The US dollar has surged against other major currencies. But will the dollar itself remain in its dominant global position? Or are we entering a new multi-polar world that will open up space for dollar alternatives? This debate has ignited again, with commodities scarce, Russia's invasion of Ukraine, the acceleration of sanctions activity, and a growing sense that the world is deglobalizing. In a special live episode of the Odd Lots podcast, Zoltan Pozsar of Credit Suisse debated the future of the dollar with his longtime intellectual collaborator Perry Mehrling of Boston University. The transcript has been lightly edited for clarity.
Points of interest in the pod:
What is the dollar? (1:41)
What does Bretton Woods 3.0 look like? (4:16)
Now vs. 1971 (10:31)
Why the world likes the dollar standard (15:01)
The world is fracturing, and it's not just commodities (19:48)
The burdens of a strong dollar on the US (27:41)
What is the future of central banks (42:34)
Is there much room for QT? (47:20)
Who will buy US Treasuries (53:17)
Tracy Alloway: (00:14)
Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway
Joe Weisenthal: (00:19)
And I'm Joe Weisenthal.
Tracy: (00:21)
So we have a very special episode for two reasons. One, we're recording this in front of a live audience. And secondly, we're gonna be featuring two of our favorite people to speak to.
Joe: (00:33)
Yeah, absolutely. We're gonna be talking about the future of the dollar, which for our entire careers, I feel like there's this question of is something going to happen to the dollar? It's going to blow up. People are going to stop using it. Whatever. I still don't even know exactly what the question means. What is a post dollar future? I don't even understand the topic completely, but we have people who actually do get it.
Tracy: (00:54)
We have a lot of time to dig into it. So without further ado, I'm going to introduce our guests for this particular debate. We have Zoltan Pozsar strategist at Credit Suisse and Perry Mehrling, Boston University professor, and also the author of the forthcoming book, “Money and Empire: Charles P. Kindleberger and the Dollar System” that's already out in the UK. It's coming to the US soon. And you can probably guess from the title, what side of the dollar debate Perry sits on, but why don't we jump into it?
Joe kind of gazumped me on that question, but like, when we talk about the future of the dollar, what exactly are we talking about? Both of you have spent your entire careers talking about money and specifically different types of money. So what is the dollar?
Perry Mehrling: (01:41)
What is the dollar? Well, so that's actually an interesting first question, as a matter of fact, because there's a lot of different kinds of dollars. We already know there's the dollars that are printed by the government. There are little green pieces of paper. There's the dollars that are the liability of the Fed that are bank reserves. And the dollars that are the liability of the banking system, which we use to make payments to each other.
But I would particularly put on the table right now, there's the whole offshore dollar system, the eurodollar system, where there are liabilities of banks that are not American banks and the assets of people who are not American. And that is now the global dollar system, which is, I think, very, very important to appreciate, and that this has grown up basically as the infrastructure of the global trading trading system.
Tracy: (02:34)
Zoltan?
Zoltan Pozsar: (02:35)
I agree with that. What is the dollar? Let me add some things to that. There is all this offshore dollars, which is not only on the balance sheet of non-American banks, but then those balances are held by countries that are either aligned or not aligned a certain view of the world. And so that's an extra dimension that I think we have learned about when we think about the dollar.
There's also the dollar in the context of price stability, where you basically have a unipolar world where there is one hegemon and basically the commodity trade is in the control of that hegemon. But then there's also a dollar in the world where the commodity market is becoming more geopolitical. Resource nationalism is creeping into the picture. And that has an impact on the price level that has an impact on inflation. So I would say that the dollar is a project.
Joe: (03:51)
Well let me ask you this Zoltan. You've been writing about this Bretton Woods III idea — this shift. And of course we've been talking about it a lot. So my question is, what is a testable hypothesis of whether you're right? What is something that does look different either now, or a few years time that would say ‘yes, we entered into some sort of new global regime?’
Zoltan: (04:16)
So the first time we talked about Bretton Woods III, I think we said that this is going to be a long-term journey, but it has started. What are some of the markers since we have first talked about Bretton Woods III that that would support the thesis? I think a number of things.
We know that the commodity market is no longer exclusively priced in US dollars. We know that certain countries are getting heavily discounted Russian commodities. For example, China. For example, India. We know that those countries are paying renminbi and rupees for those commodities. We know that Europe stopped paying certain countries euros for for gas and they paid rubles. Now there are gas flow issues obviously, but again, I think on the margin, it's no longer the case that commodities equal dollars.
