Currency Pegs Raise Dollar Tensions

By Ryan Boyle

One of the most important decisions anyone will make in their lives is whether, and whom, to marry. A well-chosen partnership can lead to a happy steady state and help to weather downturns. But even the best long term partnerships can have their ups and downs. For currencies that are wedded to the U.S. dollar, the war in Iran has put some stress into their relationships.

A fundamental support for the U.S. dollar (USD) comes from the market for oil. When demand for crude oil first ascended in the 20^th century, the U.S. was the world's leading oil producer. As U.S. wells depleted, nations in the Middle East came to dominate energy markets. In 1974, the U.S. made an agreement with Saudi Arabia to sell its oil in U.S. dollars, offering a security agreement in exchange for oil revenues being reinvested in U.S. assets. All other OPEC nations followed suit, and the petrodollar was formed.

Many oil-exporting nations, including Saudi Arabia, the UAE, Qatar, Bahrain and Oman, found the arrangement sufficiently workable to fix their currency's value to the dollar. They are not outliers: more than 20 nations keep a fixed, or hard pegged, exchange rate with the USD. Others have a soft or managed peg, targeting a value within a range of the USD. Pegged nations benefitted from a more stable and predictable currency, which secures international purchasing power. Global commerce became easier as exchange rate risk was eliminated for these nations.