The petrodollar is just a nickname given to the US Dollar as it is the primary currency used to trade oil, it is not its own physical thing. (1)
Why should I care about it?
Well, that is quite simple: Because countries trade oil in Dollars that creates a demand for US dollars. (2) Countries usually buy US debt and hold that so they can sell it for dollars when they need to buy oil. This demand for US dollars helps the USA borrow money much more cheaply compared to others, underpinning a large portion of the US’s hard and soft power.
Extra Information
History
The US Dollar became the world currency at the end of WW2 as the US economy was still intact after the war compared to the rest of the then “developed” world like the British Empire. The dollar was originally pegged to gold ($35/oz) but on the 15th August 1971 president Nixon decoupled the dollar from the gold standard (The Nixon Shock), (3) transitioning the world into the fiat currency model rather than the gold standard. So after this change the dollar remained strong, mainly because the US economy continued to boom, the government was considered trustworthy, and lots of global transactions were made in dollars.
With this the Dollar established itself as the Global Reserve Currency. However, in October 1973 the OPEC Oil Crisis, where OPEC countries stopped selling oil to countries supporting Israel in The Yom Kippur War, including the United States. (4) Oil prices shot up, 4x, and sent inflation through the roof in lots of “western economies”. So, the US and Saudi Arabia gradually moved towards trading in dollars through the 1970s with various agreements, in return for US military protection and support. (5) Other Gulf countries followed. This formed the Petrodollar system.
If you want to buy oil on the global market you then need:
- To get US Dollars
- Keep Dollar reserves ready
- Trade with the US, or hold US assets.
Creating constant global demand for the US Dollar. Which, provides benefits for the US:
- It keeps the Dollar strong as everyone needs it.
- Allows the US government to borrow easily and at lower Interest Rates.
- Allows the US to issue sanctions.
Petrodollar Recycling
With the dollars generated by the sale of oil on the global market, countries like Saudi Arabia then buy US Bonds and invest in the US, making it even stronger. (6)
Future
Russia and China are the big players here, as they have reached some agreements on oil trade in their native currencies, reducing reliance on the Dollar. There is also the BRICS, an intergovernmental organization of 11 major emerging countries, who represent 35% of global GDP (PPP) and 29% of nominal GDP (7). These countries are:
- Brazil
- China
- Egypt
- Ethiopia
- India
- Indonesia
- Iran
- Russia
- Saudi Arabia
- South Africa
- United Arab Emirates
The BRICS are not forming their own currency to challenge the Dollar but are making more and more deals in their native currencies to de-dollarize. Will explore this further in Global Reserve Currency.
However, moving away from the dollar system is not easy. Foreign holders of US treasury securities have a total of over $9.4 trillion, at the time of writing, held in reserves. (8) Switching away from this cannot happen overnight, and would of course have risks to it. So, could anything replace the Dollar? Likely contenders like the Yuan and the Euro both have their own issues, like market size and trust, hindering their ability to challenge the Dollar. Then with the might of the American military globally also reinforcing the dollar’s position as the Global Reserve Currency. I explore this in more detail in my Global Reserve Currency article.
Future Risks of a Declining Dollar
There are a few risks to watch out for.
- If more countries are moving away from the dollar over the long-term the dollar will become gradually weaker. Therefore, imported goods become more expensive (inflation).
- If there is less US debt being bought the premium to service that debt will be greater than what it is. This would make mortgages more expensive, and increase corporate bonds, all shifting money away from the stock market, reducing valuations.
- Sanctions that the US can use become weaker as the countries are no longer as reliant on the dollar as they were before. Therefore the economic damage that the US inflicted on Russia after Putin’s invasion of Ukraine would not be as effective as it would have with a strong dollar.
Future Benefits of a Declining Dollar
What could be the benefits? What could go up?
- Things which are not dollars would be the assets which would most likely go up. Assets like Gold, which has seen a renewed interest from investors but most importantly from Central Banks who have been buying gold in record quantity over the past few years. With gold being a physical asset which one can store, countries have been turning to it instead of US bonds.
- Countries who export commodities become more attractive, as do emerging markets, like China who are positioning themselves to directly challenge the dollar dominance.
- Countries who generate their own energy and therefore, don’t need to hold vast amounts of US bonds. So a drive to move away from the petrodollar, and away from oil, towards renewables, batteries, and nuclear are also opportunities to look out for.
Why not trade in a different currency?
If you use a different currency like the Euro, you are disrupting contracts, hedging systems, insurance, and pricing models. The US Dollar offers high liquidity, so you are able to buy and sell large quantities of oil without crashing the markets, while also having legal protection. Setting up a new system would be time consuming and have added risks, all of which other countries are reluctant to embark on.
Sources:
(1) – https://faculty.georgetown.edu/imo3/petrod/define.htm
(3) – https://www.federalreservehistory.org/essays/gold-convertibility-ends
(4) – https://www.britannica.com/event/Arab-oil-embargo
(5) – https://www.fxcm.com/markets/insights/opec-oil-embargo-1973-74/
(6) – https://www.atlanticcouncil.org/blogs/econographics/is-the-end-of-the-petrodollar-near/
(7) – https://www.statista.com/statistics/1412425/gdp-ppp-share-world-gdp-g7-brics/
(8) – https://www.visualcapitalist.com/whos-buying-and-selling-americas-debt-2025/