Transcription
The entire petrodollar system is supposedly once again under threat now that Iran floated asking tankers passing through the Strait of Hormuz to pay in Chinese yuan rather than in dollars. There's just one tiny problem, though. If you just look at the numbers, the entire idea of the petro dollar system quickly reveals itself as the biggest myth in geopolitics.
That being said, as with any good myth, there are, of course, some elements of truth to it. For example, it is true that in the summer of 1974, the US under Nixon and Saudi Arabia under King Faisal, signed one of the most economically and geopolitically relevant agreements of the 20th century, which saw the establishment of a so-called US-Saudi joint commission on economic cooperation. However, for a long time, the details of that agreement were a secret, which is probably how we ended up with the myth of the establishment of the petrodollar system in the first place.
And it roughly goes like this: In 1971, Nixon abandoned the gold standard, creating significant US dollar volatility and inflation in the United States. Then in 1973, the US was hit by a big oil crisis, which was caused primarily by Saudi Arabia and on other Arab nations that cut supply in general and embargoed oil to any nation who supported Israel in their war against Syria and Egypt. And as you can see here, that caused a massive spike in oil prices, fuel shortages in the US, and it significantly raised inflation.
Then we get to our famous agreement. In 1974, the US and Saudi Arabia signed it, which stated that from the Saudi side, they would only sell in US dollars. Number one. And then point number two, they would invest those dollars into the United States itself, and this would be called recycling petro dollars, and these were then recycled into US banks and treasuries. But of course, this would not be for free. On the other hand, the US would defend Saudi Arabia and help them to get started economically. 1974 was the start of the petrodollar system. The US dollar was now backed by oil and this cemented the US dollar's status as the unquestioned global reserve currency. The importance of the petrodollar could then also explain that every time a nation like Iran or Iraq or Venezuela announced that they would start selling oil in another currency, the US would put a stop to this because of course this undermined the fundamental power of the US dollar.
Very convincing sounding story. And while the story about the founding of the petrodollar system is at least a little bit closer to the truth than the modern-day petrodollar story, the fundamentals underlying it are still a big fat myth. And how do we know? Well, luckily for us, Bloomberg News requested the release of the exact details of the US-Saudi 1974 deal in 2016 under the US Freedom of Information Law.
So, what does it say? Well, here are the previously confidential documents detailing how the Nixon administration believed that this deal would work and why it would help America. It says "the commission was established on the heels of the Arab oil embargo and price increases. The embargo emphasized that closer US Arab ties were needed. The oil price increases gave Saudi Arabia a substantial amount of petrodollars which could be used for development purposes." So, two things stand out to me. Focus on price increases, and then number two, we already have a mention of petrodollars here. So, petrodollars themselves are not a myth.
Continuing the commission was perceived as an important mechanism for number one, fostering closer political ties between the two countries through economic cooperation, assisting Saudi industrialization and development, while there we have it, recycling petrodollars. So recycling petrodollars is absolutely in there. And then number three, facilitating the flow to Saudi Arabia of American goods, services, and technology. And then finally, it says, "In helping the Saudis to find a way to invest their large and growing financial reserves, we will give them added incentives to continue to produce oil in the quantity needed to meet world demand. And this is crucial: "at a stable and hopefully lower price levels."
So, takeaway number one, what really stood out to me, no mention at all whatsoever in these documents of the Saudis committing to pricing oil in US dollars or the US finding this important. It was not important. And this is actually backed up by other evidence presented by the Yaw Asamoah Substack which found that the Saudis actually kept accepting British pounds for oil for quite a while after the 1974 agreement, which we now have seen is not surprising given that it was not part of that agreement.
So in summary, what is myth and what is reality when it comes to the establishment of the petrodollar system? Well, first, let's look at what the US gives according to the myth: economic development and security. And according to reality, yeah, that's also the case. But then here are the major differences Saudi gives. Well, recycling petrodollars and reducing borrowing costs potentially for the US. Yeah, that was definitely in there. But what was absolutely not in there is US dollar transaction exclusivity not the case. The thing that was in there clearly a couple of times was oil price stability. And this is crucial because it changes the story about the US motivation for this agreement completely. The myth is: it was about supporting the dominance of the dollar. Not true at all. What matters is oil price stability. And this will honestly make a lot of sense once we start looking at the other supporting data.
