Petrodollar recycling

Especially during the years 1974–1981 and 2005–2014, oil exporters amassed large surpluses of "petrodollars" from historically expensive oil.[1][2][10] (The word has been credited alternately to Egyptian-American economist Ibrahim Oweiss and to former US Secretary of Commerce Peter G. Peterson, both in 1973.)[11][12][13] These petrodollar surpluses could be described as net US dollar-equivalents earned from the export of petroleum, in excess of the internal development needs of the exporting nations.[14] The surpluses could not be efficiently invested in their own economies, due to small populations or being at early stages of industrialization; but the surpluses could be usefully invested in other nations, or spent on imports such as consumer products, construction supplies, and military equipment. Alternatively, global economic growth would have suffered if that money was withdrawn from the world economy, while the oil-exporting nations needed to be able to invest profitably to raise their long-term standards of living.[15]

While petrodollar recycling reduced the short-term recessionary impact of the 1973 oil crisis, it caused problems especially for oil-importing countries that were paying much higher prices for oil, and incurring long-term debts. The International Monetary Fund (IMF) estimated that the foreign debts of 100 oil-importing developing countries increased by 150% between 1973 and 1977, complicated further by a worldwide shift to floating exchange rates. Johan Witteveen, the Managing Director of the IMF, said in 1974: "The international monetary system is facing its most difficult period since the 1930s."[16] The IMF administered a new lending program during 1974–1976 called the Oil Facility. Funded by oil-exporting nations and other lenders, it was available to nations suffering from acute problems with their balance of trade due to the rise in oil prices, notably including Italy and the UK as well as dozens of developing countries.[17]

From 1974 through 1981, the total current account surplus for all members of OPEC amounted to US$450 billion, without scaling-up for the subsequent decades of inflation. Ninety percent of this surplus was accumulated by the Arab countries of the Persian Gulf and Libya, with Iran also accumulating significant oil surpluses through 1978 before suffering the hardships of revolution, war and sanctions.[14]

Large volumes of Arab petrodollars were invested directly in US Treasury securities and in other financial markets of the major industrial economies, often directed discreetly by government entities now known as sovereign wealth funds.[18][19] Many billions of petrodollars were also invested through the major commercial banks of the US and Europe. In fact, the process contributed to the growth of the Eurodollar market as a less-regulated rival to US monetary markets. As the recessionary condition of the world economy made investment in corporations less attractive, bankers and well-financed governments lent much of the money directly to the governments of developing countries, especially in Latin America such as Brazil and Argentina[14] as well as other major developing nations like Turkey. The 1973 oil crisis had created a vast dollar shortage in these countries; however, they still needed to finance their imports of oil and machinery. In early 1977, when Turkey stopped heating its prime minister's office, opposition leader Suleyman Demirel famously described the shortage as: "Turkey is in need of 70 cents."[20] As political journalist William Greider summarized the situation: "Banks collected the deposits of revenue-rich OPEC governments and lent the money to developing nations so they could avoid bankruptcy."[21] In subsequent decades, many of these developing nations found their accumulated debts to be unpayably large, concluding that it was a form of neocolonialism from which debt relief was the only escape.[22]

Inflation and interest rates surged with oil prices in the 1970s, but not in the 2000s.[23]

In the 2005–2014 petrodollar surge, financial decision-makers were able to benefit somewhat from the lessons and experiences of the previous cycle. Developing economies generally stayed better balanced than they did in the 1970s; the world economy was less oil-intensive; and global inflation and interest rates were much better contained. Oil exporters opted to make most of their investments directly into a diverse array of global markets, and the recycling process was less dependent on intermediary channels such as international banks and the IMF.[24][25][26]

Thanks to the historic oil price increases of 2003–2008, OPEC revenues approximated an unprecedented US$1 trillion per year in 2008 and 2011–2014.[2] Beyond the OPEC countries, substantial surpluses also accrued to Russia and Norway,[10] and sovereign wealth funds worldwide amassed US$7 trillion by 2014–2015.[27] Some oil exporters were unable to reap the full benefits, as the national economies of Iran, Iraq, Libya, Nigeria and Venezuela all suffered from multi-year political obstacles associated with what economists call the "resource curse".[28][29] Most of the other large exporters accumulated enough financial reserves to cushion the shock when oil prices and petrodollar surpluses fell sharply again from an oil supply glut in 2014–2017.[30]

The United States dollar remains de facto world currency.[42] Accordingly, almost all oil sales throughout the world are denominated in United States dollars (USD).[43] Because most countries rely on oil imports, they are forced to maintain large stockpiles of dollars in order to continue imports. This creates a consistent demand for USDs and ostensibly supports the USD's value, regardless of economic conditions in the United States.

