What does the term petrodollar mean? What is meant by petrodollar recycling? In short, the petrodollar is not a specific thing, per se. Instead, the petrodollar is a concept which arose from a particular agreement between the United States and Saudi Arabia. First, start by considering some background information. Oil is a significant commodity. Oil is refined to power cars. People drive cars and trucks to work, to see friends, to transport stuff, and to go on road trips. Being able to transport yourself from one place to another provides a sense of empowerment and independence. Some have called driving the great American meditation. Just get in your car, play some music, and drive until you feel like turning around.
The central point about the petrodollar consists in the value of oil in a variety of applications. As an advanced country, the United States goes through a lot of oil. It turns out that other advanced countries are like America. They have a whole bunch of different applications for oil. The demand to put oil in stuff we find valuable, like cars, is really, really large. So, the thinking goes, the selection of currency oil is traded in is really, really important.
That's the theoretical background of the petrodollar agreement. The practical import of the petrodollar agreement concerns the largest oil producer in OPEC, the organization of petroleum exporting countries. Several dozen years ago, Saudi Arabia agreed to sell barrels of oil to buyers everywhere solely in terms of United States dollars. The world oil trade is denominated in dollars as a result, except in rare circumstances. Henry Kissinger negotiated this agreement, which has created demand for United States dollars. By pricing oil in dollars, oil-importing nations had to implement mechanisms to transact with dollars, which is supposed to be good for America, or something. But is it? Shouldn't the evidence of the dollar's so-called exorbitant status be exceedingly obvious after five decades of having virtually everyone in the world buy and sell barrels of oil with United States dollars?
When people talk about the petrodollar and petrodollar recycling, they are talking about an agreement between OPEC's top producer, Saudi Arabia, and America. The agreement has a couple basic components. Saudi Arabia and its state oil company Saudi Aramco sell oil for dollars. America provides defense products and services for Saudi Arabia. Suppose one of Saudi Arabia's neighbors starts to shoot missiles at Saudi Arabia. America sends in some missile defense systems, for a price. That's the high level theory behind the agreement. Saudi Arabia gets stuff, superior quality defense products and services, and America gets stuff, demand for United States dollars from oil-importing nations.
In practice, America sends actual missile defense systems to Saudi Arabia. And in practice, America has fought in areas which in no small part have been influenced by what Saudi Arabia has certainly argued are central to its security. As part of the agreement, Saudi Arabia has received a significant amount of defense support from America. The petrodollar agreement is supposed to be so valuable that the provision of defense services means America comes out ahead. Is that really true? Is the quid pro quo agreement, the "something for something" agreement, really advancing the financial position of the United States?
Look at the state of the American financial position to get a better idea of how valuable the petrodollar really is. The American government currently carries a debt load in excess of 100% of the dollar value of the aggregate economic output in a calendar year. Consider a hypothetical case to get a better sense of the magnitude of this data point. If every dollar of U.S. output, which is measured by a term called gross domestic product, went to paying down America's financial obligations in the 2023 calendar year, America would still have debt to pay down. America is the largest economic power in world history. The amount we would pay down in a single year is a really large number. That's a lot of debt!
The petrodollar and petrodollar recycling were supposed to be so valuable for America though. If the petrodollar really were so valuable, wouldn't the United States perhaps maintain a net surplus of capital, instead of owing a lot of capital to others? The proof is in the pudding. If the petrodollar were really a savvy move for advancing America's financial position then America would be in a much better financial position, because the petrodollar agreement has been in effect since the 1970s. But, in fact, America is not in a position of having a significant capital surplus as a result of the petrodollar agreement. The valid logical conclusion is simple. The petrodollar agreement has not really helped America in the way Henry Kissinger might have thought it would at the outset.
So, where is Henry Kissinger getting his numbers on the petrodollar agreement as being an agreement which advances the financial position of the United States of America?
