# Why is oil being traded in U.S. dollars?

I am trying to understand the concept of money,forex, depreciation of currency,devaluing,...(just the basic stuff). While I was reading about why oil is being traded in U.S. dollars, on the internet, I came upon reasons like at that time the other European currencies were collapsing, the convertibility of the dollar was suspended, some speculate the U.S. used military power to force deal with the Gulf countries to sell oil in U.S. dollars. I could'nt understand these things, why would they force to trade in U.S. dollars instead of just taking the oil from their country by force? Does both the ways give the same result? How is it even beneficial to the U.S.?

why would they force to trade in U.S. dollars instead of just taking the oil from their country by force?

One of the basic tenets of power is that $$control$$ is superior to $$ownership$$. War is expensive, oil must be stored before it is used, and any captured production assets must be defended and maintained at great cost.

Rather than own all of this through waging successful war, it is far cheaper to simply control it. This is accomplished precisely because the \$USD is the world's reserve currency. It is cheaper for any given sovereign nation to hold one currency in reserve, rather than to hold an adequate amount of all world currencies in reserve. Much of US global policy in the past has been in support of the US' perceived role as a stable nation supported by rule of law, which builds the necessary trust for most other nations to put their economic "eggs" into the USD basket.

But how does control enter in? As a simple picture, any time international trade is conducted, there are three transactions that take place: the buyer converts home currency into USD; then the USD is exchanged for the goods/services; and finally the seller converts the USD into home or other currencies as required. Thus there are two points of leverage in this transaction chain where the US can exert control, up to and including blocking transactions altogether.

Have you ever wondered how trade sanctions are actually enforced? This is how. Sanctioned nations are simply blocked from using USD to engage in global trade, severely curtailing their ability to transact with other nations. In the extreme, the US is able to unilaterally exclude any nation not already holding substantial reserves of USD from participating in global trade altogether. In a global economy, this is often a much more consequential tool than the threat of war.

• Thank you for answering. Please suggest a good source(books,websites,lectures,...) to understand all these in depth. Jan 16 '20 at 0:42
• (Re last para): Unless you are North Korea (and mainly trade with China)... Actually the USD is the currency of choice for smugglers and the black market in NK too, alongside the yuan. Alas it's hard to find stats on which might be more prevalent.
– Fizz
Jan 16 '20 at 3:22
• @Fizz Yes, exactly - NK does't hold a great deal of reserves at all, let alone USD-denominated. This is why I included that qualifier. China, by comparison, holds a great deal of USD reserves as well as US debt, so walling it off from global trade entirely would be impossible even if US markets could bear the resulting supply shock.
– heh
Jan 16 '20 at 15:47
• @mohan unfortunately, much of this simply follows from high-level reasoning about the strategic game of globalization. For a very America-centric take on it (a little biased, but very interesting nonetheless), I recommend listening to Peter Zeihan's talks. He's not right about everything, but he understands power dynamics.
– heh
Jan 16 '20 at 15:49

I'll try to answer your question as best as I understand it.

There are innumerable reasons for why taking oil by force from these nations would be seen as unnecessary by the US, for both political and economic reasons. Just to name one risk, the condemnation of the world community and the breach of trust in our status as a relatively non-predatory hegemon would pose substantial economic threats to America.

That aside, why it might be thought to be in the US interest to print the main reserve currency is its value as a symbol, fueling national prestige. There might have been large tangible benefits in the past, but these have declined substantially as the US share of the world economy has fallen. For more info you can check out the Triffin dilemma, or this nice piece by Bernanke: https://www.brookings.edu/blog/ben-bernanke/2016/01/07/the-dollars-international-role-an-exorbitant-privilege-2/

why would they force to trade in U.S. dollars

I'm not seeing any evidence that "force" is the appropriate word. As a piece from The Balance succinctly describes, there was a parallel evolution between the US retreat from the gold standard and the close relationship between the US and Saudi Arabia. In 1979 the United States-Saudi Arabian Joint Commission on Economic Cooperation explicitly agreed to use US dollars, but this seems to have simply been a formalization of the de-factor reality that had emerged since the end of the Second World War.

The use of dollars for oil markets is part of the more general trend that the dollar became the world's primary reserve currency. Regarding why this continues to be the case, here is a piece from Wall Street Journal (2012) which gives three reasons.

First, its allure reflects the singular depth of markets in dollar-denominated debt securities. The sheer scale of those markets allows dealers to offer low bid-ask spreads. The availability of derivative instruments with which to hedge dollar exchange-rate risk is unsurpassed. This makes the dollar the most convenient currency in which to do business for corporations, central banks and governments alike.

Second, there is the fact that the dollar is the world's safe haven. In crises, investors instinctively flock to it, as they did following the 2008 failure of Lehman Brothers. This tendency reflects the exceptional liquidity of markets in dollar instruments, liquidity being the most precious of all commodities in a crisis. It is a product of the fact that U.S. Treasury securities, the single most important asset bought and sold by international investors, have long had a reputation for stability.

Finally, the dollar benefits from a dearth of alternatives. Other countries that have long enjoyed a reputation for stability, such as Switzerland, or that have recently acquired one, like Australia, are too small for their currencies to account for more than a tiny fraction of international financial transactions.

The use of US dollars as reserve currency and its use for transaction in oil market should logically reinforce one another.

How is it even beneficial to the U.S.?

The most fundamental reason that the US has encouraged global use of the dollar, both in the oil market and as a general reserve currency, seems to be that it helps to prevent inflation. As another answer mentions, it allows the US to effectively enforce trade sanctions.