the reasons mentioned previously; the Yuan would appreciate too much.
The US is a domestic consumption-anchored economy; the two are very different, and the former isn’t really conducive to taking on the US’s paradigm as the center-point for global trade surplus absorption.
China does not peg its currency to the Dollar, rather carries out a ‘managed float’. It ensures a specific exchange rate within a certain range – primarily to keep its currency undervalued so that its exports remain desirable.
It has strict currency controls as a result and does not have an open capital account. It simply isn’t going to be able to, in its current guise anyway, take on the role the US does. I would also argue that it doesn’t want to, despite the noise that comes out of platforms such as BRICS.
Asking countries to trade with it in Yuan is political messaging, but as we have discussed, it isn’t just about what currency you trade in.
An interesting example of this has been seen recently between Russia and India. India buys Russia’s oil as well as military equipment. The 2 agreed to trade in their own respective currencies, resulting in Russia receiving a lot of Indian Rupees. However there is major trade imbalance between the 2; Russia doesn’t buy anywhere near as much as it sells to India. Russia asked India to provide it instead with Chinese Yuan given how much it purchases from China. This in itself was funny to witness, especially when we consider the not-so-great relationship between India and China.
Recent data indicates that Chinese holdings of US treasuries have actually increased, however in an incognito fashion where the holdings have shifted from the country’s Central Bank to state owned commercial banks – political messaging meets economic reality.
China Rebalancing
There is now however a potential need for China to rebalance its economy; domestic consumption as a component of their GDP lags far below developed peer countries.
Given the mess that’s been created by their real estate binge, and with trade wars starting with the US/Europe (let’s see what the US election yields on this) – China may not necessarily be able to keep relying on the Investments and Exports components of its GDP growth in the same way it has done up until now.
In theory, one way domestic consumption could be boosted is through allowing its currency to strengthen, thereby giving its population more purchasing power and therefore letting them buy more, including from outside (more imports). Sacrificing its trade balance may be seen as inevitable to keep a healthy growth trajectory for the future.
Could this change the dynamic re. China being able to absorb other countries surpluses? In theory maybe; however there are other ways in which they can look to increase domestic demand and keep that spending within the country instead; and I’d hazard a guess at this stage that this would be the preferred option.
The angst about the dominance of the Dollar and what that yields to the issuer of the currency in terms of political hegemony and leverage is a valid concern; however, it isn’t a new one. It has been discussed for decades and the downside economic effects it has on the US itself (which are rarely discussed in such conversations) is also a concern.
Re-creating or mirroring what the US has achieved in terms of the size, depth, and complexity of its market, its legal framework, its business dynamic and economic complexity isn’t something to be scoffed at or dismissed.
This article hasn’t been written to pay unbounded deference to the US either. It is to highlight the magnitude and structural realities of the global economy and global trade dynamics when the topic of Dollar hegemony arises.
Is it healthy or ‘fair’ for there to be such economic uni-polarity? Probably not. However, there is a reason for it.
If this is ever to be changed, then the reality of the situation firstly needs to be understood. The successes that have been achieved by the incumbent power need to be objectively admired because it didn’t happen overnight or with a snap of the fingers; it’s been built over a long period through solid policy-making.
Changing this reality will take time; as much time as it will take for a viable alternative to emerge.
What that is and who will achieve it is the unknown.