There’s no such thing as the petrodollar
War on Iran is changing the currency calculations of Gulf energy exporters. But the dollar’s global role depends on far more than the denomination of a barrel of oil
In the summer of 1969 Euromoney published its first issue. The magazine broadened its coverage over time, but in its first few years focused exclusively on the foreign currencies and bonds being traded in the City of London. The editor was a page short of copy when he arrived at the printer, so on the spot he wrote a back-page satire in the voice of a letter home from Herbie, an American sent to London to open an office for the Last National Bank of Boot Hill. It became a regular feature.
Herbie loves his mum and hates warm gin. He’s written as a quiet American, a rube with too much power and too little sense, sweet but unable to find most anything on a map now that he’s left the US. And in February of 1973 he arrives late to his office on Moorgate to discover his local foreign exchange and bond dealers annoyed with him. He has been neglecting their most important new customers: the Arabs, and as poor Herbie writes it, the “Librans”.
Oil was about $3.60 a barrel in early 1973. In the summer it rose to about $4.30. There’s a dawning sense in the pages of Euromoney that year that there was a new source of wealth in the world, it had to go somewhere, and that somewhere might as well be the City of London. In September of that year a headline in the magazine abandoned all subtlety and asked, simply, “What will the Arabs do with their money?”
The Yom Kippur war in October and the embargo that followed drove the price of oil above $10 a barrel by early the next year. We now mark the embargo as the beginning of what we call the petrodollar. At first, the word “petrodollar” just referred to a flood of capital from oil sales. Many countries with oil reserves did not have domestic economies big enough to invest in, and so petrodollars sloshed around the global economy looking for a return. They were seen as destabilising, and potentially destructive.
As western and in particular American diplomats descended on Kuwait and Saudi Arabia in the early 1970s, however, the word “petrodollar” came to mean a broader deal. The Saudis would price their oil in dollars and sink their dollar profits into US Treasuries. In return, the Americans would guarantee security and stability. The US dollar would float on top of the US Navy.
That deal now looks like it may be in danger. The US looks incapable of winning, ending or even articulating the purpose of its war on Iran. Oil production has dropped in Saudi Arabia, and collapsed in Kuwait, Iraq and the UAE. Iran sells almost all its oil to China, receiving not dollars, but yuan. India may now be buying Iranian oil in yuan as well. This month, the ships that did pass through the Strait of Hormuz paid a toll to Iran in bitcoin.
The US Navy is no longer guaranteeing the free flow of oil from the Gulf. Negotiations over the strait change by the hour, but for at least part of April the US Navy in fact stopped that flow. If the terms of the petrodollar deal no longer hold, it’s not hard to imagine that the deal itself is over: the US dollar no longer sails on carrier groups.
There are several different stories we tell ourselves about why the dollar is so powerful. Most of them start with the assumption of monetary sovereignty. If a state is powerful, so is its money. The economist Robert Mundell wrote that strong currencies were the children of empires, with vast, stable domestic markets, attached to far-reaching merchants. The idea of the petrodollar nestles into this story of currency and empire — the US projects power and stability, and those who enjoy that stability consent to the dollar.
To believe that, however, is to believe that powerful money begins with sovereign decisions. Washington, DC creates its money, then Riyadh and Kuwait City and Doha agree to it. But one of the most powerful things about the dollar is precisely the way the US federal government has relinquished control of it. Banks all over the world create their own dollars, on their own balance sheets, with the tacit acceptance of the Fed and the US federal government but beyond their regulatory reach.
It is this flexibility that has made the dollar a global project for the past half century. The petrodollar story gets cause and effect exactly backwards. Oil producers priced barrels and profits in dollars in the 1970s because an infrastructure of global dollar banking, what we now call the eurodollar system, was already in place — not in New York, but in London.
Already in the summer of 1973, Herbie’s bond and foreign exchange dealers were worried about a share of the business from Saudi Arabia, Kuwait and Libya for the same reason Herbie was in London in the first place. The eurodollar system was already in place, ready to absorb the new profits that came out of new oil wells. A lot of things hang on whether the Strait of Hormuz is open or closed, but dollar dominance is not one of them. The global dollar does not rest on ships and petrodollars. It rests on bankers and eurodollars.
