Word of the Day: PETRODOLLAR

Definition of ‘Petrodollars’

The money earned from the sale of oil. The term “petrodollars” was coined when the price of oil rose sharply in the 1970s. It resurfaced in the new millennium, when prices rose once again. Although petrodollars initially referred primarily to money that Middle Eastern countries and members of OPEC received, the definition has broadened in recent years.

Investopedia explains ‘Petrodollars’

Petrodollars are the primary source of government revenue in many Middle Eastern countries. In fact, these funds represent a massive amount of investment capital and, in fact, are often traded on the eurocurrency market. They are also used for development purposes. In the 1970s and 1980s, Bahrain was able to improve its industrial capacity through the use of petrodollars.

http://www.investopedia.com/terms/p/petrodollars.asp

Definition of Petrodollars

Petrodollars may be defined as the U.S. dollar earned from the sale of oil, or they may be simply defined as oil revenues denominated in U.S. dollars. Petrodollars accrued to oil-exporting nations depend on the sale price of oil as well as the volume being sold abroad, which is in turn dependent on oil production. The overall world supply of oil, on the one hand, and the world demand, on the other hand, determine sooner or later an actual market price for oil regardless of any administered pricing system. A price determined by OPEC can be maintained only so long as there is sufficient demand to absorb the amount being supplied in world markets. If demand exceeds supply, oil will be sold at an even higher price than that determined by OPEC. The opposite holds true when an oil glut occurs. This is reflected in a drop in the price after a certain time lag regardless of the price dictated by OPEC. The experience of the seventies and the eighties is no more than art application of microeconomic tools to the pricing of oil in world markets.

Petrodollar surpluses may also be defined as the net U.S. dollars earned from the sale of oil that are in excess of internal development needs. Petrodollar surpluses, accrued in the process of converting subsoil wealth into an internal income-generating capital stock, refers to oil production that exceeds such needs but is transformed into monetary units.

Since petrodollars and petrodollar surpluses are by definition denominated in U.S. dollars, then purchasing power is dependent on the U.S. rate of inflation and the rate at which the U.S. dollar is exchanged (whenever there is need for convertibility) by other currencies in international money markets. It follows that whenever economic or other factors affect the U.S. dollar, petrodollars will be affected to the same magnitude. The link, therefore, between the U.S. dollar and petrodollar surpluses, in particular, has significant economic, political, and other implications.

First, the placement of petrodollar surpluses of the Arab oil exporting nations in the United States may be regarded politically as hostage capital. In the event of a major political conflict between the United States and an Arab oil-exporting nation, the former with all its military power can confiscate or freeze these assets or otherwise limit their use. It can impose special regulations or at least use regulations for a time, in order to attain certain political, economic, or other goals. It may be argued that such actions are un-American, since they are a direct violation of the sacred principles of capitalism and economic freedom. Nevertheless, the U.S. government resorted to such weapons twice in the l980s against Iranian and Libyan assets. It follows, therefore, that governments placing their petrodollar surpluses in the United States may lose part of their economic and political independence. Consequently, the more petrodollar surpluses are placed in the United States by a certain oil-exporting nation, the less independent such a nation becomes.

Second, an oil-exporting country can have petrodollar surpluses only if its absorptive capacity is less than its earnings from the sale of’ oil for any particular period of time. It follows, therefore, that petrodollar surpluses depend on oil prices, quantities exported, and the nation’s absorptive capacity.

Third, petrodollar surpluses do not represent real wealth but rather are a vehicle by which the latter can be acquired. If kept in liquid form such as paper dollars, their purchasing power will gradually be eroded by inflation and adverse foreign exchange rates. Both are affected in the United States by a host of variables, for example, money supply, interest rates, marginal productivity, stage of a business cycle, and balance-of-payments deficit. Also a factor is U.S. monetary and fiscal policy which in turn affects some of’ these variables. Furthermore, changes in the U.S. laws and regulations have an impact on the economic variables, which may affect inflation rates and foreign exchange rates. Thus, the purchasing power of liquid petrodollar surpluses belonging, for example, to Arab oil-exporting nations is determined by a complicated set of variables whose trends and quantities are a function of’ factors that are not in the control of these countries.

Fourth, efficient allocation of petrodollars for internal investments could increase the productive capacity of an oil-exporting nation and may work to its relative advantage. However, dependency on imported consumer goods, including luxury and rare collector’s items, promotes the export of limited resources that could have been otherwise used for internal capital development.

Fifth, the economic development of an oil-exporting nation is based on the conversion of its subsoil resources into other assets such as industrial plants, equipment, education, technology, infrastructure, and other forms of real wealth, that is, real capital stock. Obviously the conversion process can be carried on at different rates. An optimum rate is achieved when oil is pumped at a level that can maximize the present discounted value of the income created in the conversation process. By pumping oil in excess of an optimum production rate, countries such as Saudi Arabia, Kuwait, Qatar, the United Arab Emirates, and others accumulated petrodollar surpluses until 1981. It is worth noting that the difference between the volume of oil actually supplied and the volume that should have been supplied in observance of standard microeconomic theory is in fact a subsidy granted, in real terms, to oil-importing nations such as the United States, Germany, France, and Japan.1

http://faculty.georgetown.edu/imo3/petrod/define.htm

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