Odd Lots - Zoltan Pozsar on His Next Big Move and the Coming Monetary Divorce

Episode Date: June 30, 2023

Zoltan Pozsar has built a reputation for covering the intricacies of money markets. For the past eight years, he published those insights as a strategist at Credit Suisse. But in this episode of the Odd Lots podcast, Pozsar reveals his next career move following his departure from the Swiss bank earlier this year. He also gives us an update on his Bretton Woods III thesis, or the idea that the global financial system is going through a "monetary divorce" from US dollar hegemony and becoming more multi-polar. He also gives us his take on the recent banking crisis and what it means for global funding markets going forward.See omnystudio.com/listener for privacy information.

Hello and welcome to another episode of the All Thoughts podcast. I'm Tracy Allaway. And I'm Joe Weizenthal. Joe, do you remember what we were doing this time last year? No. Yeah, I can barely remember two weeks ago. Yeah, no. But I actually, I remember this one, mostly because I looked it up right before we started doing this recording. But this time last year, we were preparing, organizing our first live all thoughts debate between Zoltan

Pozar and Perry Maryland. That was really fun. We got to do that again. Yeah. More debates. So we were sort of frantically doing a lot of the sort of travel arrangements and things like that for that. Sorry, waking up early in the morning, like of the day of the debate, entering names into a database so that people could get into the Bloomberg office. Yeah. Do you remember that? Yes, I do. That was fun. All right. But my point is, it's been a while since we've spoken to Zolt and Pozar. It has been a while, and it's unfortunate because he is one of our most requested guests. People would listen to him every month if we interviewed him. I agree. In fact, I think we should do monthly or even quarterly interviews with Zoltan.

But I am very happy to say, without further ado, that Zoltan is, he's back. He's back. And so, right, so he was at Credit Suisse. He left Credit Suisse. He's been kind of silent. There has been this incredible mystery about what he's going to do next. and we don't know, but he's coming on the Odd Lots podcast. So let's find out.

He's going to tell us now. Zoltan, welcome back to the show. We're so glad to have you back on. This is like when LeBron James announced on ESPN all those years ago, what he was going to do next. Very nice to be back. Thanks for having you guys. All right. So what are you doing?

Let's just jump right into it. Yeah, you were a strategist at Credit Suisse, as everyone knows at this point. And now what are you up to? Well, the next steps is, I have founded my own macroeconomic consultancy. The name of the firm is ex-unopurus, and I will be providing research to institutional investors and consult institutional investors about plumbing,

as I always have. Okay, many questions. Well, let's just start simple. What does ex-unopuris mean? X-unoplores is the opposite of a pluribusunum, which is this little motto that we can find on a great seal of, United States and on the dollar bill. It means in English out of one many. It's meant to capture two ideas. The first idea is, you know, my retrospective on what I've been doing for a strategist

for a decade is basically anticipating moments when prices fall apart in funding and rates markets. So the basic idea is that most of the time, things straight on top of each other, you know, the industry structure is orderly. And then when something bad happens, whether it's panic or a pandemic or a balance sheet constraint or liquidity constraint, prices fall apart. So out of one price, you are dealing with many prices. And so that's basically the bread and butter of what a rate strategist and a rates greater is doing, anticipating those moments and being on the right side of those moments. And then the other idea is that, you know, global macro as such,

I think it grew up as a concept and an asset class, if you will, in a unibular moment. where globalization was moving forward. The dollar was the undisputed global hegemonic currency. And so we were all kind of trading the global dollar cycle. And going forward, as we discussed in the context of Bretton v. That's no longer going to be the case. So it's kind of capturing the zeitgeist in that, you know, China is trying to extract itself from the Western financial system,

much like the Western real economy is trying to extract itself out of supply chains that are running through China. And so we are, I think, at the beginning of this era, the next five to ten years at least, where we are going to go through this monetary divorce and the dollar's hegemony is going to be challenged by some geo-financial moves that China is flooding. So out of one dominant reserve currency, we will have a world where we will have met. That's a great name. So, you know, you mentioned moments in macro. And I think last year when you released that Bretton Woods three thesis that you talked about on the show and wrote a number of research notes about, it definitely demarcated a thing that seemed to be, you know, floating out there in people's minds, this idea that maybe finally some things were changing around dollar hegemony, as you just mentioned. Talk to us about that original thesis a little bit more and whether or not you think it's been born out over the course of the last, I guess, 12 to 15 months or so.