Dollar dominance is hard to measure, and its most visible indicators aren’t necessarily the most important. Every quarter the IMF publishes the composition of foreign exchange reserves of central banks — what countries hold to support the value of their own currencies. Dollars as a share of those reserves have dropped during the past decade, from 65 per cent to 57 per cent.
If we think that currency dominance is a sovereign decision, then reserve holdings present an alarming data point — dollar assets such as Treasuries aren’t as important as they used to be. Work by the New York Fed suggests that the aggregate numbers can be misleading, however, and that the decline is driven mostly by idiosyncratic factors, such as Russia’s move away from dollars.
Reserves aren’t the only way to measure the power of the dollar. Until relatively recently, economists assumed that exporters would write out their invoices in either their own currencies or the currencies of the countries they were shipping to. During the past decade, however, work by several economists, prominent among them Gita Gopinath of Harvard, has described a “dominant currency paradigm”. To avoid currency risk, exporters write out their invoices in a dominant currency — most often the euro or the dollar.
Data on invoicing is harder to collect than for central bank reserves, but as recently as 2022, according to work by Gopinath and others, almost a quarter of global trade was invoiced in dollars. An estimate from the Atlantic Council has that even higher, above 50 per cent. This, even though only about a tenth of that trade was destined for the US. Dollar invoices don’t rest on diplomacy; they come from merchants, making their own private decisions.
Those decisions, in turn, rest on a kind of dollar dominance that’s even harder to measure. Banks outside the US mark up their own ledgers with dollar-denominated loans, building a vast pool of deposit dollars that keep dollar trade and finance liquid. If we assume that a currency can only be sovereign, produced by a country within its own borders, then these dollars are hard to see.
But you don’t need permission from the US Treasury or even the Federal Reserve to make a dollar. Any bank, anywhere can add a liability to its own balance sheet and call it a dollar. Banks in fact do this on a scale comparable to what banks do domestically in the US. According to data collected by the Bank for International Settlements, there is approximately $14tn in offshore dollars — eurodollars — booked as liabilities with banks outside the US. Domestically, the Fed and commercial banks together hold more than $19tn.
That is: about 40 per cent of all dollars are created outside of the US. No other currency enjoys anything close to that privilege. It is difficult to get data in yuan, but there are just over $3tn in offshore euros, the dollar’s closest competitor. And unlike the share of dollar reserves held at central banks, the sum of offshore dollars isn’t shrinking. It’s growing.
It was offshore dollars that dragged Herbie from Boot Hill to London. Well before the oil embargo of 1973, bankers in the City had already built a sophisticated, flexible system to bank in dollars outside the US. This is the eurodollar system. It does not yet show any signs of collapsing. It does not depend on a decision from Tehran or even Riyadh.
When it began in the middle of the 20th century, the eurodollar system was hard to understand, and not just for simple Herbie from Boot Hill. To sell something to an American, a German company got paid in dollar deposits at an American commercial bank. In theory, the company would have then started a process through the Bundesbank that would eventually present those deposits to the US Department of the Treasury, for gold.
But that’s not what happened. In the 1950s, banks in the UK began trading access to deposits in America. European companies, flush with dollar deposits in American banks, simply sold them into a liquid market in London. It was a triumph of practice over theory. Paul Einzig, a regular contributor to the FT, described eurodollars as a “remarkable conspiracy of silence”. Bankers in the City begged him not to write about what they were doing, lest someone important notice.
In 1960, a Federal Reserve economist returned from London to describe a deep global market in claims on dollar deposits. Dutch, Swiss, Scandinavian and German banks were the most active sellers of those claims, but European companies and foreign subsidiaries of American companies were in the market, too — as were oil suppliers from the Middle East. The Fed economist called these claims “continental dollars”, but reported that some people in the City were already calling them what we call them today: eurodollars.
During the next decade, that market began to add new instruments. In 1963, banks in London issued $164mn in Eurobonds — bonds, issued abroad in dollars. A decade later that had grown to $3bn. Banks in London began making loans in eurodollars, too — producing new dollars. There were arguments at the time over whether that was even possible, but in 1969 Milton Friedman published some basic arithmetic showing that the size of the market for dollars in the City was just too vast. There couldn’t just be claims on existing American bank dollars in London. There had to be new dollars as well.
