What’s the fuzz about the Petrodollar?
Did Saudi Arabia Allow the Petrodollar Deal with the U.S. to “Expire” Earlier This Month?
As the saying goes, it’s complicated.
If you’re unfamiliar with the Petrodollar Deal, here’s some background. This agreement was made in June 1974 during the Nixon administration by Treasury Secretary William Simon and his Deputy Gerry Parsky.
The deal had four main parts:
1. Saudi Arabia would price oil in U.S. dollars.
2. Saudi Arabia would invest the earned dollars in U.S. Treasury securities or large bank CDs.
3. The Treasury and banks would lend those dollars to developing economies that would buy equipment and agricultural products from the U.S.
4. The U.S. offered Saudi Arabia military protection against the Soviets and regional rivals. While the security and financial agreements were documented, they have never been publicly disclosed.
The Petrodollar Deal was beneficial to all parties involved. The U.S. supported the dollar's reserve status because other countries needed dollars to buy oil, and Saudi Arabia enhanced its national security. The recycling of Saudi dollars to developing countries boosted global trade and commodity prices, helping the world recover from the severe recession of 1974.
Clarifying the Status of the Petrodollar Deal
Recently, some dubious news sources reported that Saudi Arabia would end the petrodollar peg on June 9, 2024, after fifty years. These reports claimed that oil would now be priced in currencies such as the Chinese yuan, Indian rupee, Russian ruble, and others, signaling the end of the U.S. dollar's dominance as the world's leading reserve currency since 1914 or 1944. They speculated that new reserve currencies would emerge, most notably the proposed BRICS currency.
In reality, this is inaccurate. There have been important developments in international finance and monetary policy recently, but they are more nuanced and important than the sensational headlines suggest.
Did the Saudis just end the Petrodollar Deal as reported? Not exactly. The treaty was never a Senate-ratified treaty, but a non-binding executive agreement, essentially a written handshake. It contained annual renewal provisions and could be terminated at any time by either party.
The Saudis held up their end by pricing oil in dollars and buying US Treasuries, and the US held up its end. However, the agreement never had an explicit expiration date, so claims that the deal has expired are exaggerated. Saudi Arabia has informed the U.S. that it will not renew the agreement, but this decision must be viewed in the context of other U.S.-Saudi discussions.
The U.S. and Saudi Arabia are negotiating a new financial and security agreement to replace the old petrodollar deal. The new agreement is likely to include Saudi recognition of Israel, as part of the broader Abraham Accords initiated during the Trump administration. The U.S. will continue to provide security guarantees to Saudi Arabia, which will be extended to include uranium enrichment technology.
The Real Challenges Facing the Dollar
There have also been significant developments in international financial and monetary markets beyond the Saudi Arabian situation. Notably, major policy initiatives were announced at the St. Petersburg International Economic Forum (SPIEF) hosted by Vladimir Putin from June 5-8, 2024.
Russia announced collaboration with other BRICS+ members to develop a global payments system independent of Western systems like SWIFT and FedWire. This is critical because payments through Western systems are subject to seizure and interdiction, whereas an independent system would be safe from Western interference.
Putin also met with Dilma Rousseff, former president of Brazil and current president of the New Development Bank, which acts as a central bank and development lender to BRICS+ and other associated members. They discussed the roll-out of the new BRICS currency called The Unit. This currency will be valued based on a weight of gold (40%) and a basket of BRICS+ currencies (60%).
The Unit will not be launched for another year or longer, with formal announcements expected at the BRICS leaders’ summit in Kazan, Russia, this October. It will take a few years to add members, build infrastructure, and firm up valuation issues. Still, this currency is on the way.
Even as a payment currency, the BRICS unit could be used for a significant percentage of global trade, challenging the dollar. The BRICS unit does not signal the end of the dollar as a widely accepted currency, but when combined with the perceived weaponization of the dollar by Joe Biden and Janet Yellen, it could mark the beginning of the end.
are compelling arguments for a higher target, especially given the current economic environment, the risks associated with such a change are significant.
The Federal Reserve's credibility is a vital asset that should not be jeopardized lightly. Any move to raise the inflation target should be approached cautiously, with thorough consideration of the potential impacts on inflation expectations and economic stability. A gradual and well-communicated adjustment, if deemed necessary, might be the best approach to avoid market disruptions and maintain public trust.
Ultimately, while the idea of raising the inflation target has merits, the decision should be made with a careful weighing of the pros and cons. The Fed must ensure that any changes to its policy framework support its dual mandate of price stability and full employment, without compromising its hard-earned credibility.