The Foundations Of The Petrodollar Regime Are Shaking; Deutsche

The long-term legacy of the Iran conflict for the dollar could be the way it tests the foundations of the petrodollar regime.

That is the ominous introduction to a must-read new research report from Deutsche Bank strategist Mallika Sachdeva, who warns that if fault lines are further exposed, there could be significant downstream effects to the dollar’s use in global trade and savings, and the dollar’s role as the world’s reserve currency.

The world saves in dollars in large part because it pays in dollars.

The dollar's dominance in cross-border trade is arguably built on the petrodollar: globally traded oil is priced and invoiced in USD.

This arrangement can be traced to a deal struck in 1974 where Saudi Arabia agreed to price oil in USD and invest surpluses in USD assets, in exchange for US security guarantees.

Because oil is a core input to global manufacturing and transport, there is a natural incentive for global value chains to dollarize, and global surpluses to accumulate in USD.

The foundations of the petrodollar regime have been under pressure even before this conflict.

 Most Middle East oil is now sold to Asia not the US; sanctioned oil from Russia and Iran has already been trading off dollar rails; Saudi Arabia has been localizing defence, and experimenting with forms of non-dollar payment infrastructure such as Project mBridge.

The current conflict may expose further fault lines, by challenging the US security umbrella for Gulf infrastructure and the maritime security for global trade in oil.

Damage to Gulf economies could encourage an unwind in their foreign asset savings.

In this context, reports that the passage for ships through the Strait of Hormuz may be granted in exchange for oil payments in yuan should be closely followed.

The conflict could be remembered as a key catalyst for erosion in petrodollar dominance, and the beginnings of the petroyuan.

A bigger risk could come if the world begins to move away from globally traded oil and gas itself, to more resilient sources of energy including domestically available fuels, renewable energy, and nuclear power.

The energy choices of the Global South, Europe and North Asia will be key to track.

A move away from oil could be as powerful as the pressure to price it in other currencies.

A world that becomes more self-sufficient in defence and energy could also be a world that holds less USD reserves.

The huge strategic importance of the Middle East to the dollar’s role as the world’s reserve currency should not be underestimated.

The current conflict may be the perfect storm for the petrodollar.

Professional subscribers can read the full Deutsche Bank note: "What Iran means for the dollar: a perfect storm for the petrodollar" here at our new Marketdesk.ai portal