I think the concept is very healthy and it's alive. I personally see more and more signs that some of these themes that we have discussed on that first show when we talked about Bretton Woods v. Be our country to fruition. And also the conversation with Perry, I think we did a quick temperature check on here. idea and at the conclusion I had there was that, you know, Bretonbus III is a healthy baby boy, so to speak. So it's throwing and developing rapidly. Look, a couple of things. To frame that my answer to that question is I think it's becoming very obvious that when you talk to policy circles and investors in the West, I think the primary focus is on how do we, so to speak, de-risk supply chains that are running through. China, how do we become more self-sufficient in terms of rare or all the capital goods we need

for energy transition, chips, and so on and so forth. And so the focus in the West is on making sure that the real economy is decoupled from the East, so to speak. And when you speak to market participants and policymakers in East, the primary focus there, because they have all the supply chains, and so they are in control of that part of the equation there, the primary focuses on how do you extract yourself from the Western financial system and how do you de-risk this relationship that you have financially with the US dollar and Western international institutions and financial centers in general. And I would say that since we last spoke about this topic, there have been a number of news headlines, you know, readouts from

state visits, what have you, where, you know, things like the renminbi invoicing of commodities is moving ahead. We are reading about more and more stories where natural gas deals and oil deals are invoiced in renminbi and not the US dollar. I have not talked about this aspect of breadth and wood street, but I kind of uncovered the new aspect of it,

which is the whole central bank digital currency topic and how all that fits into breath and good street. And, you know, when you start digging in that domain, I think you uncover several things that are kind of eye-opening. So let me just offer one, for example. The real economy, real economy analog again, is, you know, in the U.S., for example, we don't allow Huawei to build cell phone towers for obvious reasons. You know, there is a risk of beefsdropping and spionage. And, you know, Central Mac digital currencies are basically the same story.

I have been kind of cursorily following CVDCs, but I couldn't really fit into an overall macro picture as to what are CBDCs about. But, you know, if you think about it, China has been quite busy trying to internationalize the rent. It used more for trade settlement purposes since the middle of the last decades. So around 2015 is when they started. And then that process somehow stalled. And I think the reason why the process stalled is that they recognize that it's pointless to internationalize your currency through a Western financial system, through London, through New York, And through the balance sheets of Western financial institutions, when you basically do not control that network of institutions that your currency is running through, for you to do something like that, you basically kneeled out a full new correspondent banking system. Okay.

And so, you know, this is also the time when Russia annexed Ukraine, so the financial sanctions became a much more dominant topic in the financial press. So I think that was a wake up for China that if they want to indeed internationalize rent fee, they need to start from scratch, and they need to build the noble financial network that they control. And so this is also the time when CBDCs become a hot topic. You know, CBDC started in China, you know, the ECNY. And the way I think about CBDCs and developments in that space today is that you basically need to imagine a world where five, ten years from now, we are going to have a renminbi that's far more internationally used than today. but the settlement of international R&B transactions are going to happen on the balance sheets of central banks.

So instead of having a network of correspondent banks, we should be thinking about a network of correspondent central banks and a world where you have a number of different countries and each of those different countries have their banking systems using the local currency. But when country A wants to trade with country B, you know, Thailand with China, for example, the effects need. of those two local banking systems are going to be met by dealings between two central banks. And so when you reimagine a system like this, it's basically a state-to-state and a central bank, a central bank network that is completely independent of Western financial centers and the dollar.

So there's a ton of development. We can develop some time later on the show, to talk about this. So there's a ton of development on netfront. And also the context here is that if you want to imagine. an alternative to a dollar-based system. The single most important thing that makes the dollar so important is that 90% of FX transactions, any given day in the world, use the US dollar as one leg of that transaction. Okay, so basically that's because we inherited the system where if you want to sell,

you know, if you want to settle a transaction between someone in Hungary in Thailand, okay, the way you will do that today is you would sell your Hungarian. foreign, buy euros, sell the euro and buy the dollar and sell the US dollar and buy so that's basically three different currency pairs, three market makers, three bid-esque spreads incredibly inefficient. But again, if you go back to this concept of correspondent central banks as opposed to correspondent banks, this transaction just can settle between the local Hungarian banking system and a local Thai banking system.

We have to do central banks as dealers of last resort. in the FX markets. And so that's the last piece I want to mention in this part, which is that, you know, in the West we are talking about this dealer of last resort thing a lot. And the context in which we talk about dealer of less resort in the West, in the U.S. case specific, is that we need a dealer of less resort for the Treasury market because the Treasury market is not mixed with it. That's where the focus is. And of course, we need the dealer of less resort in the repo market and the FXPop market. But I think it's also time to start thinking about dealer. There's a first resort in terms of FX market making for the global east and south,

which is the central bank drill turns, the central bank correspondent system that I'm describing. This is so interesting because I don't think I'd ever heard anyone talk about CBDCs within the context of like a new kind of plumbing. I mean, you hear stuff about, okay, well, you know, it's the 21st century and we need to be able to pay for stuff on our phones, which we already can do, or sometimes you hear about it in the context of privacy. I've always had this theory that CBDCs are just a way for central bankers to get invited to panels and get really plush jobs after they leave the central banking world, like

doing digital money for visa or something like that. But this is actually sort of like an interesting theory. Before we go a little bit further down this road, because I want to talk more about it, I'm still curious about the business. You know, you're going to be going out to be independent. What is your sort of vision for ex-uno-plur? which is, again, I think it's a really clever name, the opposite of epluribus unum. What is your vision for, like, what kind of business, who it'll be?

