Although Saudi Arabia has been pricing its oil exports in US dollars for decades, there has been recent speculation that the country's leaders may be considering a change. What would that mean for US financial and monetary hegemony?
GENEVA – Could changes to the longstanding “petrodollar” system undermine the greenback’s global dominance? For a half-century, the United States has sold advanced weaponry to Saudi Arabia, and the Kingdom has denominated its oil sales in dollars. But now that Saudi Arabia is openly considering pricing oil sales in other currencies, rumors are afoot that this arrangement could unravel.
The US-Saudi relationship began in 1933, one year after the Kingdom was formally established. The Saudi monarchy granted Standard Oil exclusive rights to explore the country’s Eastern Province, and this partnership led to the formation of ARAMCO (the Arabian American Oil Company) in 1938, followed by the discovery of vast reserves. In the subsequent years, oil would fuel the US-led victory in World War II, powering tanks, ships, and aircraft.
Although Saudi Arabia was officially neutral in the war, the US government had begun to characterize it as a crucial security interest by 1943. In 1945, US President Franklin D. Roosevelt met with Saudi King Abdulaziz Ibn Saud, and though their meeting was overshadowed by the Yalta Conference a few days earlier, it marked the beginning of an enduring strategic relationship between the two countries.
Quid Pro Petro
Although “petrodollars” refers simply to oil priced in dollars, the term sometimes takes on a broader significance, because surplus oil exporters who are paid in dollars will recycle them through US Treasury bond purchases, thus helping to finance US trade deficits. Whether this arrangement originated as a quid pro quo (in exchange for US security guarantees) is a source of much controversy. The debate was recently reignited by speculation that the petrodollar system had formally expired on June 9, the 50th anniversary of a military and economic pact that US Secretary of State Henry Kissinger and Saudi Prince Fahd bin Abdulaziz Al Saud signed in 1974.
The 1974 agreement inaugurated a new era of close cooperation by establishing joint commissions for economic and military collaboration. The text addresses US efforts to encourage Saudi Arabia to continue producing oil in the quantities needed to meet world demand at stable lower prices, and hints at strategic interests in enhancing political ties, but it does not mention settlement of Saudi oil in dollars or US oil purchases in exchange for Saudi Treasury investments, nor does it explicitly discuss reciprocated security guarantees. Instead, the agreement’s professed aim was to create a strategic partnership to stabilize the region and enhance bilateral relations.
Nonetheless, a month later, US Treasury Secretary William Simon and his deputy, Gerry Parsky, undertook a mission to the Kingdom under the guise of a broader diplomatic tour that had been launched in response to the Arab oil embargo that followed the 1973 Arab-Israeli War. Before entering public service, Simon had served as a senior executive at Salomon Brothers, where he was instrumental in developing the firm’s government bond trading department.
Salomon Brothers established a dominant position in the trade of US Treasury securities and reshaped the landscape of Wall Street finance in the process. Teaming up with legendary figures such as William “Billy” Salomon and John Gutfreund, Simon began issuing bonds by pooling risk. By his own account, the institution became “a scrappy, bare-knuckled, risk-taking firm.”
He then brought the same bold style (and experience managing complex financial instruments) to the Department of the Treasury. During a four-day layover in Jeddah, his team brokered a confidential agreement with Saudi officials to mitigate the use of crude oil as an economic weapon. The US would purchase oil from Saudi Arabia and furnish it with American military aid and equipment, and the Saudis would invest their oil proceeds in US Treasury bonds. Bloomberg reported the secret diplomatic cable, obtained from the National Archives database, in 2016.
Four-Dimensional Chess
Speculation that the Saudi monarchy is overhauling its oil-pricing policy, and even abandoning the petrodollars-for-security arrangement, remains unverified. But it is no secret that Saudi Crown Prince Mohammed bin Salman (widely known as MBS) and US officials have been negotiating a broader defense pact that will have wide-ranging geopolitical implications.
The newest issue of our magazine, PS Quarterly: Age of Extremes, is here. To gain digital access to all of the magazine’s content, and receive your print copy, subscribe to PS Premium now.
