MARKET NEWS

BY  Melissa Lawford

The United States is displaying its military prowess in the Middle East, but its might is underpinned by another strength: financial dominance.

Iran’s leaders have long hated the hegemony of the US dollar in global trade and markets, a status that brings huge benefits to America in the form of cheaper borrowing and wide-ranging sanctions powers.

Now, Tehran is trying to leverage the Gulf conflict to undermine the dollar.

“The Strait of Hormuz is our iron hammer for breaking dollar supremacy,” Rasul Bakhshi Dastjerdi, a member of Iran’s parliamentary economics commission, said on Monday.

He has proposed that tankers be allowed to pass through the Hormuz only if their oil cargoes are priced at least partially in Iranian rials. There have been separate reports that the Iranians are allowing vessels through if their cargoes are priced in Chinese yuan.

Such requirements represent an attack on one of the foundational pillars of America’s economic exceptionalism. Global oil trade is predominantly denominated in dollars, underpinning demand for the greenback.

But the Iranians may not need to try too hard. Donald Trump’s war in the Middle East may pose an existential threat to dollar dominance in and of itself.

The conflict is undermining the credibility of America’s security umbrella in the Gulf. As a result, the war could drain huge sums from these countries’ dollar investments as they redirect investment into defence. High oil prices could significantly reduce demand for the commodity.

‘Challenge for the petrodollar’

The war has brought “a significant challenge for the petrodollar”, Deutsche Bank foreign exchange strategist Mallika Sachdeva warned in a client note this week.

“The conflict could be the catalyst for erosion in petrodollar dominance and the beginnings of the petroyuan,” she says.

“If fault lines are further exposed, there could be significant downstream effects on the dollar’s use in global trade and savings, and the dollar’s role as the world’s reserve currency.”

The petrodollar – the fact that the world’s most traded commodity is priced in US dollars – became the status quo after the US and Saudi Arabia signed a landmark agreement in 1974.

Saudi Arabia agreed to sell its oil in dollars and invest its profits in dollar-denominated assets in exchange for American security guarantees. The rest of the Gulf Cooperation Council (GCC) states followed, and the dollar became the norm in the oil market.

Because oil is traded in dollars and is so essential to the global economy, economies have a strong incentive to invest their savings in dollar-denominated assets. Businesses want to save their money in the currency that they need to trade in. Central banks need to build dollar reserves to function as lenders of last resort.