Is it going to be, who are your clients? Like, talk to us a little bit about what your vision for your firm is. Well, thanks for coming back to that. I mean, look. I figure if you're going to announce the decision, the big decision here on Oddlots, happy to like, I'm actually also just, I'm very curious about how this world works. Okay, so look, I will offer two streams of publications in terms of research, The first one will be money, banks, and bases.

This will be the publication that most people kind of identify me with. So I would be looking at the 50 largest balance sheets in the world with a lot of attention, what the big banks are up to, what the G-sets are up to, what are they doing in their portfolios, where the balance-ship constraints. And it's going to be basically a research piece about the day-to-day working of the dollar system, as we know it today. And then the parallel publication will be money and world. order, which is going to keep track of how Bretton Woods 3 is evolving. Because, you know,

these topics of de-dollarization, the remonetization of gold, you know, using central bank digital currencies to build out, to knit out, you know, the de novo financial system, you know, the petro-U-1 and the rent-in invoicing of commodities and traded goods going forward. I think these are basically the two lenses through which one should be following. dollar funding and dollar rates markets going forward because, you know, the day to day we just have to live with, but then we absolutely cannot lift our eyes off all the geopolitical realities and challenges that the dollar will be facing. So this will be the two publications that subscribers will get. As I said, you know, it's a it's a high price tax. So, you know,

target audience is institutional investors exclusively and not and not retail investors. And so I will be completely behind the paywall and subscribers. will be able to chat with me and have conference calls and meetings. And that's basically the simple vision. I was actually going to circle back to that towards the end. But since you gazumped me, let me ask a question that sort of squares these two thoughts, like the new business and the Bretton Woods three vision. So one of the criticisms that we sometimes hear about, you know, big, bold predictions about changes in the overall financial system is that it's hard to actually invest money based on them. So I guess the question is, you know, if someone hears Brettonwood's three new central bank digital currencies,

forex lenders of first resort, things like that, what's actionable about those ideas? What does it actually mean for investors? I think it means a lot. So number one, I think if you are looking at a whole new, plumbing where, let's back off, for example, I mean, we are used to thinking about a world where there is either a dollar shortage in some regions or dollar surplus in other regions and that these surfaces get recycled either in the FX swap market or in the rates market. And, you know, I think if we end up in a world where countries are now going to have several

options, for example, as to how they pay for commodities. Let's take oil for an example. People hold dollars, many reasons. One reason why people hold dollars is because oil has been stored with priced in dollars. So if you are a poor country that needs to import oil on the margin, you need to have dollars to be able to do that. Now, if you are going to live in a world where you can pay

dollars for oil, but you can also pay renmini for oil, but if you are a gold miner, you can also pay for oil with gold, like Ghan, for example, that's basically three options you're looking at a screen, and so you will just choose whichever one is cheaper, and that picture gets further complicated by the fact that there is oil flowing west, which is one price, and oil flowing east,

which is another price. So, It's not just, again, out of one many. It's not just one price anymore, but it's a bunch of prices and a bunch of currencies and choose whichever works best for you. And also, if you go into a world where trade is not dominantly invoiced in dollars, so people don't have to borrow dollars to import stuff, and the exporters don't earn dollars exclusively. Then it's no longer a machinery where, you know,

the dollars are getting created on the margin. The dollars are getting accumulated on the margin. and a question is how do you recycle the earn dollars back into funding and rates markets. So if that world splits into, you know, we are now doing half of this in Renminbi and the other half we are doing it in dollars, then naturally, for example, the FX swap market, the landscape of the FX swap market is going to get redrawn the following way. There will be regions that used to be short dollars, but not they are not because they can, you know, source Renminbi through the Renminbi swap lines. from the BBOC. So dollar shortages in certain regions are going to disappear.

Then there will be regions that use to recycle dollar surpluses into the FX swap market. You know, maybe the Reserve Bank of Australia putting in the FX swap market and then, you know, some Japanese investor picking those dollars up in the FX swap market to hedge their treasury portfolios, what have you? You know, if Australia ends up, you know, earning only half as much dollars than as they used to in the past. and the other half is now invoiced in Renmin B, then the dollar recycling is going to suffer as well. So, you know, the supply of dollars in FX swap markets

and the demand for dollars in the FX stock market is going to get redrawn. And I think there will be some regions that are going to turn, that are going to be turned on their head. You know, so there will be positive transparency bases that will turn negative, and there will be negative prosperity basis that will turn positive. So it's just one example, for example,

in terms of FX swaps. And then in terms of, of the rest of the world's demand for treasuries, which is a big question. Again, dollars you historically need because you need to import a bunch of things which have been exclusively invoiced in dollars. But if you have a world where things are being invoiced half in dollars and half in rent fee, you know, that need to accumulate dollar reserves doesn't exist there. China, I think, is a very important example in this regard because one reason why China has

so many FX reserves is because that's kind of like your life insurance policy because all the commodities and foodstuffs that they need to import. I mean, I think the big five commodities that they import is natural gas, oil, soybeans, copper, got us, what else? But, you know, the annual bill for those imports is running the 500 billion, you know? So if you don't have the dollars to pay for those, your toast, so you have to have a lot of dollar reserves. But if you end up in a world where you can now force commodity exporters to accept your currency for those commodity imports and not the US dollar.