The US did not need to make some fancy deal for people to price their oil exports exclusively in US dollars. The South American copper men were already invoicing their exports in dollars. The European industrialists, the Japanese industrialists, all of them invoiced their exports in dollars mostly already. And everyone did it because by 1974, the dollar was already the undisputed global reserve currency. It's actually more likely that this dominance had been cemented by something called eurodollars rather than by petrodollars. But if you want to learn more about that, I have to refer you to potentially the best economics course that I've ever taken. And that is now available via our advertising sponsor, Coursera. That's right. My favorite course available via Coursera Plus is one I've completed myself many years ago, The Economics of Money and Banking by Columbia professor Perry Mehrling. And for people who watched my channel for a long time, well, they know I think that the only way to really understand money is through balance sheets. And well, this Coursera course is all about that and really helped me out understand that as well. But honestly, there's much more here. My other top two recommendations are courses by one of my favorite behavioral economists, and his name is Professor Robbert Shiller from Yale. These courses are financial markets and narrative economics. And honestly, that's just the beginning. Coursera has well over 10,000 courses from world-class university professors. And on top of that, if you want to learn genuinely useful skills for work, they have state-of-the-art courses by very prestigious partners like Google, IBM, Microsoft, and Meta. So, if you want to truly dive into the real reason that the dollar is so dominant and how it works, go subscribe to Coursera Plus and sign up for my recommended courses in the top comment below or in the description of this video.
But for now, for this video about why the petrodollar system is the biggest myth in geopolitics, it's enough to know that the establishment of the Eurodollar market had helped create the following situation around the time of the petrodollar deal. Around 1976, we can see that the US as part of official central bank reserves, the US dollar was absolutely dominating all other currencies, including the British pound. So the US dollar was already very much the dominant reserve currency. And the second part of the puzzle is that if we look at the main reserve asset, US treasuries in the 1980s when it was actually at its peak, the Saudis had been buying a lot of them and also the other Gulf countries. If we then look at US dollar treasuries, we can see that the Saudis and other Gulf countries really only held a very very very very small part of treasuries. So they were actually not that important holders of US debt.
So crucially, the US dollar did not need the oil exporters. It was actually the other way around. The oil exporters needed the US dollar because US financial markets were the only financial markets in the world that were easily able to absorb the billions and billions that the Gulf countries were earning from oil. In other words, having only this tiny tiny fraction of US treasuries, that is great news if you are a Saudi central banker or treasurer because it means that if you get into trouble and you need to sell all of these dollars to wage a war or something like that, then you can just sell it all and the price of the asset will not drop at all. On the other hand, had you invested in British government debt, you may have caused a massive British government debt crisis if there was a crisis in the Gulf and you had to sell all of it.
So yes, the 1974 US-Saudi agreement changed the world of geopolitics by making the US the protector of the Gulf States and the 1974 agreement also changed the global economy because it led to lower and more stable oil prices than would otherwise have been the case. So, talking about oil-producing countries accepting other currencies than the dollar being a threat to the reserve currency status of the US dollar, that actually from the beginning on was always simply wrong.
But today it's even more ridiculous than ever for two big reasons. Reason number one, oil is actually far less important in our economies today than it was in the 1970s. For example, at the height of the 1979 oil crisis, oil transactions accounted for about 13 to 15% of the American economy. But today, that's only about 5 to 7% of US GDP. The reasons are simply that our economies got way more efficient about using oil. For example, cars today use roughly half the amount of petrol per mile or kilometer as they did in 1975. Also, if we look internationally, we can see that these bars here represent so-called current account surpluses or trade surpluses by major oil producers, earning them dollars. And they used to be very significant. Absolutely. But today we can see that these are just absolutely dwarfed by the East Asian manufacturing surpluses. These are far more important sources of dollar demand today.
