The Breakdown - The Bretton Woods III Thesis

Starting point is 00:00:04 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.io, Arculus, and FtX, and produced and distributed by CoinDesk. What's going on, guys? It is Friday, March 11th, and today we have a fun one. It is a think-boy Friday. We are talking about the Bretton Woods III thesis. Before we get into that, however, if you are enjoying the breakdown, please go subscribe, give it a rating, give it a review, or if you want to get deeper into big, highfalutin conversations like this one, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.lee slash breakdown pod. Also, a disclosure, as always, in addition to them being a sponsor of the show, I also work with FTX.

Starting point is 00:00:57 Now, I've been around the block a bit. I know when a theory or a phrase is going to have legs. Great monetary inflation from Paul Tudor Jones was one of them. Michael Saylor's sitting on a melting ice cube was a visual version. Bretton Woods 3 has that potential. And this, of course, comes from a strategist at Credit Suisse named Zoltan Pozar. As I said, Zoltan is an investment strategist at Credit Suisse, but that doesn't really do it justice. He was a senior advisor at the Department of the Treasury, where he advised the Office of Debt Management and Office of Financial Research and served as the Treasury's liaison to the FSB on matters of financial innovation. He joined the Federal Reserve Bank of New York in August of 2007 and was in charge of market intelligence for securitized credit markets. He got a big part of his start mapping the shadow banking system, helping, for example, the IMF form their official position on it. He's been around and he goes deep and most importantly other people listen to him.

Starting point is 00:01:55 And on March 7th, he wrote a Credit Suisse economics paper called Bretton Woods 3. Quote, we are witnessing the birth of Bretton Woods 3, a new world monetary order centered around commodity-based currencies in the east that will likely weaken the euro dollar system and also contribute to inflationary forces in the West. A crisis is unfolding. A crisis of commodities. Commodities are collateral and collateral as money, and this crisis is about the rising allure of outside money over inside money.

Starting point is 00:02:25 Bretton Woods, too, was built on inside money, and its foundations crumbled a week ago, when the G7 seized Russia's FX reserves. Now, as a bit of a preview, we're going to get into what all these terms mean on Longreed Sunday this week when I read Nick Carter's latest piece for Coin Desk. However, for some background, Bretton Woods One refers to the system decided in a New Hampshire hotel by the Allies in 1944 around how the world economic order was going to be organized in the wake of World War II. Bretton Woods 1 had global currencies connected to the U.S. dollar and the U.S. dollar backed by gold.

Starting point is 00:03:02 Now, this gold backing, very famously, if you are a bitcoiner, started to really buckle under the weight of the expansionary 1960s government in the U.S., both in the form of social programs, but even more in the form of the Vietnam War. This led ultimately to 1971 when Nixon took the U.S. off the gold standard. Bretton Woods, too, as Nick will discuss further on Sunday, was all about the the petro dollar system and the dominance of the United States in the global order, which brought with it trust in the United States dollar as a reserve currency and United States treasuries as the greatest saving asset in the world. That's what Zoltan means here when he says inside

Starting point is 00:03:38 money. He's talking about something that is valuable and trustworthy because of its source, in this case, the sovereign source of the United States. But let's keep reading a few more passages from Bretton Woods III, his piece. Anyone in the commodities world is experiencing a perfect storm as correlation suddenly shot to one, which is never a good thing. But that's precisely what happens when the West sanctions the single largest commodity producer in the world, which sells virtually everything. What we are seeing at the 50th anniversary of the 1973 OPEC supply shock is something similar but substantially worse, the 1920s, Russia supply shock, which isn't driven by the supplier, but the consumer. So now, of course, you have the context of his thesis.

Starting point is 00:04:20 And this is something we've been discussing quite a bit, the deep integration that Russia's economy has with basically every other economy through their exports of oil and natural gas, of course, but also of wheat, also of heavy metals, things that are needed in high industrial production for stainless steel, for catalytic converters, for high-end electronics, etc., etc., etc. So what does it mean to be having a commodities crisis? Well, back to Zoltan. Commodities no longer trade at par. There are Russian commodities that are collapsing in price, and there are non-Russian commodities that are rallying. This rally is due to the 2022 Russia Supply Shock that we referred to above,

Starting point is 00:04:59 which, once again, is driven by present and future sanctions-related stigma. It's a buyer's strike. Russian commodities today are like subprime CDOs were in 2008. Conversely, non-Russian commodities are like U.S. Treasury securities were back in 2008. One collapsing in price, the other one surging in price, with margin calls on both regardless of which side you are on. So just to make it really clear what he's saying is that you have the exact same type of asset, let's take oil, for example, that is valued not based on how the world market values oil at that

