A common misconception about the U.S. dollar is that it has no backing. While this is true in the literal sense, as you cannot trade the dollar for gold or silver at the bank, the reality is more complex. The USD is a promissory note, an I-owe-you, but that does not mean the dollar is some fictional currency, printed arbitrarily; albeit it often appears to be.
Rather than being backed by rare metals, the USD has been backed by Saudi oil and investment for over 50 years. On June 13, 2024, that agreement ended, signaling a potential decline of U.S. dominance of the global economy and darkening the horizon for the world's greatest power.
Petrodollar
Saudi Arabia has long been the world's leading oil exporter. The nation has the second-largest oil reserves globally and the predominant refining and production industry.
Nixon took the U.S. off the gold standard in 1971 to prevent the European exploitation of the dollar, avoid governmental limitations and evade gold’s volatility. In 1973, the Arab nations of the Organization of Petroleum Exporting Countries placed an embargo on Israel-supporting nations in the Fourth Arab-Israeli War. The struggling U.S. economy instantly plummeted into recession. The world runs on oil, even the most powerful nations cannot change that.
To address this issue, Henry Kissinger went to Saudi Arabia in 1974 and issued an agreement with the House of Saud. In exchange for the U.S. security guarantees, Saudi oil would be sold exclusively with American dollars and Saudi Arabia would invest percentages of its profit in the U.S. treasury. That means that if you wanted to buy oil from the world's leading distributor, you had to buy American dollars first. The USD has since been backed by the black gold beneath Arabian sands; the petrodollar.
Beneath the Surface
The U.S. achieved the petrodollar by trading a security guarantee. While it is obvious what Saudi Arabia contributed to the deal, what the U.S. offered is more complicated. The U.S. would supply military aid and equipment in order to receive a currency monopoly on Saudi oil trades and massive Saudi investments in the treasury.
Saudi Arabia was hostile towards Israel at the time of the deal, as was the rest of the Arab world. However, the U.S. had been Israel’s greatest ally, supplying it with copious amounts of military hardware and military aid. This made securing the deal very complicated, as supplying two militaries in opposition to one another was both dangerous and potentially redundant.
Much of the deal itself is complex and some even secretive, but it boiled down to the fact that the U.S. traded its military supremacy for Saudi backing of the dollar, despite the political complications. The statesmanship regarding this effort can be credited to the serving Secretary of State, Henry Kissinger.
It is a simplification to say the U.S. dollar is backed by the U.S. military, but complexities do not change that fact. If the USD is backed by Saudi oil sales, and that agreement is reliant on provisions from and protection by the American military, then the USD is in a way backed by its military involvement with the Gulf States.
Just as Saudi Arabia has been the world's leading oil exporter, the U.S. is the world's leading arms exporter. This collaboration was mutually beneficial. The U.S. used the value of the dollar to cement hegemony and reign supreme over the late Soviet Union. U.S. dominance continued throughout the 1990s and into the 21st century.
The dominance of the market by the U.S. has coincided with the creation of the most powerful military in world history. The American armed forces are also the world's most advanced and numerous in terms of ships, aircraft and helicopters as well as in stealth technology and missiles. This military might was built on the economic dominance provided by the value of the USD. It has long been the world's reserve currency.
The Beginning of the End
Saudi Arabia's announcement that it will not renew the petrodollar agreement signals a shift in geopolitics. There are rumors that the U.S. refused to make a new security guarantee in return for the Saudi recognition of Israel, leading the Saudis to refuse a renewal of the deal as a whole. This means that Saudi oil will now be traded in Chinese RMB, Euros, Rubles and more.
Without a doubt, the end of the petrodollar will alter the future U.S. economy. It is unlikely that there will be a wholesale collapse, after all the dollar was valuable before the petrodollar and it will remain so. What is certain however is that this is another step towards global de-dollarization, and downstream from that is the reduction in demand for the USD and American influence on the globe in general.
On the horizon, the U.S. will likely increasingly rely on its military for influence, as it did to secure the petrodollar agreement and as it is doing now in regards to supporting Ukraine and Taiwan. Congress is voting on a bill that would automatically enroll citizens into the draft, including women– a strange coincidence in timing to be sure. The dawn of a new age in geopolitics may be one of economic uncertainties and militaristic assertions.
Acknowledgment: The opinions expressed in this article are those of the individual author.