The beginning of the end for the “petrodollar”?

The beginning of the end for the "petrodollar"?

The US dollar owes its privileged status in the global financial system to the Persian Gulf oil producers who sell their oil for dollars and then “recycle” the proceeds by buying US Treasury bonds. Economists coined a special term for the money involved in this scheme: “petrodollars”. The latest developments in the Middle East signal that the era of “petrodollars” may be coming to an end.

Numerous reports point out that Saudi Arabia has been one of the main forces pushing the US for a military intervention in Syria. Prince Bandar bin Sultan, the chief or Saudi intelligence, has offered to pay Washington for all expenses incurred during the intervention and some reports claim that he has threatened Vladimir Putin with terror attacks if Russia doesn’t give up supporting Bashar al-Assad. After the plans for the intervention failed, the Saudis made considerable efforts to show Washington their anger and disappointment.

The Daily Mail reports that “upset at President Barack Obama’s policies on Iran and Syria, members of Saudi Arabia’s ruling family are threatening a rift with the United States that could take the alliance between Washington and the kingdom to its lowest point in years. Saudi Arabia’s intelligence chief is vowing that the kingdom will make a ‘major shift’ in relations with the United States to protest perceived American inaction over Syria’s civil war as well as recent U.S. overtures to Iran, a source close to Saudi policy said on Tuesday.”

It is unlikely that diplomatic or political threats will impress or scare the Obama administration. However, the Saudis do have some economic leverage and some options to cripple the US finances. Fresh statements from the House of Saud indicate that the future of the “petrodollars” is uncertain. Reuters reports that “Saudi Arabia, the world’s biggest oil exporter, ploughs much of its earnings back into U.S. assets. Most of the Saudi central bank’s net foreign assets of $690 billion are thought to be denominated in dollars, much of them in U.S. Treasury bonds. All options are on the table now, and for sure there will be some impact,” the Saudi source said”. In theory, Saudi Arabia can crash the US bond market through a “fire sale” of its bond portfolio.

The impact on the US economy will be devastating, but House of Saud will have to pay a steep price for the crash. The value of its currency reserves will be wiped out and its main military ally will turn hostile. It is unlikely that the Saudis will take such risks. A more likely scenario is that the Saudis will start a slow diversification of their currency reserves and will invest more in Chinese and European assets. Such a move will not produce an instant crash but will surely damage the dollar over the long term. If the “petrodollars” disappear from the world oil trade, the dollar is likely to lose its status of the world’s main currency.

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