Starting point is 00:05:35 time, but completely divergent based on whether it's Russian oil or non-Russian oil. The collapsing price of the Russian oil is matched by the soaring price of the non-Russian oil, and this dislocation creates major problems. Now, when it comes to these sort of dislocations in the global economy, Zoltan points out that it always takes some big actor to step in and resolve the mismatch, resolve the dislocation. So who then can step in? And this is core to his thesis. Quote, if we are right, and this is a crisis of commodities, a 2008 of sorts thematically, if not in terms of size or severity, who will provide the backstop? We see but one entity, the People's Bank of China. Western Central banks cannot close the gaping commodities basis

Starting point is 00:06:22 because their respective sovereigns are the ones driving the sanctions. They will have to deal with the inflationary impacts of the commodities basis and try to cool them with rate hikes, but they will not be able to provide the outside spreads and won't be able to provide balance sheet to close Russia-non-Russia spreads. Commodities traders won't be able to either. Remember that Glencore rose from the ashes of Mark Richencoe and with Switzerland along with the sanctions,

Starting point is 00:06:44 Swiss-based commodity traders will think twice about arbitraging the spread. But the People's Bank of China can, as it banks for a sovereign who can dance to its own tune. To make things more complicated, China is probably thinking deep and hard about the value of the inside money claims in its FX reserves now that the G7 seized Russia's. So there is a lot to unpack here, but let's try to make it a little clearer. He's saying basically that in a world where the only difference between the price of Russian oil and non-Russian oil is the political pressure of Western entities, then Western central banks can't resolve that market dislocation because it's their governments that are putting the sanctions

Starting point is 00:07:23 on. Commodities traders are largely subject to the same forces. They're not stepping in and trying to close these gaps for the same fear of reprisal based on the sanctions. This is what we talked about the other day, where shipping companies are not willing to take Russian crude anywhere, even with huge discounts on the price. That leaves one actor of in Zoltan's mind, the central bank of China. As he points out, quote, it banks for a sovereign who can dance to its own tune. This means that China is perhaps not as concerned with towing the larger U.S. or Europe-led line when it comes to Russian sanctions. But even more than that, as he points out, now that the U.S. and Europe have weaponized foreign exchange reserves, China might be thinking

Starting point is 00:08:04 that their only option is to gain even more independence from that Western-led system. Nexto is the go-to platform for all things crypto. Invest in the hottest coins out there and start earning risk-free interest of up to 20% APR, paid out daily. Need cash ASAP but don't want to sell? Use your crypto as collateral and receive a credit line at premium rates. Open your NXO account by March 31st and receive up to a $100 welcome bonus. Get started today at nexo.io. That's N-E-X-O.io.

Starting point is 00:08:48 Meet Arculus, the next-generation cold storage wallet. Arculus secures your crypto using three-factor authentication, providing a simpler, safer, and smarter way to store, buy, swap, send, and receive crypto. Arculus is offline cold storage. Your private keys are encrypted on the Arculus keycard and are never online. Stay safe from hackers with no cords, no charging, no Bluetooth. Just crypto security made simple.

Starting point is 00:09:15 Buy Arculus on Amazon today. The breakdown is sponsored by FTXUS. FDXUS is the safe, regulated way to buy and sell Bitcoin and other digital assets with up to 85% lower fees than competitors. There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees. One of the largest exchanges in the U.S. FDXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTCS, you pay no gas fees.

Starting point is 00:09:47 Download the FTCX app today and use referral code breakdown to support the show. So what does China do? Zoltan says that there are two geostrategic equals geofinancial options. The first, he says, is to sell treasuries that would fund their leasing and filling of vessels to go get all of these subprime Russian commodities. Quote, that would hurt long-term treasury yields and stabilize the commodities basis and would give the PBOC control over inflation in China, while the West would suffer commodity shortages, a recession and higher yields. Yuck!

Starting point is 00:10:21 Continuing, he writes, the PBOC's second option is to do its own version of QE, printing R&B to buy Russian commodities. If so, that's the birth of the Euro-Runminbi market and China's first real step to break the hegemony of the euro-dollar market, and would give the PBOC control that is also inflationary for the West and means less demand for long-term treasuries. Yuck! That can't be good for long-term treasuries either. So what's the conclusion? Well, here's what he says. The Fed and other central banks will be able to provide liquidity backstops, but those will be Band-Aid solutions. The true problem here, is not liquidity per se. Liquidity is just a manifestation of a larger problem, which is the Russian

