Non-Dollar Trading Is Killing the Petrodollar — And the Foundation of U.S.-Saudi Policy in the Middle East

BEIRUT — A profound transformation of the global monetary system is underway. It is being driven by a perfect storm: the need for Russia and Iran to escape Western sanctions, the low interest rate policy of the U.S. Federal Reserve to keep the American economy afloat and the increasing demand for Middle East oil by China.

The implications of this transformation are immense for U.S. policy in the Middle East which, for 50 years, has been founded on a partnership with Saudi Arabia.                  ESCAPING SANCTIONS

As economic sanctions are increasingly part of the West’s arsenal, those non-Western countries that are the target — or potential target — of such sanctions are devising a counterpunch: non-dollar trading. It would, in effect, nullify the impact of sanctions.

Whether in yuan or roubles, non-dollar trading — which enables countries to bypass U.S. claims to legal jurisdiction — will transform the prospects facing Iran and Syria, particularly in the field of energy reserves, and deeply affect Iraq which is situated between the two.

President Putin has said (in the context of reducing Russia’s economic vulnerabilities) that he views the dollar monopoly in energy trade as damaging to the Russian economy. Since hydrocarbon revenues form the most substantive part of Russia’s revenues, Putin’s desire to take action in this area is not surprising.

In the face of sanctions, Putin is seeking to reduce its economic dependence on the West. Russia has signed two “holy grail” gas contracts with China and is in negotiations to offer the latter sophisticated weaponry. It is also in the process of finalizing significant trade deals with India and Iran. All of this will be to the benefit of Iran, too: the Russians recently announced a deal to build several new nuclear power plants there.                                                                                                        THE RISE OF THE PETRODOLLAR

The dollar’s role as the world’s reserve currency was first established in 1944 with the Bretton Woods agreement. The U.S. was able assume this role by virtue of it then having the largest gold reserves in the world. The dollar was pegged at $35 an ounce — and freely exchangeable into gold at that rate. But by 1971, convertibility into gold was no longer viable as America’s gold resources drained away. Instead, the dollar became a pure fiat currency (decoupled from any physical store of value), until the petrodollar agreement was concluded by President Nixon in 1973.

The essence of the deal was that the U.S. would agree to military sales and defense of Saudi Arabia in return for all oil trade being denominated in U.S. dollars.

As a result of this agreement, the dollar then became the only medium in which energy exchange could be transacted. This underpinned its reserve currency status through the need for foreign governments to hold dollars; recirculated the dollar costs of oil back into the U.S. financial system and — crucially — made the dollar effectively convertible into barrels of oil. The dollar was moved from a gold standard onto a crude oil standard.

U.S. interest rates were then managed so that oil exporters (who formerly looked to gold as the basis of their reserves) would be indifferent to whether they stored their currency reserves, earned from oil exports, in U.S. treasuries, or in gold. The value was equivalent.

According to Sprott Global, a specialist U.S. energy consultancy: