Petrodollars and the System that Created It
Petrodollars and the System that Created It
Will the Petrodollar Collapse?
By Kimberly Amadeo Updated May 28, 2019
The petrodollar is any U.S. dollar paid to oil-exporting countries in exchange for oil. Since the dollar is a global currency, all international transactions are priced in dollars. As a result, oil-exporting nations must receive dollars. Most of them own their oil industries. That makes their national income dependent on the dollar's value. If it falls, so does their revenue.
As a result, most of these oil exporters also peg their currencies to the dollar. That way, if the dollar’s value falls, so does the price of all their domestic goods and services. That helps these countries avoid wide swings in inflation or deflation.
Petrodollar System
The petrodollar system is tied to the history of the gold standard. The 1944 Bretton Woods conference established the U.S. dollar as the world's reserve currency. After World War II, the United States held most of the world's supply of gold. It agreed to redeem any U.S. dollar for its value in gold if the other countries pegged their currencies to the dollar.
On February 14, 1945, President Franklin D. Roosevelt formalized an alliance with Saudi Arabia. He met with Saudi King Abd al-Aziz. The United States built an airfield at Dhahran in return for military and business training. It also cemented the relationship between the dollar and oil. The petrodollar was born. This alliance was so critical that it survived differences of opinion over the Arab-Israeli conflict.
In 1971, U.S. stagflation prompted the United Kingdom to redeem most of its U.S. dollars for gold. President Nixon removed the dollar from the gold standard to protect the remaining U.S. gold reserves.
As a result, the value of the dollar plummeted. That helped the U.S. economy as its export values also decreased, making them more competitive.
A falling dollar hurt oil-exporting countries because contracts were priced in U.S. dollars. Their oil revenue dropped along with the dollar. The cost of imports, denominated in other currencies, increased.
In 1973, Nixon asked Congress for military aid to Israel in the Yom Kippur War. The newly-formed Organization of the Petroleum Exporting Countries halted oil exports to the United States and other Israeli allies. The OPEC oil embargo quadrupled the price of oil in six months. Prices remained high even after the embargo ended.
Petrodollar Recycling
In 1979, the United States and Saudi Arabia negotiated the United States-Saudi Arabian Joint Commission on Economic Cooperation. They agreed to use U.S. dollars for oil contracts. The U.S. dollars would be recycled back to America through contracts with the U.S. companies.
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