China's President Xi Jinping recently extended a significant proposal to Saudi Arabia and other Gulf nations: China will continue purchasing their oil and gas over the long term, but payments will be made in yuan instead of dollars, which has been the primary currency for oil transactions for over 75 years. In exchange, China will provide advanced solar technology and manufacturing support to help these nations diversify their economies while their oil remains in demand.

Western analysts have largely dismissed this development, believing that the Arab states will remain tied to the dollar, overlooking the broader implications. The Arab nations have not officially responded, but they may find this offer appealing, especially given the substantial aid it includes to manage a potentially disruptive energy transition. Historically, the West sought their oil without offering much in return, while China is proposing a mutually beneficial arrangement.

Is this trend truly significant? Absolutely. Moving away from the long-standing dollar-oil connection would reduce the dollar's utility in other areas, complicating the financing of the United States' considerable trade deficit and undermining its global influence.

If Xi's vision materializes, the US may have to rely less on borrowing and military might, shifting to a more manufacturing-based economy. While some may view this as a positive change, the reality of manufacturing can be challenging, and a forced transition might be seen as a loss of status. It remains uncertain whether the US can sever its reliance on credit without causing political turmoil.

Historical Context of the Dollar in Oil Trade

The dollar's dominance in oil transactions dates back to the 1974 Petrodollar Agreement between the US and Saudi Arabia. Following a 1973 oil embargo by Arab producers in response to US support for Israel, oil prices skyrocketed, prompting the US to forge a deal to stabilize both its currency and access to oil. The US agreed to provide military protection to Saudi Arabia in exchange for oil sales exclusively in dollars, the purchase of American weapons, and the reinvestment of surplus dollars in US assets.

This arrangement continued until the 2008 financial crisis, which raised concerns about the reliability of the US financial system just as the Shale Revolution began reversing the decline in US oil production. Subsequently, the US needed less oil from Saudi Arabia and other Middle Eastern sources.

While Saudi Arabia continued to procure US weaponry, the American public grew weary of Middle Eastern conflicts, leading to increased skepticism regarding US military assurances. Consequently, China emerged as the primary growth market for Gulf oil, alongside Russia, while simultaneously developing a robust solar manufacturing industry and producing electric vehicles.

The dollar has remained the leading currency for oil trade, largely due to a lack of viable alternatives. However, growing discontent with the dollar has arisen from the US's frequent imposition of unilateral sanctions on nations it views as problematic. These sanctions have affected major oil exporters like Iran and Venezuela, leading to an expanded list of targeted countries. The most severe sanctions restrict access to the international financial system known as Swift.

US politicians often favor sanctions as they create a façade of strength without incurring direct costs or risking American lives. In contrast, many countries view these sanctions as arbitrary and contrary to international norms, often hindering trade for nations not involved in the disputes.

Countries like Iran have become adept at navigating around Swift, and the BRICS nations—Brazil, Russia, India, China, and South Africa—have explored alternatives to the dollar. However, tangible progress was limited until Russia's invasion of Ukraine, which resulted in its exclusion from the international trading system and the freezing of its dollar and euro reserves.

This pivotal moment invigorated efforts to establish substitutes for the dollar in oil sales and global trade. China now pays for Russian oil using yuan, bypassing Swift, while India and Turkey are reportedly using their own currencies for transactions.

China's Comprehensive Energy Proposition

The significance of these developments became evident during Xi's visit to Saudi Arabia in December, where he met with leaders from the UAE, Qatar, Kuwait, Oman, Bahrain, and other nations. This cordial gathering contrasted sharply with President Biden's earlier visit, which had been marked by tension due to the Crown Prince's involvement in the assassination of journalist Jamal Khashoggi.

As highlighted in an opinion piece from the Dubai-based Gulf News, Arab nations are increasingly interested in China's expanding markets, investments, and technological advancements, particularly as these engagements come without the political strings often attached by the West.

Xi introduced a "new paradigm of all-dimensional energy cooperation," committing to purchase "large quantities" of oil in yuan on the Shanghai futures exchange. He also emphasized collaboration in clean technologies such as hydrogen, energy storage, wind and solar power, and smart power grids, alongside promoting localized production of new energy equipment.

Additionally, Xi mentioned enhancing investment cooperation in the digital economy, nuclear technology, data processing, and telecommunications, proposing deeper collaboration on digital currencies through the m-CBDC Bridge project. This initiative aimed to create a blockchain ledger for cross-border payments using central bank digital currencies, with participation from the central banks of China, the UAE, Hong Kong, and Thailand.

Critically, these digital currencies would circumvent Swift and diminish the effectiveness of US sanctions.

While many on Wall Street may overlook these developments, financial expert Zoltan Pozsar has conducted an in-depth analysis of Xi's address, predicting a significant shift in relations between China and the Gulf Cooperation Council (GCC), akin to China's current ties with Russia and Iran. This could position China as a dominant player in global oil markets, granting it access to cheaper energy than its Western allies reliant on dollar transactions, potentially leading to increased inflation and industrial decline in the US.

China's ultimate aim appears to be diminishing US financial supremacy and its capacity to impose sanctions rather than directly replacing the US in the global financial landscape. Chinese leaders recognize that the US model, which encourages foreign investment and reliance on cheap imports funded by debt, has weakened its domestic manufacturing and impoverished many citizens. They aim to avoid similar pitfalls.

Implications for the Future

The New Energy component of Xi's proposal deserves greater attention. Unlike many Western countries, China has a coherent short- and long-term energy strategy. In the short term, it continues to support domestic coal production while securing oil access, all while establishing the world’s largest solar manufacturing capacity and producing wind turbines, batteries, and electric vehicles.

For Arab nations, the need to diversify their economies amid ongoing oil demand is critical. Both Saudi Arabia and the UAE have announced ambitious renewable energy projects, capitalizing on their abundant sunlight and wind resources. They are actively seeking alternative revenue streams to reduce reliance on oil.

For China, these nations represent a significant market opportunity to offset potential declines in Western demand for its solar technology as the US and EU ramp up domestic production. Should the Gulf's renewable energy sector expand quickly enough, China could fulfill Xi's promise of localized energy equipment production. The investments outlined in Xi's offer are tailored to meet the Arab states' aspirations for economic diversification.

Ultimately, Xi's proposal exemplifies the "win-win cooperation" his administration frequently promotes and could also yield environmental benefits. The rapid rise in energy consumption in the Gulf, particularly for water desalination, has significantly contributed to CO2 emissions over the past decade.

The immediate assumption might be that the US stands to lose the most. However, for many Americans, the prospect of extricating themselves from Middle Eastern affairs may not seem so undesirable. Given the legacy of US involvement in regional conflicts and the repercussions of 9/11, a shift away from dependence on OPEC could alleviate some burdens.

The primary concern remains the potential erosion of the dollar's reserve currency status and the associated advantages of low-cost borrowing. While there is growing awareness of the detrimental effects of this dependency, breaking free from the cycle of cheap consumerism presents its own challenges. The psychological ramifications of losing global standing and facing accusations of failure in leadership will complicate any transition.

Navigating this shift without succumbing to authoritarianism or engaging in conflict will be a formidable task for the US, and success is far from guaranteed. But that discussion is for another time.