Odd Lots - This Is Zoltan Pozsar's Vision For Bretton Woods III

Episode Date: April 7, 2022

Over the last several years, most economic crises have been solvable by money. Swap lines. Bailouts. Central bank asset purchases, and so on. But now the world is experiencing something new: A problem that money can't easily solve. When it comes to, for example, avoiding Russian energy, there's no simple solution. Money can't buy an instant energy changeover. This is all part of a new regime that Zoltan Pozsar, Managing Director and head of Global STIR Strategy at Credit Suisse, likens to Bretton Woods III. On this episode, he returns to spell out his framework, and what it means for financial markets, the dollar, and the new world economy overall.See omnystudio.com/listener for privacy information.

Thanks for listening to Odd Lots. Follow the show on Amazon Music for more future episodes or just ask, Alexa, play the Odd Lots podcast on Amazon Music. Hello and welcome to another episode of The Odd Lots podcast. I'm Tracy Alloway. And I'm Joe Wisenthall. Joe, you're in Vegas, right? I am. I decided to take a little break from life and be in the desert for a couple days and play some poker. So it's pretty nice out here. Commuting in the desert. If I sound a little weird, it's because I'm not in the studio with you.

Do you know, this is kind of weird, but whenever I think of poker nowadays and poker chips, I always think, this is probably just me, but I always think of Zoltan Pozar's analogy of how reserves are kind of like poker chips. Do you remember that? We have lots of different kinds of monies in the existing system. And they might even have the same name, like dollars, dollars, dollars. But a lot of them are sort of like all pegged to each other one to one, cash. money in your bank account, bank account money held at the Federal Reserve, not that dissimilar from dollar poker chips in a casino. Right. But this is something that's been coming up in various ways on recent episodes of odd lots, this idea that you do have different types of money.

And at any one point of time, there could be changes in how the world thinks of that money or how it uses it. And you know, for years and years, we've had the euro dollar system, basically these synthetic dollars that are sort of sloshing around in the global financial system. We've had reserves courtesy of the central banks and quantitative easing and things like that. And now I hesitate to use the term inflection point, but once again, it feels like as central banks begin to tighten, as we see this big question mark over the role of the dollar given the sanctions against Russia, it feels like this question of what is money, what could a new monetary system actually look like is coming again to the fore.

Yeah, exactly right. And then the other element that's extremely big right now is, and the Russian sanctions were part of this, but it's clear that like FX reserves aren't enough security, especially in a world of commodity disruption, supply chain breakdowns, things like that. It's great to have money. It's great to have foreign currencies, particularly if you're a vulnerable emerging market and so forth. But A, as Russia has discovered, you could lose access to your FX reserves. And more importantly, and Afghanistan, that's right. But more importantly, like, even if you have

ample reserves, you also need food, you also need wheat, you also need natural gas. If you're in Canada, maybe you need a maple syrup stockpile. In the U.S., of course, we just saw the announced release of some of the SPR oil. These are also very important. So we're also in a regime in which physical things really matter again, big time. Right. And there's not necessarily a guarantee that, you know, the financialized commodities are going to be, I guess, redeemable one for one against the physical commodities. It feels like that's what we're learning right now. Well, whenever we're talking about big money ideas, there is, of course, one person who we turn to, and I already mentioned his name, but we are going to be speaking once again to Zoltan Pozar.

He's a strategist at Credit Suisse, a multi-time Oblot's guest at this point, and he's been writing about these themes, including an earlier note a few weeks ago talking about the threat to the dollar's dominance. And he's back to go into further detail about how he sees a new monetary system actually evolving. I feel like after we did that last episode with him a few weeks ago, bam, everyone wanted to like, okay, the dollar system is in trouble. Yeah, but what's next? And then he published what's next. And now he's going to talk to us about what's the next. But we were having a fast turnaround because there's so much demand for like the next chapter of this story. It's the natural cycle. Zoltan writes something and then he comes on all thoughts to talk about it.

So Zoltan, thank you so much for coming back on the show. Very nice to be back. Instead of looking forwards, why don't we begin by looking backwards and why don't you give us your overview of what the existing monetary system actually looks like? Because I think that's going to help us frame your vision of the future. Yeah, so before we look at the existing system, let's just go all the way back to the Second World War and, you know, the system that grew out of that. And that was the original Bretton Woods system. You know, this was the unipolar world where the U.S. basically shaved the course of things to come. You know, the Eurodollar was not a dominant currency back then immediately after the end of the Second World War, but it became. the dominant reserve currency and a dominant phenomenon over the 40, 50 years. And so, you know, Bretton Woods was about gold. Everything was linked to gold.