A memo in 1971 from the Bank for International Settlements agreed. In 1964 there had been $9bn in total new eurodollar loans — new offshore dollars. By 1970 that had grown to $41.5bn. This was the system that Herbie and his local bond and foreign exchange brokers worked in: flexible, inventive, expanding.
Eurodollars were convenient for policymakers in the US, because they delayed the return of American bank deposits to Fort Knox. And they were convenient for policymakers in Europe, because they kept profits booked in America from causing inflation at home. It was already clear what eurodollars were good for: mopping up wealth.
Already in December of 1973 you can see evidence of frantic new deals in eurodollars to build new oil infrastructure: $200mn to Pertamina, Indonesia’s state oil company; $12mn to an oil shipping consortium; $35mn to the Sultanate of Oman. Herbie writes home to Boot Hill that he has printed up too many Christmas cards that read “The Problem of Success” and is considering selling some of them to investors arriving from the Middle East.
By February 1974 most of the magazine is dedicated to the question of oil wealth. The value of the dollar has risen, since America is less affected by the price of oil than heavier importers, and it’s clear that the only capital markets with the capacity to take in oil profits are the dollar markets in New York and eurodollar markets in London. Herbie’s bond broker has just returned with a tan from Kuwait, and everyone in the City is buying tropical gear at Moss Bros. Herbie, as usual, is confused. Visitors from the Middle East used to need him to sell their oil, he writes to his mother; now they need him to place their money. He is headed there himself, “crazed with the spell of far Arabia”, as soon as he can find a plane ticket.
The political scientist David Spiro has collected data on where petrodollars went. In 1974, $11.5bn went to US deposits and Treasuries, and $24bn went into the City. By 1982, the Americans had set up a special facility for the Saudis to buy Treasuries, and there was $94bn of petrodollars in the US. In London that year there was $116bn in petrodollars. Diplomacy can move markets. But it can’t make markets up from scratch.
Currencies aren’t just vibes, powerful in some general sense because countries are. The global market for eurodollars works in specific ways that we can understand. Most significantly, the Federal Reserve has made clear that it will protect eurodollars in a crisis. The Fed maintains swap lines with a few trusted central banks. It swaps dollars on its own balance sheet, temporarily, for euros or yen on theirs. In turn, those central banks can lend dollars to their own commercial banks if their own eurodollars start to look questionable. The Fed does this because a global banking collapse would be bad for Americans, too, but it’s not hard to see why the Bank of England, the Bank of Japan and the European Central Bank appreciate the favour.
At the height of the crisis in 2008, the Fed held $554bn in swaps with other central banks — it had temporarily bought euros, pounds, Swiss francs, Australian dollars, Brazilian reals. Again during the pandemic in early 2020, the Fed held $358bn in swaps. No other central bank offers anything like this protection.
Since 2008, the People’s Bank of China has extended swap lines to 40 countries. Offshore yuan are hard to measure, but the existence of the swap lines suggests they must exist. But the swaps from the PBoC are untested in a crisis. According to Aditi Sahasrabuddhe of Brown University, one of the authors of a recent working paper on the swap lines, the possibility of a security threat from China acts as a deterrent to signing these swaps. That is: for the dollar, swap lines are a diplomatic tool more powerful than a carrier group.
The global dollar system was not set in motion by a single diplomatic coup — oil for dollars. It was invented quietly by private actors, then endorsed and protected by the US. America didn’t just push its dollar out into the world. It found dollars in London, then decided to protect them. If there’s any threat to the global dollar system, this is where it will show up, in America’s willingness to support dollars created abroad that it doesn’t otherwise regulate.
As the Trump administration continues to haggle and embargo and improvise in the Strait of Hormuz, the US may be losing power as an empire. But a currency is not the same thing as a country. America extends a financial security umbrella to dollars created abroad. Should it ever become clear that the Fed is not willing to extend the diplomatic generosity of its swap lines — that’s when it would be time to worry.