That's number one. What is also obvious is that in the Western world, we have inflationary impulses that we are dealing with, which we haven't really had to deal with in several decades. Whether this cycle of inflation will be successfully halted or not is I think going to have an impact on certain currencies’ status in reserve portfolios. I'm not talking just about the US dollar, but basically G7 currencies, the sterling, euros, dollars. I think there's a lot of work that needs to be done still to basically maintain confidence in these currencies. I mean, Paul Volcker, again, he was the last central banker that had to deal with a similar episode and he did something very fast and in a very draconian fashion, I think we can also say that what we are doing today in the west is heading in that direction, but not the intensity with which we are doing it.
So to me again, it's a working hypothesis. I have been writing about aspects of this Bretton Woods III idea, you know, the war and interest rates, war and industrial policy. All of these things I think are just trying to look at the concept from many different angles, stress testing it. So far, I think I'm internally consistent and building up the narrative around it. It's a way of kind of stress testing, whether you make sense. But again, if it fits together, it fits together and we'll see, but let me just say we are six months into this, right? I mean, Rome wasn't built in one day, God didn't create the world in one day either. Probably not in that order, but I think it's a work in progress.
Tracy: (07:24)
But can I just press on, I guess, what do you look at to judge the dollar’s dominance? Is it pure exchange rate? Because on that basis, the dollar's done pretty well over the past six months. Is it central bank reserves? Those have been diversifying for some time now. Trade financing, invoicing dollars, bond issuance? What are you looking at?
Zoltan: (07:46)
What am I looking at? So I would say two things. The big picture conclusion I have arrived at and I think I'm articulating this piece by piece in in my pieces is that when you think about the dollar and again, let me just use Perry's workhorse, which is that money has four prices: There's par, interest, foreign exchange, and the price level.
So my work and conclusion about all this is when you think about the dollar, and you try to understand the future of the dollar from an exchange rate perspective. I mean, it's an exchange rate, it's a nominal thing, right? But versus the euro and the yen, I think the dollar is always going to be strong in the present context, right? Because at least the US is energy and commodity self-sufficient. Other regions of the world are not.
And so that has an imprint on their exchange rates. What I think about in terms of dollar weakness is basically the dollar getting devalued versus commodities. Because again, if you take a step back and look at everything that's happening in terms of east and west, you know, the G7 versus the Eurasian land mass, resource nationalism, all these things, I think what we are learning is that the west is exposed to the east in terms of commodities. We have a number of issues in the commodity markets, which we can talk about. A decade of no investment. As I said, you know, resource nationalism type markets everywhere. So I think commodity prices can go much higher from here. And a dollar can get devalued in terms of commodities in that sense.
So the way I would say this is in the 1930s, you know, central banks — when we had a commodity-based money system — they raised the price of money in terms of commodities, because when you devalue versus gold, that's what happens. Today I would say we will have a version of this in the sense that the geopolitical realities of commodities shift the way from your control, and you basically are dealing with much higher commodity markets, and a devaluation of the dollar in that sense. But everything is relative.
Joe: (10:03)
So Perry obviously want to bring you in. When you think about the last two years or anything you're seeing now, and obviously in the sweep of history do you see anything fundamental? Do you see regime change of sorts, whether you'd call it Bretton Woods III? Or is it, yeah, we have inflation. That happens sometimes, or commodities are scarce. Commodities were expensive in the early 2000s too. Have we been here before?
Perry: (10:31)
Well, many people are trying to draw an analogy between the present situation and the immediate post-1971 when there was inflation in the 70s and so forth. And when Nixon basically tried to say, you know, we we don't want to be the top dollar anymore because it constrains us too much. And I think those analogies are misplaced, and also don't draw the right lessons from the 70s. I do take a longer historical perspective.
And in your introductory remarks, you were saying we've been here many times: ‘the dollar is, you know, going away.’ Yes. Okay. And I've just written a book basically about it, so about the construction of the dollar system after the death of sterling, basically 1931, you could say and it took a while before we were able to reorganize the global trading system around the dollar.
And that's sort of what the Bretton Woods meeting was there to basically acknowledge like the future's going to be a dollar world. And it was, and gradually the world grew, the system grew, this is important to appreciate. And the traumas of the system, like ‘71, turned out in retrospect to be growing pains. That what happened after ‘71 was not the end of the dollar system, but the offshoring of the dollar system, and then other crises where we added Asia and actually after the global financial crisis, if you look at what happened in capital markets, you mentioned bond markets — this is the extension of the global dollar system to the global south, really for the first time when the national champions in the global south are able to borrow in dollar capital markets, basically because interest rates are zero in the north.
