Daily Times

The US dollar has reigned supreme as the world’s reserve currency for decades, a power fuelled by the petrodollar system. The petrodollar system refers to the arrangement where oil is primarily traded in US dollars. This seemingly simple concept has had a profound impact on the global economy and political landscape for decades. But whispers of a changing landscape are growing louder. De-dollarization, the process of reducing reliance on the dollar, is gaining traction, potentially reshaping the global financial order.

The story of the petrodollar’s rise and reign began in the 1970s, following the collapse of the Bretton Woods system, the US negotiated a landmark agreement with Saudi Arabia. The foundation of the petrodollar system was laid in the aftermath of World War-II. The US emerged as a dominant economic power, with a strong dollar backed by a large gold reserve.

Meanwhile, oil-rich countries like Saudi Arabia needed a stable currency for their booming oil exports. A pivotal moment occurred in 1971 when President Nixon ended the convertibility of the US dollar to gold, effectively severing the direct link between the dollar and its gold backing. Oil, the world’s lifeblood, would be priced and traded exclusively in dollars. This, as explained in a 2024 Atlantic Council article “What the end of petrodollars means”, secured the dollar’s dominance.

The Saudis have transacted in non-dollar currencies for many years.

The petrodollar system had a profound impact. It provided stability to oil markets, fuelled a vibrant US financial sector, granted the US significant economic and political leverage and cemented the US dollar’s dominance by making it the lingua franca of international trade. Countries buying oil needed dollars, which increased demand for US Treasury bonds and strengthened the US financial system. Simultaneously, the US also gained significant leverage over oil-producing nations. By controlling the flow of dollars, the US could exert political and military influence in the Middle East to ensure oil supplies remained stable.

However, as a 2023 research paper published by the South Centre, “The Dollar Still Dominates, but De-dollarization Is Unstoppable” argues, this dominance is coming at a cost. As the developing nations realised that their reliance on dollar-denominated oil imports made them vulnerable to US economic fluctuations and foreign policy decisions – the concept of de-dollarization was seeded.

De-dollarization means a deliberate effort by countries to reduce the use of the US dollar in international transactions and holdings. There are several key factors driving de-dollarization. According to a 2023 J.P. Morgan report, “De-dollarization: The end of dollar dominance?”, the weakening US economy, the weaponization of sanctions by the US, the rise of alternative powerhouses like the BRICS, recent geopolitical tensions and a changing global economic landscape are raising questions about the dollar’s future.

BRICS nations, in particular, are leading the de-dollarization charge. They are diversifying their foreign reserves, promoting trade settlements in local currencies, and developing alternative financial institutions like the BRICS New Development Bank, as discussed in a recent article from BRICS Plus: de-dollarization and global power shifts in the new economic landscape. De-dollarization, if it unfolds, could have significant global consequences. To point out a few scenarios, this would translate into.

Reduced US influence: A decline in dollar use could weaken the US’s ability to influence global economic policy and exert financial pressure on other countries.

Increased volatility: A shift away from the dollar could create uncertainty and instability in global financial markets.

Rise of alternative currencies: The decline of the dollar could pave the way for the emergence of new reserve currencies or a basket of currencies.

Is the world ready for such a great economic shift? Perhaps not.

The recent social media frenzy about the end of petrodollar agreements between the US and Saudi Arab sent shock waves across global financial markets. Giving a glance into its volatility, heavy reliance and global impact. However the truth is that the Saudis have transacted in non-dollar currencies for many years, and there are no historical records of a formal treaty, much less with a specified expiration date, governing the loose arrangement that has come to be called the ‘petrodollar system.’

Saudi Arab’s recent announcement to move away from exclusive dollar-denominated oil sales marks a turning point, it is a result of many complicated geo-political and economic events/decisions. Also, Saudia is not the only country turning away from the US dollar, many see benefits in decreasing their reliance on the US dollar. While the dollar remains the dominant reserve currency, the trend towards de-dollarization is undeniable and unfolding right before our eyes.

A complete dethroning of the dollar is unlikely in the immediate future. However, a multipolar financial system, with a greater role for other currencies, is a distinct possibility, which is also well explored in the book “BRICS Plus: de-dollarization and global power shifts in new economic landscape”.

The evolving de-dollarization trend presents both opportunities and risks. It has the potential to create a more stable and equitable global financial system but could also lead to increased market volatility in the short term. As the world navigates this shift, the future of global power dynamics and financial stability remains an open question. And an interesting one to observe in the coming months.

The writer is Foreign Research Associate, Centre of Excellence, China Pakistan Economic Corridor, Islamabad.