The Petrodollar

The dollar's continued dominance after the end of Bretton Woods was not accidental. It was secured, at least in part, through a set of agreements negotiated between the United States and Saudi Arabia in 1974 that linked oil pricing to the dollar and recycled oil revenues into US Treasury securities. The arrangement -- which remained secret for decades and was only partially confirmed through Freedom of Information Act requests filed by Bloomberg News in 2016 -- established what analysts came to call the petrodollar system: a mechanism that created persistent global demand for dollars by ensuring that the world's most essential commodity would be priced and traded in American currency.

The negotiations were conducted by Treasury Secretary William Simon and his deputy Gerry Parsky. In exchange for guaranteeing Saudi Arabia's security, selling it American military equipment, and shielding it from a congressional effort to force oil-producing nations to limit price increases, the United States secured Saudi agreement to price oil in dollars and to invest its resulting dollar surpluses in US Treasury securities. The Saudis also agreed to use their influence within OPEC to maintain the dollar as the oil pricing currency for other member nations.

The strategic logic was compelling on both sides. For Saudi Arabia, American security guarantees were more valuable than any alternative arrangement, and dollar-denominated Treasuries were the safest available store of value for their oil revenues. For the United States, the arrangement solved the post-Bretton Woods problem of dollar demand: even without gold convertibility, the world would need dollars to buy oil, and oil-exporting nations would recycle those dollars into US assets, financing American deficits.

Any nation that challenges the petrodollar system risks regime change, sanctions, or military intervention. The pattern is consistent and the enforcement has been vigorous.Adapted from David Spiro, The Hidden Hand of American Hegemony (1999)

The petrodollar arrangement helps explain several otherwise puzzling features of American foreign policy in the Middle East. The consistent support for Saudi Arabia despite its human rights record, its export of the Wahhabi ideology that nurtured al-Qaeda, and its responsibility for the September 11 attacks reflects not merely strategic calculation about oil access but specifically about dollar-denominated oil revenues and their recycling into US assets. Any disruption of the arrangement -- any shift toward pricing oil in euros, yuan, or some basket of currencies -- would reduce global dollar demand and thereby raise the cost of US deficit financing.

Saddam Hussein's 2000 announcement that Iraq would price its oil in euros, and Muammar Gaddafi's proposal for an African gold dinar, are often cited in this context. Whether these announcements contributed to subsequent US military action is difficult to demonstrate with the available evidence, but the pattern is noted by analysts across the political spectrum. The relationship between dollar hegemony, petrodollar recycling, and US military commitments in the Middle East is a structural feature of the postwar global order that mainstream economic analysis has been reluctant to examine directly.