And then in 1971, we took the dollar off gold. And then we basically said that we will guarantee price stability. And that's what became the Fed's mantra and everything in the fiscal and monetary domains was about making sure. that price stability is there as an anchor to a currency that was only a paper form of money. And then the system evolved further within this stable prices, nominal worlds that we had once we removed the peg to gold. We had a crisis in 1997 of fixed exchange rates. Southeast Asia then started to accumulate reserves as a lesson from that. In 2003 years later, China,

joined the WTO. They started to export and manufacture everything for the rest of the world. They accumulated a huge amount of FX reserves. All of these reserves basically were recycled into U.S. Treasuries. This is, you know, Greenspan's conundrum, you know, his hiking rates, but the back end of the curve doesn't move. Ben Bernanke called it the global savings glut. Before Ben Bernanke, David Fulkerz, Lendauer, Deutsche Bank and Mike Dooley, they call this Bretton Woods 2. So basically, the shift from Bretton Woods to Bretton Woods too is the shift from a gold-backed dollar to a dollar governed by the idea that the guarantee price stability. And because the guarantee

price stability, it's okay to accumulate your dollar reserves in treasury securities. And, you know, that system was fine. But again, you know, you have Minsky moments and Paul McCully and, you know, stability begets instability and shadow banking. So all that system blew up in 2008. And then accumulation of US Treasury securities stopped in certain parts of the world. And then the big central banks like the Fed and the ECB started to buy the debt of their own governments. And that, you know, led to income inequality and soaring stock prices and some of the things that we are kind of dealing with at the present. And then, you know, the last time of I was on the show, you know, we talked about this piece that I wrote about, how we need a new Volcker

moment and a little bit of volatility and risk assets and wealth destruction. We can bring people back into the labor force and all that stuff. And so then, then instead of a Volcker moment, we got a Putin moment and we basically have war. And out of this war, something will also emerge. And, you know, out of this, I think this Bretton Woods three framework that I started to kind of develop and run with is a world where we are again going to go back to commodity back money, where gold once again is going to play a big role. And not just gold, but I think all forms of commodities because, you know, this crisis is about commodities. This is about, you know, the largest commodity exporter. This is about metals and grains and energy. And so in a way, you're back to where you started from after the Second World War,

but it's going to be a little bit more different and a little bit more complex. It's not just gold, but its commodities more broadly. And it's not just one currency that's dominant, but there is going to be, you know, as a reflection of a multilateral world, a multitude of currency. You know, rubles, if you want to get Russian oil, R&B, if you want to get stuff out of China, you have the dollar, and, you know, if you trade with the U.S. And so it's a fragmented system where commodities play much bigger role

and where price stability is a big issue in certain parts of the world. So this is a very complex mosaic that they need to navigate here. And, you know, that's what Bretton Woods 3 is about. That was fantastic. I want to, you know, before we even dive further into what this Brettonwood 3 looks like, I was reading your latest note. And you cite some ideas from your sometimes co-author and one-time co-guess on this podcast, Perry Merlin, which talks about essentially the four prices of money.

And I don't think many people really think about that. I think, okay, maybe the interest rate or the risk-free rate at a given country is sort of a price of money, so to speak, and the Fed adjust that. But as you point out, like, money is priced in many different ways. Can you talk a little bit about that? Why is that an important idea to understand that any given currency has so many different inherent prices? Yes. Yes. Actually, I think the next guest you should have after me is Perry, because from what I understand, he doesn't agree with me. He thinks he doesn't. Yes. So it's interesting. The dollar rates of And obviously he's going to have this beautiful new book, Money and Empire, which is Charlie Kindleburger and the birth of the dollar system.

And that's about why the dollar is the dominant currency and how it became the Dominican. And from what I understand, I haven't caught up in a couple of months. He does not agree with Brettonville Street. So it will be a wonderful kind of counter-thesis. I pretty much owe the structure of my understanding of the very much. world to Perry's writings and Paris teaching. So I think he has done a tremendous service, I think, to anyone who is trying to understand monetary frameworks and money markets and whatnot. So with that, so the four prices of Perry, so there's four prices which are par interest,

foreign exchange, and the price level. So what does he mean by this? PAR basically means that currency and a bank deposit and a bank deposit at JPMorgan and a bank deposit at Citibank always trade at one. Okay, so money fund shares and bank all that stuff, right? PAR broke in 2008, right? The money funds broke the buck, you know, bank deposits were not certain. So you need to increase deposit insurance, all that stuff. Interest is about the time value of money. money today versus money tomorrow.

You know, what it costs for me to park in my liquidity if I lend it to you for three months to go play in a desert in Vegas. I'm good for it, by the way. Yes, yes, yes. And then, so that's the time value, just the basic idea. And then there's obviously different money market. So there's the repo market, the FX swap market, unsecured money. You know, these all have like, you know, different prices.