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This more comprehensive agreement aims to formalize a mutual defense commitment, grant US access to Saudi territory, prohibit Chinese military bases in Saudi Arabia, normalize Saudi-Israeli relations, and provide support for a Saudi civilian nuclear program. Because the treaty was in the works before October 7, 2023, many top US policymakers view the provision concerning Saudi-Israeli diplomatic normalization as the motive for Hamas’s attack on Israel.
In response to the war, the Kingdom has indeed reaffirmed its commitment to the Palestinian cause and called for a cessation of Israeli military activities in Gaza. It is making clear that it views the establishment of an independent Palestinian state within the pre-1967 borders, with East Jerusalem as its capital, as a precondition for normalizing relations with Israel.
History is repeating itself. The same issues featured prominently in discussions between Roosevelt and King Saud 79 years ago, when they met aboard the USS Quincy in the Suez Canal. Predicting a future land conflict, the monarch strongly opposed Jewish settlements in the Middle East as a solution to the Nazi Holocaust.
Regardless of whether any previous agreement carried an expiration date, Saudi Arabia, in theory, could always renege on past commitments, such as by opting not to hold US Treasuries, or by choosing not to price oil in dollars. After all, the Kingdom has ambitions to establish itself as a regional powerhouse, and this involves a complex balancing act. It is eager to counter Iran and Turkey’s influence and to maintain strategic alliances with the US for military and economic support. But it is also exploring deeper economic ties with China, which is investing heavily in the region through its Belt and Road Initiative.
This dual approach requires careful management of regional dynamics and relations with other key players – notably Iran, Israel, and Turkey. Invoicing oil in currencies that are not the largest, deepest, most liquid in the world might make sense if Saudi Arabia is settling transactions in currencies of countries, like China, with which it has significant cross-border ties, and this diversification strategy could signal a shift in global trade dynamics. Or, Saudi Arabia might try to use the threat of invoicing in alternative currencies as leverage to secure a better US deal, or to advance its goal of a two-state solution to the Israel-Palestine conflict.
Currency Roulette
The credibility of this threat hinges on how far Saudi Arabia is willing to diversify its economic flows away from the US. Moreover, if disagreements over human rights and democracy start to weigh on Saudi-US ties, the Saudis might no longer want to maintain the same level of dollar holdings, for fear of their exposure to US sanctions.
Of course, some experts do not consider sanctions to be a valid concern. As Jeffrey Snider notes, many commentators overlook the crucial role of the eurodollar system in limiting the effectiveness of US enforcement by providing a decentralized network of dollar-denominated assets through bank deposits outside the US. Nonetheless, Brad Setser of the Council on Foreign Relations points out that Saudi Arabia has indeed been diversifying its asset purchases with bank deposits and equities since 2014, when its current-account surpluses began to give way to deficits.
If we zoom out (see Chart 1 below), we can see that Saudi Arabia has not been a consistent surplus country. While the surplus increased with the 1973 oil embargo, it declined from the early 1980s – following the second oil price shock of 1979, which followed the Iranian Revolution – to 2000, when high government spending on public services, subsidies, infrastructure projects, and the military coincided with falling oil prices.
In its quest to diversify the Kingdom’s economy and enhance social welfare, the Saudi government increased its expenditures on several fronts. The rationale behind expanding public services was to build a healthier, more educated population that could contribute to and benefit from a less oil-dependent economy. Investments in education, in particular, were geared toward equipping the Kingdom’s young, rapidly growing population with skills suitable for various sectors beyond oil.
There were also large investments in infrastructure development from the 1980s to 2000, with a focus on building and upgrading roads, bridges, and utilities to promote economic activity, facilitate the movement of goods and people, and improve the quality of life. The aim was not only to drive economic growth but also to integrate disparate regions more seamlessly into the national economy.
Recognizing the threat of regional volatility following the 1980-88 Iran-Iraq War and the 1990-91 Gulf War, Saudi Arabia ramped up its military spending. The conflict between Iran and Iraq had killed 500,000 people and heightened instability across the Middle East, prompting concerns about potential spillover effects and shifts in regional power dynamics.
