How Petrodollars Affect the U.S. Dollar

Fact checked by Katharine BeerReviewed by Chip StapletonFact checked by Katharine BeerReviewed by Chip Stapleton

You may have heard the term “petrodollars” in the news from time to time. Petrodollars are not a currency; they’re simply U.S. dollars that have been exchanged for crude oil exports. The term rose to economic and political prominence in the mid-1970s amid growing interdependence between the U.S. and crude oil exporters.

Foreign oil exporters’ reliance on the U.S. dollar (USD) as the principal means of exchange and store of value reflected the dollar’s already established role as the global reserve currency, which continues without serious challenge to this day.

The dollar’s global stature and wide use stem from the U.S. economy’s leading global role and its openness to foreign trade and investment. These advantages proved irresistible to oil exporters, and their reliance on the dollar in turn extended its dominance.

Key Takeaways

• Petrodollars are dollars paid to oil-producing countries for their exports.
• The petrodollar emerged as an economic concept in the 1970s as growing U.S. imports of increasingly costly crude oil increased the dollar holdings of foreign producers.
• Petrodollar recycling is the reinvestment of crude oil export revenue denominated in dollars.
• The dollar’s status as the leading global currency preceded petrodollar’s rise and has continued amid increased U.S. energy production and widening current account deficits.

Why Petrodollars Matter

Petrodollars are U.S. dollars earned by countries through the sale of oil and other petroleum products. They have significant implications for the U.S. economy and the strength of the dollar. Here’s a comprehensive explanation of their importance:

• Global oil trade in U.S. dollars: Since the 1970s, the vast majority of international oil transactions have been conducted in U.S. dollars. This means that countries need to hold U.S. dollars to purchase oil, creating a consistent demand for the currency.
• Recycling of petrodollars: Oil-exporting countries often invest their excess U.S. dollars in U.S. Treasury securities and other dollar-denominated assets in order to keep them safe while earning a return. This process, known as petrodollar recycling, helps finance the U.S. government’s budget and trade deficits.
• Increased demand for U.S. dollars: The global oil trade’s reliance on the U.S. dollar increases the currency’s demand, helping to maintain its value and status as the world’s primary reserve currency.
• Lower borrowing costs for the U.S.: The increased demand for U.S. Treasury securities from oil-exporting countries helps keep U.S. interest rates lower than they might otherwise be, benefiting the U.S. government and consumers. That is because as bond prices like Treasuries are bid up, their yields naturally fall.
• Geopolitical influence: The petrodollar system gives the U.S. a degree of leverage over oil-exporting countries, as they rely on the stability of the U.S. dollar and have a vested interest in maintaining the currency’s strength.

The petrodollar system has provided significant benefits to the U.S. economy, helping to maintain the dollar’s value and its status as the world’s primary reserve currency. However, it also creates dependencies and potential risks that policymakers must consider when making economic and geopolitical decisions.

The term “petrodollar” was first coined by Ibrahim Oweiss, a professor of economics at Georgetown University, in 1973.

Rise of the Petrodollar

The Bretton Woods system of fixed currency exchange rates tied to gold through the U.S. dollar collapsed in 1971 because the global economy and its demand for safe assets outgrew the available supply of bullion.

Only the dollar could realistically fill that void, and as the global supply of dollars grew amid U.S. trade and budget deficits, so did the accumulation of petrodollars earned by oil exporters benefiting from sharply higher crude oil prices.

Exporters accepted dollars because they had no alternative: it was the currency of their leading customer and, even more importantly, the currency of international trade and finance. Growing mutual dependence led to deals between the U.S. and Saudi Arabia setting the terms for the reinvestment of Saudi petrodollars in U.S. Treasuries in 1974 and for U.S.-run development projects in Saudi Arabia in 1979.

The development of oil and gas reserves outside the Middle East starting in the late 1970s eventually spread the petrodollars around to new exporters like Norway, whose sovereign wealth fund was worth $1.4 trillion at the end of 2021 and held nearly 1.5% of all publicly listed global equities.

Returns on Petrodollar Recycling

The most important benefit from the reinvestment of petrodollars in the U.S. and abroad was that it allowed business to proceed as usual. Foreign oil exporters could keep supplying crude and get paid in the most useful currency, while the U.S. maintained its economic, financial, technological, and military pre-eminence.

The rise of the petrodollar forced the U.S. to share political and economic power with the developing countries supplying its energy. In addition to development projects and cross-border investment flows, the petrodollar also financed U.S. weapons exports that accelerated the Mideast arms race.

The petrodollar extended the dollar’s global dominance by fueling demand for dollar-denominated investments outside the U.S., including in the burgeoning eurodollar market.

$888 Billion

The global net oil export revenue from OPEC members in 2022, according to the U.S. Energy Information Association.

