Petrodollar's Prominence and Petroyuan's Promise

A tie-Up between the Saudi and Chinese Central Banks Shows Beijing's nous in geo-economic policy making but still has critical shortcomings

The term ‘petrodollar’ gets thrown out there a lot – often in bad analysis and misleading takes about what gives the dollar its global geopolitical strength. In essence, it refers to fact that the global market for oil is denominated in dollars, and those that oil sales around the world help cement the dollar’s dominance. Taken a step further, it also refers to the recycling of surpluses by oil producing countries in the Middle East into US Treasuries and other dollar-denominated assets, essentially meaning that even when oil prices are very high, something that hurts the US consumer, the structure of the international political underpins the strength of the dollar system.

I believe that the dollar’s dominant role internationally comes depends on factors that ultimately have little to do with the so-called petrodollar at least from the view of the fact that oil is denominated in the currency. I tend to view the dollar’s global strength as a result of a series of policy moves (which largely intended to weaken the dollar not to make it the new gold) from the aftermath of the collapse of the Bretton Woods system in 1971 and the fact that dollars and US government assets are essentially the asset that money flows into whenever there is a global crisis. Think for a minute about the fact that a fisherman in Brazil or a businessman in Beijing or even an oligarch’s bodyguard in Russia even now is likely to have, or aim to have, a wad of dollars somewhere because they know that they can trade it.

In other words, the fact that oil is denominated in dollars has more to do with the fact that the dollar is trusted and widely as opposed to the idea that the dollar is widely used and trusted because it can be used to buy oil.

Nevertheless, the petrodollar is not an unwelcome feature of the dollar system, particularly from a US policy point of view. The petrodollar does undoubtedly indeed help drive global demand for dollars not only in the actual buying and selling of oil but in banking and commodity markets related to the sale of black gold and related hydrocarbons, markets that technically even larger than the huge oil market itself.

The past week has, however, seen a notable challenge to the petrodollar emerge.

On 20 November China and Saudi Arabia announced a currency swap for their respective central banks line worth 50 billion yuan, roughly $7 billion, a year. China has expanded the use of swap lines to allow other countries to trade more in its currency and the most prominent beneficiary has been Argentina, which has used its line to borrow yuan from Beijing and remain current on its IMF obligations as the Fund accepts payments in yuan and thus essentially freeing up dollars for repayments elsewhere.

But repeat-defaulter Argentina and Riyadh are very different borrowers.

Trading in yuan would normally not be so attractive for Saudi Arabia – Beijing is the world’s largest energy importer by a considerable distance and buys a lot of oil from Saudi Arabia, some $65 billion of the stuff in 2022, 21.7% of its oil exports by one measure, meaning that it runs a substantial deficit with Beijing in comparison to its overall trade surplus. In other words, Beijing sends more money to Saudi Arabia than Saudi sends to China. It has little headline need for yuan as a result, and the dollar denomination of such trade historically means it has little worry that China’s capital controls will leave it with a glut of funds stuck in Chinese money. So there is little need for the swap line in terms of paying for Saudi Arabia’s own imports from China.

Furthermore, Saudi Arabia does not have major debt concerns, though it is set to run a deficit this year, forecast in September at 2% of GDP by Riyadh, and for which it has just also agreed a new dollar-denominated $11 billion borrowing from international banks including China’s ICBC, highlighting how much more dominant the dollar remains. I tend to disagree with him that this strategy will be effective, but Saudi Arabia’s Crown Prince and de facto ruler Mohammed bin Salman (MBS) has been spending his dollars lavishly on investing in global sports such as golf, Saudi Arabia’s own football (soccer) league, and his own vision for Saudi Arabia including the promised city of Neon in hopes that it can provide a new base for the Saudi economy in the future. Hence MBS September declaration to Fox News that he does not care about so-called sportswashing claims because “if sportswashing (is) going to increase my GDP by 1%, then we'll continue doing sportswashing”.

Many have written that Riyadh’s real interest in reaching the agreement is in working to create structures towards mitigating the potential impact of (future) US sanctions – see here from the International Institute for Strategic Studies and here from ChinaFile/ the Asia Society. MBS of course has experience as a Western pariah and in the early days of the Biden Administration relations where extremely poor, with Biden having released intelligence that showed MBS was involved in the murder of the journalist Jamal Khashoggi in the Saudi consulate in Istanbul in 2018. No serious sanctions followed other than the barring of some of the fall-guys MBS had selected for taking the blame for the scandal. Nevertheless, even if US sanctions policy explicitly aims to keep Russian oil flowing, albeit just at a reduced rate of profit with the G7-led ‘oil price cap’. the US and wider Western sanctions on Russia have highlighted to MBS that the risk is there. While Riyadh is currently seeking to lower tensions with Iran and reach a peace deal in Yemen, MBS has long term aspirations that will likely see him again incur Western wrath in his expected lifelong rule,

But Beijing is particularly interested in the structure because it believes that it can help create a ‘PetroYuan’.

China has previously taken notable steps towards creating such a market, for example creating an oil futures market in Yuan in 2017 and Xi Jinping announcing in a visit to Saudi Arabia last December that it was an explicit aim of Beijing's to buy oil from Saudi Arabia in Yuan. Some have also raised the idea that de-dollarizing the oil trade is in China’s interest for its own sanctions concerns, whether that be in relation to sanctions on Beijing or its suppliers but there I am more doubtful, after all it continues to buy Russian oil and before that Iranian oil (which was more explicitly sanctioned than even Russian oil is today) without any real much concern for how Washington responds to this.

Undoubtedly such challenges deserve far more attention from policy makers than they are currently getting. I would argue in the long-term this is the most potentially geopolitically significant development in at least the last week, though other crises in the Middle East are getting exponentially more attention.

My friend Daniel McDowell – whose book on sections and threats to the dollar system I can not recommend enough –  over on Twitter, explicitly stated “I do not think this is the beginning of the end of the petrodollar,” a comment I fully agree with. The reason is because Saudi Arabia is unlikely to trust the yuan as a reserve for its assets or an attractive market anytime soon. After all, MBS is not buying Chinese sports teams and franchise but Western ones like Newcastle United and golf’s PGA tour (technically a merger with Saudi’s recently established tour that has given out gob-loads of money to players).

At the end of the day, which currency denominates the international political order is far more about where money ends up than what it is used in individual transactions.