The Decline of the Petrodollar and Diminishing US Privileges in the Middle East

Since the emergence of the so-called “Petrodollar” in 1973, the US Dollar (USD henceforth) has held a unique position in the international system because the USD was the only accepted currency for oil purchases in most OPEC member states. Yet starting in 2000 with the Euro, other currencies have challenged the dominance of the dollar. The fate of the Euro in this competition appeared sealed in 2003 with the US-UK led invasion of Iraq, in which concerns over possible Petrodollar challenges were a major factor leading to the invasion (Clark, 2005). Yet today, various currencies, markedly the Euro and RMB have made significant dents in the dominance of the Dollar and have led to questions about its long-term viability (Fouskas and Gokay, 2012: 65-76). With the US now a net exporter of oil (thanks to the shale revolution), the fate of OPEC and by extension the Petrodollar is in serious doubt (Blackwill and Harris, 2016: 90). The aim of this essay is to examine the present situation vis a vis the Petrodollar, and to discuss the causes and effects of its likely decline both on the international system. A Petrodollar is defined as “any U.S. dollar paid to oil-exporting countries in exchange for oil” (Amadeo, 2018).

The first major challenge to Petrodollar dominance came from Iraq which indicated in early 2000 that it would only accept Euros for its oil. While this would damage Iraq’s already crippled economy, the Euro had hit an historic low which allowed Saddam to make major profits. This could have marked a shift towards a world with multiple reserve currencies but that was delayed by the invasion of Iraq in 2003. Two of the biggest opponents of the invasion were France and Germany, the two largest Euro powers, which stood to suffer major losses (Grosskurth, 2006: 42-3). Both in terms of actual investments in Iraq and the loss of potential economic power from a possible Petroeuro. This lead to France blocking a security council resolution to legalise the invasion (Dimitrova and Stromback, 2005: 399). If the Euro were to emerge as a second accepted currency among OPEC members and other major oil exporters such as Russia or Iraq, the Euro would be strengthened enormously as a result of reinvestment and mirror the current situation of the USD. The subsequent decline in demand for USD would severely weaken the currency as the reinvestment of petrodollars provides a significant investment stream to the US and enable the government to keep interest rates low (Looney, 2004: 26-7).

One likely cause of the declining significance of the Petrodollar is the reduction in Middle East oil exports to the US as a result of shale oil. This fundamental shift in the oil market has driven down oil prices which, while strengthening American energy security, has had serious unintended consequences for the Petrodollar system (Blackwill and Harris 2016: 204-19). The reduced flow of USD from America has prompted a re-evaluation of the Petrodollar system by many of the Gulf states and this is exacerbated by the fact that other nations still import vast amounts of oil from the Middle East. Of particular note are China, Japan, South Korea and India, all of whom import significant quantities from the Middle East (Gokay, 2015: 1).

Most OPEC nations today use the Petrodollar, although not as exclusively as before and in the case of Iran only to a limited degree (for reasons that are self-evident). Yet the dominance of the USD is coming under increased threat. It has been reported that China seeks to begin trading RMB for oil in the near future and has begun to price oil in RMB (Chatterjee and Meng, 2018). In 2017, China surpassed the US to become the world biggest oil importer (Marex, 2018) which signals a sea change for several reasons. China represents a great power rival to the US in the Persian Gulf, something which has prompted many states to contemplate a shift in alliances. At present, Chinese companies control ports in Egypt, Iraq, Oman, Saudi Arabia and the UAE (Hutchison ports, 2018) and are also constructing a facility in Qatar (Ship technology). The “Belt and Road” initiative continues to entice Gulf states, notably the UAE which has been very receptive to Chinese investment and gave Xi Jinping an extremely warm welcome on his recent visit to the country (Tiezzi, 2018).

Iran has indicated that it is willing to start trading in Euros and this has found approval with the EU, in particular, Euro member states and states with large Euro reserves (Paraskova, 2018). This decision was likely prompted in no small part by the US exit from the so-called “Iran deal” which has forced Iran to look for new oil markets after the US re-instituted its embargo. The American posturing with regards to Iran has been antagonistic and often increased tensions in the region. The present US administration is especially aggressive and has caused some to speculate about the possibility of a US-backed regime change (Walt, 2018). There is already considerably ideological support for such action among many prominent neoconservatives (Bacevich, 2016: 222) and such action would buy political favours from nations like Saudi Arabia, Iran’s main rival. Yet such action without providing economic incentives for states to remain on the Petrodollar, would not address the underlying causes of the weakening Petrodollar effectively and may actually accelerate its atrophy.