And so there is spreads between OIS, curves and these other money markets. Interest, you think about two ways. You either trade it in terms of OIS, you know, how many times the Fed is going to hike, are we going to cut rates, or you trade the bases around OIS. You know, trust currency basis blows out because it's money fund reform or it blows out because COVID-19 hits and everybody needs to fund credit lines that corporations are taking down. You know, this is where you think about the bond basis that blew up in early 2020 when

the pandemic hit. So, you know, this is about basis between various money market curves and various prices of money. Foreign exchange is, you know, figs door floating exchange rates, the price of dollar versus the price of other currencies. You know, foreign exchange is what broke in 1997, for example. When South Korea abandoned it, it's the FX SEG. And then there is the price level, which is basically the price of commodities in terms of money. And by that, you know, we mean basically energy grains, metals and all the goods that get created from these raw materials. And so once again, the par interest, foreign exchange, and price level prices of money, as Perry has taught us, is is the four prices. And basically this little historical review that I gave you tells you that

crises that happen, the big crises that have happened since 1997, which again, Southeast Asia, 2008 and March 2020, these were all crises of money. 1997 was about a broken FX bag. 2008 was a crisis of par. And March 2020, when the bond basis blew up, that was a crisis of interest. Price level type stuff, you know, the price of commodities in terms of money, hasn't really been a big deal since 1973. So we were lucky and we basically had only those types of crises where the central bank

has to step in because it's a nominal exchange rate and it's a nominal bond basis and it's a nominal thing that, you know, the reserve primary fund cannot pay par back. And so it was a dollar problem and a euro problem in the case of the sovereign debt crisis. And a central bank that deals with a nominal crisis in its own currency has it easy because what do you do as a central bank? You provide emergency liquidity to people that have the trouble assets and can't fund. And you also buy the trouble assets, which is either some peripheral sovereign debt or subprime mortgages or treasury securities in March 2020. I mean, in 1997, with South Korea, it was different because it was the IMF that had to step in to provide the dollars because they didn't have the spotlines.

But the bottom line is, these are all crises where someone has to put balance it on the line, buy the trouble assets, pump in liquidity, and problem salt. Today is different because, you know, the price level is where real meets nominal. You are talking over the price of real goods in nominal terms, and central banks can't do a bloody thing about commodity shortages, you know, the type of environment that we are that we are going through now. And I'm sure you'll ask next, you know, So there's the four pillars of commodity trade and we'll come to that next, but that's basically the four prices. You know, you've been writing a lot about funding stresses showing up as a result of the volatility that we've seen in commodities recently. Yes.

So I guess I'm wondering, is there a tension there between saying that commodities as funding collateral can suddenly decline in price and cause a lot of problems for people? and including commodities as part of the sort of monetary framework of the future. Like, how do you sort of think about that tension? Yes. So first of all, you always like to kind of ask me the things I'm wrong about. So, yes, full disclosure. I have to. But yes, I know.

This is very interesting because I was very right, but I was very wrong. You know, I was right that the commodity derivative complex and the commodity trading world is going to have a liquidity crisis. We are having that liquidity crisis. Where I was wrong is that none of this is going to show up in traditional measures of funding space. And, you know, you always learn from your mistakes. What I have learned, the commodity trading world completely funds itself through bank credit lines. they do not tap the FX swap market, they do not issue CP, they don't do anything in the repo market because they don't have the type of financial assets that the repo market would accept as collateral for funding. So you then basically have a world where you have, okay, the two extremes, you know, you have the commodity trading world on left and then you have one and a half trillion of cash in the reverse repo facility sitting there.

And then you have the big banks, again, the old Vizus J.P. Morgan as the poster child, you have $500 billion that JPMorgan holds at the Federal Reserve Bank of New York. Again, the funding stresses that the commodity role is having are being lessened by more and more and more lending that big banks provide to commodity traders. But because the big banks are sitting on files of cash, okay, they can just lend that money. the commodity traders in need, but they don't need to raise that money on the margin. And so because they don't have to raise money on the margin, they just don't have to repel market or the FX property. You don't have to issue CP. So, you know, the traditional kind of stir domain of spreads is very calm.

However, that doesn't mean that there is no stresses in a commodity trading problem. And we know that there are stresses because Peabody Energy had to pay 10% interest when they took their credit line from Goldman Sachs. I think Bloomberg wrote an article about this, right? And we know that, you know, Trefiguura was in the news about taking credit line from a consortium of four banks, then trying to raise equity from Lackstone. Then, you know, a day later, all the commodity creators were basically writing a letter to central banks that they need emergency security support.

So the strain is there. The strain has a multitude of sources here. again, back to this idea that everything that the commodity traders do is financed by banks. And again, I think, you know, we all live and learn and learn as we go. You know, one thing, for example, I've learned from commodity traders is that, you know, when it comes to these credit lines that the traders use to finance themselves is, you know, you get X amount of credit through a credit line from a bank. You draw 70% of it to lease a ship to fill up the ship with cargo.

But you don't use 100% of that credit line because while, the goods are in transit, you will have to pay variation margin, right? I mean, prices go up, prices go down, depending on the physical side of the trade you are on, you will either get paid money or you will have to pay money. And for that too, you will tap a credit line from a bank. And so when you have a price shock and when you have all this volatility, you, A, need more money to move the same amount of physical goods around. And you also need more credit to be able to pay margin on all this cargo as it is in transit.

