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The Petrodollar, simplified

US Rep. Ilhan Omar (D-MN) (L) talks with Speaker of the House Nancy Pelosi (D-CA) during a rally with fellow Democrats before voting on H.R. 1, or the People Act, on the East Steps of the US Capitol on March 08, 2019 in Washington, DC. (AFP photo)
US Currency. (File Image0

The Russia Ukraine conflict has changed the global market in many ways; it has affected energy prices and accelerated the demise of the US dollar, Not only has the US dollar weakened but it has also affected other dollar dependent currencies, such as the petrodollar.

The petrol dollar in a nutshell

Petro-Dollars are crude oil export revenues denominated in US dollars, a term which gained currency in the mid 1970s. The Bretton Woods system of fixed currency exchange rates tied to gold through the US dollar collapsed in 1971 because the global economy and its demand for safe assets outgrew the available supply of bullion.

Only the dollar could realistically fill that void. And as the global supply of dollars grew amid US debt and budget deficits, so did the accumulation of petrol dollars earned by oil exporters benefiting from sharply higher crude oil prices.

The global popularity of the US Dollar does not depend on the goodwill of oil exporters. It is based on US data, as the world's largest economy and goods importer with liquid capital markets backed by the rule of law, as well as military power.

Petro dollars are not a distinct currency but simply US Dollars accepted as payment for oil purchases.

Should the US lose Petrodollar dominance would it crater the world's economy? Not really. Analysts believe that any market, a stock market, a wheat market, or the oil market, requires a unit of measure. The importance of the US economy made the dollar the obvious choice for most markets.

But there would be no real difference if the Euro, the yen, or even bushels of wheat, were selected as the unit of account for the oil market. It's simply an accounting issue.

Let us imagine that prices in the oil market were quoted in the yen or bushels of wheat. If oil were priced in wheat, than the price of a barrel of oil will be 20 bushels. If oil were priced in either the yen or wheat, it would have no direct consequence for the dollar.

If the dollar were still the preferred asset among oil sellers, then they would ask for the dollar equivalents of the yen or wheat price of oil. The calculation would take only a billionth of a second on modern computers and business would proceed exactly as it does today.

Recently, we learnt that Saudi Arabia has expedited discussions with China to price some of its oil sales in Yuan. It has been surmised that the Saudis are unhappy with recent US policy decisions that take some of the wind out of Saudi Arabia's bullion sales.

Of course, the question remains, would such a move hurt the US economy? If such a deal were to be finalized It would mean 25% of Saudi oil would be traded in Yuan, which is a lot of money.

This could mean that the importance of the Petro dollar will become less integral to the strength of any economy in about 20 years. It has been projected that by 2040 about 70% of global passenger vehicle sales will come from electric vehicles and fuel for internal combustion vehicles is set to peak in 2027, plateau for about 10 years, then drastically plummet.

The future of oil production is bleak which makes the potential loss of petro dollar dominance more imminent. The Russia Ukraine conflict has become another factor.

Stiff sanctions, led by the United States, imposed on Russia mean Russian exports cannot be paid for in US dollars; consequently, the Kremlin is seeking alternatives like trading oil with India in rubles or rupees.

The Saudis for the first time are talking about selling oil to China in exchange for Chinese currency. This is similar to the India-Russia rupee-ruble deal.

If this Saudi oil sale in Yuan to China pact takes off then other countries may ask for similar treatment. This will surely shake the ground beneath the dollar hegemony.

We don't quite have a global currency, nor is there yet a viable alternative to the US dollar.

The world would be a more complicated place if every country tried doing business in its own currency.

Given current trends, it would appear that the status of the US dollar as the "king of the trading and invoicing world" is being challenged.

 


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