In an op-ed Tuesday, Bloomberg columnist Aaron Brown argues that the war in the Middle East has broken the petrodollar system, a major part of the global economy that helps maintain the dominance of the U.S. dollar while easing the cost of running massive federal budget deficits.
The petrodollar system traces back to 1974, Brown writes, when Henry Kissinger struck a deal with Saudi Arabia to price oil exclusively in dollars in exchange for a security guarantee, an arrangement that soon became the standard in the Gulf. The massive dollar-based profits were increasingly recycled into U.S. assets, including U.S. Treasuries.
“The arrangement was elegant in its circularity: Oil consumers paid dollars for energy, those dollars flowed to Riyadh and Abu Dhabi, and from there back into Washington’s debt,” Brown writes. “For 50 years, this petrodollar loop quietly subsidized American borrowing costs and cemented the greenback’s role as the world’s reserve currency.”
The war with Iran has “fractured” that system. Following Iran’s closure of the Strait of Hormuz, huge quantities of oil and gas are now stuck in the Persian Gulf. At the same time, central banks are selling Treasuries as they seek to raise cash to help cover the rising cost of energy, and there has been no “flight to quality” into Treasuries as investors seek safety.
“The petrodollar loop requires two moving parts: dollars earned and dollars invested,” Brown says. “Both have stopped.”
The system always had a political premise, Brown writes: “That in a global crisis, the United States is a stabilizer or bystander, not a combatant. But the calculus changes when the US itself is the belligerent; when the conflict is partly America’s war, driving the oil shock, straining Gulf relationships, and generating the fiscal pressure that has bond investors worried about US budget deficits. Not completely. Not permanently. But enough.”
The 1974 arrangement has helped shape global finance for decades, Brown says, through wars and panics, but it may be coming to an end. “The petrodollar loop was always a political arrangement dressed in financial clothing,” Brown says. “Now that the politics have changed, the finance is following.”