So this is where the liquidity strains are coming from. And, you know, it's a mess because, you know, banks are basically facing credit trusts when they are lending into the commodities world. And not only that, but basically you have a shock in terms of the nominal amount of money you need to lend, the nominal amount of balance sheet that you commit to this world. And I guess one lesson from this, and again, conceptually,

and again, in extreme terms, just to concentrate the mind and the sparks and thinking, the value of, say, $500 billion of deserves at the Fed, if you're a large bank, is worth a lot more in a world where inflation is low and low. stable and commodity prices are low and stable, where the only thing you have to worry about is, you know, where am I going to lend my next 10, 50, 30 billion dollars to harvest the next cross currency basis? So 500 is worth a lot more in a world like that. Then in a world where basically you need to lend an extra 100 billion dollars to all sorts

of commodity traders to move around and to finance all commodities imagined. So that is happening now, which is another way of saying that. this lowest comfortable level of reserves that we like to think about in terms of how much QT can the Fed do and how much reserves can we take out. That LCLR, again, the minimum level of reserves, the banks feel comfortable of running with is going up as we speak. We don't know how much because it's unobservable, but the Fed does this periodic surveys about LCLR. I think it's time to do a survey like that now, because these are issues. And I don't think that the issues in a commodity world are going to fade away anytime soon. They're probably going to get much,

much worse. There is liquidity strains. They just don't show up as such. And by the way, the moment some big name can't pay and defaults as a result. And again, you can use your imagination. It doesn't have to be a commodity trader. It can also be a CCP, the default. fund of a CCP. Someone can't pay margin in a, in a futurist exchange. You know, the LMEs, the LME case with nickel is a interesting case in point. But again, the other thing that people like to rub in as, well, this was not a Lehman 2.0 after all. But give me a break. Lehman took a year to happen. You know, BNP couldn't fund the subprime exposure and its money funds in August of 07. And by the time we got to Lehman, 12 months have passed.

I think the writing is all over the wall that a lot of things are happening. A lot of things have happened in 30 days. This is like, I think, 2008 kind of compressed in time. And again, things can get first. So I think we need to be approaching this with an open mind. We need to be thinking about a lot of scenarios. And we should not assume that just because we haven't had any blowups today, there won't be any. But once those blowups come, the flavoring.

the markets are going to change because then counterpart to risk is going to be something you worry about, which is not something we have to worry about since 2008. So, you know, keep an open mind and I think we need to be humble. And, you know, I'm the first one to recognize that. Keep an open mind about the awful things that could be coming in the next year. Yes, yes. And again, I'm the first person to, you know, admit you can be right, but lose a lot of money because you express your views wrongly. So yes, you know, pro-o-IS and cross-currency, which would not have to be.

been the right way to express any of these things, but they are happening nonetheless, and things are not getting better. They're getting worse. I've thought of this already to be incredibly helpful, and just thinking about like, okay, a commodity, a price level shock is very different. And fundamentally, other types of like financial nominal shocks, it might be politically unpalatable. It might have been politically unpalatable to do tarp or maybe for the Euro crisis. It might have been politically unpalatable to bail out peripheral spreads, but it could be done and it can kind of be done at the push of a button. And it's kind of trivially simple if you build up the will. And then fundamentally, commodity shocks are just not like that. They are not in a category where there is a button you can press and

solve it. And so what do you talk about that further? Because that's sort of the direction of this Brettonwood's three vision is the challenge that arises in a period of commodity volatility. And you talked a little bit about it just now with what it means to. liquidity in the system and funding various margin positions and so forth. What do you sort of like build from there about the sort of implications and the different of a sort of a commodity driven account? Yes. So again, so maybe we should we should just start from the four prices of money and then let's do that build you know kind of build out the the mirror image of all that in the physical world. Exactly. Exactly. You know the the the four

The fourth price is the price level, the price of commodities and money. And then so commodities, so what's the thing about commodities? Well, commodities, you know, the dirty thing about commodities, the ugly thing about commodities is that most of it is coming from the developing world and most of it is being consumed by the developed world, right? I mean, Russia, China, OPEC countries, you know the deal, right? First. Second, all these commodities, not only that you can't print them like money, but you need to move them around. You know, you need to ship them. Most of this is seabor. You know, you don't fly commodities. You ship them. You know, wet cargo, dry cargo, much like in the world of money, you know, when we think about, you know, when we talk about, you know, the token system and how reserves move around in the money markets.

always need balance sheets for some bank to borrow here and lend there and harvest some funding spread, you know, fund in repo, lend in FX swaps, make a spread. In the world of physical commodities, you know, that balance sheet is basically a ship. You load cargo in port A, you bring it to port B. You know, the cargo is not money. The cargo is a commodity, but you encumber capacity, of ship capacity to move stuff around. So there is that. And then of course, there's the par value of money equivalent in the physical world, which is protection.