And so there's a win-win here that the pension funds want to lend the money and they want to borrow money. And so in that longer horizon, you see that these financial crises, these periods of trauma, you know, like the global financial crisis, which people said, ‘oh, the dollars are a goner.’ You know, obviously it was like, it was a crisis at the very core, it emerged stronger than ever. And so that's what I think, that's the perspective that we need to take. So what is the current crisis? Okay. I maybe take a different view because I can take a longer view. I'm not working for Credit Suisse.
Joe: (12:59)
A note ever couple of weeks versus a book every 10 years...
Perry: (13:02)
I try to write them more fast than that, but they do take time. The thing that I would like to throw into the mix here is the pandemic. Okay. Not the war in Ukraine or tensions in Taiwan or something, but what came before that, which is two years of extremely loose monetary policy throughout the entire world, involvement of the state, you know, this was war finance, this was war time. Okay. And we're switching, and then the pandemic is over. We don't know, maybe. Okay. And so we're in the process right now of switching from war finance to peace finance. And that is a rocky road. Okay. So I would analogize all of this to like immediately after World War II.
You know, when the reigns of the monetary system in the United States had been in the Treasury, the Fed's job was simply to finance the government, whatever it took. And if the government is issuing bonds and no one wants to buy them, the Fed will buy them. And so that's how war finance works, right? That's how pandemic finance worked, you know, and that worked, not just that way in our country, but in every country around the world. That's how it worked.
You may remember that just before the pandemic, there was an attempt to begin reigning in the elasticity from the global financial crisis to the taper tantrum and all that sort of thing. That's where we were, that's where we are now. Okay. That's what Powell wants to do. And it's the right thing to do. We've been in a period of elasticity. Now we're moving into a period of discipline and that period of discipline will reestablish the dollar. I believe that's, that's what I think is happening actually.
Tracy: (14:45)
So just on this topic, and I'm kind of hoping that you'll channel Kindleberger here, but what are the benefits of a dollar system outside of the US? I think everyone is fairly familiar with what the US gets from it, but what do other countries get? Especially at a time when the US is tightening monetary policy, when some economies, notably emerging markets probably don't necessarily want to see a tightening of financial conditions.
Perry: (15:10)
So I will give you Charlie's answer — Charlie Kindleberger's answer. Everyone called him Charlie. So I will call him Charlie. I call him Charlie throughout the book. And I actually did know him, as a matter of fact, and used to visit him. But everyone called him Charlie, even if they didn't know him.
What I discovered in writing this book is that Charlie's view of the world was very much influenced by his teacher at Columbia, Henry Parker Willis who was one of the creators of the Federal Reserve system in the United States. And what did the Federal Reserve system do? It united these disparate little regions into a par clearing area inside the United States. So that you had a unified monetary system in this country that had never had it before, never had a central bank before.
Historians will correct me on that, but this was a big achievement. What Charlie wants to do, starting in graduate school at Columbia, is do the same thing for the world. The logic of why it's a good thing to have one currency for the whole country and par clearing for the whole country, the logic is just the same for why it might be a good idea to have one currency for the whole world. And that's what people get out of it, is that it makes it makes it easier to do trade, to do calculations, to unite the globe into a unified economy. And that's basically what it is. I'm very influenced by the writings that come out of the BIS appreciating that we really live in a unified world.
This notion of separate nation states with separate currencies. This is something that was inherited in our minds from World War II, when that system had all broken down. But that's not the world we live in now. It’s a global dollar system. And it has a lot of advantages for now that does mean, which you were just coming to at the end, that basically there's one monetary policy that matters. And that's US dollar monetary policy that then gets filtered out to the whole rest of the world. And that's what's happening now. We're moving into discipline mode. And we're already seeing where the weak points are in the global system. And those are going to be managed in the next couple years.
Joe: (17:39)
So Zoltan, do you see like, you know, the coordination costs essentially from, ‘okay, it's great. We have like one unit of account, and then we're gonna have multiple ones.’ Like, what are the costs in your view from, as you said, we are already seeing some commodities price outside of dollars or an increase in the commodities price outside of dollars. What are going to be the costs to the world economy, if your sort of vision or your sort of characterization proves out?
