The Iran war puts the petrodollar regime to the test

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0:53This is The Indicator from Planet Money. I'm Waylon Wong. And I'm Adrian Ma. The U.S. dollar is known as the world's reserve currency. That means countries widely conduct their business in U.S. dollars, and they save and invest in U.S. dollars. And a big driver of the dollar status as reserve currency is the global oil market. And that's because of something called the petrodollar system. It's a 50-year arrangement that emerged from a previous oil shock, and it's being tested by the current war in Iran. Today on the show, what is the petrodollar regime? How does it benefit the U.S.? And what will it mean for everyday Americans if this system goes away?

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2:18It's even harder to do it efficiently. But with LinkedIn, you get all the tools you need to grow in one place. With LinkedIn, simplify your sales, marketing, and hiring so that you can actually run your small business. Learn more at linkedin.com slash indicator show. In 1973, Egypt and Syria launched an attack on Israel. The surprise attacks came early this morning in the air and on the ground. The Egyptians apparently have taken control of at least a portion of the East Bank of the Suez. This came to be known as the Yom Kippur War. The U.S., under President Richard Nixon, provided Israel with aid and arms.

2:56This angered the Arab countries, which imposed an oil embargo on the U.S. This set off what's considered the first worldwide oil shock. We don't know how short we're going to be on gasoline for the car or fuel for the furnace. All we know is we're going to be short and we'll have to get by on less. One person who spent a lot of time analyzing this era is David White. He's a historian at the University of North Carolina, Greensboro, and author of a book about U.S.-Middle East relations and the petrodollar. If you could pick a period of history or, like, an event that you've studied where you could be a fly on the wall, what would you pick?

3:33Hmm. That's a good one. I would be curious to be in the room when Treasury Secretary Bill Simon first met with the Saudis in 1974. That's a pretty nerdy pick, I have to say. Quite. I was going to say like, oh, I wanted to see the Beatles in concert for the first time. Or like be there when they invented the chocolate chip cookie. Like in the Nestle Toll House test kitchen. Exactly. But, you know, David being David, he wanted to be there at this pivotal moment, which is just after the oil shock. David says that the U.S. and Saudi Arabia understood that the future of their relationship was at stake.

4:17There's a real sense on both sides that this could be a rupture point. And you can see going through the declassified documents from the United States, the deep sort of distrust on both sides, but also a desire to try to patch up this relationship. David says the U.S. recognized that Saudi Arabia and other oil-producing countries were now major players on the world stage. The price of oil had quadrupled in the last months of 1973. Saudi Arabia was making a lot of money, and its government needed somewhere safe to invest all those earnings. They're angry about how the United States conducted itself during the Arab-Israeli war, but the Saudis have traditionally relied on the United States for security guarantees, as a place to invest, as a place to do business.

5:09So both sides have strong reasons to distrust each other, but also strong reasons to try to come back to the table. It was during this time that Treasury Secretary Bill Simon met with the Saudis. So did Secretary of State Henry Kissinger. And what emerged from these meetings was an arrangement. Here's how it worked. The Saudis would agree to price their oil exports in U.S. dollars. And in exchange, the U.S. would provide economic and military support. David said some historians believe that the U.S. even gave the Saudis a discount on purchases of U.S. Treasury bonds. So like a buy one, get one free?

5:44Yeah, I do love a BOGO. I don't think in this case it was quite so simple, but we also don't know exactly what they worked out. We don't have like a smoking gun document where this like explicit quid pro quo, you know, I've never seen at least. Yeah, and you went looking, right? I've been looking for a while. But it is clear that the United States, at the very minimum, wants the Saudis and other Arab oil-rich states and Iran as well to continue to do at least most of their business in dollars. They are pushing the Saudis to try to invest in U.S. Treasury securities and in the larger U.S. economy, both in the public sector and in the private sector.

6:27OK, so as far as we know, there's no official memo laying out these promises. But in June of 1974, the U.S. and Saudi Arabia signed a broad agreement on military and economic cooperation. Henry Kissinger and the Saudi Minister of Commerce and Industry were at the ceremony.

6:47That's Kissinger joking, do I have to sign in Arabic? As we know, Kissinger was always known for his quips. Yes, among other things. Well, this was the start of the petrodollar system. Oil had already been priced in dollars before 1974. But now Saudi Arabia and other countries in the region were affirming a commitment to price oil in U.S. dollars and to invest their earnings in things like U.S. treasury bonds. Some economists and historians call this system petrodollar recycling. And the flow of petrodollars from the Middle East to the U.S. was significant. David says Saudi Arabia was the largest foreign buyer of U.S.

7:25treasuries in the early days of this arrangement. And between 1974 and 76, its purchases of these bonds accounted for 12 percent of the federal deficit in the U.S. Petrodollar flows started to wane in the 1980s as oil prices went down. But the broader petrodollar regime stayed in place. Saudi Arabia and other Gulf countries pegged the value of their currencies to the U.S. dollar. Most of their investments overseas were denominated in dollars as well. That means these countries could hurt the U.S. economically by dumping their dollar investments in bulk. This is also a risk with other countries that hold lots of dollar assets, whether it's China or the United Kingdom.

8:03In fact, China wants to challenge the dollar as reserve currency, and it's taking aim at the all-important petrodollar regime, which, as we know, is a key part of the dollar's reserve status. In 2023, China and Saudi Arabia signed an economic cooperation agreement worth$7 billion. China is Saudi Arabia's largest trading partner and wants more trade to be priced in yuan rather than dollars. So what does this mean for those of us who are not diplomats or oil traders? Well, if the U.S. dollar loses its status as reserve currency, it could get weaker. That would make imports more expensive, meaning inflation would go up.

8:41Plus, without foreign investors buying up treasuries, the U.S. government could see its borrowing costs go up. That could mean higher interest rates for everyday people on cars and home equity loans. But as we've covered on the show before, it's not so simple to sell America. The seller could lose money, too. And there may not be a good alternative to U.S. treasuries or the dollar. I would say that the petrodollar regime and the power of the dollar in the global financial system has been remarkably durable. It's been one of the post-World War II architectures that has upheld the strongest. David says the petrodollar regime has deep roots.

9:27It's a hard system to change quickly. Still, it's not sacrosanct. In fact, one new place just opened for business in Chinese Yuan, the Strait of Hormuz. Iran has reportedly been collecting some tolls in Yuan to transit the strait. It may be more symbolic than a real blow to the petrodollar regime, but the system does appear vulnerable. And oil exporting countries in the Middle East could go shopping for a new arrangement if the U.S. proves to be an unreliable geopolitical partner. This episode was produced by Cooper Katz, McCammon, engineered by Sino Lafredo. It was fact-checked by Sierra Juarez.

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