Protection because, you know, as I've learned from Paul McCulley, you know, money is either a purely public or a public-private partnership, which in English means banking doesn't work unless there is a central bank, right? because nobody can take their money out of a bank all at the same time. You need someone who's going to do the protection if that happens. Similarly, when you move all these foreign cargo from the developing world to the developed world on ships, which are like balance sheets and are like kind of banks in the bank balance sheets in the real world equivalence of the nominal world of money, protection in the case of commodities

is about making sure that sea lanes are open. Traits are open. You know, there's no pirates. You know, no one's blocking the passage of your ships, that type of stuff. And that's also something that the state needs to be involved in because, you know, the high seas have to be policed. I mean, it's basic stuff. You know, what the Navy is to shipping lanes, you know, that's exactly the same as the Fed is to the promise of a par value of a back. Yeah. And, you know, Bretton Woods, too, as a concept, was born when China started to accumulate FX reserves. But really, it existed much earlier ever since, you know, the 73 oil price shock where, you know, you ship oil, you get dollars and then you reinvest those dollars into treasuries. You know, China did the same, but they did it with goods. And so that, but that's basically Bretton Woods, too. That's euro dollars. That's petrol dollars. That's all of that. And, you know, we had a unipolar world.

where everything flows to the US and everything was paid for in dollars and all those dollars were recycled back into treasuries. And so now there's a break in history. And now we are learning that all the commodities, I mean, not all of them, but a lot of them in the case of Russia come from, you know, Russia is the single largest commodity exporters, is expert in the world. Russia and Ukraine, you know, wheat and all that comes from that is a very important block. when it comes to the supply of physical commodities.

And things are getting gumbed up. Commodity doesn't come out of that region as easily. If it comes out of that region easily, now they don't accept dollars as a form of payment. They want rubles as a form of payment. If Europe doesn't take the raw material, crude oil and whatnot that comes out of Russia, Russia will have to reroute the shipment of those to the east,

China, which is going to buy cheap Russian stuff. But if you do that, then you basically have to revamp shipping lanes. You basically end up, as I talk about this in my piece yesterday, with a severe shortage of vessels capable of moving oil cargo on long distances. You know, there's a big difference between shutling Baltic crude from Primorse to Hamburg than it is to ship it from the same port to somewhere in Shankar. high. Okay, so you end up with shipping capacity issues. If China is now buying cheap Russian oil, then they're going to buy less Middle Eastern oil. And then, you know, all the Middle Eastern

oil will now have to go to Europe because, you know, Europe finds it acceptable to buy it from the Middle East, but then all of that goes through the Suez Canal. You know, do you have the right ship, you know, to transport that oil? If it's a VLCC tanker, then that cannot pass through the canal. So, you know, it's going to take more time to ship. stuff around. It's going to take more types of specific types of ships. There will be ship shortages as a direct analog to balance sheet shortages and G-SIP shortages in the financial world. You will have issues of Suez, Egypt, wheat, oil. Egypt was a huge importer of wheat from Ukraine, for example. And as any country that doesn't have a lot of wheat stockpiles are going to have

to pay up for wheat on the world markets. How do you extract a pound of flat? from somewhere else so that you can pay for your wheat if there's a food shortage. You can hike the transit fees through the Suez Canal. But just think about the enormity and the whole plumbing that underline the physical movement and trading of commodities is extremely complex. And in 2008, nobody really understood the plumbing because you didn't have to, because it worked fine until it didn't. Right.

Okay. And I think we are, again, 30 days into this war and we are 30 days into figuring out how basically all these things that we used to do very efficiently are going to be done in the future and how the rerouting of these ships and, you know, boycotting commodities from here and giving it to there, how that's all going to play with the level of prices. But basically, you know, Bretton Woods three is about that and not only about that, but also redrawing the terms in which we accept payments. Russia is now selling in rubles, the Saudis are going to sell, consider selling oil to China and invoicing it in R&B.

The big point about that is that when we have the petrol dollar and the euro dollar as the dominant form of international money, you guys know probably everybody who listens knows banks make loans and create deposits, right? That's how things get done. when Glencore brings commodities from Port A to Port B, you know, they go to JPMorgan to borrow money to lease a ship, then another pile of money to fill up the ship, then another pile of money to pay margin as that cargo is in transit and you need to post margin on futures. So when everything is priced in dollars, you know, you borrow dollars to move stuff around. the dollar deposits gets created. Glancourt gives it to the Saudis. The Saudis give it to Sama, and Sama shows up at a treasury auction.

You have Euro-dollars that were created through this whole process that will then get recycled into treasures. The U.S. didn't really have to think about demand for treasuries for the past, I don't know, ever since 1973, because this was the game we played. So now if all of a sudden somebody starts

surprised things in Google, somebody starts to price things in R&B, the creation of Euro-Dollars on the margin is going to change. I'm not saying it's going to go down, but the pace of it is definitely going to change. And again, the U.S. Treasury needs to think about this because if you have less creation of euro dollars, you will have to change the way you fund your issuance. If the petrol dollar recycler is not going to show up at auctions, someone will have to, the Fed, right? Otherwise, you have a failed auction. So I think these are all things that, you know, this is Brett and Boots 3, basically, right?

And so this is not immediate. It's inevitable, but it started. You just touched on demand for treasuries there, and you touched on quantitative tightening earlier and the idea that given everything that's happening in the world right now, you know, shipping is more expensive, commodities are more expensive, there's lower risk appetite, you need to conserve balance sheet, things like that. that there's going to be higher demand for bank reserves from the banks. Should the Fed be doing quantitative tightening at this moment in time?