You basically have gained sovereignty from a monetary perspective. And so, again, you will not have to run with as much FX reserves. And so, you know, this is going to have feedback effect on, you know, demand for treasuries in general. And on the margin, you know, things are always in the margin by. So I think if these themes are going to play out over the next five to 10 years on the margin, you know, demand for treasuries and the recycling of dollars in the front end and the back in the of race markets, I think, is going to get pushed around. Would you anticipate, you know, or do you have some timing?

Like, we talked about this on a recent episode with Carthick-Sankeran, but that we'll see, you know, there are a lot of countries around the world that float dollar bonds for one reason or another. Do you anticipate that we'll see if Renminbi internationalization continues, that we will see various EMs float more Renminbi bonds? Or would that be a crucial aspect towards a successful, internationalization of R&B? I think it can be a part of R&B internationalization.

I mean, you know, it's just a way of kind of raising offshore R&B that's out there. And then you can either tap swap lines with the PBOC, you know, that's a very important aspect of it. I mean, BBOC has swap lines with way more countries than the U.S. has swap lines with, for example. So there is, you know, when you kind of look at the topography of that BBOC spotline network, and then you look at the topography of the central banks that are actively planning to have a CBDC or they actually have a CBDC pilot up and running already. I mean, there's a perfect overlap, you know, so if you think about the FX swaps as the funding angle to the rent fee that you don't have in a system gap, and then if you look at the CBDC as the kind of swapping and clearing

of existing local currencies in the system, I mean, you basically have a spot FX market and a funding market infrastructure around it. So, you know, you can internationalize the R&MB that way. You can nationalize it by, you know, EF companies raising RMP bonds to raise term R&B liquidity. But again, I think the most important thing here is that we are starting to see evidence that more and more commodity trades are being settled in RENMB. And also, over the past year, the Renminbi's share of trade finance has increased tremendously. I think it has increased from barely 1% to 5% in a 12-month period. And now it's at far with the euro share of trade finance. And again, if that one 12-month period is any sign, you know, you project that 5-10 years out, you can have a lot of ground that the rent-50 gain.

You know, Zoltan, you mentioned changes in structural demand for treasuries. And I wanted to ask you about this because this is one of the, I guess, last research notes that you wrote at Credit Swiss. I think it was in January, so definitely not the final one, but you were talking about at some point the Fed's going to need to come in and support the Treasury market once again because you have all these natural buyers of bonds who are starting to step away. And I think you talked about potentially the Fed having to restart asset purchases as soon as the summer. Is that something that you still see on the table? Well, it's the summer.

So let's put it this way. I mean, we have now the off-to-run buyback program that's up and running, if I'm not mistaken, correct? Yep, you're right. Yep. Okay, so there is that. And then we had, you know, the problems around SBB and some other banks. So let's just put it this way. I think that when we think about these, what is the government going to have to do to step in on the margin to calm things down?

I always tell you that the answer is always along the spectrum. So I think we are in the ante room of something. You know, we are dealing with illiquidity with the buybacks. So far so good. We have dealt with underwater bank portfolios. I mean, the bank term funding program, effectively your ability to raise, you know, to value underwater bonds at the Fed at par and raise liquidity. That way, if you have to, I think that's a pretty,

That's a pretty big support to market functioning. So I think, you know, things are happening on the margin, which kind of points to the Fed and the Treasury building scaffolding around the Treasury market to deal with the illiquidity issues and kind of this lack of marginal buyer issues that we have been talking about. You know, the other point here is that, you know, in the front end there's a ton of liquidity. And so all this issuance that the Treasury has been doing and will be doing is going to be front end heavy. you know, so that's another way of dealing with treasury market functioning. I mean, you have $2 trillion in the property facility.