Then the Gulf War brought conflict to the Kingdom’s doorstep. Iraq’s invasion of Kuwait not only threatened the regional balance of power; it also posed a direct security threat to Saudi Arabia, owing to its geographic proximity. Saddam Hussein’s aggressive behavior was reason enough for the Kingdom to invest significantly in enhancing its military capabilities, including modernizing its air and ground forces and bolstering its naval strength.
In Search of Security
Over the past decade, similar challenges have surfaced, with geopolitics playing an important role. In 2014, the world witnessed a dramatic drop in oil prices, owing primarily to an oil glut caused by the boom in US shale energy. The shift toward greater US production disrupted global oil-price stability and posed challenges to Saudi Arabia and other traditional oil-exporting economies.
In response to these economic pressures – and as part of a broader strategy to mitigate the impact of volatile oil prices – Saudi Arabia launched Vision 2030. Again, the plan was to diversify the Saudi economy away from oil dependence by investing heavily in sectors such as health, education, infrastructure, and tourism, as well as in new industries.
Several public transportation projects are underway to modernize and expand the country’s infrastructure. These include the Riyadh Metro, a six-line network to ease congestion in the capital, the Jeddah Public Transportation Program, comprising both metro and bus systems, and the Mecca Metro for accommodating pilgrims during the annual Hajj pilgrimage. There are also rail investments (like the Haramain High-Speed Railway) and plans for future rail expansions through Saudi Arabia Railways, reflecting the government’s desire to connect major cities and economic hubs. City-specific bus networks and sustainable transport solutions like those proposed for NEOM (Neo Mustaqbal) – a planned “smart” megacity – complement these efforts.
Though it echoes past major spending initiatives, Vision 2030 represents a more transformative approach to diversifying Saudi Arabia’s economy, given its emphasis on promoting sectors like technology, renewable energy, and tourism, which were not major focuses in previous decades. The plan now is to reduce oil dependency dramatically by fostering new industries and revenue streams, whereas earlier efforts still largely leaned on the petroleum sector.
At the same time, Saudi Arabia’s security concerns have multiplied, owing to new conflicts in the region. Its 2015 military intervention to support the Yemeni government against Houthi rebels involved considerable military expenditure, and it then had to contend with the rise of the Islamic State, which seized control over significant swaths of territory in Iraq and Syria. These and other developments called for higher defense spending and strategic repositioning to address the growing threat of terrorism and regional instability.
The Implications of an Unlikely Scenario
Despite the decline and periodic reversal of Saudi Arabia’s external surplus since 2014, the cumulative current account is close to $1.5 trillion (see Chart 1), suggesting sizable dollar-denominated holdings. Even if the Kingdom has diversified into eurodollars, rather than predominantly holding US Treasuries, secondary sanctions could oblige foreign custodians of dollars outside the US to block or otherwise restrict the use of those assets. It is thus impossible for the Saudis to dismiss the risk of US dollar coercion entirely.
Moreover, there are other reasons why Saudi Arabia will likely continue to hold large dollar reserves. An important consideration is that the riyal’s exchange rate is pegged to the dollar. As shown in Chart 2 below, the riyal was detached from the US dollar when the Bretton Woods system fell apart in 1971, following US President Richard Nixon’s decision to suspend the dollar’s convertibility into gold. Saudi Arabia responded by moving toward a floating exchange rate, though its exchange-rate regime was not entirely flexible, because it was tied to the International Monetary Fund’s Special Drawing Rights, whose value is based on a weighted average of major international currencies. In 1986, Saudi Arabia returned to a dollar peg. Maintaining a fixed exchange rate to the dollar requires large dollar reserves, because monetary authorities need to be able to intervene in foreign-exchange markets (by exchanging dollars for their domestic currency) to counteract market pressures or speculative attacks.
This dependence on the dollar, while currently beneficial for economic stability and security, also positions Saudi Arabia at a pivotal crossroad, where any major shift in oil-pricing strategy could have ripple effects. If Saudi Arabia were to price oil in currencies other than dollars, the immediate impact on dollar hegemony would likely be tempered by oil’s modest share in global trade. But the wider repercussions might nonetheless prove substantial. A shift away from the dollar could influence other commodity markets, affect global financial stability, and alter the dynamics of international trade agreements. If Russia, Saudi Arabia, and the world’s other largest oil producers (apart from the US) all shift away from the petrodollar, unpredictable consequences are inevitable.
