The Death of the PetroDollar

Earlier this month, the internet was flooded with reports, stating that the “50-year petrodollar agreement” between the United States and Saudi Arabia had expired and that the petrodollar was now dead.

Over the years we’ve written on the PetroDollar on several occasions. But this time, just as in the case of Mark Twain, “the Death of the PetroDollar has been greatly exaggerated”. Ten years ago, we published an article entitled Oil, Petrodollars and Gold. In that article, I showed how the demonetizing of gold eventually led to Henry Kissinger making a deal in 1973 with Saudi Arabia to denominate all their oil sales in U.S. Dollars in exchange for the Kingdom receiving U.S. military assistance. Within two years all of OPEC had gotten in on the deal.

This deal may sound trivial, but it had monumental effects. When Nixon was forced to stop redeeming U.S. Dollars for Gold (because the dollar had been secretly inflating for years) the Dollar lost all credibility and it was on the verge of losing its “reserve currency” status. Countries had lost their faith in the Dollar and inflation was roaring. But, this simple arrangement was a sign of Kissinger’s genius. He reasoned that, since every country needs oil… to buy it, every country would need a supply of dollars. These dollars would circulate outside the U.S. (i.e., between Oil producers and Oil consumers) and sop up the excess supply of Dollars inside the United States, thus reducing inflation. Plus it would restore our reserve currency status. And that is exactly what happened.

No 50-Year Deal

But according to Peter C. Earle, Senior Economist at the American Institute for Economic Research (AIER), , there was no formal deadline to this deal.  He said,

Last week several reports suggested the termination of a US-Saudi petrodollar agreement, and speculated a Saudi Arabian move to sell oil on world markets in various currencies, including the Chinese yuan. The accounts were rife with inaccuracies: the Saudis’ have transacted in non-dollar currencies for decades, and there has never been a formal treaty, much less with a specified expiration date, governing the loose arrangement that has come to be called the ‘petrodollar system.’

Well, that’s not exactly true either. In 1974,  Henry Kissinger, (U.S. Secretary of State), and Prince Fahd, the second deputy prime minister (and later king and prime minister) of Saudi Arabia, signed the United States-Saudi Arabian Joint Commission on Economic Cooperation which was originally intended to last 5 years but has been renewed repeatedly since then. So, there was an agreement but it wasn’t for 50 years.

And ever since its inception, the petrodollar arrangement has suffered stresses. Big countries don’t like the idea that they need inflated U.S. dollars in order to buy oil. They would much rather be able to use their own currency and gain the benefits of inflation themselves. In my articles, How Does a Country “Export” its Inflation?and What are “Foreign Exchange Reserves”? I outlined the benefits of being the reserve currency:

Being used as a foreign exchange reserve currency sharply increases the value and usefulness of that currency. When a particular nation’s currency is the de facto reserve currency, that’s nation’s economic power and influence is automatically spread globally. Like any other commodity, the value of the reserve currency is based on supply and demand… by rigging an artificially high demand for its currency, the U.S. was able to print more dollars without sparking significant inflation at home. In effect, it was able to export its inflation to other oil-consuming countries because after it printed them and spent them those dollars went abroad and never returned home, so they had no effect on domestic inflation.

But cracks were developing way back when I wrote the 2014 article mentioned at the top of this article. In it I said,

In the years since 1975 the dollar has suffered 340% inflation and consequently many of the oil producing nations felt cheated having to accept a depreciating asset like the dollar for their valuable oil. Especially disgruntled were those who were not on the receiving end of the arms deals like North Korea, Iran, Venezuela and Syria all of which have tried or are moving away from the petrodollar. Some people believe that the real reason for the war in Iraq was because they threatened to stop using the dollar and so they were made an example for the other oil producing countries.

However, it was only a temporary deterrent. Other countries that would not be politically expedient for the U.S. to attack like the BRIC countries i.e. Brazil, Russia, India and China have begun negotiating oil deals in their own currencies rather than the U.S. dollar.

So, the BRIC countries have been fighting against the Petrodollar for at least 10 years. Then, last year we published an article on Fintrend.com called Will a New BRICS Currency Dethrone the U.S. Dollar? Once again the petrodollar was under attack. So far, the Petrodollar has survived. But that doesn’t mean that the Petrodollar will last forever. Recent actions by the U.S. to confiscate Russian assets held in  Europe in retaliation for the war in Ukraine have given countries like China valid reason for concern. What if the U.S. unilaterally decided to write off all the T-Bills China owns? This worry has caused an increase in demand for Gold as an alternative to holding U.S. Treasury debt, reigniting some of the same problems that Kissinger faced.

Will Crypto Become the New Reserve Currency?

An interesting side note is the rise of Crypto over the last 10 years. During that period Bitcoin has gone from a couple of dollars to a recent high of almost $75,000. And, it is referred to as “Digital Gold”.  Like Gold, it has a limited supply that can’t be altered (supply does grow but increasingly slowly and with a maximum limit). This means that rather than supply increasing faster than demand and thus inflating and becoming worth less (or eventually worthless), increased demand combined with limited supply will make Bitcoin worth more as time goes on. Additionally, as more of the supply is stored and not circulating that will further increase the value (by decreasing the available supply). It is not unreasonable for oil-producing countries to begin accepting payment in Bitcoin.

On the one hand, countries like China and Russia fear Bitcoin because their “subjects” are using it to get their wealth out of the government’s control. On the other hand, a few countries in South America are using Bitcoin to help get their own inflation under control and even making it legal tender. So there are forces on both sides of the Bitcoin question.

What About Ethereum?

Ethereum (ETH) has an entirely different value proposition. ETH is not so much a store of value as a medium of exchange, and the supply isn’t limited numerically like Bitcoin. ETH (the currency)  is used to power transactions on the Ethereum blockchain. The fees are minimal but they can be deflationary. What happens is that when a transaction is performed on the Ethereum blockchain the fee charged is “burned” or destroyed (they don’t go to some corporation) this reduces the overall supply of ETH benefiting all holders of ETH just like a stock buyback benefits the owners of Apple stock. Ethereum, supply does not have a ceiling like Bitcoin but, the higher the usage rate, the higher the transaction fees. If high usage persists, then fees could rise beyond the issuance rate. This is where the deflationary force takes effect. To keep fees down ETH Layer 2 applications have been created that effectively clump transactions together reducing the ETH fees by processing multiple transactions for the same fee.

There are also ways that the ETH supply can increase, so it is considered to have a “semi-elastic” supply. New ETH is allocated to holders of old ETH who “stake” or agree to lock up (or deposit) 32 ETH or at current prices about $100,000 worth of ETH. These stakes are used to guarantee the blockchain against false entries.

Will ETH Become the New Reserve Currency?

Just like the Petrodollar required U.S. dollars to buy oil, in the new paradigm ETH is required to perform transactions on the Ethereum Blockchain. Why does this matter? Who cares, you’re not doing transactions on the Ethereum blockchain are you? Well, maybe you are and you aren’t even aware of it. As of this writing, there are over a million transactions per day handled on Ethereum. That isn’t a Million Dollars worth of transactions, that is a million individual transactions (Plus multiples more on the L2). On the other hand, Visa does just under 800 million transactions a day. So, Visa currently is 800 times bigger than Ethereum. But, very shortly, there will be apps available to merchants that will allow financial transactions for pennies versus 3-5% on VISA. If you are a merchant and you can process a transaction virtually free or give 3% to VISA which will you choose?  Then, if you are a normal consumer you might not even realize that you just performed an ETH-based transaction.  This shift could easily make ETH the new “transactional reserve currency” while Bitcoin becomes the “storage reserve currency”.

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