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Time Out For The PetroDollar Conspiracy

Politics / Fiat Currency Oct 26, 2013 - 10:02 AM GMT

By: Andrew_McKillop


I have plenty of articles published on this subject, and I break up the 40-odd years of “the petrodollar system” into at least 3 clear main phases. More important, the present one is the last one. For a valedictory and uncertain, but official argument for the present phase, the US Federal Reserve Bank of NY has a full statement

Always thought of by its US and Saudi inventors as a win-win, it has several downsides and can be lose-lose, also. For the global economy it is only lose-lose. Just as important, the petrodollar and its related recycling started as a secret political initiative and will end political, but possibly public. Its economic, financial and monetary roles were always placed in the back seat, and handed over to “experts”, for example in the US Fed system, IMF and BIS to whine about. The main policy pillars of “the system” - favouring US-Saudi economic relations and bolstering the US dollar – do not have any significant relation to, and do not resist comparison with the real role, weight and influence of oil and oil trade for the USA, even if it can be construed as sometimes highly favourable to Saudi Arabia.

Taking the USA's total for physical oil trade turnover, that is exports plus imports as about $450 billion a year in 2012, this can be set against either US GDP or US sovereign debt to see how small “the petrodollar system” really is. We could also compare it with Wal-Mart Inc's turnover of about $469 billion a year in 2012. To be sure, leverage helps a million (we mean a trillion), but that also applies to real estate, mortgages and bolstering the “value” of Facebook, Apple or Google shares.

One key factor turning a theoretical and political win-win into an economic, financial and monetary lose-lose, certainly for the USA, stems from US debt and “dollar hegemony”, both of them pushed only one way – further - by the petrodollar system.

The number one American export is US dollars, more precisely the repayment of current dollars and promise of future dollars on loans to be received and goods to be imported by the USA.  Like any fiat money it is paper currency backed up by absolutely nothing, but the rest of the world's need to import oil (for around 160 countries out of 200) means they need dollars to buy oil – when and if it is billed and settled in dollars. Other trade goods and services, in majority, are billed and settled in dollars, but there's no basic reason this has to be treated as permanent and obligatory. The same applies to oil.

As I already said, the petrodollar system is above all political and concerns the US and Saudi Arabia before anybody else, or anything else. Due to current-ruling Saudi potentates, notably the so-called “Intelligence chief” Prince Bandar bin Sultan claiming Saudi rule over President Obama's decisions on Syrian bombing, and raging about Obama's non-bombing, the threat of Saudi Arabia “abandoning the petrodollar” has been circulating. When or if Saudi oil exports were increasingly billed and settled in currencies other than the USD, the present semi-monopoly would disintegrate.

One de facto result would be a strengthening of the USD's world value after a ritual and probably impressive period of “trial by market”. To be sure market logic, we mean panic would take some time to adjust to the real world, as ever, but the main reason the dollar would strengthen would be the USA's need to print and issue far less and far fewer “chaff dollars”.


The doomster argument is all to easy. The biggest reason why good relations with Saudi Arabia are so important to the United States is because the petrodollar semi-monopoly will not work without them.  For decades, Washington has bowed and cowed, and gone to extraordinary lengths to mollycoddle the Saudis, despite the huge Saudi exposure to any theoretical crash of the USD's value.

Supposedly, Saudi players still believe what they thought Phase One of the petrodollar system meant.  During its early days (1972-1985) it meant large gains for KSA – more political than economic – but after that it meant several years (1986-1991) of large political-and-economic losses. We could even argue “the system” was de facto idled or mothballed for most of the 1992-2001 period, during which it did little for the USA and much less than nothing for Saudi Arabia. Continuing with that line of reasoning, “the system” was only brought back into life, under George W. Bush and Hank Paulson, from about 2005. The above-cited US Fed bank of NY statement especially concerns this last phase – although the bank does not treat it that way.