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GENEVA – Could changes to the longstanding “petrodollar” system undermine the greenback’s global dominance? For a half-century, the United States has sold advanced weaponry to Saudi Arabia, and the Kingdom has denominated its oil sales in dollars. But now that Saudi Arabia is openly considering pricing oil sales in other currencies, rumors are afoot that this arrangement could unravel.
The US-Saudi relationship began in 1933, one year after the Kingdom was formally established. The Saudi monarchy granted Standard Oil exclusive rights to explore the country’s Eastern Province, and this partnership led to the formation of ARAMCO (the Arabian American Oil Company) in 1938, followed by the discovery of vast reserves. In the subsequent years, oil would fuel the US-led victory in World War II, powering tanks, ships, and aircraft.
Although Saudi Arabia was officially neutral in the war, the US government had begun to characterize it as a crucial security interest by 1943. In 1945, US President Franklin D. Roosevelt met with Saudi King Abdulaziz Ibn Saud, and though their meeting was overshadowed by the Yalta Conference a few days earlier, it marked the beginning of an enduring strategic relationship between the two countries.
Quid Pro Petro
Although “petrodollars” refers simply to oil priced in dollars, the term sometimes takes on a broader significance, because surplus oil exporters who are paid in dollars will recycle them through US Treasury bond purchases, thus helping to finance US trade deficits. Whether this arrangement originated as a quid pro quo (in exchange for US security guarantees) is a source of much controversy. The debate was recently reignited by speculation that the petrodollar system had formally expired on June 9, the 50th anniversary of a military and economic pact that US Secretary of State Henry Kissinger and Saudi Prince Fahd bin Abdulaziz Al Saud signed in 1974.
The 1974 agreement inaugurated a new era of close cooperation by establishing joint commissions for economic and military collaboration. The text addresses US efforts to encourage Saudi Arabia to continue producing oil in the quantities needed to meet world demand at stable lower prices, and hints at strategic interests in enhancing political ties, but it does not mention settlement of Saudi oil in dollars or US oil purchases in exchange for Saudi Treasury investments, nor does it explicitly discuss reciprocated security guarantees. Instead, the agreement’s professed aim was to create a strategic partnership to stabilize the region and enhance bilateral relations.
Nonetheless, a month later, US Treasury Secretary William Simon and his deputy, Gerry Parsky, undertook a mission to the Kingdom under the guise of a broader diplomatic tour that had been launched in response to the Arab oil embargo that followed the 1973 Arab-Israeli War. Before entering public service, Simon had served as a senior executive at Salomon Brothers, where he was instrumental in developing the firm’s government bond trading department.
Salomon Brothers established a dominant position in the trade of US Treasury securities and reshaped the landscape of Wall Street finance in the process. Teaming up with legendary figures such as William “Billy” Salomon and John Gutfreund, Simon began issuing bonds by pooling risk. By his own account, the institution became “a scrappy, bare-knuckled, risk-taking firm.”
He then brought the same bold style (and experience managing complex financial instruments) to the Department of the Treasury. During a four-day layover in Jeddah, his team brokered a confidential agreement with Saudi officials to mitigate the use of crude oil as an economic weapon. The US would purchase oil from Saudi Arabia and furnish it with American military aid and equipment, and the Saudis would invest their oil proceeds in US Treasury bonds. Bloomberg reported the secret diplomatic cable, obtained from the National Archives database, in 2016.
Four-Dimensional Chess
Speculation that the Saudi monarchy is overhauling its oil-pricing policy, and even abandoning the petrodollars-for-security arrangement, remains unverified. But it is no secret that Saudi Crown Prince Mohammed bin Salman (widely known as MBS) and US officials have been negotiating a broader defense pact that will have wide-ranging geopolitical implications.
Secure your copy of PS Quarterly: Age of Extremes
The newest issue of our magazine, PS Quarterly: Age of Extremes, is here. To gain digital access to all of the magazine’s content, and receive your print copy, subscribe to PS Premium now.
