Published in China Watch： 2026年4月14日
The Middle East Situation Shocks the “Petrodollar”
Pan Yuanyuan
The military strikes launched by the United States and Israel against Iran triggered a powerful chain reaction in financial markets. As shipping through the Strait of Hormuz remains persistently disrupted, international oil prices continue to rise; in March alone, the price of London Brent crude futures for May delivery surged by 45%. Also in March, foreign central banks sold off $82 billion in US Treasury bonds; consequently, the volume of US Treasury bonds held by foreign central banks at the Federal Reserve Bank of New York has fallen to its lowest level since 2012.
For a long time, oil-exporting nations in the Middle East have forged an energy-security alliance with the United States; consequently, denominating oil trade in US dollars became standard practice—an arrangement known as the “petrodollar” system. This system rests upon four pillars: the security relationship between the Gulf states and the United States, the pricing of oil in US dollars, US demand for oil, and the holding of US dollars and dollar-denominated assets by countries in the Middle East and elsewhere. Following the recent outbreak of hostilities involving the United States, Israel, and Iran, all four of these pillars have come under increased pressure.
The conflict has eroded the credibility of the security guarantees provided by the United States. In this conflict, which has now lasted for over a month, although the United States has weakened Iran’s military capabilities, Iran has successfully utilized and maintained its capacity to blockade the Strait of Hormuz, thereby demonstrating that the role of the United States in the Middle East is now vastly different from what it once was. The failure of US air defense systems to protect its Gulf allies from attack has made it difficult to ensure the continuous supply of oil through the Strait of Hormuz at reasonable prices. Moreover, US military bases situated within allied nations have themselves become targets of attack, thereby rendering US security guarantees no longer credible. As Deutsche Bank FX strategist Mallika Sachdeva noted in a report to clients: “The current conflict may expose further fault lines, by challenging the US security umbrella for Gulf infrastructure and the maritime security for global trade in oil.”
The ongoing conflict has further diminished the necessity of pricing and settling oil transactions in US dollars. Oil serves as the lifeblood of the modern economy and constitutes the largest commodity by volume in global trade. The practice of pricing and settling oil in dollars has played a pivotal role in establishing the dollar’s dominant position within global commerce. To settle import payments, companies worldwide must hold the currency required for such transactions—namely, the US dollar. Similarly, national central banks must build up dollar reserves to fulfill their role as lenders of last resort. “Petrodollars” serve as the cornerstone of the dollar’s global dominance. Currently, approximately 80% of global oil transactions remain denominated in US dollars, although this practice stems more from convention than from legal mandate.
The Strait of Hormuz serves as the world’s most critical choke point for oil transport, through which approximately 20% of the globe’s oil and liquefied natural gas is shipped. What was once a strait open to free navigation has, in the wake of this conflict, effectively become a “trump card” in Iran’s hands. As the duration of the strait’s obstruction has lengthened, the search for alternative trade routes and payment mechanisms has gradually risen to the top of various nations’ agendas. These trade routes and mechanisms constitute “tributaries” lying outside the established dollar-denominated system. Consequently, should the conflict continue to drag on, these “tributaries” could potentially swell into a “mainstream” parallel to the dollar; the practice of trading parties denominating and settling transactions in currencies other than the US dollar could well become the new norm, not only in the oil trade but in global commodities trade as a whole.
The primary market for oil from the Gulf states is Asia. As a result of the shale gas revolution, the United States has become an energy-self-sufficient nation and is no longer heavily dependent on oil imports from the Gulf states. In 2025, Saudi Arabia’s oil exports to China, Japan, and South Korea are projected to be respectively 4.96 times, 2.75 times, and 2.93 times the volume of its exports to the United States. Continuing to settle transactions in US dollars entails significant exchange rate and other risks, while offering only quite limited returns. Jim O’Neill, a former Goldman Sachs economist and former Minister at the UK Treasury, points out that the ongoing conflict could draw Gulf nations closer to China, India, and other major oil-consuming nations, as the growing economic opportunities within the Asian region become increasingly attractive.
