Petrodollars are U.S. dollars that are paid to oil-exporting countries in exchange for oil. Since the dollar is a global currency, all international transactions are priced in dollars. Therefore, oil-exporting nations pretty much have to receive dollars. This makes their national income dependent on the dollar's value. If it falls, so does the government revenue. As a result, most of them also peg their national currencies to the dollar. That way, if the dollar falls, so does the price of all their domestic goods and services. This helps these countries avoid wide swings in inflation or deflation.
Where Do Petrodollars Go?:
A 2006 U.S. Treasury Report indicated that increased oil prices generated an extra $1.3 trillion in revenue for OPEC countries since 1998. Oil revenue has been spent on increased imports, higher wages for government employees, increasing reserves, and retiring debt. Oil producing countries used these funds to provide a cushion to fall back on. They learned from the 1998 recession, when demand for oil fell and prices declined. These actions helped to lower volatility in their economies, and therefore the global economy.
Some Dollars Can't Be Accounted For:
Up to 70% of the $700 billion in OPEC's investable reserve funds couldn't be accounted for by the Bureau of International Settlements. The BIS only reported OPEC members, so that the non-OPEC funds were also unaccounted for. The Treasury reported that oil exporting countries purchased about $270 million in U.S. securities. Based on other information, they suspected the unaccounted-for funds were invested in construction loans, regional stock markets, private equity funds and hedge funds. An unknown amount of funds could have been invested in U.S. assets through foreign intermediaries,and therefore untraceable.
Impact of Hidden Petrodollars:
Hidden petrodollars increases global volatility due to the sheer amount - $400 billion. If it is in U.S. Treasuries, a withdrawal of that size could trigger both a decline in the dollar, and higher interest rates. This probably will not happen, since the U.S. is also oil's best customer. (Source: Petrodollars and Global Imbalances, Occasional Paper No 1, February 2006, Department of the Treasury, Office of International Affairs.)