Subscribe Now
This more comprehensive agreement aims to formalize a mutual defense commitment, grant US access to Saudi territory, prohibit Chinese military bases in Saudi Arabia, normalize Saudi-Israeli relations, and provide support for a Saudi civilian nuclear program. Because the treaty was in the works before October 7, 2023, many top US policymakers view the provision concerning Saudi-Israeli diplomatic normalization as the motive for Hamas’s attack on Israel.
In response to the war, the Kingdom has indeed reaffirmed its commitment to the Palestinian cause and called for a cessation of Israeli military activities in Gaza. It is making clear that it views the establishment of an independent Palestinian state within the pre-1967 borders, with East Jerusalem as its capital, as a precondition for normalizing relations with Israel.
History is repeating itself. The same issues featured prominently in discussions between Roosevelt and King Saud 79 years ago, when they met aboard the USS Quincy in the Suez Canal. Predicting a future land conflict, the monarch strongly opposed Jewish settlements in the Middle East as a solution to the Nazi Holocaust.
Regardless of whether any previous agreement carried an expiration date, Saudi Arabia, in theory, could always renege on past commitments, such as by opting not to hold US Treasuries, or by choosing not to price oil in dollars. After all, the Kingdom has ambitions to establish itself as a regional powerhouse, and this involves a complex balancing act. It is eager to counter Iran and Turkey’s influence and to maintain strategic alliances with the US for military and economic support. But it is also exploring deeper economic ties with China, which is investing heavily in the region through its Belt and Road Initiative.
This dual approach requires careful management of regional dynamics and relations with other key players – notably Iran, Israel, and Turkey. Invoicing oil in currencies that are not the largest, deepest, most liquid in the world might make sense if Saudi Arabia is settling transactions in currencies of countries, like China, with which it has significant cross-border ties, and this diversification strategy could signal a shift in global trade dynamics. Or, Saudi Arabia might try to use the threat of invoicing in alternative currencies as leverage to secure a better US deal, or to advance its goal of a two-state solution to the Israel-Palestine conflict.
Currency Roulette
The credibility of this threat hinges on how far Saudi Arabia is willing to diversify its economic flows away from the US. Moreover, if disagreements over human rights and democracy start to weigh on Saudi-US ties, the Saudis might no longer want to maintain the same level of dollar holdings, for fear of their exposure to US sanctions.
Of course, some experts do not consider sanctions to be a valid concern. As Jeffrey Snider notes, many commentators overlook the crucial role of the eurodollar system in limiting the effectiveness of US enforcement by providing a decentralized network of dollar-denominated assets through bank deposits outside the US. Nonetheless, Brad Setser of the Council on Foreign Relations points out that Saudi Arabia has indeed been diversifying its asset purchases with bank deposits and equities since 2014, when its current-account surpluses began to give way to deficits.
If we zoom out (see Chart 1 below), we can see that Saudi Arabia has not been a consistent surplus country. While the surplus increased with the 1973 oil embargo, it declined from the early 1980s – following the second oil price shock of 1979, which followed the Iranian Revolution – to 2000, when high government spending on public services, subsidies, infrastructure projects, and the military coincided with falling oil prices.
In its quest to diversify the Kingdom’s economy and enhance social welfare, the Saudi government increased its expenditures on several fronts. The rationale behind expanding public services was to build a healthier, more educated population that could contribute to and benefit from a less oil-dependent economy. Investments in education, in particular, were geared toward equipping the Kingdom’s young, rapidly growing population with skills suitable for various sectors beyond oil.
There were also large investments in infrastructure development from the 1980s to 2000, with a focus on building and upgrading roads, bridges, and utilities to promote economic activity, facilitate the movement of goods and people, and improve the quality of life. The aim was not only to drive economic growth but also to integrate disparate regions more seamlessly into the national economy.
Recognizing the threat of regional volatility following the 1980-88 Iran-Iraq War and the 1990-91 Gulf War, Saudi Arabia ramped up its military spending. The conflict between Iran and Iraq had killed 500,000 people and heightened instability across the Middle East, prompting concerns about potential spillover effects and shifts in regional power dynamics.
Then the Gulf War brought conflict to the Kingdom’s doorstep. Iraq’s invasion of Kuwait not only threatened the regional balance of power; it also posed a direct security threat to Saudi Arabia, owing to its geographic proximity. Saddam Hussein’s aggressive behavior was reason enough for the Kingdom to invest significantly in enhancing its military capabilities, including modernizing its air and ground forces and bolstering its naval strength.