According to proponents of the petrodollar warfare hypothesis, this in turn allegedly allows the US government to gain revenues through seignorage and by issuing bonds at lower interest rates than supposedly they otherwise would be able to. As a result, the U.S. government, according to this theory, can run higher budget deficits at a more sustainable level than most other countries can. The theory points out that a stronger USD also means that goods imported into the United States are relatively cheap (although the country's exports become relatively more expensive for the rest of the world).

Another component of the hypothesis is that the price of petroleum is more stable in the U.S. than anywhere else since importers do not need to worry about exchange rate fluctuations. Since the U.S. imports a great deal of oil, its markets are heavily reliant on oil and its derivative products (jet fuel, diesel fuel, gasoline, etc.) for their energy needs. As the price of oil can be an important political factor, U.S. administrations are quite sensitive to the price of oil.

Political competitors of the United States therefore have some interest in seeing oil denominated in euros or other currencies. The EU could also theoretically accrue the same benefits if the euro replaced the dollar.

The petrodollar system originated in the early 1970s in the wake of the Bretton Woods collapse. President Richard Nixon and his Secretary of State, Henry Kissinger, feared that the abandonment of the international gold standard under the Bretton Woods arrangement (combined with a growing US trade deficit, and massive debt associated with the ongoing Vietnam War) would cause a decline in the relative global demand of the U.S. dollar.[44] In a series of meetings, the United States — represented by then U.S. Secretary of State Henry Kissinger — and the Saudi royal family made an agreement. The United States would offer military protection for Saudi Arabia's oil fields, and in return the Saudis would price their oil sales exclusively in United States dollars (in other words, the Saudis were to refuse all other currencies, except the U.S. dollar, as payment for their oil exports).

By 1975, all of the oil-producing nations of OPEC had agreed to price their oil in dollars and to invest surplus oil proceeds in U.S. government debt securities in exchange for similar offers by the U.S.[45]

A U.S. soldier stands guard duty near a burning oil well in the Rumaila oil field, Iraq, April 2003

In 2000, Iraq converted all its oil transactions under the Oil for Food program to euros,[46] even though the move was deemed by analysts to "fly in the face of financial logic",[46] since it meant that Iraq would earn less interest on its oil revenues, which were held in a UN-monitored escrow account in New York. Also, the switch would create "cumbersome new administrative processes" because Baghdad decided to keep also its existing deposits in dollars, which meant that the oil-for-food program would maintain two accounts, one in dollars and one in euros.[46]

Several commentators writing contemporaneously with the buildup to the invasion[47][48][49] linked Iraq's Nov 2000 re-denomination of oil from USD to euros and the possibility of more widespread adoption of the euro as an oil pricing standard to the risk that that would place on the post-Bretton Woods use of the USD as the international reserve currency and the impact that that would have on the US economy, and theorised that one of the fundamental purposes for war in Iraq would be to force Iraq to revert to pricing its oil in USD.

After the U.S. invaded Iraq in 2003, Iraq returned the denomination of its oil sales to the US dollar, despite the greenback's then-fall in value.[50]

The Government of the Islamic Republic of Iran ostensibly takes this theory as fact. As retaliation to this policy, which is seen by Tehran as "neoimperialism",[51] Iran made an effort to create its own bourse, which started selling oil in gold, euros, dollars, and Japanese yen.[52] In mid-2006 Venezuela indicated "support" of Iran's decision to offer global oil trade in the euro currency.[53] Muammar Gaddafi of Libya had tried to implement the gold-for-oil plan in 2011[54] and the introduction of a Libyan gold dinar.

In 2005, William Roberts Clark, Professor and Faculty Associate, Political Science Department, Center for Political Studies, University of Michigan, Ann Arbor, published a work which claimed that a "petrodollar warfare" was under way between mainly the euro and the United States dollar waged in the field of world petroleum trade.[55]

Over the years, multiple scholars expressed the view that the Iraq War was conducted to re-assert the dollar hegemony in the wake of Saddam Hussein's attempts to switch from petrodollar in the oil trade and to sell Iraqi oil in exchange for other currencies or commodities.[56][57][58]