19 Jun 2019
What is the Petrodollar?
No, this isn’t yet another cryptocurrency. Petrodollars are US dollars that are paid to oil exporting countries for the sale of crude oil. In other words, it is a system of exchange of oil for US dollars between the countries that purchase it and the ones that produce and sell it. Initially, these were referred to as the money that the Organization of the Petroleum Exporting Countries (OPEC) and the Middle Eastern countries received. The definition has broadened in recent years and now includes several other nations as well. Since petrodollars are represented as USD, their purchasing power depends on the value of the currency and the core rate of US inflation. So, petrodollars are impacted by economic factors in the same way as the US dollar. When the value of the dollar plummets, so does that of petrodollars and, in turn, the government’s revenue.
Why was the Petrodollar System Introduced?The petrodollar system came into existence as a result of the oil crisis of the mid-1970s, when oil price touched record high levels. It helped increase the stability of oil prices, which were denominated in USD. The term gained popularity again in the early 2000s, when oil prices started rising once more. The origins of this system can be traced back to the Bretton Woods Agreement, which replaced the gold standard with the USD as the reserve currency. Under this agreement, the dollar was pegged to gold and other currencies were pegged to the dollar. But due to large stagflation, it was announced by US President Nixon, in 1971, that the greenback would no longer be exchanged for gold to drive US economic growth. This led to the introduction of the petrodollar system, under which Saudi Arabia and the US mutually agreed to set oil prices in USD. It meant that in order to purchase oil from Saudi Arabia, a country would first have to convert their currency into US dollars. The remaining OPEC countries followed suit and priced their oil in USD as well.
Recycling of the PetrodollarThe petrodollar system can lead to the generation of surplus, which is known as petrodollar surplus. Since petrodollars are just US dollars, such surplus can raise the US dollar reserves of oil exporting nations. This, then leads to a need to recycle the extra petrodollars, which can be done in a number of ways. They can be used for domestic consumption or investment, for lending to other countries or for the purchase of bonds and T-bills from the US. This increases the liquidity of the American financial markets. Through the investment of petrodollar surpluses, oil exporters can decrease their dependence on oil revenues. Many countries have actively recycled their surplus petrodollars in one or more of the ways mentioned above. Here are some of the largest petrodollar recyclers in the world.
- Saudi Arabia SAMA
- UAE Abu Dhabi Investment Authority
- UAE Abu Dhabi Mubadala Investment Company
- Russia National Welfare Fund
- Qatar Investment Authority
- Kazakhstan Samruk-Kazyna
- Alaska Permanent Fund