The financial world may be on the brink of significant upheaval as the dominance of the dollar could be challenged by Saudi Arabia's decision not to renew its 50-year petro-dollar agreement with the United States (US).
This deal, which expired on 9 June, had long underpinned the global economic supremacy of the US.
Originally established in June 1974, the decision not to renew the contract allows Saudi Arabia to sell oil and other commodities in various currencies, including the Chinese RMB, Euro, Japanese Yen, and Chinese Yuan, rather than exclusively in US dollars.
Furthermore, the potential adoption of digital currencies like Bitcoin may also be explored.
In a related development, Saudi Arabia's central bank has become a full participant in Project mBridge, a cross-border initiative led by the Bank for International Settlements (BIS) in Switzerland that experiments with central bank digital currencies (CBDCs) for international trade.
Understanding Petrodollar & Petrodollar Recycling
Petrodollars refer to the revenues from crude oil exports that are denominated in US dollars.
They are not a separate currency but rather US dollars used by oil exporters to conduct transactions.
The term became widely recognised in the mid-1970s when escalating oil prices led to substantial trade and current account surpluses for oil-exporting nations.
At that time, as well as today, oil sales and the resulting current account surpluses were expressed in dollars due to the US dollar's status as the most extensively used global currency.
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What is Petrodollar..?
The term "petrodollar" refers to the U.S. dollar's role as the only currency used for crude oil transactions on the world market....
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The global preference for the US dollar is not contingent upon the favour of oil exporters; it is rooted in the US being the world's largest economy and importer of goods, possessing deep and liquid capital markets, and being supported by the rule of law and military strength.
The US dollar's widespread use in paying for crude oil reflects the historical preferences of non-US oil suppliers.
Oil exporters favour the US dollar because it is the dominant global currency for international investments, making it the most practical repository for accumulated oil revenues, which must earn a return to be of value.
There is no formal "petrodollar system."
The reinvestment of oil export earnings, sometimes referred to as "petrodollar recycling," is an example of how these funds are utilised.
An early instance of this was the 1974 agreement between the US and Saudi Arabia, which channelled Saudi petrodollars into US Treasury securities.
Subsequent arrangements involved using Saudi oil export proceeds to finance US aid and development projects in Saudi Arabia and to fund US weapons sales to the kingdom.
Many oil exporters now allocate their petrodollars to stocks, bonds, and other financial instruments through sovereign wealth funds.
So What is the Petrodollar Agreement & Why Did Saudi Arabia Not Renew it?
The petrodollar agreement, established in response to the 1970s oil crisis, was a pivotal deal between the US and Saudi Arabia following the US' departure from the gold standard.
Signed in June 1974 and under its terms, Saudi Arabia agreed to price its oil exports exclusively in US dollars and invest surplus oil revenues in US Treasury bonds.
In return, the US provided military support and protection to the kingdom.
According to Katja Hamilton of BizCommunity, this deal required foreign countries to hold US dollars to purchase oil from Saudi Arabia.
At the time, American officials were optimistic that the agreement would encourage Saudi Arabia to increase oil production and serve as a model for economic collaboration with other Arab nations.
While escalating global tensions and shifting geopolitical allegiances are often cited as reasons, the changing dynamics of the global oil market have also played a crucial role.
The world's gradual shift toward alternative energy sources has reduced reliance on oil over the past decade.
Even oil-rich countries like Saudi Arabia have adapted to this trend.
The Kingdom aims to generate half its electricity from renewables and natural gas by 2030 and plans to plant 10 billion trees to achieve net-zero emissions by 2060.
To support these goals, Saudi Arabia has launched over 80 initiatives, with investments exceeding $188 billion.
Furthermore, the rise of new oil-producing nations, such as Brazil and Canada, has challenged the traditional dominance of Middle Eastern oil, prompting Saudi Arabia to rethink its strategies.
This confluence of factors has led to the expiration of the longstanding petrodollar agreement, reflecting a broader shift in the global energy landscape.
Saudi Arabia Joins BIS' CBDC Project mBridge
In an effort to establish a robust and innovative framework for cross-border payments, the Saudi Central Bank (SAMA) has become a full participant in Project mBridge, a cross-border initiative that explores the use of CBDCs for international trade.
This development was announced by the Bank for International Settlements (BIS) on Wednesday.
Josh Lipsky, who runs a global CBDC tracker at the US-based Atlantic Council, said:
"The most advanced cross-border CBDC project just added a major G20 economy and the largest oil exporter in the world. This means in the coming year you can expect to see a scaling up of commodity settlement on the platform outside of dollars – something that was already underway between China and Saudi Arabia but now has new technology behind it."
Project mBridge has achieved a significant milestone by reaching the minimum viable product (MVP) stage after three years of development.
The BIS has invited private sector financial firms to contribute new solutions and use cases that can further enhance the platform and demonstrate its full potential.
Experts have noted that the MVP stage signifies that the mBridge project is now accessible to commercial banks within the six participating member countries for real cross-border payment applications, marking a significant advancement in facilitating cross-border payments using CBDCs.
