Since arriving at the Oval Office, the Trump administration has worked to tackle the United States’ massive trade deficit by pursuing aggressive tactics, especially towards China. Aimed at revising previously established trade deals and establishing tariffs, is tactics reinforce his pompous beat that “countries have been taking advantage of the United States for many years and this is the president that has stopped it.”
Amidst this trade turmoil, China has taken steps to negotiate a potential economic deal that could harm United States’ economic, social, and political supremacy. The deal regards increased Chinese influence over oil and the petrodollar, a term conceived in the 1970s to describe surplus US dollars oil importers receive, which are then used to invest in US markets and other developing nations.
Most importantly, the petrodollar creates a strong pillar for the United States’ economy as it ensures that nearly all barrels of oil sold on the world marketplace are bought using US dollars, a situation which keeps the U.S. dollar relevant in the world market. Recent conversations between Saudi Arabia and China have dealt with lifting the dollar off oil and replacing it with China’s national currency, the yuan. This motion directly threatens the petrodollar influence on the world and could lift the roof off steady inflation in the United States, create unsupported national deficits, and stir economic turmoil in the United States.
What is the Petrodollar?
Understanding the potential consequences of Saudi-China negotiations requires an understanding of the petrodollar, its origins, and its effect on U.S. monetary and political policy. The petrodollar, better understood simply as the U.S. currency used and received as the only medium through which all world oil transactions are made, gives regimes such as Saudi Arabia a vast trade surplus in dollars due to its immense portion of the oil market. These US notes are then invested in US Treasury markets and in markets of other debtor countries or developing nations.
The petrodollar reflects a relationship between oil and the dollar but originates less as much from oil as it does from United States international monetary policy and aid measures. These measures, active especially during the 1960s, resulted in the outflow of dollars from the US even though John F Kennedy and Lyndon Johnson passed laws attempting to restrict foreign lending and disincentivize foreign investment. This later part was mainly due to the Bretton Woods System, which created a fixed relationship between the value of the dollar and other currencies.
As all these policies gradually led to an overvalued dollar, then-president Richard Nixon, in August of 1971, proposed tax cuts and a 90 day freeze on prices and wages. Lastly, with gold reserves struggled to keep pace with the dollar, Nixon announced that he would suspend the use of the gold standard. This move shocked the world and led to a steep devaluation of the dollar. Soon after, in 1974, the petrodollar was created as oil replaced the recently-detached gold medium as a way to regulate the dollar. Except, in this case, oil would grow seemingly without regulation and would soon become the most ubiquitous commodity in the world.
From another perspective, Saudi Arabia and other oil exporting nations are using their trading surpluses to fund the national debt of the United States, other oil-exporting nations, and that of the developing world. Since 1978, the importance of the US dollar in a process called petrodollar-recycling is two-fold: The Saudi government helps fund United States debt and keeps the dollar powerful by creating a constant demand for the dollar in international markets, even though the United States runs multi-billion dollar deficits and continues to print an exorbitant amount of dollars. Matching the large supply of U.S. dollars with demand is crucial for inflation control, which is the most valuable asset for the US in this petrodollar deal. Recent history has proved the lengths at which the US will go to protect the deal.
In 2000, Saddam Hussein, then-president of Iraq, announced that Iraq was moving to sell its oil in euros instead of dollars. At the time, Baghdad oversaw the sale of $60 million of crude oil a day, which was about 5 percent of world oil exports. This was an explicit threat to the petrodollar and United States economic dominance, and would green light other Arab nations to change the nature of their oil transactions.
Protectionism of the petrodollar can be an ulterior motive that explains US intervention into oil-exporting nations. In the years after Saddam’s announcement, President George Bush asserted that his regime possessed weapons of mass destruction. Following 9/11, the United States invaded Iraq, deposed Saddam Hussein, and converted Iraqi oil sales back to the U.S. dollar. This exact pattern was repeated with Muammar Gaddafi when he attempted to create a unified African currency backed by Libyan gold reserves to to sell African oil. Shortly after his announcement, rebels armed by the US government and allies overthrew the dictator and his regime. After his death, the idea that African oil would be sold on something other than the dollar quickly died out.
In order to stabilize the petrodollar, the United States also needs a stable Middle East. Sanctions are one way to control Middle Eastern affairs. Because oil is found in so many aspects of world operations, major world deals are made in dollars and pass through American-connected banks, allowing the U.S. government to monitor, control, and sanction such deals. Paired with the immense sale of arms and weapons to Saudi Arabia, the United States provides countless incentives for the Saudis to stay in the deal, helping Saudi Arabia remain a prominent Middle Eastern power.
In the end, the linchpin of this relationship is Saudi Arabia’s confidence in the United States dollar, as it indicates the weight of the Saudi’s trade surplus power. If these conditions are fulfilled, any cheating or straying from Saudi Arabia’s under-the-table agreement would be illogical and detrimental. However, the United States’ continuing trade and fiscal deficits are weakening the dollar and Saudi petrodollar holdings. Combine this with the unforeseen rise of China and conciliatory actions by China towards Saudi Arabia, and the United State’s petrodollar is in obvious trouble.
Earlier this year, the Chinese Ambassador Li Huaxin was pictured with Saudi officials as he praised Saudi Arabia’s Vision 2030, which calls for stronger economic cooperation between the two nations. This pact pressures Saudi Arabia to adopt the “petro-yuan,” which would effectively axe the petrodollar. Although Saudi Arabia relies heavily on U.S. military power, Saudi Arabia warming ties with China closeness are alarming. China’s growing economy and standing in the world could undermine the attitude towards the United States. Above anything else, a shift in alliances could threaten America’s standing in the Middle East and world.
The prospective decline of American power through the destabilization of the petrodollar could disrupt a balance of power that has ensured relative world peace since the Cold War. A weak US economy would leave the nation with a weaker and drive a new dual-hegemony between Russia and China, who signed an Eurasian Economic Cooperation pact on May 17th in Astana. As Russia continues to “heat” Europe through its natural gas reserves, which are not sold via the dollar, taking global energy off the dollar – by taking it off of oil altogether – is a future possibility.
In the last few months, the United States’ reaction to the Chinese-Saudi Arabia negotiations have been rather quiet with little report to no media attention . With President Trump’s continued rhetoric and talk, it is clear that tariffs and a trade war will be of continual focus, at least much more relative to the possible attack at the petrodollar, and indirectly, at inflation in the United States.
Time will tell if President Trump continues with the United States’ historic and desperate protectionism of the petrodollar. However, as other nations like China and Russia rise to power, America should be weary of confrontation in this region. In the end, America has an interesting competitive advantage in its petrodollar deal with regional powers like Saudi Arabia. A final wild card–better energy technology and natural gas, especially from Russia and Iran–can weaken OPEC supremacy over the oil market, and thus the petrodollar. However, this is not as dangerous as Chinese intervention into crushing the petrodollar. Nevertheless, with a trade war ensuing, a new battle is in the horizon and time will tell what happens.
Image Credit: Milad Mosapoor/Wikimedia Commons