One thing on the US side is however sure and certain – in no way would US debt have grown so fast, to such extremes, nor the trade deficit have ballooned in the absence of the “petrodollar system”. That would certainly not have been a catastrophe! US gains throughout all the phases or formats of “the system” were always more apparent than real – but the US political elite feeds off appearances, which is one of its basic defects.

The Saudi side, unfortunately, only has defects. With Bandar bin Sultan these are monstrously evident. One of his latest tirades was to also criticize the US for not backing Saudi Arabia's military rampage in nearby small-sized Bahrain, killing hundreds of peaceful demonstrators against the ruling Sunni clique of Bahrain, which totally depends on Saudi support. Concerning Syria, of course, the Saudis could in theory always go and fight their own war, but that is not at all the way that Saudis “heroically” do things. Presented as a supposed sign of bargaining strength with Washington, aides to bin Sultan repeatedly point out that KSA central bank foreign exchange assets are close to $700 billion “and are almost exclusively denominated in US dollars”. The Saudis could sell these, of course, but dumping that amount on the markets in a princely flourish will result in stupendous losses for Saudi Arabia.

Due to “the system” always having been secret as well as political, most Americans and the majority of non-Americans have absolutely no idea about it. Because of this, they can more easily believe the one-liner that terminating “the system” could only “severely damage the U.S. and world economy”. 

Without the prop of petrodollar recycling and its leverage, operated by the US Federal Reserve banking system, and the leading money market banks, it would be very unlikely that the US could run its present fantastic annual trade deficits. The US economy would have to “re-localize”, or “de-offshore”. Would this be a disaster?


Conversely, the disaster for Saudi Arabia would be real and would not ebb away after a few weeks of market panic. We would assume that Bandar bin Sultan's was able, domestically, to put his threats to execution, and Saudi Arabia suddenly sold a large slab of its $700 billion FX stash. It would also exactly invert the petrodollar system – henceforth demanding oil payment in any currency but the dollar. No dollars accepted! What price would KSA set for its oil exports? What would other OPEC exporters do? How would they settle oil sales?

Almost certainly the global oil market system would mutate back to pre-1987, before widespread market trading mainly in dollars. Oil supplies and sales would utilise a wide range of settlement systems. These included baskets of currencies, trade offset bilateral arrangements, barter-type settlement, netback deals, technology deals, even gold and other PMG metals used as payment.

In any event total oil shipments would decline for some time – possibly months or several years. Expressed in some reliable measure-of-value, excluding fiat currencies, oil prices could only decline. Saudi Arabia's government, basically its royal family and its princely clans, gets 92% of its revenues from oil. Putting the Bandar bin Sultan menace to execution, they would have blown their stash of central bank FX reserves, and weakened their economy going forward, probably for years ahead.

For the US and inevitably, the end of petrodollars and their recycling will mean an end to the era of cheap imports and super low interest rates, but will also reset the global economy – not at all to the disadvantage of the USA. China, now the world's No 1 oil importer, will be obliged to move fast to replace dollars for its oil trade. This will mean the RMB appreciates, which is what China doesn't want, but has to accept. One thing is certain, Saudi sabotage of the US dollar will not be germane to China – which holds about $1.25 trillion of US Treasury bonds.

The likelihood of China aligning with the US – if only to save its dollar stash – can be taken as relatively high, but it is sure and certain that China will be limiting its purchase of US debt in the future and itself seeking other trade-and-currency arrangements. This is already a “sombre signal” for the US, but only if it want to continue its race to the cliff edge.

Unfortunately, the petrodollar system, although “secret” only works if the rest of the planet has faith in it, and due to “the system” becoming dysfunctional, perverse or non-performing the United States is systematically destroying the faith in the dollar that the rest of the world has in our financial system. Put another way, if for no other reason (and there are plenty!) US debt growth had to decline, due to the petrodollar system terminating, this could only further limit the USA's reckless accumulation of debt. Given the broken back out-of-sight state of national finances and economic expectations in most countries this would be a “disaster”, but in real terms is not.

By Andrew McKillop


Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2013 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisor.

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