It seems like the timing isn't exactly optimal. Yes. Well, sure. They should because there's a lot of excess liquidity in the system. And just to be clear, the knee-jerk response is, yes, we need higher rates. We need the hike. We need to shrink the balance sheet. Which makes sense because, you know, we blew up the balance sheet for the past.

decade and a half because inflation was persistently too low and we tried to reflate, right? So now that inflation is here, we need to deflate. And also, you know, before the war, I mean, I wrote a lot about so how is this QT going to play out? There's going to be beautiful QT and ugly QT, active QT versus passive QT. And now you just need to do a war on peace edition. You know, Bretton Woods three messes this up for two reasons. Number one, as we mentioned before, the low.

lowest level of reserves is going up. So banks need more reserves, all else equal, which means that when you think about the marginal buyer of treasuries as QT progresses, I would say that in this quote unquote new world order that we are in, banks will have less appetite to buy treasuries for their portfolios, trade reserves for treasuries, than before the war, because credit needs from the commodity, trading world, you know, and from everybody else ultimately, right, because everybody will have to pay more for

goods and trade finance and all that is going up. So if they will buy less, then, you know, all this money that's in the reverse repo facility is going to be more important much earlier on in the QT process than before. And so there we have one and a half trillion dollars or so. And so fine. But then again, the other thing about Bretton Woods three, is that, you know, we're just talking about the creation of less euro dollars on the margin. And who creates money in the system, the central bank and private banks? And this tend-off between, you know, the Fed shrinks, the balance sheet takes money out of the system that always needs to be understood in the context of how much lending and money creation is in the system

because the Fed can take out money. But if there's more private deposits and more private money getting created through the banking system, you know, the two things can offset each other. But now we are saying is the Fed is going to take liquidity out. The creation of euro dollars is going to slow on the margin. So the OPEC countries and whoever used to recycle euro dollars and petrol dollars is not going to do as much of that. And so that's an issue. Then another issue, this whole idea of, okay, well, you know, you just froze half a trillion dollars of G7 inside money.

so maybe it's time to diversify away from our existing holdings of U.S. treasuries. So maybe some reserve manager are not only not going to buy and recycle less Eurodollars, but they are going to trim their exposure to U.S. treasuries. And so, you know, I say all this because, you know, if the banks don't buy and the Fed doesn't buy and there's less petrol dollar recycling and there is diversification from existing holdings of ethics reserves, it inevitably. mean that those balances in the overnight reverse repo facility will be soaked up pretty quickly

through poor quality demands, but demand nonetheless. The guys that fund in the repo market are basically dealers that are getting backed up with treasury inventory and the RV funds, which are in it for a basis. I mean, it's all a levered position, long the bond, short, the future fund in repo, that type of stuff. not a pretty form of demand, but a form of demand nonetheless. But again, you know, you go from steady, sleepy, reliable buyers in the Middle East and China to fast money stuff that is levered.

But it's going to be fine because we have the standing repo facility. So even if you end up with a repo deficit, you know, thank God the standing repo facility is there. So you can just kind of see this that, you know, another legacy of Bretton would be will be that all this is going to be less international. It's going to be more domestic. It's going to be some domestic people-funded entity that's going to fund this, not the rest of the world. Let's talk about the other currencies

and the roles that they'll play. And so as you mentioned, okay, Russia is going to be selling its commodity exports and oil and gas. Or maybe Saudi Arabia starts selling, invoicing an R&B for sales to China. And so then the question naturally emerges, Like, well, how significant is this?

There's a lot of arguments against the role of these currencies playing big. I mean, rule of law questions and market debts and the degree to which the Chinese will ever open up its capital accounts and so forth. Yeah, yeah. So where do you see these going? Like, because this is what these headlines get everyone excited like, oh, oil might be sold in R&B. What does it mean? But there are some difficulties for these currencies to overcome to have any more significant. Sure.

People are not born who they become, right? So you're born as a baby and then, you know, you learn to walk and talk and then we all end up doing something with our lives, right? So again, back to where we started from. After the Second World War, the U.S. dollar was not what it is today. It became that. No currency is born a reserve currency. It becomes it. The sterling was what it was, and then the dollar came.

And then dollars became Eurobathers. The R&B is what it is. and then it will become something else. All these work, I mean, it's kind of funny, and it makes more sense in the present. But, you know, we all obsessed about, you know, the internationalization of the R&B and all the correspondent banking stuff and all the Hong Kong onshore, onshore, onshore, offshore, and the volumes are not that big. All that stuff was the baby is born, the baby is learning to walk, the baby is walking.

That's the plumbing. That's the basic stuff. And then there's a catalyst. like the war that we are looking at now and the whole conversation we are having now. And then things will change, but then you basically have an infrastructure to build on. And then things can go very fast. I also get it that China has a closed capital account. People like to have open capital accounts.

