The Petrodollar

Petrodollars are a system in which US dollars are earned from crude oil exports by oil-exporting countries.  Petrodollars play a vital role in the global economy since the 1970s. To give some context, the Bretton Woods system which preceded Petrodollars, was international monetary management system established in 1944.  The intention following WWII was to create economic stability and growth, which would be enabled through four key features:

1. Fixed but adjustable exchange rates: Member nations to Bretton Woods would peg or fix their currency exchange rates to the US dollar, with a 1% fluctuating margin.

2. US dollar linked to gold: The US dollar was the only currency to be directly convertible to gold at a fixed exchange rate of $35 per ounce. 

3. Creation of key institutions: The agreement created the International Monetary Fund (IMF) to oversee the system and to provide temporary financial assistance to countries with a balance of payments issue. The World Bank was also created as part of the Bretton Woods agreement, whose mission was to finance post-war reconstruction and development projects.

4. Prevention of competitive devaluations: “Beggar thy neighbor” or economic policies that sought to improve domestic economic conditions through the harm of other countries was to be avoided through the use of the Bretton Woods system.  Examples of “Beggar they neighbor” economic policies include tariffs and quotas, currency devaluations, export subsidies, export bans, and other ‘zero-sum’ game economic techniques.

Well, the Bretton Woods agreement lasted until the early 1970s at which point, the US and the world pivoted from a US dollar to gold-based system, to a petrodollar system. In this petrodollar system, the US dollar was to be the currency for settlement of the sale of oil.  For example, Country A would settle the sales of oil for export to Country B, in the US dollar currency.  Country A could then invest those US dollars into US Treasuries, US equities, US real estate, and US debt.  This petrodollar system was fundamental to the geopolitical and economic environment seen between 1972 and 2022.  To be clear, US dollar is not the only currency accepted for settlement; oil exporters are free to accept payment in a currency of their choosing. However, the ability to then convert those cash assets into other asset classes such as equities, debt instruments, etc. are limited to those markets within that currency. So in the example above, if Country A settled in Country B currency, then investments would be limited to Country B markets, which may or may not be the most desirable place to invest.  Therefore we see reflexive properties between petrodollars and US dollar denominated assets and markets.