In Search of Security
Over the past decade, similar challenges have surfaced, with geopolitics playing an important role. In 2014, the world witnessed a dramatic drop in oil prices, owing primarily to an oil glut caused by the boom in US shale energy. The shift toward greater US production disrupted global oil-price stability and posed challenges to Saudi Arabia and other traditional oil-exporting economies.
In response to these economic pressures – and as part of a broader strategy to mitigate the impact of volatile oil prices – Saudi Arabia launched Vision 2030. Again, the plan was to diversify the Saudi economy away from oil dependence by investing heavily in sectors such as health, education, infrastructure, and tourism, as well as in new industries.
Several public transportation projects are underway to modernize and expand the country’s infrastructure. These include the Riyadh Metro, a six-line network to ease congestion in the capital, the Jeddah Public Transportation Program, comprising both metro and bus systems, and the Mecca Metro for accommodating pilgrims during the annual Hajj pilgrimage. There are also rail investments (like the Haramain High-Speed Railway) and plans for future rail expansions through Saudi Arabia Railways, reflecting the government’s desire to connect major cities and economic hubs. City-specific bus networks and sustainable transport solutions like those proposed for NEOM (Neo Mustaqbal) – a planned “smart” megacity – complement these efforts.
Though it echoes past major spending initiatives, Vision 2030 represents a more transformative approach to diversifying Saudi Arabia’s economy, given its emphasis on promoting sectors like technology, renewable energy, and tourism, which were not major focuses in previous decades. The plan now is to reduce oil dependency dramatically by fostering new industries and revenue streams, whereas earlier efforts still largely leaned on the petroleum sector.
At the same time, Saudi Arabia’s security concerns have multiplied, owing to new conflicts in the region. Its 2015 military intervention to support the Yemeni government against Houthi rebels involved considerable military expenditure, and it then had to contend with the rise of the Islamic State, which seized control over significant swaths of territory in Iraq and Syria. These and other developments called for higher defense spending and strategic repositioning to address the growing threat of terrorism and regional instability.
The Implications of an Unlikely Scenario
Despite the decline and periodic reversal of Saudi Arabia’s external surplus since 2014, the cumulative current account is close to $1.5 trillion (see Chart 1), suggesting sizable dollar-denominated holdings. Even if the Kingdom has diversified into eurodollars, rather than predominantly holding US Treasuries, secondary sanctions could oblige foreign custodians of dollars outside the US to block or otherwise restrict the use of those assets. It is thus impossible for the Saudis to dismiss the risk of US dollar coercion entirely.
Moreover, there are other reasons why Saudi Arabia will likely continue to hold large dollar reserves. An important consideration is that the riyal’s exchange rate is pegged to the dollar. As shown in Chart 2 below, the riyal was detached from the US dollar when the Bretton Woods system fell apart in 1971, following US President Richard Nixon’s decision to suspend the dollar’s convertibility into gold. Saudi Arabia responded by moving toward a floating exchange rate, though its exchange-rate regime was not entirely flexible, because it was tied to the International Monetary Fund’s Special Drawing Rights, whose value is based on a weighted average of major international currencies. In 1986, Saudi Arabia returned to a dollar peg. Maintaining a fixed exchange rate to the dollar requires large dollar reserves, because monetary authorities need to be able to intervene in foreign-exchange markets (by exchanging dollars for their domestic currency) to counteract market pressures or speculative attacks.
This dependence on the dollar, while currently beneficial for economic stability and security, also positions Saudi Arabia at a pivotal crossroad, where any major shift in oil-pricing strategy could have ripple effects. If Saudi Arabia were to price oil in currencies other than dollars, the immediate impact on dollar hegemony would likely be tempered by oil’s modest share in global trade. But the wider repercussions might nonetheless prove substantial. A shift away from the dollar could influence other commodity markets, affect global financial stability, and alter the dynamics of international trade agreements. If Russia, Saudi Arabia, and the world’s other largest oil producers (apart from the US) all shift away from the petrodollar, unpredictable consequences are inevitable.