Zoltan: (18:07)
Yes. Well, perhaps before I answer that question, I mean, listening to Perry, you know, Charlie Kindleberger grew up in a certain period, right? Which is post-World War. You know, we have a unified clearing system in the US. Let's kind of replicate that in the world. And you can replicate that in a world where you basically have one hegemon, right? That's a unipolar world order and it has a currency for it.
But I think everywhere I look today we basically have that unipolar world order being challenged. I wrote about this, so we can talk about some aspects of this. I think, you know, if you take a step back and you want to kind of distill everything that has been happening since February, you basically have several blockades here, right?
You have a blockade of Europe from an energy perspective. You have a blockade of a big pile of FX reserves from a financial perspective. You've had a week long blockade of an island in the South China Sea. And we are designing a blockade of China from a chip sufficiency perspective, not even sufficiency, but, you know, to be able to make chips with ASML machines, to be able to upgrade machines that make memory chips. You know, that's the news about memory chip manufacturers with facilities in China, the latest iteration is Nvidia, which makes AI chips — as the experts of the media on chip matters know. So you basically have a very complex kind of chess game.
Joe: (19:45)
I thought you were kind of going to insinuate that the AI chips were going to replace us...
Zoltan: (19:48)
I mean probably, but again, the significance of this is that, you know, the eCNY and, and everything. China is about AI and there's a lot of AI infrastructure being done. China is probably the one sovereign that you associate with AI. And so the Nvidia news is significant from that perspective.
So you have these multiple blockades. So if the physical world is becoming fragmented, I don't think it's any longer appropriate to think about, the world as a unified whole, where you basically need to replicate the unified clearing system in the US to the rest of the world.
You know I didn't mention this before, but you asked what markers am I looking for. The invoicing of flows in different currencies in commodities is one thing. But also when you look at the stocks of FX reserves. You know, the fact that China for example, is letting its Treasury portfolio run down since the beginning of the war is another important little bit that you need to keep an eye on. Because I think just as the real world is getting disentangled, the financial world is getting disentangled.
And so these are all, you know, little bits of pieces that we will follow for the next, six months, 12 months, five years. And I think the world is going to look very different. I think the historical analog here is, I remember I was trying to get an internship in Washington DC in the year 2000. I was writing emails from Hungary to Congressman, “You know, China just got admitted to the WTO and like, what the hell does this mean for the world?”
Well you know, give eight years and you have $3 trillion of Treasuries, right? You know, what is the next five year going to look like? I have no idea, but, you know, if the weighted average maturity of these Treasuries in FX reserve portfolios is like five years, I mean, the world could look very different five years from now. So again it's a glacial progress, but it's a progress. And I think it's time to start thinking about how the financial landscape is going to evolve when we read about the real world getting more and more fractured every day.
Tracy: (22:09)
So Perry, just on that reserves point, I mean, it is true, if you look at FX reserves over the past decade or beyond, you can see central banks diversifying. So renminbi reserves have gone up. I think South Korea and Canada, and some other places have gone up as well. Dollar reserves going down. When you see something like that, what do you think is happening? What is the rationale for doing that?
Perry: (22:36)
Well, diversification, but this is small potatoes. The numbers you're talking about are really quite small. The evidence of dollar dominance is still pretty overwhelming. I think now Zoltan says wait five years. So maybe, but wait five years, other things could happen too. You know it's not obvious to me at all that the trend is your friend in this. Remember that wars are hot houses in many ways. And I mean, now I'm talking about the pandemic. Not Ukraine. A lot of things have changed in the pandemic. A lo of technology was developed in order to enable us to continue on with our life. This has changed how we work.
This has changed where we live. There's a lot of dislocation that has happened. And that's what you're seeing in supply chains. But it's even local inside the United States. You know, people haven't yet sort of all settled down by any means. Remember what happened in World War II, there were separate spheres, right? And the effect was that Germany, you know, invented a lot, a whole chemical industry, you know, and we developed atomic energy and there was a lot of stuff developed in World War II that we then rode that wave basically for the next 30 years, the 30 glorious years, you know, we're building on those developments. So it's not obvious to me that we are entering into a gloomy period. Deglobalization — we haven't used that word yet here — but Zoltan uses it all the time in his writing.
I wouldn't say he is a fan or advocate. He sees deglobalization. I'm not sure. I think China has its own problems. Russia has its own problems. He mentions in some of his notes — I don't know where you get this factoid — but that because of our anti-immigrant stance, 2 million jobs have left. And the people have left. Well, they've gone somewhere, you know, and they gained skills here, and now they're somewhere and they're building firms and doing things some, but that's gonna take a little while.
