The Truth About the Petrodollar Pact

The flood of articles and social media posts claiming a longstanding “Petrodollar Pact” between the U.S. and Saudi Arabia expired on June 9 (after 50 years) have unintentionally steered readers wrong. TipRanks covered the subject in an article titled: U.S.-Saudi Petrodollar Pact Ends after 50 Years. This would certainly be critical news for investors worldwide. However, upon closer examination, it becomes clear that the “pact” never existed in the way the dozens of reports described it. This article aims to set the record straight and shed light on the truth behind the petrodollar system.

What’s Known About the Petrodollar

The United States-Saudi Arabian Joint Commission on Economic Cooperation was established 50 years ago, on June 8, 1974. The Commission was formed shortly after the 1973 OPEC oil embargo in order to strengthen economic ties between the two countries. The two countries were motivated to forge a more formal arrangement that would ensure mutual benefits from their collaboration.

Contrary to recent reports, Saudi Arabia continued to accept other currencies, such as the British pound (GBP), for its oil even after the agreement. This indicates that there was no requirement for transactions to be conducted exclusively in U.S. dollars.

A more secretive arrangement emerged later in 1974, where Saudi Arabia agreed to invest heavily in U.S. Treasurys in exchange for military support. However, this was not the “petrodollar pact” described in social media posts. This deal, revealed in 2016 through a Freedom of Information Act request by Bloomberg News, was focused on strategic financial cooperation rather than enforcing a strict dollar-only oil pricing system.

In a blog post, Paul Donovan, chief economist at UBS Global Wealth Management (NYSE:UBS), addressed the erroneous reports about the 1974 agreement. He clarified that the agreement was about economic cooperation and did not include any stipulation requiring Saudi Arabia to price its oil exclusively in U.S. dollars.

Trends in Global Commodity Transactions

While the U.S. dollar remains dominant in global trade, including oil and other commodities, there has been a gradual shift towards using non-dollar currencies. Major emerging economies like Russia, Iran, and China have been trading commodities in currencies such as the yuan, rubles, dirhams, and rupees. This move is partly driven by U.S. sanctions and a desire to reduce dependency on the dollar.

For instance, Russia and China have increased their use of the yuan in oil transactions. In 2023, Russia became China’s top crude supplier, with most payments made in yuan. Additionally, the UAE and India signed an agreement to trade oil in their local currencies, marking a significant step towards de-dollarization in the region.

The Dollar’s Enduring Dominance

Despite these shifts, the dollar’s role as the world’s primary reserve currency remains largely unchallenged. The latest data from the International Monetary Fund (IMF) shows that while the dollar’s share of global reserves has declined slightly, no other currency has emerged as a significant rival. Most oil transactions, especially those involving Saudi Arabia, continue to be conducted in dollars, reflecting the deep economic and military ties between the U.S. and Saudi Arabia.

Furthermore, the dollar’s dominance in global financial systems means that even when other currencies are used for transactions, they often revert to dollars for investments and reserves. The tight linkage between the dollar and global oil markets, dating back to a 1945 agreement to exchange U.S. security guarantees for Saudi energy supplies, continues to reinforce the dollar’s central role.

Takeaway

The numerous reports about the end of a petrodollar agreement between the U.S. and Saudi Arabia appear to be based on misunderstandings, further compounded by the rush to deliver important financial news to readers.

While there have been noticeable changes in the currencies used for some global commodity transactions, the U.S. dollar remains the dominant force in global trade. The factors underpinning the dollar’s dominance are not easily replaced, ensuring its ongoing central role in world economies for the foreseeable future.