The decline of the Petrodollar will have severe consequences for the Middle East and the US. It has already been established that “Dollar hegemony has always been critical to the future of the US-dominated global hierarchy” (Gokay, 2015: 5). The switch from one currency to multiple currencies will have profound effects on the balance of power within the Middle East and would severely harm the US economy both overseas in internally.

Unimpeded access to energy recourses is key for the US to maintain its hegemony (Gokay, 2003: 84) and with the advent of shale energy, the US is now less dependent on the Middle East oil and gas. This has led to a decline in US oil imports from OPEC member states to levels not seen in at least 25 years (USEIA, 2018). This new-found freedom from imported energy has created new options for American foreign policy and yet the Middle East still sits at the center. This decline in oil exports to the US undermines the economy of several Middle Eastern countries even more as the value of oil is very low and as such, they earn less money from the US. It has been suggested by some that the US and the middle east engage in a trade dubbed “the Petrodollar-Weapondollar cycle.” (Nitzan and Bichler, 1995) in which large amounts of Petrodollars are used by the leaders in the Middle East to purchase American weapons and by extension hold onto power despite popular opposition both internally and externally (Chomsky, 2011). The decline of US oil purchases has not been followed by a reduction in arms buying from states more closely aligned with the US-such as Saudi Arabia which signed a record-breaking arms deal in 2017 (Roberts, 2017)-however other states have been willing to shop for arms elsewhere. Qatar, for example, is involved in talks with Russia to purchase anti-aircraft systems (Reuters, 2018). This would seem to imply that many nations in the Middle East are aware of the declining American imports and so now seek to re-align themselves with larger export partners. As the nations in the region begin to purchase arms from other countries, they may start selling oil in exchange for the buyers own currency, which would over time reduce their security ties with the USA.

Saudi Arabia’s ties to the US are particularly strong but have been strained by the shale revolution and subsequent decline in oil prices. Saudi Arabia has been running a budget deficit since 2014 (Trading economics, 2018) and is burning through its foreign currency reserves with incredible speed (Martin, 2016). This is at a time where it is involved in a costly intervention in Yemen which has placed additional pressure on its financial reserves (Brinded, 2015). Saudi Arabia’s attempts to bankrupt shale producers by selling oil at these low prices have not been particularly successful and it is unlikely that prices will reach pre-2014 levels any time soon (Conca, 2015). So, while at present the Saudis stick to the petrodollar system, the flow of currency from other nations continue to rise which means that in the future, the Saudis may begin to accept other currencies from its larger buyers unless the US can increase its security commitments or force Middle East nations to comply. Chalmers Johnson (2004) suggested that as the US economy declined (as a share of the global economy) then the US would be forced to use military might to maintain its empire and the end of Petrodollar hegemony would probably constitute such a threat. The US will likely be able to prolong the life of the Petrodollar by gaining Saudi support which can, at present, be bought with weapons sales and diplomatic support, however, if Saudi Arabia’s economy continues to decline, then soon greater action may need to be taken.

As with Iraq 15 years ago, a war would appear to solve the problem, albeit only momentarily. In this case, a war with Iran would seem most likely. It has repeatedly threatened the US and has long been demonised by US foreign policy makers (Mearsheimer and Walt, 2007: 280). Many in the present administration seem to believe that the successful defeat of Iran could solve a number of their economic and geopolitical problems. Various nations in the Middle East have positioned themselves somewhere between Saudi Arabia and Iran in the purported “Saudi-Iranian rivalry” (Mabon, 2012: 84) and the defeat of Iran would force them into Saudi Arabia’s orbit and by extension, force them to continue to use Petrodollars. While it is likely that this may temporarily reaffirm the Petrodollar, the cost of maintaining this will soon become unsustainable as imperial overstretch accelerates and the US lacks the funds to sustain its empire (Johnson, 2004: 82). Yet such action could turn many of the states in the Middle East against the US which may galvanise it on the world stage.

In conclusion, the Petrodollar system has enabled the US to assert immense control over a key resource in the modern world. However, as the US declines as the world sole superpower and other nations demand more oil while the US now exports oil, it is likely that allegiances will shift to those who contribute more to the Gulf economies. Such shifts will erode the US position in the Middle East as well as the USD value, which in turn threatens the strength of the US economy as she prince of imports rises. As the Petrodollar comes under increasing threat and as the US ability to maintain its hegemony withers, the question that remains unanswered is whether or not the US will use military force to try and maintain its position or whether it will save its strength for another conflict.

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