In Washington you will often hear about the size of the US deficit, and it grows every year. What you rarely hear about is why the US dollar remains strong even with deficits not on a decreasing rate of any kind.

In an article by Mile Dolan of Reuters, the real reason why the US dollar is strong is a deal between the US government and Gulf states. US protection in exchange for access to Gulf energy, oil priced in dollars and recycling of billions of dollars in US arms sales, technology and American stocks and bonds.

The arrangement since the 1970’s underpins the dollar’s status as the world’s reserve currency and has been central to the US-Saudi relations ever since.

The Gulf states of Saudi Arabia, the UAE, Qatar, Oman and Bahrain all peg their currencies to the dollar, and which require them to have reserves estimated to about $800 billion.

In addition, the sovereign wealth funds are estimated to have invested over $6 trillion in the US stocks, bonds, private equity and other US heavy investments.

The US Treasury lists Saudi Arabia and the UAE funds among the top 20 national holders of Treasury securities with almost $250 billion between them.

The petrodollar system rests on 3 pillars: America’s need for oil, the pricing of oil in dollars and the Gulf’s region security relationship with Washington.

Does the war shift those pillars or how strong are those pillars after the war is over?

Linking to dividend paying stocks, the US economy is the world’s biggest and can stand some shocks to it, but if the petrodollar system ever changed, the deficit would mean the same thing to the way you apply the deficit to every other country in the world. Invariably interest rates would go up and deficit spending would actually have to be done. None of that will change in the next year or two, but it is always worth understanding.

There are more questions than answers, till the next time – to raising questions.