A Petroyuan Would Be a Kick in the Gut for the Dollar

Last week, I asked the question: is the US undermining the dollar’s credibility?

It appears the answer is — yes.

In another blow for dollar dominance, Saudi Arabia is reportedly considering pricing at least some of its Chinese oil sales in yuan.

According to the Wall Street Journal, the move would “dent the US dollar’s dominance of the global petroleum market and mark another shift by the world’s top crude exporter toward Asia.”

The “petrodollar” serves as a crucial support for the US dollar.

The majority of global oil sales are priced in dollars. This ensures a constant demand for the greenback. Every country needs dollars to buy oil. This helps support the US government’s borrow and spend policy with its massive deficits. As long as the world needs dollars for oil, the Federal Reserve can keep printing dollars to monetize the debt.

ZeroHedge explained how the process works.

One of the core staples of the past 40 years, and an anchor propping up the dollar’s reserve status, was a global financial system based on the petrodollar – this was a world in which oil producers would sell their product to the US (and the rest of the world) for dollars, which they would then recycle the proceeds in dollar-denominated assets and while investing in dollar-denominated markets, explicitly prop up the USD as the world reserve currency, and in the process backstop the standing of the US as the world’s undisputed financial superpower.”

Saudi Arabia has sold oil exclusively for dollars since 1974 under a deal with the Nixon administration. If the Saudis shift away from the dollar and sell oil for yuan, it would be bad news for dollar dominance. And good news for the Chinese currency.

According to the WSJ, China buys more than 25% of Saudi oil exports.

If priced in yuan, those sales would boost the standing of China’s currency. The Saudis are also considering including yuan-denominated futures contracts, known as the petroyuan, in the pricing model of Saudi Arabian Oil Co., known as Aramco.”

China and Saudi Arabia have been talking about yuan-based oil contracts for six years. But Saudi Arabia’s frustration with the US has apparently accelerated those talks. According to the WSJ, the Saudi government is increasingly unhappy with decades-old US security commitments to defend the kingdom along with the Biden administration’s attempt to reinstitute the Iran nuclear deal.

The Chinese rolled out yuan-based oil contracts in 2018. They have been modestly successful, but haven’t dented the dollar’s dominance. If Saudi Arabia begins doing business in yuan, it would be a kick in the gut for the dollar.

And it would be a boon for China. The Chinese would love to limit their exposure to the dollar.

Needless to say, US officials are not pleased with this development. A senior US official called the idea of the Saudis selling oil to China in yuan “highly volatile and aggressive” and “not very likely.”

Calling the move “aggressive” is ironic given how the US has used the dollar as a weapon for decades.

But this could be nothing but talk. Selling oil in yuan would come with some risks to the Saudi economy. The Saudi riyal is pegged to the dollar. Prince Mohammed’s aides have reportedly warned him of unpredictable economic damage should the country hastily start selling millions of barrels of oil for yuan.

Regardless, it’s no surprise that the Chinese and Saudis have ramped up talks in recent weeks. The weaponization of the dollar has been on full display.

After Russia invaded Ukraine, the US cut some Russian banks, including the central bank, off from the SWIFT payment system.

SWIFT  stands for the Society for Worldwide Interbank Financial Telecommunication. The system enables financial institutions to send and receive information about financial transactions in a secure, standardized environment. Since the dollar serves as the world reserve currency, SWIFT facilitates the international dollar system.

SWIFT and dollar dominance gives the US a great deal of leverage over other countries.

But that leverage depends on the dollar’s role as the reserve currency. It shouldn’t shock us that we’re seeing blowback from the US using greenbacks as a foreign policy carrot and stick.

A drop in the demand for dollars would be bad news for a US government that depends on dollar demand to fund its out-of-control spending. Imagine a world in which the Chinese didn’t need dollars.

China ranks as the biggest foreign holder of US debt. If it continues to divest itself of dollars, who will pick up the slack? The Federal Reserve has been buying Treasuries hand over fist for the last two years, keeping its big fat thumb on the bond market. But it’s tapering purchases and supposedly planning on shrinking its balance sheet. If global demand for Treasuries drop precipitously — and it would in a world without the petrodollar — the US government would either have to drastically cut spending or the Fed would have to continue printing money to monetize the debt.

Even if this is nothing but talk, it underscores the fact that the dollar is on shaky ground. US policymakers would be wise to consider future dollar weaponization carefully.