Risks to the Petrodollar

There are, however, potential risks. If oil-exporting countries decide to accept other currencies for oil or invest their reserves in other assets, it could weaken the demand for the U.S. dollar and potentially undermine its status as the global reserve currency. This could happen, for example, due to scalating geopolitical tensions between the U.S. and oil-exporting countries, as these countries may seek to reduce their dependence on the U.S. dollar

This has already begun to happen in certain cases. In 2018, China launched its first crude oil futures contract denominated in yuan, with the intention of creating an alternative “petroyuan” to the petrodollar system. Russia has also been working to reduce its dependence on the U.S. dollar, with President Vladimir Putin stating in 2019 that the country was aiming to “de-dollarize” its economy. Putin has doubled down on this following Russia’s invasion of Ukraine, remaining a leading oil exporter despite economic sanctions. Iran and Venezuela, also faced with U.S. sanctions, have turned to other currencies for oil transactions. Iran has been accepting euros, yuan, and other currencies for its oil for years already, while Venezuela has been using the euro and the Chinese yuan.

Aside from geopolitics and de-dollarization abroad, as the world moves towards cleaner, green and renewable energy sources, the demand for oil may decrease over time. This could eventually lead to a reduction in petrodollar flows as the demand for oil and its importance as the core energy commodity around the world wanes.

Doomsday Predictions vs. Reality

There’s an inherent tension between global demand for investable assets denominated in a widely used currency and the likelihood that issuing such liabilities in volume over time will dent the issuer’s creditworthiness, eroding confidence in its currency. The conundrum, first outlined by economist Robert Triffin in 1960, is now known as the Triffin Dilemma.

In practice, the advantages of a dominant reserve currency accrue to users immediately, while the drawback Triffin identified manifests at a glacial pace with unpredictable timing. The British pound accounted for 30% of global foreign exchange reserves as late as 1968, nearly a century after the U.S. supplanted the U.K. as the largest global economy.

As of 2023, the U.S. economy still accounted for nearly a quarter of global GDP and was more than 40% larger than its nearest rival, China. The U.S. also maintains world’s largest current account deficit. As Triffin noted, a large current account deficit is unavoidable for the issuer of a reserve currency.

Global economies continue to evolve in ways that can ease stresses on the system. For example, the U.S. became a net oil and petroleum products exporter in recent years, reducing the flow of “petrodollars” in favor of plain old dollars accruing to oil-producing states like Texas. The reshoring process, which gained extra impetus amid supply chain disruptions caused by the COVID-19 pandemic, could eventually slow or even reverse the growth of the U.S. trade deficit.

How Did the Global Oil Trade Settle in U.S. Dollars in the First Place?

Following the collapse of the Bretton Woods system in 1971, which ended the U.S. dollar’s convertibility to gold, the value of the dollar began to decline. In an effort to stabilize the dollar and maintain its global dominance, the U.S. formed a series of strategic agreements with Saudi Arabia and other OPEC countries. These agreements, though not explicitly mandating the use of dollars for oil transactions, created a system where oil-exporting nations would price their oil in dollars, invest their surplus dollar reserves in U.S. Treasuries, and purchase U.S. goods and services. In return, the U.S. tacitly provided military protection and access to its markets. As a result, the dollar became the default currency for oil transactions, cementing its status as the world’s reserve currency. This arrangement benefited both the U.S. and oil-exporting countries, as it created a stable demand for dollars and provided a reliable investment vehicle for oil revenues.

How Much of the World’s Oil Trade Is Priced in U.S. Dollars?

As of 2023, approximately 80% of the world’s oil transactions are priced in U.S. dollars.

Did Saudi Arabia Drop the Petrodollar?

In June of 2024, a news story made headlines claiming that Saudi Arabia failed to renew a secret 50-year deal with the U.S. to keep oil priced in dollars, which was not entirely accurate. It is true that the U.S. and Saudi Arabia established a Joint Commission for economic cooperation in June 1974, which aimed to help Saudi Arabia spend its sudden influx of dollars on American products. In July of the same year, Saudi Arabia agreed to invest oil dollars in U.S. Treasuries, although this agreement was kept confidential until 2016. However, Saudi Arabia at the time was mainly exporting its oil in exchange for British Pounds, and remained doing so for years after.

However, in the early 2020s, Saudi Arabia indicated a willingness to negotiate oil sales in other currencies as well. This possibility has little impact on financial markets, as the Saudi riyal remains pegged to the dollar, and the country’s financial assets are primarily dollar-focused. The dollar’s reserve status depends more on how money is stored than on how transactions are denominated.

The viral story, which seems to have originated in the crypto world, is an example of confirmation bias among those eager to see the dollar’s decline. However, the petrodollar system’s demise is not as imminent as suggested, and the U.S. dollar’s strength remains secure, despite the gradual diversification of global reserves.

The Bottom Line

The rise of petrodollar oil export earnings reflected and further entrenched the primacy of the U.S. dollar in global trade and investment. Big gains in domestic energy supply have diminished the U.S. economy’s reliance on oil imports, and petrodollar reinvestment. Meanwhile, the global economy remains deeply dependent on the dollar as a reserve currency.

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