The consensus view that the U.S. war with Iran is putting a key component of its economic might at risk was challenged on Thursday by an analyst who argues a victory for President Donald Trump will ultimately cement the dollar’s role as the world’s dominant currency.
Iran’s effort to leverage control of the Strait of Hormuz, and disrupt global energy markets, alongside a tariff regime put in place by President Trump last year that has complicated global trade relations, is testing the so-called Petrodollar system put in place during the early 1970s.
Established during the peak of the Arab oil embargo of 1973, the agreement effectively ensures that all countries buy and sell oil based on prices set in dollars. That’s pegged the greenback to global energy demand, while also creating a structural need for countries around the world to buy and hold dollars, a dynamic that lowers U.S. interest rates and deepens currency market liquidity.
James West, head of energy and power research at Melius, argues in a note published Thursday that while the pact may be under strain, it will likely be strengthened by U.S. protection of Gulf energy assets.
“The petrodollar was always a security guarantee dressed up as a currency arrangement,” he said. “What is playing out across Venezuela, Iran, and the broader BRICs periphery is a reassertion of that guarantee—a reminder that the dollar’s reserve status is a commitment extended to those who operate within U.S.- anchored security architecture.”
The war also has the potential to be dollar positive because it could result in the U.S. cementing its place as the prime mover in the oil markets, West explains. “In a postconflict scenario, the U.S. is positioned to consolidate its role as the world’s dominant energy exporter,” he said, noting that it’s geographically removed from geopolitical risk, energy independent, and increasingly in control of energy assets across the world. “Success in the current war would ensure the dollar remains the dominant currency for oil trade.”
Others aren’t so sure. With the U.S. now relying far less on oil imports owing to its developments in shale production and looser regulations, big energy importers such as China and India are buying more crude from Saudi Arabia and other Gulf region states.
Efforts to trade crude in local currencies, rather than the dollar, are also ongoing. That would ease the cost of energy imports for both major economies, such as China, and developing ones, such as Vietnam.
Beijing is also expanding its Cross-Border Interbank Payment System, or CIPS, to facilitate non-dollar trade and bypass the U.S.-backed Swift architecture. Around 180 trillion in yuan-based payments passed through CIPS last year, equal to around $25 trillion, with daily average volumes growing an annual rate of 32%.
Trump has threatened to apply a “100% tariff” and warned countries they could say “say goodbye to selling into the wonderful U.S. economy” if they were to create or support any so-called ‘de-dollarization’ effort.
The war with Iran, however, could accelerate it, according to Deutsche Bank strategist Mallika Sachdeva. Reports suggest Tehran is already looking to price and sell its oil exports to China in yuan, the currency used by the world’s second-largest economy, in exchange for safe passage through the Strait of Hormuz. Such a move could “test the foundations of the petrodollar regime” and create “significant downstream effects to the dollar’s use in global trade and savings, and its role as the world’s reserve currency,” she writes.
And rather than reinforcing the U.S. security position, the war could undermine it, Sachdeva argues. “The current conflict may expose further fault lines, by challenging the U.S. security umbrella for Gulf infrastructure and the maritime security for global trade in oil,” she writes. “[It] could be remembered as a key catalyst for erosion in petrodollar dominance, and the beginnings of the petroyuan.”
Which way it goes has big implications for the U.S. economy. Federal government debt is forecast to rise past $50 trillion within the next decade, according to recent projections from the Congressional Budget Office, and topped the $39 trillion mark earlier this month.
Reserve currency status effectively protects the U.S. from having to rein in explosive spending and unfunded tax cuts, as foreign nations recycle their trade dollars (which don’t earn interest) into Treasury bonds (which do).
That keeps government borrowing costs lower than they would normally be, holds down mortgage rates and ensures that lawmakers can continue to promise tax cuts. Should that status wane, a sharper financial reckoning in Washington would shortly follow, with implications for stocks, bnds, and other markets.
Markets aren’t there yet, however, and the dollar has gained around 3.8% against a basket of its global currency peers since the war began on Feb. 28, as investors rush to safe-haven assets and react to the surge in global crude prices.
But last year’s performance for the greenback, the worst in a decade, should remind investors that dollar dominance is no longer guaranteed.
Write to Martin Baccardax at martin.baccardax@barrons.com