Due to their energy density, oil and its refined products are the backbones of our economy. One gallon of gasoline pushes, on average, a car, and its contents, for 24.2 miles (equivalent to 10.3 kilometers per liter). One gallon — a two-tonne car! 

Further,  the price of crude oil—around $80 per barrel, or 42 gallons (159 liters)—makes it one of the cheapest liquids ($1.90 per gallon, 50.3 cents per liter). A liter of San Pellegrino or Coca-Cola costs around $2, four times as much as crude oil. Olive oil costs around $13, vodka $4, a Canon printer black ink $270, Dom Perignon Brut $346, nail polish $777, and Chanel Perfume No.5 $1,173.

Do We Still Need Fossil Fuels?

Despite being relatively and absolutely cheap, significant increases in oil prices regularly wreck economic growth and lead to inflation, as seen in the aftermath of the Russian invasion of Ukraine.

A graphic from 2016 visualizes the comparative size advantage of the global oil market to all other raw materials. Since then, the oil price has risen from $50 to $80 per barrel, and global annual consumption has increased from 94 to 102 million barrels a day. This has resulted in a demand for oil worth $8 billion per day, or roughly $3 trillion annually.

The US consumes roughly 20 million barrels per day (mbpd) and produces around 12.5 mbpd. That leaves 90 mbpd of consumption for the rest of the world. Crude oil, like most commodities, is priced in US dollars. When a non-US country wants to import oil, it first needs to acquire dollars to pay for it. Depending on exchange rates, countries can find themselves paying more for the same amount of oil.  Currently, global oil consumption creates a demand for US dollars amounting to $7 billion a day, or $2.6 trillion per year. 

Oil exporting countries cannot simply sell the dollars they receive into local currency. Saudi Arabia, for example, had a current account surplus in the third quarter of 2022 of $47.3 billion. Selling those dollars in exchange for Saudi Riyal would lead to a dramatic reduction in the amount of Riyal in circulation, thus pushing up its value. This would threaten to break the currency peg to the US dollar, which has been fixed at 3.75 Riyal per dollar since 1986. Most local currencies of net exporting nations are simply too small to be able to absorb massive dollar inflows.

What to Do with all the Dollars

The dollar proceeds from oil exports continue to pile up. Non-US countries call them foreign exchange reserves, and they are usually seen as positive. However, for the US, this is worrying. Currently, the country is approaching a $1 trillion per year trade deficit. When more money is exiting the US than entering, and imports exceed exports, the trade deficit must expand. 

Until the US resolves its trade deficit, it will continue to export its debt. Its trade partners, in the aggregate, will be forced to purchase treasury securities rather than goods and services. “Foreign official institutions” (for example, central banks and sovereign wealth funds) have amassed nearly $4 trillion in US government debt. Private foreign entities accumulated another $3.5 trillion. The “net international investment position” (NIIP) of the US- which measures the difference between a nation’s stock of foreign assets and a foreigner’s stock of that nation’s assets-  has declined to more than negative $16 trillion, from a mere $2 trillion in 2006.

A negative NIIP means more dividends and interest payments flowing to foreign nations. It is not a coincidence the Swiss National Bank is among the largest shareholders of some US corporations, as mentioned in this article.

Non-US countries are effectively financing the US’ fiscal and trade deficits by purchasing large amounts of debt issued by the Department of Treasury. A large fiscal deficit, in turn, allows the US to spend as much money on its military budget than the next ten countries combined. To put it bluntly, some countries pay for the bombs being dropped on the heads of their constituents.

The Problem with Current Account Deficits

Normally, a country with large current account deficits will soon find its currency under pressure. In a system of freely floating exchange rates, import prices would rise, volume would reduce, and exports would boost due to heightened competition. The trade deficit would therefore shrink.

The longer a country runs a current account deficit, the greater the likelihood of a debt crisis. Many non-US countries rely on dollar-denominated debt for funding. A decline in local currency makes those dollars more expensive to service, often making debt restructuring necessary.

In the case of the US, this does not happen, as it has virtually no debt in foreign currency, and can always “print” more of its own currency to repay foreign debt. Due to the status of the dollar as the world’s reserve currency and “involuntary” accumulation, the normal exchange rate mechanism does not work. The US can keep running current account (and fiscal) deficits with impunity.

