A U.S.-Saudi Breakup Threatens the Demise of the Petrodollar

There are, perhaps, fewer more important– or more delicate – relationships between countries than the one between the United States and Saudi Arabia.

The very reason the U.S. dollar is the world’s reserve currency dates back to a deal struck in 1971 between Secretary of State Henry Kissinger and the Saudis, during which the petrodollar was brought into existence.

The U.S. promised to always protect the House of Saud – militarily. In exchange, the Saudis would only accept dollars for their oil. Under Saudi pressure, all of OPEC soon followed suit.

This meant every nation on the planet needed dollars if they wanted oil.

Currently, however, this crucial relationship is arguably at its least stable since the birth of the petrodollar.

This discontent was blatantly obvious during President Obama’s recent visit to Saudi Arabia.

Despite tradition dictating that government leaders show their respect for visiting foreign diplomats – with the U.S. President being the most revered in the world – Obama was not greeted at the airport by Saudi Arabia’s King Salman.

Further, Saudi TV and media pretty much ignored his visit which would, anywhere else, have been great cause for publicity and excitement.

This diplomatic slight was likely the result of the President having referred to the Saudis as “free-riders” in an interview with The Atlantic in March.

Dangerous Politics

The tension between the two countries further increased recently, thanks to the passing of a bill by the Senate – the Justice Against Sponsors of Terrorism Act (JASTA) – which would allows the families of the victims of 9/11 to sue Saudi Arabia, pending the verdict as to whether any of the country’s officials were involved in the 2001 terrorist attacks.

This means, if even a single low-ranking government clerk is found to have been involved, Saudi Arabia could be sued by each and every American family that lost someone that day.

While there is a loophole that the Secretary of State may only engage “in good faith discussions” with the defendant concerning the resolution of claims to satisfy the law, Saudi Arabia stands to lose a significant sum of money in compensation for pain and suffering – not to mention the stain on the country’s reputation on an international scale.

The Saudis are fuming hotter than the sands in the Arabian Desert on a sultry summer day.

Between Obama’s remarks and the potential legal trouble, Saudi Arabia is losing its faith in its bond with the U.S.A.

Another key part of that distrust stems from the U.S. lifting sanctions against its rival, Iran.

Further, Saudi Arabian bigwigs feel that the U.S. did virtually nothing to save its long-time Sunni partner, Hosni Mubarak – the former President of Egypt who was forcibly removed from office and subsequently convicted of corruption in 2015. This has given the Saudis cause to wonder whether they’re the next Sunni regime to be dumped by the U.S.

It is, however, the 9/11 bill that has been causing the most turmoil lately.

As soon as it became international news, the Saudi media had a field day. One daily Saudi newspaper, Okaz, blared the headline: “Congress’ Satanic Deed Opens the Gates of Hell for the World’s Largest Country.” You don’t even have to read between the lines to see how the nation feels about the United States.

Although the headline certainly over-simplified a truly complex issue, the article made a valid point. If this bill is signed into law, what’s to stop other countries from suing the United States for damages and death caused by the U.S. military? Or even to stop other countries from using this same legal action against one another?

The Justice Against Sponsors of Terrorism Act is, in effect, a Pandora’s Box. Tit-for-tat lawsuits will likely fly back and forth across the globe soon.

Future Black Swans

Politics aside, it’s crucial to take a look at possible implications of this growing gulf between the U.S. and Saudi Arabia – especially where the financial markets are concerned.

Everyone, including investors, ought to quickly come to grips with the fact that the United States is dealing with a brand new Saudi Arabian regime.

As I detailed previously, the keys to the Kingdom are in the hands of 30-year old Deputy Crown Prince Mohammed bin Salman.

The man known to some as MbS, is a no-BS kind of leader. His authoritative style varies in many ways from those of his predecessors, but, more than anything else, he has no fear of the U.S. This sets him apart from most Saudi leaders.

For MbS, the “playbook” is open. He has made it amply clear that he’s not going to shy away from conflict with the U.S.

He is not, however, stark, raving mad, and knows better than to wage a physical war against the most powerful country on the planet. Instead, his options for action are what the financial markets refer to as “black swan” events.

The first battleground for which would be within the oil markets.

The Saudis have already completed Stage 1 in their oil strategy – driving prices down, and hurting certain producers such as U.S. shale.

Now Stage 2 is underway. The country’s rig count is up 45% and counting, over the past two years.

The ultimate goal is to lift Saudi production capacity from 12 million barrels a day to 20 million barrels a day in the shortest time possible. The end game is to flood the market with so much oil that even Iran would struggle to maintain numbers as well as exports.

Ultimately, MbS hopes U.S. oil players will drown in the flood.

Oil market participants think MbS is bluffing. Hindsight is, of course, 20/20. But only time will tell.

The Saudis may also move to break the bond between the dollar and the Saudi riyal. That bond has been set at 3.75 riyal to the dollar since 1986.

A riyal devaluation may be MbS and the Saudis’ big move towards the end of the petrodollar.

China, Russia, and India, among others, are urging an end to the “hegemon” dominance of the U.S. dollar in the international monetary system – particularly with regard to the pricing of commodities. They now have a sympathetic ear in an unhappy Saudi Arabia, the only country who can effectively put an end to dollar dominance.

For the United States, this would be a big change. The global economy would have to find its footing with another currency.

China is waiting in line – so that could be the petro-yuan. But let’s hope it doesn’t come to that.

The end of the petrodollar system would tank the stock market and affect the U.S. standard of living.

So, thanks to our politicians kicking sand into the face of Saudi leadership that’s no longer afraid of standing up to the United States, after all these years – the death of the petrodollar is now a very real possibility.

Good investing,

Tim Maverick

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By Tim Maverick