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Petrodollar
Context: With the The 50-year-old petrodollar agreement between the US and Saudi Arabia expired commentators predicted the end of the US dollar as the world’s reserve currency, suggesting the Chinese yuan could take its place.
Historical Context
- In 1973, amid significant economic and political uncertainty like the oil crisis, the US forged the petrodollar agreement with Saudi Arabia.
- This pact involved Saudi Arabia selling oil exclusively for dollars and reinvesting those dollars into US Treasury bonds to support American fiscal deficits.
- In exchange, Washington committed to supplying military equipment to Saudi Arabia and ensuring its national security, creating a notable “oil-for-security” relationship.
What is petrodollar and what does its withdrawal mean
- Petrodollars are oil export revenues denominated in U.S. dollars. Petrodollars are not a distinct currency; they are simply U.S. dollars accepted as payment by an oil exporter.
Impact of withdrawal of petrodollar:
- In the foreseeable future, the dollar’s dominance will remain.
- But a gradual democratisation of the global reserve currency may be underway, giving way to a world in which more local currencies like Chinese renminbi, the euro, and the Japanese yen can be used for international transactions.
Argument in support of end of petrodollar
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- Waning influence of the U.S. on the world stage, both economically and politically.The US debt has reached $31 trillion, with a budget deficit exceeding 16%, which many experts deem unsustainable.
- Since the American shale oil revolution and the pursuit of energy independence, traditional oil-producing allies like Saudi Arabia have sought alliances with countries such as China. This shift aims to lessen their reliance on US demand for their oil.
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- Saudi Arabia’s Yuan Oil Sales: Saudi Arabia’s decision to sell oil to China in yuan represents a significant blow to the petrodollar system.
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- China has sought to increase its geopolitical influence by forging economic and political alliances with numerous allies and investing in developing countries through the Belt and Road initiative. Eg 400 billion USD deal with IRAN.
- Russia’s Ruble Mandate: Russia has mandated the use of rubles for selling oil and gas to Europe, reducing the demand for dollars.
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- Even India and Russia have entered into an oil deal where transactions are conducted in Indian rupees.
- Over 90% of trade between China and Russia is now conducted outside the US dollar.
Argument against end of petrodollar
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- The U.S. dollar continues to enjoy greater preference for investment than any other country.
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- The year 2022-23 is an example of how investment funds rushed to U.S. shores after the Federal Reserve raised rates at short intervals, signalling high investor confidence in U.S. treasuries and the U.S. dollar.
- The Saudi Arabian government and wealth funds favour investments in the U.S. Treasury bills and imports of advanced American technologies, including Artificial Intelligence.
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- China’s Yuan hype :
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- The Belt and Road Initiative (BRI) has plagued partner countries like Sri Lanka, which have struggled to repay loans to China. This practice, known as “Debt-trap diplomacy,” has caused many countries to feel pressured.
- Chinese demand suffered due to the implementation of the zero-COVID policy, which imposed significant strain on the economy alongside a collapse in the real estate sector.
- China, with its heavily restricted markets and low-quality exports, does not possess a better investment prospect and trade partner than the U.S.
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Way forward
- The discussion surrounding the decline of the petrodollar and the emergence of the petroyuan is complex and multifaceted.
- Although China has made notable progress in expanding its global influence, the U.S. dollar remains dominant due to the strong economic and political foundations of the United States. If a transition to a new global reserve currency occurs, it will be a gradual process fraught with challenges.
- For now, the U.S. dollar continues to be the leading force in global finance.
- In order that a currency could replace dollar It must be freely tradable with a stable economy backing it, ensuring users can rely on its value and stability without concern about the issuing country.