How the petrodollar regime came to be, and what losing it would mean for the U.S.
The global oil market has supported the U.S. dollar for over 50 years. But the system shows signs of cracking under the Iran war.
Business
The U.S. dollar is known as the world's reserve currency, and a big driver of that status comes from something called the petrodollar system. Wailin Wong and Adrian Ma of The Indicator chronicle the history of the petrodollar and why the war in Iran threatens its status.
WAILIN WONG, BYLINE: In 1973, Egypt and Syria launched an attack on Israel. This came to be known as the Yom Kippur War. The U.S., under President Richard Nixon, provided Israel with aid and arms. This angered the Arab countries, which imposed an oil embargo on the U.S. This set off what's considered the first worldwide oil shock.
ADRIAN MA, BYLINE: One person who's spent a lot of time analyzing this era is David Wight. He's a historian at the University of North Carolina at Greensboro. David says that the U.S. and Saudi Arabia understood that the future of their relationship was at stake.
DAVID WIGHT: You can see, going through the declassified documents from the United States, the deep sort of distrust on both sides, but also a desire to try to patch up this relationship.
WONG: David says the U.S. recognized that Saudi Arabia and other oil-producing countries were now major players on the world stage. The price of oil had quadrupled in the last months of 1973. Saudi Arabia was making a lot of money, and its government needed somewhere safe to invest all those earnings.
MA: It was during this time that Treasury Secretary Bill Simon met with the Saudis. So did Secretary of State Henry Kissinger. And what emerged from these meetings was an arrangement.
WONG: Here's how it worked. The Saudis would agree to price their oil exports in U.S. dollars, and in exchange, the U.S. would provide economic and military support. David said some historians believe that the U.S. even gave the Saudis a discount on purchases of U.S. Treasury bonds.
MA: OK. So as far as we know, there's no official memo laying out these promises. But in June of 1974, the U.S. and Saudi Arabia signed a broad agreement on military and economic cooperation.
WONG: This was the start of the petrodollar system. Oil had already been priced in dollars before 1974, but now Saudi Arabia and other countries in the region were affirming a commitment to price oil in U.S. dollars and to invest their earnings in things like U.S. Treasury bonds.
MA: And the flow of petrodollars from the Middle East to the U.S. was significant. David says Saudi Arabia was the largest foreign buyer of U.S. treasuries in the early days of this arrangement.
WONG: Petrodollar flows started to wane in the 1980s as oil prices went down, but the broader petrodollar regime stayed in place. Saudi Arabia and other Gulf countries pegged the value of their currencies to the U.S. dollar. Most of their investments overseas were denominated in dollars as well.
MA: That means these countries could hurt the U.S. economically by dumping their dollar investments in bulk. This is also a risk with other countries that hold lots of dollar assets, whether it's China or the United Kingdom.
WONG: In fact, China wants to challenge the dollar as reserve currency, and it's taking aim at the all-important petrodollar regime, which, as we know, is a key part of the dollar's reserve status. One new place just opened for business in Chinese yuan, the Strait of Hormuz. Iran has reportedly been collecting some tolls in yuan to transit the strait.
MA: It may be more symbolic than a real blow to the petrodollar regime, but the system does appear vulnerable. And oil exporting countries in the Middle East could go shopping for a new arrangement if the U.S. proves to be an unreliable geopolitical partner.
(SOUNDBITE OF LADY WRAY SONG, "HOLD ON")
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