From Petrodollar to Mineralyuan – FPIF

Despite his controversial legacy, it’s difficult to deny that Henry Kissinger was one of the most brilliantly influential minds of the twentieth century. Although perhaps most well-known for his role in steering the Vietnam War, his actions in the Middle East in 1974 arguably had a more profound impact on the future of the United States and its global economic hegemony.

In 1971, faced with a crisis of rising inflation and the country’s first international trade deficit of the century, President Richard Nixon shocked the world by unilaterally deciding to divest the dollar from the gold standard. The end of World War II and the Marshall Plan ushered in an era of interconnected economies, and the dollar, by virtue of the Bretton Woods Conference, had become the default currency for international finance. Without alternatives, the rest of the world was forced to weather the consequences of this economic disruption. Although Nixon had successfully bought some time—and political goodwill at home—the loss of gold backing created a vacuum that another commodity would soon have to fill.

A significant contributing trigger for World War II, particularly in the Pacific—access to oil and the ability to refine it—remains at the forefront of geopolitical discourse today. In 1945, the Roosevelt administration deftly arranged for Saudi Arabia, the world’s largest oil exporter, to provide the United States with a reliable stream of oil in exchange for military assistance and protection. And although the relationship continues today, it has not been without significant challenges.

As the architect of the peace negotiations at the end of the Arab-Israeli War of 1973, National Security Advisor (and later Secretary of State) Kissinger saw an opportunity emerge from the crisis. In exchange for supporting some concessions against Israel’s expansionist ambitions—and continuing the Roosevelt-era military sales and defense arrangement—he convinced King Faisal bin Abdul Aziz to agree to a deal that required that all oil transactions be conducted using the dollar. This effectively bonded U.S. currency to the world’s most valuable resource and cemented its preeminent status in international trade and investment. As the other OPEC nations soon followed suit, excess “petrodollar” profits were reinvested into the United States, often through purchasing currency reserves, closing the loop of a new international financial system that the oil-dependent world would continue to feed.

For 50 years, the United States has benefited from Kissinger’s master negotiation. It continued to catalyze the nation’s rise during the Cold War and has allowed the United States and its allies to effectively isolate potential adversaries from the global economy. The comparative strength of the dollar and its value as an international reserve currency have protected America’s consumers, businesses, and institutions from the harmful effects that could (or perhaps should) be felt as a consequence of rising inflation and exponentially increasing national debt—until today. With growing popular concern for the consequences of climate change and the dramatic rise of a new global power, cracks are beginning to form in the delicate foundation of U.S. economic supremacy.

China, Climate, and REEs

The ambitious goals set in the Paris Climate Agreement have put pressure on nations to seek and dedicate effort toward developing energy alternatives, many of which will rely on successfully exploiting new natural resources. Most notably, these will include Rare Earth Elements (REEs). As an essential component in most of the “green” technology that will fuel the campaign against climate change, REEs represent a global commodity value chain capable of rivaling petroleum and potentially threatening to erode U.S. hegemonic authority.

The meteoric rise of China and its systematic, long-term strategy to become indispensable to the global economy present numerous challenges to the established world order, including the nation’s dominance of the REE value chain. Through decades of careful maturation of the extraction, refining, and manufacturing processes and with an economic system capable of dissuading international competition, China has successfully ensured its near absolute monopolistic control over the “fuel of the future.” As of 2022, China accounted  for 60 percent of mined production, 85 percent of processing capacity, and 90 percent of permanent magnet production. Considering the substantial investment and time required for the United States to catch up, coupled with increasing international suspicion of the stability of age-old American institutions, the “petrodollar” might one day be replaced by a new fiat currency—one backed by the new critical natural resource, and defined by the nation that controls it.

In 2022, Larry Flink, CEO of Black Rock, predicted that “the decarbonizing of the global economy is going to create the greatest investment opportunity of our lifetime,” and those companies, cities, and countries that fail to adapt will be “left behind.” Between now and 2030, the International Renewable Energy Agency (IRENA) asserts $5.7 trillion as the required annual global investment for the world to be on pace to reach the ambitious 2050 climate goals, and the associated shift away from fossil fuels continues to create market share prospects in the energy sector. However, neither United States nor others in the modern industrialized world are poised to compete with China for this exponentially expanding economic opportunity.

Identifying any modern technology that does not rely on rare earth components is difficult. They power cell phones, computers, medical equipment, satellites, and almost all instruments of modern military power. Predictably, the industrialized world has become utterly dependent on an uninterrupted supply. Unable to compete with operational costs and unwilling to tolerate environmental challenges, “Western” countries, in the era of globalization, have been complicit in China’s steady development of its monopoly. And while this stands to impact a wide swatch of economic sectors, one in particular remains especially vulnerable.