Next, reason number two, the petrodollar myth is even more ridiculous than ever today. Have a look at this incredibly important chart. And what you see here are, in the blue line, US energy imports and US energy exports in orange. And of course, there used to always be a massive, massive difference. The US was the biggest oil importer in the world. But since 2020, that situation has changed. The US is now a net oil exporter. So even if at some point it was nice for the US to have petrodollars be invested back into the US and then they could potentially then use them to continue importing all of that oil, that story today is absolutely no longer true.
But okay, this oil deficit was still the case for decades. So maybe the US used petrodollar recycling to finance their imports for decades and now the oil-exporting Gulf countries own much more of US debt than they did in 1980. I thought this was fairly plausible. A lot can happen in 40 years, after all. And we know that the Gulf countries' wealth funds are absolutely massive. They have trillions in US debt and equities. That's absolutely true. And, for my video on the Gulf economies, for example, I calculated that they can survive a complete blockade for years because of how insanely rich they are, and that's truly unique across global economies. So, does the US depend on Gulf petrodollars that were invested between the 1980s to 2020? When it comes to treasuries, the answer is absolutely clearly: no. That's not the case. Saudi Arabia, the biggest oil exporter, is all the way down the list, behind so many economies that we barely talk about in geopolitics. Um, India, Taiwan, Ireland, Luxembourg, Belgium, the United Kingdom, and Japan, they all have far far higher holdings of US debt.
But okay, quite famously, the Saudis have switched to equities. So, let's have a look at equities. The stock market as well. The Gulf countries are massive investors there, for sure. But US stock markets are worth $72 trillion US dollars, and if we look at the wealth of all wealth funds and central banks in the Gulf, we get about $4 trillion combined. And not all of that has been invested in stocks. It's been estimated that they combined about 1% of the US stock market. So while petrodollar recycling still happens, it's real. The US clearly does not need petrodollars, the petro states simply have no better place to store their wealth than the gigantic US markets.
And just as the final icing on the cake to disprove once and for oil that the petro dollar is still a thing. The blue bar over here is the size of the entire oil market in 2025, which was about $3 trillion. That's a lot. Absolutely. It's a massive market. But if we look at foreign exchange markets, then we can see that their size traded per day was 9.6 trillion, and that is per day. Okay, that's per day. Oil markets in a year are smaller than foreign exchange markets in a day. So what happens if we look at a year for both of them? Well, given that foreign exchange markets are open for about 260 days, uh that means that their size is about $2,496 trillion US versus $3 trillion on an annual basis for oil markets. It is barely visible in our graph as a percentage of foreign exchange markets.
So in conclusion, the petrodollar story is the biggest myth in geopolitics. The US dollar status as the world reserve currency is not at all determined by oil producers invoicing in dollars. Yes, the 1974 deal was important, but it was about oil price stability, never about US dollar dominance. It was already dominant by the time. Sure, petro dollar recycling was mentioned in the agreement, but even in the 70s and 80s, petrodollars from the Gulf were only ever just a fraction of total US investments. And fast forward to today, we see that the petrodollar support for the US dollar argument is even more ridiculous than ever. Despite, of course, being still important, well, clearly very important, it's far less important for the global economy today than it was back then. That's reason number one why it's ever more ridiculous. And then second, the US is now a major oil exporter rather than importer, which can explain why the original petrodollar deal, after being renewed for years between Saudi Arabia and the US is no longer in place, actually. Um, and the Saudis have started hedging their geopolitical bets during the breaks and accepting other currencies while the dollar is still dominant. And while it could lose that dominance, there are a lot of countries around the world that are looking to displace the dollar. If this happens, it would have absolutely nothing to do with the petrodollar.
But yeah, that's my take. What do you think? Let me know in the comments. And if you want to know the real details of how the global dollar system works, go sign up to the economics of money and banking via Coursera Plus in the link in the description or top comment below. And see you next episode.