Worriers about the dollar can calm down: Iran’s ‘petroyuan’ move won’t topple the greenback

(SeaPRwire) –   Even in the midst of a flood of troubling news from the Middle East over the past few weeks, an Iranian proposal to potentially grant safe passage to oil tankers paying in Chinese yuan rather than U.S. dollars caught people’s attention.

Attributed to an unnamed Iranian official, this threat triggered a wave of warnings that Tehran could leverage its control over the Strait of Hormuz not only to jeopardize global oil access but also to disrupt the dollar-centric international monetary system. The argument goes that by undermining the petrodollar, Iran might set off the collapse of the dollar’s dominance—a cornerstone of U.S. power. Proponents of these alarming scenarios also foresaw other risks, such as weakening America’s security commitments to Saudi Arabia and other Gulf oil-producing nations.

“The conflict could be remembered as a key catalyst for erosion in petrodollar dominance, and the beginnings of the petroyuan,” with potentially “significant downstream effects to…the dollar’s role as the world’s reserve currency,” Deutsche Bank analysts warned in a report last week.

The war’s impacts will certainly be severe—but the dollar won’t be affected. The U.S. currency’s strength is built on solid ground, and Iran’s petroyuan move appears to be just another instance where fears about the dollar’s leading position have been unfounded. Even if the petrodollar system loses some strength, it won’t make much difference: Despite the size of global oil markets, the factors behind the dollar’s dominance are unrelated to oil.

The dollar’s position comes from two unique traits no other currency has. First is the depth, scope, and liquidity of U.S. financial markets—especially the Treasury bill and bond market, where large quantities can be traded without causing major price shifts. This characteristic is vital during financial crises, when companies rush to secure the cash required to fulfill upcoming obligations.

The second trait is America’s open capital account—meaning money can flow across U.S. borders almost without restriction. While many nations have open capital accounts, China does not, which is a key point. Moreover, no country—even those with open accounts—has the same depth and scope as U.S. markets.

The dollar has repeatedly proven its critics wrong and still plays a role in global transactions that’s way larger than the U.S. economy’s size. It makes up more than half of central banks’ foreign currency reserves, and a comparable share of cross-border export invoices, international bank loans, and bond issuances. Network effects solidify its position: everyone has a reason to use the dollar because so many others do.

The dollar’s deep-rooted position is most clear in the operations of the obscure yet massive foreign exchange swap market. Here, global entities—multinational companies, banks, insurance firms, securities dealers, and pension funds—protect themselves from currency swings. The Bank for International Settlements (BIS) reports that outstanding swaps now exceed $100 trillion, with around 90% involving the dollar (much smaller shares involve the euro, Japanese yen, and other currencies). This shows the countless ways the dollar is used for lending, borrowing, and investing.

So why do so many people fixate on the petrodollar? It’s largely due to a story that’s not strongly based on facts. The popular tale says that in the mid-1970s, the U.S. made a deal with Saudi Arabia: it would provide military aid and protection to the ruling House of Saud, and in return, Saudi Arabia would only accept dollars for oil and invest the earnings in U.S. Treasuries. This became a model for other oil exporters.

People who were there at the time have a different recollection. David Mulford, a young investment banker hired by the Saudi Arabian Monetary Agency (SAMA)—the country’s central bank—as an adviser in 1975, was one of the few foreigners allowed to live in the desert nation. In his 2014 memoir, he described how a team of six experts worked in SAMA’s run-down offices to manage “a portfolio growing at $5 and later $10 billion every thirty days,” using just one slow telex machine to communicate with the rest of the world.

As it happens, oil was already mostly priced in dollars, and as Mulford noted, Saudi Arabia had few options but to invest its earnings in dollar-denominated assets. According to Mulford, who later became a U.S. Treasury undersecretary and ambassador to India, “In most markets outside the U.S. in those days a currency trade of just $10 million was enough to move markets, so there were practical limitations on the amount of currency diversification that we could achieve.” Furthermore, “purchases of German [bonds], or Japanese yen bonds, or Dutch guilder bonds, or Swiss franc notes were just not possible in the sizes common in the U.S. market.”

In short, it was the U.S. market’s unmatched depth, scope, and liquidity—not a secret agreement—that led Saudi Arabia to opt for the dollar.

Petrodollars were a key driver of the dollar’s global spread in the 1970s and subsequent decades, since much of oil exporters’ income was deposited in dollar accounts at banks worldwide, mainly in Europe. However, they play a far smaller role in today’s global dollar market.

Jess Hoversen, chief economist at Column—a San Francisco-based financial services company—cited IMF research noting that 44% of oil sales earnings went into offshore dollar bank accounts in the 1970s, but this dropped to 27% by the early 2000s. She estimates the percentage is now in single digits, as oil exporters now direct their earnings toward domestic development and sovereign wealth funds, which then invest heavily in global stock markets and startups.

Yet the dollar market has grown dramatically even as petrodollars have declined. Hoversen pointed out that the offshore dollar credit market was $2.5 trillion in 2000 and reached $14.2 trillion last year. “This tells us that the dollar is very structurally resilient,” she writes.

The discussion over the dollar’s dominance will keep going, especially since the Trump administration has shaken investor trust with moves like challenging the Federal Reserve’s independence. But unless the U.S. inflicts much more serious harm on itself, the dollar will remain the top global currency for the near future—even if Iran requires oil payments in yuan.