According to the Kalecki Profit Equation, named after the Polish economist Michal Kalecki, the sum of all flows of the three sectors of an economy (government, private and foreign) must balance to zero. A government running a fiscal deficit will cause a surplus to pop up in either the private sector (households and corporations) or the foreign sector (as a surplus from the viewpoint of foreign countries), or a combination of both. 

Consequently, a foreign sector surplus (as in the case from the US viewpoint) must create a negative US government sector balance (a fiscal deficit). If the government tried to run a balanced budget, the negative sector balance would appear in the private sector, with households being forced to dissave or go deeper into debt, while corporations’ profits would disappear.

Repercussions of Dollar Overvaluation 

The more dollars non-US countries accumulate, the more it appreciates in value. This, in turn, means US consumers pay less for imported goods than they would otherwise, and foreign purchasers, in contrast, overpay. This also translates into a higher standard of living for US residents and a lower one abroad. 

A growing US fiscal deficit implies a growing trade deficit. Under President Reagan’s administration, it was common to hear economists refer to the twin deficits, as both the fiscal and trade deficits grew considerably. Abroad, this means that workers are forced to produce goods for US consumers in exchange for fiat money. This comes at the detriment of US workers, as production moves to lower-cost countries, thanks in part to an overvalued dollar. Since the 1980s, employment in the US manufacturing sector has declined from almost 20 million to 13 million today. This, in turn, allowed China to become the world’s leading manufacturer.

Oil Price as a Threat to Dollar Dominance

The flow and foreign accumulation of dollars depend mainly on two things: the price of oil and the willingness of oil exporters to invoice in dollars.

Lower oil prices equal fewer dollars, which means less recycling of those so-called petrodollars. Cheap oil, therefore, is against US interests and must be kept off the market. It is not a surprise the US has tossed some of the (potentially) largest oil producers, like Russia, Iran, Iraq, and Venezuela, with either war or heavy economic sanctions (Venezuela has the largest proven oil reserves in the world, amounting to almost 300 billion barrels). 

Military adventures in the Middle East have been misunderstood as a fight for oil; in actuality, the purpose has been to suppress supply. A few select nations (e.g. Saudi Arabia) are “allowed” to enjoy full production, albeit in exchange for large orders for US weapons manufacturers and a promise to not sell oil in any other currency than dollars.

Proponents of selling oil in euros (such as Saddam Hussein, former President of Iraq) or against a gold-backed pan-African currency (Muammar Gaddafi, former leader of Libya) have been removed.

Threat from Energy Transition to Alternatives 

Given that the dollar’s status as an international reserve currency depends on oil, it should not come as a surprise that the US is vehemently opposed to any form of alternative energy.

President Reagan famously removed solar panels from the White House that had been installed by former President Jimmy Carter in 1979. The panels ended up in a museum in China, the world’s leading producer of solar energy modules (75% world market share), cells (85%), and wafers (97%).

In 2017, legislators in the state of Wyoming, which generates 90% of its energy from coal,  introduced a bill to prevent Wyoming utilities from selling electricity generated by wind or solar farms. In 2021, the same state tabled a bill that would ban the sale of electric vehicles by the year 2035. 

Texas banned government agencies from doing business with financial firms that won’t invest in fossil fuels and firearms. The state also banned several asset management firms like UBS, Credit Suisse, and Blackrock for violating ESG (Environmental, Social, and Governance) guidelines. The Teacher Retirement System of Texas, with $183 billion of assets under management, is among the top five public pension systems in the US. The US has spent enormous funds to become energy independent and a net exporter of energy. But though renewable energy is growing fast, it will take even longer for the country- once considered the leader in science and innovation- to cut its overreliance on fossil fuels. 

In today’s global commerce, fossil fuels offer less value and more unfavorable terms of trade, of the kinds often found in emerging economies. Former Saudi oil minister Sheik Yamani famously said, “the Stone Age did not end for lack of stone, and the Oil Age will end long before the world runs out of oil.” As the sun sets on the Oil Age, the days of the dollar as the anchor of the international monetary system seem numbered.

[Naveed Ahsan edited this article.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.