The Invisible Green Line: Understanding the Petrodollar System

Photo via Green Central Banking/dpreezg/Envato

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There is a system that is currently running the world that rather goes unacknowledged, despite it controlling prices, government policy and energy. It’s not the central banking system or the stock market. It’s the petrodollar system. The petrodollar system affects most major economies and heavily dictates US relations to other countries and is a large reason for what keeps the U.S. dollar strong on a global scale. However, its history can be tied to modern day ideas of economic colonization and has led to the creation of economic initiatives like BRICS—challenging the economic and political relations of the US with developing countries. The system has become extremely relevant in terms of the current ongoing conflict in Iran, and has a history that is rooted specifically in the Middle East, which can offer an alternative lens to view the war in Iran through the global oil economy. 

To put it simply, the petrodollar system was established in the 1970s that mandates that global producers and exporters of oil must price and sell their oil exclusively in U.S. dollars. This forces all countries to acquire or at least hold U.S. dollars to purchase oil, increasing the demand for U.S. dollars, and in turn strengthening the currency on a global scale. Allowing it to be established and preserved as the world’s primary reserve currency.

The relevancy of oil in terms of global relations cannot be emphasized enough. Oil is the world’s primary energy source powering over 90% of global transportation, and provides power for heat and electricity. It’s what allows for trade to happen efficiently and is the driver behind modern manufacturing systems. It is what keeps our modern economy functioning. Because of its significance, countries need to constantly buy and sell oil in order for their own economies to function, creating a global oil market that bleeds into all aspects of relations between countries. 

However, to fully understand how the petro dollar was established, it is important to look at the history of the U.S.’s economy after the second world war. The aftermath of WW2 left many countries across the world in dire economic situations. Europe and Japan faced severe economic ruin, with the war resulting in major infrastructure damage, unprecedented inflation and food shortages forcing them to regress to a barter economic system and impeding further industrialization. In contrast, the U.S. was able to improve its manufacturing base during the war and did not suffer the same economic consequences as the war took place on a different front physically separate from the country. 

Additionally, by 1947 the U.S. held 70% of the world’s gold. With the U.S. emerging the clear economic superpower after the war, it was only clear that the country was going to be able to hold a lot of leverage on the creation of a new economic world order. This materialized at the Bretton Woods conference, which was a meeting of 44 allied nations with goals of establishing a stable international monetary system, and fostering global economic growth. This conference established fixed exchange rates that pegged gold to the U.S. dollar. This means that the dollar’s value was tied to a specific amount of gold, which established the U.S. dollar as the primary global reserve currency and allowed foreign central banks to convert dollar holdings into gold. This established a new economic world order that was backed by the U.S. dollar and solidified the U.S. as the leading economic superpower.   

However, in 1971 then president Nixon decoupled the U.S. dollar from the gold standard, creating a global economic shock which forced the global economy system to transform into a fiat currency system. This is the current money system of the world and it allows countries to use money like the dollar or yuan (that has no intrinsic value) to not be backed by a physical commodity like gold or silver. Its value is instead derived from government decree and public trust. After the dollar was taken off the gold standard, the U.S.’s economy remained strong because the majority of global transactions taking place were done in U.S. dollars regardless.
In 1973, this all changed when  the OPEC oil crisis ensued. The oil crisis began as a form of protest where Arab oil producing countries stopped supplying oil to countries who supported Israel in the Yom Kippur War, in order to gain political leverage. The consequences were felt heavily in the U.S. with the price of oil quadrupling leading to massive shortages. In response to this the U.S. decided to make an agreement with Saudi Arabia, the largest oil producer in the Middle East. If Saudi Arabia exclusively sold its oil in US dollars, the US would provide military and political support to the country. Due to this, the other oil producing countries in the Middle East followed, essentially creating the petrodollar system. 

The petro dollar system has since then kept the U.S. as the leading global economic superpower, while simultaneously yielding negative effects for developing countries. A prime example would be the latin american debt crisis, which was caused by the over recycling of petro dollars. Following the 1973 oil shock, oil exporting countries would deposit their surplus into western banks which then would heavily lend out to latin american countries at very low interest rates. This led to over borrowing with the catalyst being the US federal reserve raising interest rates drastically in order to combat domestic inflation.Debt servicing became impossible for latin american countries resulting in an entire decade of lost economic growth for the region. 

The petrodollar system in the context of the middle east has made middle eastern countries reliant on western markets with the US dollar reinforcing a dependency on western financial systems. Oil wealth allows middle eastern economies to exert wealth but at the hands of western power. This can be connected to the current conflict in Iran. Unlike many other middle eastern countries, Iran has heavily operated outside of the petro dollar system because it has been experiencing U.S. sanctions since the 2008 financial crisis. This isolation has forced Iran’s economy to engage differently in oil trade, relying on barter systems and transactions in non U.S. dollars like the Chinese Yuan. This can be considered another additional factor that further ‘others’ Iran in through western eyes by not participating in the petro dollar system. 

In a region that is largely dictated by western constraint, Iran represents a rare case of monetary independence. Because of this, tension in Iran can be understood not just through the lens of nuclear proliferation but also through the broader context of oil and the world economy. The straight of Hormuz can be a clear example to explain this connection. It is one of the world’s most critical oil transit points, that any disruption whether its political tension or military action results in oil prices surging immediately. This consequently will raise the demand for U.S. dollars which reinforces the petro dollar system. However Iran complicates this dynamic a little bit. Iran is still able to operate on the margins of this system by utilizing different mechanisms for trading oil, showing that the system is not only dependent on the demand of oil, but also the reliance countries have on U.S. dollars. Even if only done in limited amounts, when replicated by other countries it has the potential to erode U.S. monetary dominance. 

The conflict in Iran and the creation of economic blocks like BRICS shows that the petro dollar system is something that can be contested and is not accepted as a foundation for the global economy (especially in developing economies). While it continues to reinforce U.S. economic power, through geopolitical tension, sanctions and the rise of alternative trading systems, there arises the possibility that the system can be more heavily challenged, threatening the current economic world order. Understanding the petrodollar system, therefore, is essential not only to interpreting past economic history, but to analyzing the deeper forces shaping conflicts today.

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This article was edited by Abigail D’Angelo.