How Petrodollars Affect the US Dollar

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

Since the 1970s, the global oil trade has been predominantly conducted in U.S. dollars (USD), creating a symbiosis between America’s currency and the world’s most traded commodity. This arrangement, known as the petrodollar system, has been a cornerstone of U.S. economic dominance for decades. However, recent geopolitical shifts and the rise of alternative payment systems have tried to challenge this long-standing model.

Oil exporters’ reliance on the U.S. dollar 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. The USD stands at about 58% of the world’s reserve currencies, down from more than 70% at the beginning of the century, but still far higher than competitor currencies.

The dollar’s global stature and wide use stem from the U.S. economy’s leading global role and openness to foreign trade and investment.

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 dollar’s strength. Here are elements of their significance:

• Global oil trade in U.S. dollars: Since the 1970s, most international oil transactions have been conducted in U.S. dollars. Countries thus need to hold U.S. dollars to buy 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 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 has increased demand, helping 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’s because as bond prices rise, their yields naturally fall.
• Geopolitical influence: The petrodollar system gives the U.S. a degree of leverage over oil-exporting countries, which rely on the stability of the U.S. dollar and have a vested interest in maintaining its strength.

The petrodollar system has significantly benefited the U.S. economy, helping maintain the dollar’s value and status as the world’s primary reserve currency.

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.

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

Only the dollar could realistically fill that void. 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 higher crude oil prices.

Exporters accepted dollars because they had no alternative: it was the currency of their leading customer and, more importantly, the currency of international trade and finance. The alliance between the U.S. and Saudi Arabia set the terms for the reinvestment of Saudi petrodollars in U.S. Treasurys 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 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 almost 1.5% of all publicly listed global equities.

Returns on Petrodollar Recycling

The most significant benefit of reinvesting petrodollars in the U.S. and abroad is that it allowed business to proceed as usual. Foreign oil exporters could keep supplying crude and get paid in the most tradable currency, while the U.S. got to maintain its economic, financial, technological, and military preeminence.

The rise of the petrodollar forced the U.S. to share political and economic power with the developing countries that supplied its energy. In addition to development projects and cross-border investment flows, the petrodollar financed U.S. weapons exports, accelerating 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, risks. If oil-exporting countries decide to accept other currencies for oil or invest their reserves in other assets, that could weaken demand for the U.S. dollar and undermine its status as the global reserve currency. This could result, for example, from escalating 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. In 2018, China launched its first crude oil futures contract denominated in yuan to create an alternative “petroyuan” to the petrodollar system. Russia has also been working to cut its dependence on the U.S. dollar, with President Vladimir Putin stating in 2019 that the country was aiming to “de-dollarize” its economy. This plan got U.S. buy-in of sorts when Russia’s invasion of Ukraine in 2022 prompted a U.S.-led global sanction regime against Russia that shut it out of the dollar and euro-based exchange systems. Russia’s economy has since done better than many analysts expected, but no country would want the calamities its economy has faced in the meantime.

Iran and Venezuela, facing U.S. sanctions in the last decade, have turned to other currencies for oil transactions. Iran has accepted euros, yuan, and other currencies for its oil for years, while Venezuela has used the euro and the Chinese yuan. The politicization of dollarization—the American use of the powerful dollar to punish so-called “rogue” regimes—has led to a backlash, but the petrodollar system remains firmly in place.

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

Doomsday Predictions vs. Reality

In economics, there’s what’s known as the Triffin Dilemma, named for the economist, Robert Triffin, who first suggested it in 1960. The Triffin dilemma refers to the conflict of economic interests that arises for a country whose currency serves as the world’s reserve currency. Specifically, it describes the tension between the following:

1. The need to supply the world with enough of the reserve currency to facilitate global trade and growth.
2. The requirement to maintain confidence in the value and stability of that currency.

The dilemma arises because these two goals are often at odds: issuing more currency can undermine its value, while maintaining its value can restrict global liquidity. If it’s too valuable, it’s not good as a global currency; if it falls in value, it’s better for liquidity but less attractive otherwise.

In practice, the advantages of a dominant reserve currency accrue to users immediately, while the drawback Triffin identified happens, if at all, at a glacial pace with unpredictable timing. The British pound accounted for 30% of global foreign exchange reserves as late as 1968, almost 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 almost a quarter of global gross domestic product—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 stress on the system. For example, the U.S. has been a net oil and petroleum products exporter in recent years, reducing the flow of “petrodollars” in favor of 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.

Saudi Arabia and the PetroDollar: A Misinformation Story

In mid-2024, inaccurate headlines claimed that Saudi Arabia failed to renew a secret 50-year deal with the U.S. to keep oil priced in dollars. In 1974, the petrodollar era began when the U.S. and Saudi Arabia agreed on an alliance—the agreement was officially secret until 2016. This is well known. However, it was never the case that Saudi Arabia decided to sell its oil exclusively in USD; its main currency in the mid-1970s, for example, was the British pound.

However, Saudi Arabia had increasingly denominated much of its oil transactions in USD in the ensuing decades. This changed in the early 2020s as the kingdom began negotiating oil sales in other currencies. But this is six and one-half dozen of another: the Saudi riyal remains pegged to the dollar, and the country’s financial assets are primarily denominated in dollars. The dollar’s reserve status depends more on how money is stored than 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; there’s profit for many out there holding crypto and other assets if others can be convinced to put their dollars there instead. Always treat such stories skeptically: while events happen, the U.S. dollar has what cryptocurrencies won’t have for a long time, if ever—a vast global system premised on its success. Yet, these types of stories form the background for numerous scams, leading to enforcement actions by the U.S. Securities and Exchange Commission and the U.S. Department of Justice.

The petrodollar system’s demise is not looming, and the U.S. dollar’s strength remains secure despite the gradual diversification of global reserves.

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 dollar’s value began to decline. The U.S. formed a series of strategic agreements with Saudi Arabia and other OPEC countries to stabilize the dollar and maintain its global dominance. Though not mandating using dollars for oil transactions, these agreements created a system where oil-exporting nations would price their oil in dollars, invest their surplus dollar reserves in U.S. Treasurys, and buy 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.

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.

Is the Petrodollar a Separate Currency From the U.S. Dollar?

No. Petrodollars are the name that is used to describe dollars that are received in exchange for oil exports.

The Bottom Line

The petrodollar system has been a crucial pillar of U.S. economic strength for almost half a century, creating a symbiotic relationship between the global oil trade and the value of the American dollar. This arrangement has ensured a consistent demand for U.S. currency and Treasury securities, allowing America to maintain lower interest rates and finance its deficits more easily.

A decline in the petrodollar system would have far-reaching consequences for the U.S. economy and the international financial order. A shift away from dollar-denominated oil trades could reduce demand for USD, potentially leading to a weaker dollar, higher interest rates, and increased borrowing costs for the U.S. government and consumers. Moreover, it could accelerate the transition to a more multipolar global financial system, altering the balance of economic power and reshaping international trade relationships. Over time, the percentage of the world’s reserve currencies in USD have diminished, yet no currency is rising to take its place—far from it.

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