In addition to the six full participants in mBridge, nearly 30 other official entities, with some of the better known observing members include the Bank of Israel, Bank of Namibia, Bank of France, Central Bank of Bahrain, Central Bank of Egypt, Central Bank of Jordan, European Central Bank, the International Monetary Fund, the Federal Reserve Bank of New York, the Reserve Bank of Australia, and the World Bank.
This grants them access to a "sandbox" environment for experimenting with the technology.
Major global financial institutions, including Goldman Sachs, HSBC, and China's six largest state-owned banks, are also actively involved in the project.
Project mBridge was initiated in 2021 as a collaborative effort among the BIS's innovation hub, the Bank of Thailand, the Central Bank of the United Arab Emirates (UAE), the Digital Currency Institute of the People's Bank of China, and the Hong Kong Monetary Authority.
The project aims to test the feasibility of CBDCs for instantaneous cross-border trade and other payment scenarios using the mBridge Ledger, a blockchain developed for the project.
According to a BIS press release on 5 June, the project seeks to address key inefficiencies in cross-border payments, such as high costs, slow transaction speeds, and operational complexities.
It also tackles issues related to financial inclusion, particularly in regions where correspondent banking has diminished, leading to increased costs and delays.
Multi-CBDC arrangements that link different jurisdictions within a single shared technical infrastructure hold substantial promise for enhancing the current system.
They could enable immediate, low-cost, and universally accessible cross-border payments with final settlement.
A platform built on a new blockchain, the mBridge Ledger, supports real-time, peer-to-peer cross-border payments and foreign exchange transactions.
In 2022, a pilot involving real-value transactions was successfully conducted, and since then, the mBridge project team has been investigating the potential for the prototype platform to evolve into an MVP, a stage that has now been achieved.
Future of Dedollarisation & Potential Imminent Collapse of US Economy
The US dollar holds the position of the most powerful and widely utilised currency globally.
For numerous oil-exporting nations, receiving payments in US dollars is highly advantageous.
The petrodollar agreement has solidified the USD's status as the world's reserve currency, contributing to a period of prosperity for Americans who benefited from being the preferred market for global corporations.
Oil's significance as a key commodity in international markets has automatically elevated the US to a pivotal role in the global economy.
Additionally, the influx of foreign capital into US Treasury bonds has supported low interest rates and a robust bond market.
However, the US dollar's dominance in the petrocurrency arena has faced challenges in recent years.
Countries worldwide have been diversifying their assets and attempting to reduce the USD's dominance due to concerns about being excluded from the greenback-based financial system if sanctions are imposed.
This is a response to the US using the petrodollar system to exert influence in foreign policy, a strategy often seen as a move towards dedollarisation.
The petrodollar has been criticised for being a tool of war and dominance.
The rise of Eastern powers signals the end of this era and the emergence of a multipolar world where power is distributed rather than monopolised.
This trend challenges the US dollar's dominance in payment systems.
Saudi Arabia's decision not to renew its 50-year petro-dollar agreement is indicative of the petrodollar's uncertain future.
Saudi Arabia's dedollarisation could inspire other oil producers to seek independence from the US dollar.
This shift has been underway since Russia's invasion of Ukraine and the subsequent Western sanctions, which led to the formation of new trading alliances and altered partnership agreements.
The implications of dedollarisation are significant.
For the US, it could lead to reduced geopolitical leverage and higher borrowing costs, with detrimental effects on American hegemony and domestic socio-economic conditions.
Currently, US economic data suggests a slowdown, particularly in the goods sector, with services also showing signs of cooling.
Indicators such as the ISM and PMI, along with new orders, point to weaker GDP projections.
Despite this, the latest CPI data shows an average year-over-year inflation rate of 3.4%, which Fed Chairman Jerome Powell has described as "way too high," emphasizing the need to achieve the sustainable 2% target.
If the dollar loses its status as the world's reserve currency for oil transactions, the US's ability to influence market rates for its imports will be severely diminished.
The US economy's reliance on foreign demand for dollars to purchase oil extends beyond securing cheaper imports.
The global demand for the dollar is what allows US Treasury bonds to support low interest rates.
With rising fuel prices and increased costs for goods and services, Americans could face a severe economic downturn.
Daniel Krupka, Head of Research at Coin Bureau, suggested:
“However, the end of the agreement could be bad for the USD insofar as Saudi Arabia decides to convert these non-USD currency proceeds into other assets, such as gold or BTC.”
Brian Mahoney, co-founder of Acre, pointed out:
"The symbolism of the end of the US-Saudi petrodollar agreement marks a shift toward a future that is further economically and geopolitically fragmented. It means that the world’s currency for top energy assets like oil is no longer priced just in dollars, opening the door to alternative assets instead.”
While some analysts downplay the threat to the USD's status as the reserve currency, many recognise that the expiration of the petrodollar agreement could weaken the USD and US financial markets over time.
Although the US dollar is expected to remain the preferred global payments currency in the short term, the decisions made today will undoubtedly have lasting implications for the future.
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