You're just going to issue where you can most likely soak up a lot of liquidity without any glitches. But again, I think this underlying issue that we are talking about, that the world is probably going through a split where demand for treasuries from the rest of the world is probably not going to be what it once was. It's going to be an issue. And as these issues pop up, we are going to be dealing with them. in a step-by-step fashion. But again, I think these illiquidity problems are present

and we are dealing with them as they pop up. I want to get, you know, your take further on, like, some of the banks and particularly the aftermath of SVB, et cetera. But before we do, you know, going with thinking back a year ago, this conversation or versions of this conversation might have been much more commodity-centric. And obviously, oil has fallen quite a little bit. There was a lot of stress a year ago about the,

European electricity costs, which have come down significantly. Generally, there's been a lot of easing there. But I'm curious, like, was that just a sort of like a one-time reset in terms of maybe post-pandemic shocks and, of course, the invasion of Ukraine and that things are settled? Or will sort of like commodity fragility, commodity, commodity, anxiety about sourcing energy be sort of a permanent or semi-permanent condition over the next several years as part of this sort of Bretton Woods 3.0 vision.

Yeah, so, you know, to be intellectually honest to ourselves and to the listeners, yes, we did talk about, you know, commodities creating a bigger role in, you know, reserve management practices and whatnot, among many other teams. So I would say that for me, what survives that commodity aspect

of the Bretton Woods three pieces is that, I think gold is definitely something that's coming back as a theme. I mean, just to give you a very good example, and when I saw, I think Barry Aiken Green was a co-author on that paper. The IMF published a paper about gold, and the title, I think, was a barbarous relic no more. And it was co-authored by Barry Eichgreen. So I'll hide behind a little bit.

But I think it's noteworthy when someone like Barry Eichol Green, probably the official biographer of the dollar writes a paper like that. And I think we are seeing this more and more in the data that especially the countries that are not geopolitically aligned to the U.S. are shunning treasuries and shunning the dollar and they are buying gold instead. I think there's also a number of other headlines, which I think are important to keep an eye on because individually they might not sum up too much. But I think in the totality of these things, probably point a trend.

And Ghana and Russia basically had an oil for gold deal whereby Russia ships oil to Ghana and Ghana pays gold for the oil that they receive. I mean, the basic idea was that a country that has been pretty billion of FX reserves, US dollars mostly, that also mines a lot of gold. It's kind of pointless for them to spend their precious dollars on oil when they can just swap gold for oil and kind of get their oil that way. and then they have, you know, FX reserves left for other stuff, you know, for pharmaceuticals, for example. Again, geopolitics is the angle here, but, you know, Russia and Iran are establishing a special economic zone along the Kaspian Sea, where the trade is going to be settled in a gold-backed digital token. I forget which country it was, but, you know, there's another gold-rich African country which is playing with this idea of a gold-backed digital token. And again, I think these are interesting developments, but again, some of the last ones that I mentioned are probably on the fringes.

But again, you know, in the IMF data and in the data of gold council, we see this massive increase in foreign central banks purchases of gold. So that gold aspect definitely survives. And yes, you know, energy markets have gone up and they have come down. But again, I think it's just hard to escape the reality that, you know, Saudi Arabia is not exactly falling over backwards to increase oil production. But in fact, there is this stag of war where I think the Crown Prince has a domestic economic agenda. It needs oil prices to trade between $100 a barrel for them to pull up that quite ambitious, domestic and regional and also geopolitical agenda. And I think there is a stug of war between the oil consumers and the oil producers where, you know, things haven't really broken out into either side. But I think that OPEC is basically giving us a body language where, you know, if there's not enough demand for oil and oil producers,

prices are falling. We need our revenue, so we're just going to not supply such that prices don't fall too much. So again, I think the commodity shortage and this, you know, I think the theme that I used was our commodity or problem. I think it's definitely there in oil. Again, you know, Russian oil, surprisingly, I think it all found a way to alternative markets. So, you know, tanker rates are up. You know, we talked about this a year ago that tanker rates being the balance sheet for, you know, the real economy, balance sheet equivalence in the oil market and the banker rates are through the roof because these shadow fleets have to be assembled to find alternative markets for Russian oil. And I think, you know, the supply chains are probably

getting more caught up in this theme involving, you know, energy transition, you know, getting the lithium and all these things that are needed for that. So I would say that the commodity aspect is a mixed bag except for gold. That other African country, I think it was Zimbabwe doing a gold-backed digital token. And so I guess make of that what you will. But I wanted to go back. Well, make up, make up, well, I just wanted to say to make up that what you bill. And perhaps a lot of countries that are going to be, I don't know, the sanctioned countries that's put it out there.

But I think that's precisely, I mean, you know, these are not the countries that you think about when talking on the financial press about things. But I think the underlying theme here is very much one where if you look at this unibular world that we are, you know, talking about. whether it's supply chains or whether it's the monetary regimes, whether it's, you know, foreign policy alignments between East and West, you know, two great powers and a bunch of unaligned, non-aligned countries. I think it's important to pull in these fringe countries because, you know, there is power in numbers and like, yeah, one country's GDP is not much, but, you know, when you kind of clump them all together

and they kind of sign into one system as opposed to another system, these things are going to be meaningful on the margin. So I think that's why it's important to. think about best-case countries, so to speak. But that's why we mentioned. Yeah. And I mean, US dollar transactions, I think, are a pretty big thing in Zimbabwe. So, you know, the fact that they're experimenting with a new type of thing to try to maybe get away from that is interesting. But I wanted to go back to what we saw in the banking system because everyone who knows your origin story probably knows that, you know, started out working at the New York Fed. There was the famous

shadow banking chart that you did before the financial crisis, sort of laying out how this entire system actually worked. What do you make of the most recent banking crisis? And I know some people take issue with actually labeling it a crisis. We can call it a banking drama or whatever. But is the drama over for now? Well, let me tell you this. It feels very different from 2008, obviously. I mean, there it was an existential moment. And the central nervous system of the global dollar system was at risk, you know, the big banks.