Starting point is 00:10:59 non-Russian commodities basis, which only China will be able to close. Do you see what I see? Do you see inflation in the West written all over this? This crisis is not like anything we have seen since President Nixon took the U.S. dollar off gold in 1971, the end of the era of commodity-based money. When this crisis and war is over, the U.S. dollar should be much weaker, and on the flip side, the R&B much stronger, backed by a basket of commodities. From the Bretton Woods era backed by gold bullion to Bretton Woods 2 backed by inside money, i.e. treasuries with unhedgeable confiscation risks, to Bretton Woods 3 backed by outside money, gold bullion and other commodities. After this war is over, quote unquote, money will never be the

Starting point is 00:11:40 same again. Dot, dot dot. And Bitcoin, if it still exists then, will probably benefit from all of this. So fucking hell, right? Alex Gladstein writes, pretty wild analysis from Credit Suisse. Hard to believe it's real, but if so, it predicts end of current monetary order, new dominance of outside over inside CB money, inflation in the West, higher treasury yields, and dollar devaluation, Bitcoin to benefit if it survives. Not everyone is as convinced, D.C. analysts write, Zoltan needs to pass the bong, to be honest. But what if you're sitting there saying, I still feel like I'm not totally getting this? Never fear this is really deep intense stuff. Here is a summary thread from Rory Murray Murray. The previous monetary regime, which Zoltan calls Bretton Woods 2, is over, dead, finito.

Starting point is 00:12:25 It died when the U.S. and its allies seized Russian central bank assets, ending the period of central bank immunity. Never again will central banks be made men in the Koso Nostra way. Commodity price spikes are being driven by margin calls on traders who need to close short futures positions. But when that's over, they are left holding the bag on Russian commodities for physical delivery that can no longer be delivered. The central planners are totally unprepared for this type of commodities crisis. We've been looking everywhere but at a self-imposed gunshot to the head because why would we have ever needed to pull that trigger? There is a balkanization of commodity markets unfolding currently that will require a complete and entire reset for

Starting point is 00:13:01 commodity houses. Credit agreements, operational structure, pricing models, risk management, you name it. It needs to be recreated for the new world. The PBOC is absolutely rethinking at Central Bank reserves right now. One response may be for the Chinese to print money to buy commodities. Lots of implications there, all of them bad for the dollar in the long run. LT rates skyrocket in the short term and it doesn't help the West with inflation. We are still stuck. The Fed can provide liquidity, but this isn't a liquidity crisis here. When this is all over, what comes next?

Starting point is 00:13:32 Now, part of the challenge for people trying to make sense of this is that there aren't a lot of people who specialize in our experts in all of the different things going into this. As Tracy Allaway from Bloomberg writes, I don't think anyone has a very good handle on the nexus between Russian money. commodities trading houses, European and Chinese banks, etc. All very murky. However, not everyone agrees. Here's a countertake from Mona Ali, an associate professor of economics at the State University of New York. Zoltan is mostly right, but he is wrong about the future of the dollar. His analysis of geomonetary dynamics is spot on. World money has core periphery dynamics. Regime shifts are non-linear events. Keens himself recognized that world events can't be measured using probability. Is this 1971 when Nixon, when Nixon dealing the dollar from gold causing monetary havoc? Not if the Fed has institutionalized dollar

Starting point is 00:14:21 liquidity via swaps and standing repo facilities to money markets, as it did last year. If anything, the dollar will become stronger and more weaponized. Ours is a hybrid global dollar system, where sovereigns are enmeshed in shadow finance, i.e. money markets. While the PBOC can dance to its own tune, the world economy dances to the tune of the world dollar. Think of the dollar as a money military matrix backed by legal supremacy. I agree with Zoltan that we have entered. Bretton Woods 3, a term I've been using in my own slow book in progress. But this is not Zoltan's Bretton Woods 3 of commodity-backed currencies in the East, but I wager a weaponized global dollar system. Stability at the core of the global dollar system will be countered by

Starting point is 00:15:01 tremendous instability in the global south. That will propel its own terrifying dynamics of perpetual conflict and immiseration made worse by climate change. This is the world we are handing over to our kids. There are two ways a weaponized global dollar regime could play out. The most likely one is this more military and monetary aid to regimes aligned with the American apex of the world dollar order. The less likely trajectory is defangging the dollar via green north-south state aid. So the interesting thing here is you have two people agreeing that we are going into Bretton Woods three, but very different senses of how it plays out.

Starting point is 00:15:34 One who sees the rise of a new commodity-backed monetary regime in the east led by China as a new force that counters the weight of the dollar around the world, and the other that sees the weaponization of the dollar as the norm going forward, not just a last resort. So what do I think? Well, first of all, we are in the deep end of the pool here, so I want a caveat that these are all just speculations, and this isn't an area where I'm an expert.