Foreign reserve managers and central banks worldwide may also pivot toward asset classes other than the US dollar. Traditionally, funds from Middle Eastern nations have flowed heavily into the United States; these capital sources include the region’s approximately US$2 trillion in reserves, sovereign wealth funds holding assets worth roughly US$6 trillion, and public pension funds exceeding US$1 trillion. In 2025 alone, US Treasury securities held by Saudi Arabia and the UAE are projected to total approximately US$250 billion; furthermore, since the beginning of this year, several Middle Eastern sovereign wealth funds have announced plans to invest in the United States.
However, following the outbreak of hostilities involving the United States, Israel, and Iran, these investors began to rebalance and diversify their portfolios. Given that Middle Eastern nations must tap into their dollar reserves to bolster domestic economies, repair war-damaged infrastructure, and strengthen defense capabilities, the trend of raising “emergency funds” by selling off US Treasury bonds is expected to persist. At the same time, the conflict has served as a reminder to US allies and key sources of capital that they, too, will bolster their domestic self-sufficiency in energy and defense—pivoting toward coal, nuclear power, and new energy sources, as well as expanding the use of electric vehicles—a shift that will also reduce their reliance on the US dollar.
Regarding US Treasuries, the confluence of war-related geopolitical risks, concerns over persistent US inflation, and expectations that the Federal Reserve will not cut interest rates this year caused Treasury yields to surge in March to their highest levels since June 2025. The Treasury market witnessed a massive sell-off—a sell-off of a magnitude not seen since 2012. A substantial portion of US debt is held by foreign entities; the sell-off of US debt reduces external reliance on dollar-denominated assets. A spokesperson for the Iranian Parliament once warned that financial institutions funding the US military budget are “legitimate targets,” and that those purchasing US Treasury bonds are, in effect, purchasing “a signal for an attack on your headquarters and assets.”
Since the outbreak of hostilities, the US dollar has appreciated by approximately 4%. This is attributable to the fact that the United States is a net exporter of oil and that, during periods of heightened geopolitical tension, the dollar continues to serve as a reliable safe-haven asset. Market consensus suggests that the dollar will strengthen further in the short term; however, its long-term depreciatory trend is unlikely to be reversed. Indeed, even prior to the conflict involving the United States, Israel, and Iran, the dollar was already on a downward trajectory, and the “petrodollar”-based system was already facing pressure from multiple fronts.
First, relative to the dominance of the US dollar, the scale of the US real economy is comparatively small, and the country’s share of the global economy is liable to decline further. Should this share fall below a certain threshold, a currency lacking the backing of “hard power” would harbor fatal intrinsic flaws. Second, the United States is increasingly leveraging its dominance in the economic and financial spheres to coerce other nations into compliance—a practice that erodes external confidence in the dollar. From Trump’s tariff policies to frequent economic sanctions—ranging from freezing the overseas assets of other nations, attacking the independence of the Federal Reserve, and launching a raid on Venezuela to seize its oil, to the current actions in Iran—the perception of US policy as unstable and unpredictable has deepened step by step, and the credibility of the US dollar has been severely undermined. Finally, the infrastructure for non-dollar settlements has been broadly mapped out and is partially in place. When extreme events disrupt the normal functioning of the market, traders will attempt alternative trade routes, provided that they remain technically feasible; consequently, the dollar’s formerly unique status as a conduit will become less significant.
According to data from the International Monetary Fund, the US dollar’s share as a global hard currency declined by 14 percentage points between 2000 and 2025. This indicates that while the dollar will not be dethroned overnight, nations share a tacit understanding: US reliability is gradually diminishing, and excessive reliance on the dollar system is not necessarily the optimal choice. Consequently, the quiet process of nations reducing their holdings of dollar-denominated assets has never ceased.
The question at hand is: what role does Iran play in this trend? In his The History of the Decline and Fall of the Roman Empire, the eighteenth-century British historian Edward Gibbon posited that empires do not disintegrate abruptly, but rather collapse gradually over the course of a prolonged process. History has repeatedly demonstrated that a single strategic blunder or miscalculation can accelerate this process. The vast “petrodollar” empire may well be governed by a similar historical logic; the conflict involving the United States, Israel, and Iran could prove to be precisely such a watershed moment. If the dollar was already situated on a long downward slope, then in the future, the decline of its privileged status may become even steeper, and its descent even swifter.