So the big banks were a source of strength this time. I would say that we basically have three institutions that became collateral damage, either to crypto or the tech inclusion or, you know, your inability to make, to underwrite, you know, mortgage is intelligently. So, you know, signature bank is crypto-related. SVB, I think, is a very unique case because what it kind of tells you is that it is important for a bank to kind of be diversified, both in terms of its lending portfolio and

also its deposit mix. You know, when I was following the SVB debacle, the thing that came to find for me was, I I don't know if you remember this, basically, but Bear Stearns used to have two hedge funds, which were the first hedge funds to blow up. Oh, I remember. Yeah, yeah. I forget what they were called, but they had the, I think, the Bear Stearns and Hence Leverage Fund or whatever they were called. You know, those hedge funds were the first ones to blow up because they had the worst assets imaginable,

and they had the worst liability structure imaginable. Yeah, I think they were, like, really high-yield structured credit or something like that. Yes, a high-ield, structured credit, you know, CDOs, so that stuff on the asset side and, you know, overnight funding, so fickle funding. You know, SVB, I would say, is a case where on the liability side, I mean, we know who the big depositors, who the clients were, we were reading about some of them in the financial press. But basically, you know, if you think about the tech sector, the venture capital sector where all the valuations have basically taken a big nose dive after tech stocks corrected, you basically, you basically, had the depositor base that was liquidity constraints. So they basically pulled money from one bank where a lot of tech entrepreneurs kept their cash.

And so that's a liquidity drain and it wasn't diversified. On the asset side, SVB had a lot of duration. I mean, you know, you guys know that my bread and butter is, you know, going through all the cold reports of the biggest institutions. And, you know, I mean, very few banks have as big a share of their HVLA portfolio. in strips, stripped mortgage spec securities, as they did, but they had a lot of coupon export.

They had a lot of principal exposure there. They had a lot of duration in these portfolios, and they didn't hedge them properly. They also had a lending book where they were lending to, say, you know, customers that were pulling funds away from them. But again, the collateral on that lending book was tech-related, so you had valuation issues.

That was just kind of a perfect storm. Systemic? Absolutely not. But it hurt them. And, you know, First Republic, I mean, I have to say I have a friend in New York who once texted me, my First Republic was going under, saying, I didn't realize I got such a great deal on my mortgage that it's going to be the end of First Republic. And I said, you know, I told him that, well, next time you get a mortgage that's too good to be true,

you should also short the bank. Maybe the mortgage is going to pay itself up faster than you anticipate. So, so again, I think this is basically the story of these three banks that got into difficulties. The solution that the Fed crafted for. some of these liquidity problems. I think they were extremely powerful. I was surprised, even shocked, when I saw the terms of the BPFB. When I talked to my context, there were two types of responses to this BTFB program. Number one, yes, that's the right move, because the letter and spirit of Basel 3 says that treasuries and genie makes and reserves are level one assets, no haircut. But again,

that assumes that you also have the brains to hedge the interest rate exposure there. And also, I mean, you know, you can put some of these bonds that are underwater into a whole maturity portfolio where if you are sitting on huge market-market losses, it doesn't hit your bank's equity and you don't have to book those losses and it doesn't hit your capital. But again, that assumes that your deposit base is sticky. And so you're not going to move deposits in the aggregate to the point where you actually have to liquidate these underwater bonds. And, you know, it was not the case for SVV. It's case for other banks, like Bank of America, for example.

And the other response to the BTFB is that this should not have happened because it basically euthanizes the need for interest rate risk management in bank portfolio. So it was kind of a polar response. But again, what's done is done. I think it's a part of the system. How I think the BTFB is going to be there as a standard feature of the system, much like standing three-people facility and swap lines are there. So, you know, these facilities tend to be born and then they. around. But it's again, it's the part of the scaffolding that we have. I mean, imagine, imagine the treasury market coming under strain because some of these banks have to meet,

you know, liquidity shortfalls and then instead of pledging to the Fed off market to get liquidity, you basically have to dump it on dealers. And imagine what that would have done to the treasury market. So we just basically kept these treasuries off the grid, so to speak. When SVB failed, there were sort of two conversations that sprung up right afterwards. One had to do with like the sort of like, okay, all deposits in the U.S. are, do we just accept that they're all implicitly guaranteed regardless of what the formal FDIC cap is? And then there's also a conversation about, you know, 5,000 banks in the U.S., which is like, I think, probably the most banked country in the world. Do we just sort of, you know,