But for Christ's sakes, what's the difference between an open capital account that ex post can be shot, to the case with the CBR versus an ex-empty-closed capital account that you know that over time is going to open up. People also tend to forget when China became a part of the World Trading Organization and, you know, it started to accumulate surpluses. I mean, I was a, the surpluses were first accumulated in bank assets. And then the Chinese started to buy bills. And then they started to buy two year, five year, 10 year treasures. Then I bought mortgages. Then they funded CIC and then they started to do private equity. Right. Big stake in Blackstone, I think, right? In 2008, they bought.

The point is, surpluses accumulate and as more and more accumulates, you change the way you do things. If the dollar became the dollar through lend lease, you know, we lend you money and then you lease stuff from us. You know, maybe the Chinese are now going to, we'll lend you money and then maybe you buy our corn and wheat reserves or something like that. It doesn't matter. The more trade, the rest of the world is invoicing the Chinese R&B, the rest of the world is going to you accumulate. R&B surpluses. Those surpluses initially will inevitably accumulate on Chinese banks' balance sheets. And then the Chinese banks get to a point that we just don't want to have all these surplus on our balance sheet because it's using too much capacity. State, please take it off our books.

The state will start issuing debt to take all that liquidity surplus off the balance sheet of the Chinese banks. And then as the rest of the world accumulates more, you know, and it's going to start with central bank bills again, you know, held by foreigners. And then, you know, the foreigners, they accumulate more, they will have more and more long. And so that's going to be the birth and the development of the debt securities market in China. I mean, all this stuff is a step-by-step process, again, just as a child is born and learns to walk and talk and does other things in life. So I think this is going to be a path. This is, I think, inevitable.

I think it started already. The infrastructure for it has already been built. And I think this is going to pick up from here going forward. On the topic of alternate currencies, this is something that came up in one of your previous research items where you were talking about the possibility of people holding reserves in something other than dollars. And you mentioned Bitcoin, but it had this big caveat around it, which was you put in parentheses if Bitcoin still exists by then.

What do you see as Bitcoin's utility here, if any? Joe sparked the kind of bilateral conversation on that too by email, which was interesting. And by the way, Joe, my caps lock got stock. So whatever you said in your article is capitalized. It was not intentional. I thought you were very excited about. No, no, no, no, no. I was like, oh, I, Zolt is extremely excited. It is in caps. It came out beautiful. Yeah, it says a sovereign has to be involved with the question of money and Bitcoin is basically short the sovereign. You know, Bitcoin is short the sovereign, which is precisely, which is precisely why you can't have Bitcoin in China.

Because you can't be short the sovereign in China. There's no outlet for political frustrations. It's one party. Not to be facetious or anything here, but I mean, if we are talking about commodity shortages and energy shortages, and if it takes a tremendous amount of energy to mine the marginal Bitcoin, I mean, that just makes no sense. You mean, energy is wasted. Energy is going to be wasted on mining something that...

So the question is, why would governments who are already facing commodity shortages continue to allow for the energy intensive mining of the thing that short the sovereign? Yes. I mean, if you are releasing record demands from the strategic petroleum reserve, and like, I don't know, you see what I mean? So it's like if all the strategic petroleum reserves are empty. And then, you know, people are using corn to make ethanol. and then people are hungry and like you're burning ethanol to mine Bitcoin or something. That makes no sense. But that's one.

And the other thing, the whole central bank digital currency, how does that fit into this? I think Bretton Woods 3 is not about that because we are talking about rethinking reserve assets. This is FX reserves, which is a nominal pile of wealth versus commodity reserves, real versus nominal. The central bank digital currency is a liability side question for central banks. Like what technology do I use to distribute my liabilities? This is like landlines versus cell phones or you stream your movies or you schlep to a video store and get a V-Agen tape and stick it into a machine to watch it. That's that. Bretton Woods 3 is about how do you invoice stuff?

How do you get stuff from port A to port B? Once you get paid, what do you choose is your office? is it a real asset, is it a nominal asset, that type of stuff. You know, listening to this conversation, it does not necessarily strike me as a negative environment for the U.S., especially vis-à-vis other rich countries because, okay, maybe the dollar doesn't have the same status. On the other hand, unlike other rich countries, tremendous ability, at least, in theory, to produce oil, tons of natural gas, tons of open space for wheat, corn, and soy, metals. If we want to mine them, we have rich countries.

Earths here, you know, some of the more advanced tech, it's sort of a political choice when we're going, it doesn't necessarily seem like in a world in which, and of course, our military. And so to the degree that the military is the price of shipping or the price of protection for a lot of shipping lines, obviously the U.S. far and away is still the strongest military in the world. It seems like even in a new regime, the U.S. has tremendous built-in advantages and stores of wealth. So yes, when you think about, let's say, three regions, you know, U.S., Europe, Asia, China, yeah, Eurasia, again, conceptually very high level. The country that's buying stuff on sale cheaply, stocking up, is going to be China, right? Because that's where all the Russian commodities

you're going to go. Let's just get a picture. The country that can fill some of the, you know, you can frack your way out of this or throw your wheat out of this. this US is fine. I think Europe is in a very delicate position because this is basically, you know, between Russia and Europe and, you know, the German reliance in Russian fossil fuels. And so yes, you know, I think this is,

you know, Bretton Woods three, I think, is also a world where the East certainly has some, I don't know, quote unquote renaissance and it has it better. And inflation is less of a problem there. the West has quote unquote some relative decline. It's not going to go down the cubes, but this is a multipolar world, which is not meant to be, you know, status quo, but, you know, someone rises, someone declines, but still too dominant. Inflation is probably more of a problem in the West. And then I think Europe is very much in the middle.