The Waning of Oil and the Dollar

In the decades following WWII, the rise of the G7 economies (represented by the United States, Japan, and the European Economic Community) closely paralleled the rapid expansion of the automobile industry and access to refined oil. Historically, car companies have been responsible for 3.5 percent of the global GDP, a dramatically high stake for a single product. The sophisticated magnets that power the more than 30 motors in today’s electric vehicles (EVs) depend entirely on rare earths. And, as EVs become a cornerstone of the impending “green revolution,” auto manufacturers are pivoting to maintain market share.

The G7’s successful investment in the automobile industry was no accident or stroke of fortune. It was a carefully calculated strategy that combined a dominant, post-war industrial capacity with a monopoly over the vital natural resource that fueled it. But even at the height of its global hegemonic power, the United States and its allies had to contend with OPEC. Today, no such “check” exists for China. It would take a minimum of 15 years and a radical change in investment strategy to create significant competition in China’s rare earth supply chain.

Even today, as the full pivot from oil dominance has yet to take effect, the global market is beginning to entertain alternatives to the almighty dollar. In 2015, the IMF decided that China’s role as a “major trading country” and recent liberal reforms to monetary policy warranted the yuan’s (or renminbi) inclusion in the international “basket of currencies” that make up the value of Special Drawing Rights (SDR), the paramount international reserve asset. And although the dollar maintains the lion’s share of SDR value, comparatively higher percentage growth continues to encourage foreign trade and investment using the yuan.

In August, BRICS voted on its first-ever membership expansion inviting Saudi Arabia, Iran, Ethiopia, Egypt, Argentina, and the United Arab Emirates to join in 2024. As of this writing, Argentina has declined and Saudi Arabia is still considering its options. However, the other four countries have joined, and dozens of others (including oil giant, Venezuela) are petitioning for future membership. With solid support from both China and Russia, many of these nations can reasonably expect accession in 2025. These moves will give BRICS control over an increasing percentage of all oil reserves while helping fulfill the bloc’s “ambition to become a champion of the Global South.”

Despite its hesitation with BRICS, Saudi Arabia, a loyal co-architect of the U.S. petrodollar, is actively looking to re-balance its relationship among superpowers, most notably through a recent agreement for a massive currency swap with China. In 2013, China surpassed the United States as the number one importer of crude oil and has since been negotiating with the Gulf nation to conduct business in yuan. Closer ties with BRICS and persistent dissatisfaction with Washington may prompt Saudi Arabia to finally dispense with the agreement set by Kissinger nearly half a century ago.

Is U.S. Hegemony Nearing an End?

With China eroding the foundation of the petrodollar and shoring up control of the next new top commodity, the question remains: at what point is the U.S.-led financial system truly at risk? Despite surpassing American manufacturing capacity and maintaining the second-ranked global economy, China still needs to gain some of the foundational monetary system principles necessary to provide an alternative that the rest of the worldwide community can feel confident with. Even as Beijing competes in the oil market and tightens its monopoly over the REE supply chain, its vastly interconnected economic system remains reliant on Western partners and their financial institutions.

The United States has the advantage of incumbency and the reputation for leading liberal democratic institutions. However, in an era of increasing political polarization and divisiveness—both in the United States and among its European allies—lack of cohesion and compromise limits the extent to which the West can counter the long-term strategies of potential adversaries. In his 2021 book, Principles for Dealing with the Changing World Order, the CEO of Bridgewater Associates Ray Dalio warns that with 40 percent of the U.S. population believing that a civil war is possible, the legal security that underpins the dollar is losing its luster. Excess public spending, indebtedness, and inflation further risk the dollar’s credibility.

Although the West seems incapable of agreeing on a comprehensive strategy for maintaining a desired world order, China and its rapidly growing group of partners are having a different experience. During the August summit, the leaders of many BRICS member nations celebrated the bloc’s expansion as a necessary challenge to the decades-long, U.S.-led international economic system. Working together, BRICS can create a global market that is independent and impervious to the effects of Western-initiated financial interruptions. Fearing the power of economic sanctions, the likes of which Russia and Iran have long suffered, the group is fervently looking for alternative fiat currencies, even going so far as to suggest new, hybrid ones. Considering the complexities of globalized international finance, however, only one reasonable option exists: the yuan, backed by a critical resource like Rare Earth Elements.

Although it’s unclear who the “Kissinger-equivalent” may be in the comparatively secretive Chinese government, it’s apparent that someone is taking a page from the legendary statesman’s playbook. Predicting (and contributing to) the impending fall of the petrodollar—as it goes the way of the gold standard—China is carefully setting the conditions for the next big pivot to a new fiat currency: the “mineral-yuan.” Without a dedicated effort to reinvest in the supply chain of critical raw materials like Rare Earth Elements, the United States is at significant risk of losing control over its long-held, dominant instrument of international economic power and authority.