does anything change with the business model of banking, or do we just sort of accept that there are these contradictions and these tensions? but we sort of, we don't talk about them, and we just sort of let these issues go on and occasionally we have to clean up a mess, but by and large, there's some of these structural questions about the banking system,

we just sort of kick the can and let them persist. Well, look, I mean, I don't think that blanket deposit insurance is in the cards. Right. But I think, again, you know, other than the BTFB, we have this other tool, which is the FDIC steps in between the Fed

and the troubled institution. And so there's a capital buffer. So, you know, it's some of the same playbooks in a different fashion that we have seen in 2000. You know, that that always has to be secured to its satisfaction when it's planting, you know, but always wants to eliminate threat at risk and, you know, the FDIC is sending it being plus the special loans. That the Fed extends to trouble, the institutions serve exactly that purpose. So I think we will be dealing with whatever problems we will be dealing with on a case-by-case basis. Again, I think SVB, you know, conceptually the problem.

of underwater security portfolios we kind of dealt with. Commercial real estate is going to be a slow burning problem. Perry Merton likes to say a bank can be insolvent but liquid, but it cannot be solvent and illiquid. You know, for as long as deposits don't run, we will be able to deal with these issues. You know, interest on reserves is matter from heaven. You know, it's providing banks a steady stream of interest income.

So if you have capitalization issues, that's going to be a backdoor way of kind of refilling your capital base. You know, back during the early 1980s when the global curve was in charge, and we had the Latin American debt crisis. And banks were underwater and had their capital issues. You know, the Fed had to generate a steep yield curve in the system, which was a way to recapitalize the banks, you know, with interest from reserves. You know, that's no longer necessary.

So that's actually easier. So I think the banking system is fine. now. I think we had a scare and you know we are definitely going to be dealing with issues in credit portfolios. We are going to be dealing with CRE lending books. There will be consolidation across the banking system, but there are many levers that the Fed can pull to help clean things up. You know, JPMorgan, for example, was an institution that came as a healthy hand. As I like to remind people, I haven't written about Wells Fargo in a long time, but, you know, Don't forget.

Now you can. Now I can. That bank is still under an asset cap. It has a ton of unused balance sheet capacity. So, you know, that's a lot of balance sheet capacity to want chain if you need a healthy private tan to clean up some stuff. I mean, some of the banks that are already very big and were big beneficiaries of dislocations and banking prices in recent times are probably not going to be able to add much to their

balance you because they are already too big. But, you know, I think Wells Fargo is another kind of case in the back pocket of the Fed that could be pulled out if need be. So I think the system is fine. I think we are just going to be dealing with these micro dislocations here and there, you know, regional bank here, regional bank there, treasury market. But again, people will be dealing with these things. But, you know, the name of the game is to anticipate these and be appropriate position. Well, can I ask one more question, just going back to your sort of shadow banking origins, but the expectation now seems to be that, you know, if banks maybe have to hold even more capital or maybe de lever in one way or another, that a lot of that activity is going to end up being pushed into shadow banks, essentially. So private equity perhaps or some sort of non-bank lender. And to some extent, this is what we've seen since the 2008 financial crisis by design of the financial regulators. There is some concern that even more starts to get pushed out now. And maybe if you have interest

rates that remain substantially higher, that's going to be a big hit for both corporate credit and commercial real estate. Should we worry about exposure to those sectors in non-banks? Yes, because I think credit has yet to have its reckoning. and commercial real estate has yet to have its reckoning. But again, it's better to suffer those losses in non-banks than banks because banking crises are very nasty things. But if these losses get booked and absorbed in balance sheets that are, I don't want to say not levered because they are,

but that leverage doesn't really have much to do with money markets. That's orders of magnitude better to deal with. than dealing with a lot of these concentrated exposures in the banking system. Regarding that shadow banking question that you also asked, Tracy, I think where we started this conversation that, you know, world trade, trading of commodities is going to get invoiced in currencies other than just the dollar. You know, rent fee and all these central bank digital currencies,

market making and FX markets, you know, migrating to the balance sheets of central banks. and instead of correspondent banks, you should be imagining correspondent central banks. If that thesis is true, I think over time that's going to provide talent should leave to all the G-Sibs, because FX market making credit lines exclusively provided in U.S. dollars from oil and copper and other commodities around. You know, that's the bread and butter domain of JPMorgan Bank of America and Citibank. You know, if you kind of move to this world that I'm describing, you know, that's going to provide. balance sheet relief for the big US banks on the margin, you can use that for other things,

you know, as the shadow banks are licking their wounds because they are suffering their credit and real estate problems. You know, the banking system is going to be potentially a source of strength in a sense that not only do you have the capital to land, but you also have a balance sheet to do so. So I think things are going to work themselves out. I think it's a good thing that things are happening in shadow banking system. The shadow banking system we are talking about today is very different from the shadow banking system. I didn't come up with the sexy definition of shadow banking. That's very early.

