What are petrodollars?

Petrodollars are US dollars paid to an oil exporting country for the sale of goods. Simply put, the petrodollar system is an exchange of oil for US dollars between the countries that buy oil and those that produce it.

The petrodollar is the result of the oil crisis of the mid-1970s, when prices reached record levels. It has helped to increase the stability of oil prices denominated in US dollars. The term regained notoriety in the early 2000s when oil prices rose again.

Although the petrodollars initially referred primarily to the money that the Middle East countries and the members of the Organization of the Petroleum Exporting Countries (OPEC) received, the definition expanded to include other countries these last years.

Understanding petrodollars

Petrodollars are oil revenues denominated in US dollars. They are the main source of income for many OPEC oil exporting members, as well as other oil exporters in the Middle East, Norway and Russia.

Because petrodollars are denominated in US dollars – or greenbacks – their true purchasing power depends on both the base rate of US inflation and the value of the US dollar. This means that petrodollars will be affected by economic factors in the same way as the US dollar. So if the value of the dollar goes down, the value of petrodollars also goes down, and so does government revenue.

History of the Petrodollar system

The origins of the petrodollar system go back to the Bretton Woods agreement, which replaced the gold standard with the US dollar as its reserve currency. Under the agreement, the US dollar was linked to gold, while other world currencies were linked to the US dollar. But due to massive stagflation, President Nixon announced in 1971 that the greenback would no longer be exchanged for gold to stimulate economic growth in the United States.

This led to the creation of the petrodollar system, where the United States and Saudi Arabia agreed to set oil prices in US dollars. This meant that any other country that bought oil from the Saudi government would have to exchange their currency for U.S. dollars before closing the sale. This led the other OPEC countries to follow suit and to assess their oil in American currency.

Key points to remember

  • Petrodollars are US dollars paid to an oil exporting country for the sale of oil, or simply an exchange of oil for US dollars.
  • Petrodollars are the main source of income for many OPEC members and other oil exporters.
  • Because they are denominated in US dollars, the purchasing power of petrodollars depends on the value of the US dollar. When the greenback falls, so do petrodollars.

Petrodollar recycling

The petrodollar system creates surpluses, called petrodollar surpluses. Since petrodollars are mainly US dollars, these surpluses lead to an increase in reserves in US dollars for oil exporters.

These surpluses must be recycled, which means they can be channeled to domestic consumption and investment, used to lend to other countries, or be reinvested in the United States through the purchase of bonds and bonds. from the Treasury. This process helps to create liquidity in the financial markets in the United States.

By investing their surpluses, these exporters reduce their dependence on oil revenues.

The collapse of the Petrodollar system?

With the decline in purchasing power of the greenback, some countries have started to debate the benefits of the petrodollar system. Countries like Iran, Russia and India have considered changing the base value of their exports in their own currency rather than the US dollar. (For related reading, see “How petrodollars affect the US dollar”)

At the end of 2020, China announced that it planned to switch to the price of oil in yuan. Because it is the world’s largest importer of oil, China sees it as a logical change to set the price for the most important commodity in the world.

[Important: Venezuela dropped the petrodollar in 2020 and began pricing oil in euros and the yuan.]

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