So now when we think about this medium term, what it means for commodities and inflation and who wins. who loses. Some of the themes that come out of this is Larry Fink is right or rather is probably more informed than all of us on this forum. I do agree that globalization, as we know, it is probably over. So what are some of the things that are coming out of that and some of this conversation? Resource nationalism is a part of Bretton Woods three. More military spending, you know, Europe for sure and the U.S. at least sea lanes, whatnot is definitely coming out of this stockpiling of commodities definitely coming out of this. Rethinking supply chains is definitely coming out of this.

Bretton Woods 2 was about a singular supply chain, Foxcom making everything. And Bretton Woods 3, if all that world order is torn up and we have to duplicate production facilities and supply chains and all this. We need to provide a lot of investment and capital into that. So, you know, not to mention all the ESG and cutting, you know, the investments related to that. I think the investment needs for the world that Bretton Woods 3 reflects is going to need more commodities, is going to need more capital. And so, you know, the West, I think, has things to worry about because, you know, we are basically talking about upping investment in the West at the expense of consumption, which is exactly the mirror image of the problem China has, which is they had too much investment and too little consumption. Like even kicking it even higher in the hierarchy, the whole conversation, I think China needs

a stronger exchange rate than the U.S. needs a weaker exchange rate, kind of. More consumption, less investment there, more investment less consumption here. The types of investments that we are talking about are investments that are going to be driven by the state and by corporations as they rethink their existence. Zoltan, I feel like we could talk about this for hours. Thanks so much for coming back on. That's fantastic. Yeah, that was really good.

Thank you very much, guys. It's always great, having Zoltan on the show. And one of the things that came out of that is, I mean, I really think the sort of summary of all of it is that if you're interested in interest rates and the economy, you know, say you're a short-term interest rate strategist or a stirred trader or whatever, you're going to have to start paying attention to shipping and commodities and all the micro in order to do the macro. You know what?

I thought that was one of the best conversations ever to think, you know, people always talk about turning points, right? Oh, it's a deflection point. It's a turning point post dollar. It's, you know, we've been talking about for years. I thought that was one of the best conversations I've ever heard that actually put some like meat on the bone, so to speak, of what that looks like and thinking about what are the price equivalents when it comes to commodities, storage, protection, the equivalent of maintaining par. And then what are the institutions that have to build up around that to sort of recreate a more commodity-centric world economy. It was like extremely, extremely interesting. Right. And then just underscoring in what a poor position, a lot of the

central banks are in order to do this. Because under Zoltan's framework, you know, this idea of you have the sort of nominal monetary stuff, things like price levels and par and interest or the future value of money, stuff like that. But the problem is emanating from the real, which of course central banks don't really have any control over. Right. We can hope, okay, if we slow things down a little bit, tap the brakes, maybe things are okay and we get some easing in the price of oil. But everybody knows it.

I mean, everybody knows that the issues that are arising right now, at least some of them, like particularly on the food and energy side, are pretty far from, like, something that the Fed, any central bank, let alone even the Fed can handle. Yeah. And I mean, the other point he made is that the last time the Fed really had to fight inflation, which would have been with Volker in the sort of late seven years, early 1980s, that it was such a different world then. And a lot of the problems were sort of emanating from a space where the central bank could have an impact and it was

doing it in a sort of maybe not totally unilateral world, but a more cohesive West, certainly. And people could sort of follow on, follow suit. And now that might not be as possible. And I just want to say, I love this analogy. So it's like, what is the commodity equivalent of balance sheet space? And you talked about like space on ship, shipping. It's so interesting to like try it. It's like I find it to be a very useful exercise to think about these different things like interest rates and obviously curves or what's the equivalent of a yield curve and obviously like a commodity's futures curve, things like that. It's a very useful thought exercise to think about how strains might emerge and how government policies might. have to be different in this new world. And poker chips as tokens. Synthetic dollars. Still pegged one to one against the dollar at this one. Excellent.

All right. Shall we leave it there? Let's leave it there. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Allaway. And I'm Joe Wisenthall. You can follow me on Twitter at the stalwart.

Big thanks to our producers, Magnus Henrickson and Colin Tipton. follow the Bloomberg head of podcast Francesca Levy at Francesca Today and check out all of our podcasts under the handle at podcasts. Thanks for listening. Hey there, Oddlots listeners. We are very happy to let you know that we've been nominated for a Webby Award. Yeah, I'm not, you know, Tracy, I'm not normally like a big awards person, but now that we're nominated for one, I'm really excited.

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