The gold standard may have ended in the early 1970s, but something else quietly took its place for the next 50 years: oil. The so-called “petrodollar” system was not well understood for much of the time, but a secret agreement between Henry Kissinger and Saudi Arabia ensured that the dollar remained the dominant reserve currency. The outbreak of war in Iran is exposing America’s Achilles heel, although China has positioned the “petroyuan” as the heir apparent, and to top it all off, the Saudis quietly killed the petrodollar two years ago.
The US-Israeli war on Iran has put a spotlight on the strength of the “petrodollar”, which forms the cornerstone of US dominance in global trade, but economists have warned that the currency architecture has been fraying at its edges for years.
Analysts are seeing the 2020s as the biggest shift in global relations with the dollar since 1974, and every day Iran’s war continues, the cracks in the old system are widening. To be sure, the dollar is still highly influential, but it is no longer the only game in town.
To understand this moment requires a little rewind to see how we got here.
In 1974, the US made an agreement with Saudi Arabia in which the Gulf nation agreed to sell oil only in US dollars. In return, the US will provide military aid and security. Under then-President Richard Nixon, the United States sought to protect global demand for the U.S. dollar after the end of the gold standard in 1971. After the 1973 oil crisis, the US was motivated to strengthen its own oil supply chain.
Because oil was fundamental to almost every industry and yes, the “petrodollar” became ubiquitous, and the dollar became the cornerstone of the global economy: oil-rich countries needed a place to keep their growing reserves of dollars and turned to US treasuries. Countries that bought oil did so in greenbacks.
This cycle has made the US dollar a currency structure that has lasted for over 50 years. $800 billion is needed to support Saudi Arabia, as well as Qatar, Oman, Bahrain and the United Arab Emirates as a result of pegging their currencies to the US dollar. The Gulf Cooperation Council sovereign wealth fund has invested more than $2 trillion in US assets.
However, the ongoing conflict in the Gulf has exposed the weakness of the petrodollar in a new way. After the first US-Israeli invasion, Iran effectively closed the Strait of Hormuz, through which 20% of global oil supplies trade. Industry experts say some ships are able to bypass the choke point by paying in Chinese yuan.
According to economists, the Gulf countries have been quietly diversifying their trading partners for years before the current conflict, trading oil outside the US dollar and therefore by definition destroying the principle of the petrodollar as a special currency for oil trade. EBC Financial Group analyst Michael Harris wrote in a note on Monday that the dollar’s share of global foreign exchange reserves has hit a 25-year low, falling from 71% in 1999 to about 57% today.
Signs point to China being the big winner of the de-dollarization push. In 2024, Saudi Arabia did not formally renew its commitment to price oil exclusively in dollars. While the 1974 agreement was not a formal commitment and its secretive nature leaves a question mark as to whether it will result in a policy change, Saudi Arabia has still taken steps to diversify its trading partners. In 2023, the state and China signed a $7 billion currency exchange agreement. The Central Bank of Saudi Arabia is also a major participant in the mBridge digital payment platform, which allows direct currency exchange via blockchain.
“This change reflects fundamental economic realities,” Harris wrote. “China replaces the United States as Saudi Arabia’s largest oil customer. Economic gravity points toward the yuan while the currency regime points toward the dollar.” The Saudis are largely still doing deals with China in dollars, but the door is now open.
The weakness of the petrodollar has also been quietly exposed in the years before Saudi Arabia’s currency swap with China. The US was among a handful of countries to impose sanctions on Russia after it annexed Crimea in early 2010. As a result, Russia began dollarizing its economy, agreeing to exchange 150 billion yuan, or about $25 billion, with China. Although Iran has been selling oil to China for decades, their relationship has strengthened since the US reimposed sanctions in 2018 and 2019. China’s oil purchases account for 90% of Iran’s oil exports.
“With the current war, there’s been a renewal of the fact that Iran has been selling a lot of its oil in yuan for years because it doesn’t want to tie up or cooperate with the United States and it’s trying to avoid U.S. sanctions,” said David White, a historian at the University of North Carolina at Greensboro. fate. “It’s trying to find buyers, and that’s primarily China.”
Economists at Deutsche Bank have warned that US and Israeli attacks on Iran will continue to strengthen ties with China, which in turn will strengthen the yuan against the dollar.
“In this context, reports that ships may be offered passage through the Strait of Hormuz in exchange for oil payments in yuan should be closely followed,” analysts said in a note to clients last month. “The conflict can be remembered as a major catalyst for the erosion of petrodollar dominance, and the beginning of the Petroyoun.”
More broadly, White said, the revived spotlight on the petroyuan, as well as President Donald Trump’s continued threat of a double-whammy attack on Iran, have signaled to other countries that there are instances in which the petrodollar may not be the most favored currency. While more than 90% of cross-border trade in the U.S. is conducted through the petrodollar, according to a Deutsche Bank report, that share has fallen to about 70% trade invoicing in Asia-Pacific, and 20% in Europe.
“That, in itself, is not a reason to dismantle the entire system,” White said. “But I think the increasing aggressiveness of the United States in many areas — both in terms of sanctions and war — has made many countries wonder, ‘Do we want to be completely pegged or dependent on the dollar if things fall apart for whatever reason?'”
According to Fadel Kaboub, associate professor of economics at Denison University and president of the Global Institute for Sustainable Prosperity, China has positioned itself to capitalize on any rift in confidence in the petrodollar. China consumes about 15 million to 16.6 million barrels of oil per day, which is 15% to 16% of the world’s total oil consumption.
In 2018, China launched the Shanghai International Energy Exchange, a subsidiary of the Shanghai Futures Exchange, providing international investors with a currency system beyond the US petrodollar.
From the perspective of the Gulf countries, trading in the yuan is “not a geopolitical deal,” Kaboub said. fate. “This is not a security agreement. This is just a logical common sense business transaction. From a Chinese perspective, this is the building block of where China wants to be in 50 years.”
While the petrodollar was first cemented to Gulf allies as capable of providing a “security umbrella” and currency alternative during times of geopolitical tension, China is following the US playbook, Kabub said. But China has also invested heavily in renewable energy sources — including nearly four times as much operational electricity from solar power as the U.S. — recognizing the need to maintain economic dominance at a time when the world is no longer dependent on oil. Timing is especially important as the US is struggling relatively to maintain and repair its aging grid system, which has threatened how quickly it is able to scale its AI ambitions.
“They know they need to be an industrial and high-tech powerhouse that can impose their own currency and their own financial system on the rest of the world,” Kabub said of China.
The fortunes of the petrodollar are at a turning point during the Iran war. If Iran is able to maintain resilience against U.S. and Israeli forces, “that could be a major turning point,” Kaboub suggested. Iran is a relatively small nation, and by maintaining control of the Strait of Hormuz, could signal to other countries that there is a viable currency architecture outside of the petrodollar. Conversely, if the US gains control of the Straits of Hormuz, the petrodollar may retain its dominance. On Tuesday, Trump threatened to attack major Iranian power plants and infrastructure, as well as the death of “an entire civilization” if Iran does not reopen shipping channels.
To be sure, even with cracks in the base of the petrodollar, the currency is still far from irrelevant.
“I’m not going to say the petrodollar is dead, because that’s wrong,” Kaboob said. “It’s still very dominant in international transactions. I’m not going to say that there’s a petro-youth that’s a rising superpower. It’s not there yet.
“It’s there as a potential alternative, but it has a long way to go to position itself as a major alternative to the dollar,” he concluded.
This story was originally featured on Fortune.com