Who said that shadow banking is money market funding of capital market lending. And I think the general understanding about shadow banking these days is that anything that happens outside of a bank that involves credit is shadow banking. That's not true to me at least because you know, you have to have a very strong money market component, which is what applies things. And so that shuttle banking is fine. And if you will, you know, basically a lot of traditional bread and butter Western financial market making, credit provisioning, financing functions, migrating to the balance sheet of central banks, CBDCs, different currencies. I think that's the new shadow banking terrain that I will be focusing on and I will be mapping and thinking about because I think that's the frontier.

that's going to drive rates and funding markets going forward. All right, Zoltan, I have one last very tiny question, and I'm only asking this really because I need to know it for the outro of the episode. Are you going to join Twitter? I will not be doing Twitter. Really? I will not do social media. Really?

Maybe we can say this at the end. I will say the name of my website where people can go and let's join. Wow. Incredible. Yeah. That's an incredible restraint. It's an incredible restraint. I'm very impressed by it.

Is it a good thing? Is it a good thing? I think it's a good thing. I mean, it will make you very scarce. But it's an incredible restraint. So I'm impressed. No, I will be strictly behind the table. And probably this could be my last public appearance.

And then I would just disappear beyond the paywall. Okay, well. This is a gift for all thoughts. Thank you. It was a. Thank you. It was a pleasure. Thank you very much for having me.

All right. Well, thanks so much, Zoltan. And the website, the new website, is Xunopurus.org. You should definitely check that out. Joe, I love talking to Zoltan. Me too. That's such a treat. The quote about, like, we are in the ante room of something.

I'm going to steal that for coverage. But I thought, I mean, look, every time we talk to him, there are a number of really interesting big picture points. The one thing I would say is, I remember when the Bretton Woods three thesis came out last year, there were a lot of people saying that this was never going to happen. And many of those people now have sort of tweaked that statement to, oh, you know, it may happen, but not for a long time. You know what I think is a really interesting point that I don't think gets discussed enough in this, which I appreciated Zoltan bringing up. It was, you know, people look at this from a very sort of like financial angle or they talk about China specifically.

But I liked that he brought up, you know, all these other countries, the sort of non-aligned countries, they matter to a significant degree, particularly when added up and sort of the politics of unaligned countries who don't necessarily see the world through the same lens as the U.S. or have the same perspective on many of these global trends, obviously some of the BRICS. nations, et cetera. Like, I just the pure, like, you know, geopolitics is sort of gets trotted out too much, but the sort of like the sovereignty and the impulses and desires of all these other countries, they really matter. And as their wealth grows and as their need grow, what they do economically and who they trade with is going to sort of be determinative to

some extent about who rises and falls. Well, the other thing I thought was really interesting was this idea of maybe outsourcing more dealer functions to the central base. And if you were to do that, it could potentially solve some of the concerns that you just outlined, but also free up some balance sheet for big banks to do other types of activities, maybe more like non-market making activities, more loans, things like that. I hadn't really considered that. Yeah, that's a really, it's a really interesting point. And no one else has really talked about that, but, you know, we do sort of live in this era in which sort of like state capitalism or state directed capitalism is such a big thing, right? And so the extent to which central banks become bigger

sort of active dealers rather than just sort of behind the scene supporters of private banks is something to take seriously. And maybe there is a context there in which the sort of the CBDC or digital currencies could sort of have like a natural fit in that framework. Yeah. We need a new map. Yeah, we really do, don't we? Well, maybe Zoltan will publish one at his new research firm. Shall we leave it there? Let's leave it there. All right. This has been another episode of the All Thoughts podcast.

I'm Tracy Allaway. You can follow me on Twitter at Tracy Alloway. And I'm Joe Wisenthall. You can follow me on Twitter at the stalwart. Our guest, Zoltan Posar, is not on Twitter, but you should go check out his brand new website, exunoplurus.h. I certainly will be.

Follow our producers, Carmen Rodriguez, at Carmen Armin, and Dashel Bennett at Dashbot. and check out all of our podcasts under the handle at podcasts. And for more Odd Lots content, go to Bloomberg.com slash OddLots, where we have transcripts, a blog, and a newsletter, and you can chat 24-7 with fellow listeners about all of these topics. I'm sure there's going to be a lot of discussion about this one in there on the Odd Lots Discord at Discord.g.g.

It's a lot of fun. I go in there a lot. And OddLots listeners, if you enjoy these podcasts, If you like listening to the guests that we have on, like Zoltan Pozar, please go and leave us a review on any of the big podcast platforms. If you like us, please let us know. Thanks so much. Thanks for listening.