Starting point is 00:15:57 That said, what seems correct to me is the sort of self-evident assertion that China is the only non-aligned central bank big enough to make a bid for these discount Russian commodities. What's less obvious to me is that that's a bid that they for sure want to make. China stepping in as Russia's savior has massive political implications. We tend to think of China and Russia is in cahoots, one, because they literally are and talk about their positive relationship even just before this all happened. And two, realistically, though, more because we see them as the two actors with the most expressed interest and past collaboration in a financial system not totally led by the U.S. dollar. However, I think it would be an error to extrapolate from that alignment that they are, in fact, the same.

Starting point is 00:16:37 My sense is that Putin is trying to reclaim a specific economic influence from decades ago, while surrounding himself with the image of Russian imperialist leaders from the past, while China believes in something very different, while China views itself on an inevitable path to reclaim economic superiority and a global context from a much longer lineage than that. China has had this massive economic transformation, the likes of which have never been seen in modern history, which feels too many in that leadership apparatus,

Starting point is 00:17:05 not as some new power, but as a reclamation and return to the norm. And if that's the case, and you've been extremely specifically and deliberately playing out a sequence of steps with this idea in mind over the course of years or even decades, and this hoarse selfie blowhard from the freezing north decides to get frisky with a neighboring country on the doorstep of Europe, are you really going to let that change your plan? I suppose the answer is maybe if you think it benefits more than it costs you. But I think a lot of people are just assuming that it benefits China more than it costs them, and I'm just not sure that's the case.

Starting point is 00:17:41 Sure, they could buy these cheap Russian commodities and start a new China commodity-backed currency market, but who's the sphere of influence for that? And what are the implication to other parts of China's economy where they're enmeshed with the U.S.? And by the way, there are some indicators that China isn't ready to throw their lot in with Russia all the way. Reuters yesterday reported, quote, Russia says China refuses to support. supply aircraft parts after sanctions. Basically, Boeing and Airbus aren't sending components to Russia anymore, which is hugely problematic because planes need new parts all the time. And so Russia's been trying to figure out where they can get these parts from, and China has just said no.

Starting point is 00:18:20 Doesn't exactly seem like the action of an ally who's ready to throw in all the way. Now, of course, none of this is to say that China isn't making these very long-term strategic calculations that Zoltan is talking about. But I don't think it's necessarily adhere to their clear path, and I don't think that just because China can, they're gonna. What about this cryptic Bitcoin statement? Well, it's worth pointing out that Zoltan is not a Bitcoin bull by any stretch of the imagination. I think to me, his argument about Bitcoin is more of a new type of cleanest dirty shirt argument. In that Bitcoin, for all of its failings in his eyes, could represent a pretty unique force in this new outside commodity money era. It could

Starting point is 00:18:58 represent a hedge against currency devaluation, but also a hedge against confiscation risk, which, for the first time since World War II is now a major risk even for G20 nations. The question, of course, becomes why not just gold? Well, gold is sort of showing that while it may be good as a non-confuscatable commodity reserve, it isn't particularly good in the context of a domestic currency collapse. It can be used as a medium of exchange reserve without giving up that confiscation protection, i.e. it needs to be housed at a clearinghouse to be of any use to settle trade at a meaningful pace. So the nuance here isn't that Pozar is saying that Bitcoin is going to benefit because all of a sudden people are going to become Bitcoiners. He's saying that if it survives, it may be the only

Starting point is 00:19:37 thing that can maintain trade in a world where no one can agree on terms for insider money like U.S. Treasuries. Now, one more thing before we wrap, and this is something that I discuss more on Sunday's LRS, which is that everything in this Bretton Woods three thesis needs to be filtered through the lens of big prognostications. There is a temptation to make big, big predictions when we have these huge moments of history that we feel like we're living through. The world almost never proceeds as cleanly or in a way as easily described as the theories that we use to explain them. And in that context, even if we are moving into a new era, a new place of the U.S. dollar, I think it's highly unlikely that we see sudden rapid shifts.

Starting point is 00:20:21 Instead, history tends to be moments of punctuated equilibrium and then long years of lots of rational and irrational actors figuring out what to do next. Which brings me to the question, is the Bretton Woods three thesis correct? I think that's actually two questions. One is clearly, is Zoltan's version of it correct? But I think the second and probably more relevant is, are we in a new era? For me, I will say no fucking idea. But sort of seems like buy Bitcoin, just in case. I want to say thanks again to my sponsors, nexus.io, Arculus, and FTX. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.

The Breakdown - The Bretton Woods III Thesis

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.