Is Saudi Arabia Turning to the Yuan?

In the aftermath of the failure of the post-war Bretton Woods monetary system, the dollar’s position as the world’s reserve currency was strengthened by the development of the petrodollar system. Middle Eastern oil-producing countries agreed to price their oil in dollars, accept only dollars as payment for oil, and invest their dollars in US government debt. In exchange, they received copious amounts of military hardware and military assistance from the US government. Those countries that tried to buck the dollar and accept euros and other currencies for their oil found themselves facing invasion by US forces (Iraq) or economic sanctions (Iran).

That is why Saudi Arabia’s recent consideration of the Chinese yuan is so earth-shattering. While the United States could easily forsake its relationships with Iraq and Iran, countries with whom it had shifting and turbulent relationships in the past, the US government’s relationship with Saudi Arabia has been the anchor of the petrodollar system and the driving factor in US Middle Eastern policy. If Saudi Arabia were to open up to the yuan it could have significant ramifications on world markets and on the future strength of the dollar.

While Saudi Arabia funding its government operations in yuan would be a significant development, it would be even more shocking if Saudi Arabia were to start accepting yuan in payment for oil. That would stimulate the further acceptance of the yuan in international markets and decrease international demand for the dollar. It would weaken the dollar and erode the value of dollar-denominated assets. That would also stimulate demand for precious metals such as gold and silver, as investors in dollar-denominated assets would seek to diversify their portfolios away from the weakening dollar.

Of course, the Saudi riyal is pegged to the US dollar, so a weakening dollar would weaken Saudi Arabia’s currency too. But the currency peg has been under attack for years, with more and more pressure being put on the government to end it. If that peg were to be undone, that would be the ultimate signal that the Saudi government is moving away from the dollar and closer to the yuan.