The whole supply chain stuff was all disrupted by the pandemic. It's being disrupted even more by geostrategic things, but it will get reconstructed. And it's not clear to me that this is a pivot point where we shift from a market-determined system. This is the big point that Charlie always makes. The reason we have dollar hegemony, okay, is not because it's a unipolar world. In fact, the US doesn't really wanna do this. You know, this is a public good that the US is providing the rest of the world.
Joe: (25:34)
So I wanted to ask about this, because you mentioned, okay that if you look at past crises and you see after the great financial crisis, after each one of these periods of stress, the dollar has gone from strength to strength. Is that a burden? I mean, people talk ‘exorbitant privilege’ like it's a good thing. But there was also talk, especially pre-pandemic, when a lot of the issues were like insufficient demand and there was an argument that dollar is too strong. And so is this good for the US, these series of crises where the dollar keeps getting stronger?
Perry: (26:06)
So maybe not. Maybe not. Monetary policy, this image we have in the world, that every country is separate and they can run their independent monetary policies if they have flexible exchange rates, I think it's not true of any country. It's not true of countries in the periphery. It's not true of the country in the center, because US monetary policy is global monetary policy.
And so it has consequences. It rebounds on the United States. The reason I titled my book Money and Empire is precisely because of this, to really highlight the kind of contradiction between our political reality, which is nation states and and our monetary reality, which is global. Okay. And how do you manage that? It is managed right now by central bank cooperation mainly. And the backstop of the global system is this intricate system of central bank backstops, liquidity swaps, and so forth.
And these new FIMA repo facilities and things that extend it further to the Global South. But US monetary policy is a global monetary policy. And so that's what's happening. The US has decided now is the time. I'm sure this was in collaboration and discussion with other major central banks. They knew that this was not a surprise. And so they're coming along, you know, they're ratcheting up in their own time. And that's how the politics are working, that it's cooperation between the central banks in the different countries. Will that hold? We don't know, geostrategic stuff says maybe not.
Zoltan: (27:50)
Yes. I would say the dollar — being the issuer/custodian of the reserve currency, I guess it comes with responsibilities and, you know, baggages too, if you will. But let me just have a comment about the dollar bouncing back ever stronger. Again, my formative years were, I don't know, 1997 and onward. That's when I took my first macro class. And so yes, the Asian financial crisis was a formative period, for me at least. That was the first financial crisis that I followed as a first year macro student. And so, yes, that was a crisis where it was an offshore dollar crisis, and a certain part of the world got weaker. And then the Washington Consensus came in and kind of cleaned things up. And so that was one episode.
You know, ‘08 was a domestic crisis. That's when we get into the QE habits we've been having. Then we’ve been having smaller crises since then. I mean, we discussed the Treasury cash futures crisis, the repo crisis. What did we do about that? You know, the pandemic itself, it happened, but again, the position that the financial system was in at that point in time was that you were woefully illiquid to be able to provide all those credit lines to all these corporations. If something like that would happen today, we would be a lot more liquid to deal with that. But, you know, that was another crisis. And then again, today, this crisis of the price level that we have, is a crisis that we haven't had since the 1970s.
So it feels to me like that the dollar crises are coming closer and closer to home. And basically I think the period that we are living through at the moment is we have trust in an institution, the Federal Reserve, which is tasked with delivering price stability. And I think we are learning that, you know, can the Fed deliver price stability just by hiking interest rates? Or are there kind of forces in the real world, whether it's a shortage of cheap goods, cheap energy labor, all these things, you know, is it as easy as raising interest rates from 0% to 5% to slow inflation down? Is it as easy as, as shrinking the balance sheet to slow inflation?
Let me just offer one observation, which is that, you know, everybody likes to talk about the fact that, well, maybe we are in a bond bear market and Wall Street is so young nobody has seen rising interest rates. So we don't know how to trade it. A version of that is that we haven't seen an inflation episode, so we don't know how to think about inflation. We have seen something like what happened in the 70s, but we haven't seen anything that, you know, happened a hundred years ago, 1914, 1948, all these things. So my impression talking to clients is everybody thinks about the spike in inflation charts as if it's another basis. Okay. You know, we are used to thinking about crisis because we had crises of bases, you know, a FX rate and a market rate a cross currency basis, a LIBOR/OIS, a cash treasury futures basis, AAA CDOs versus AAA Treasuries.
There's a basis that creeps in always. And it's always as simple as somebody throws balance sheet at it, and the basis closes. This crisis of the price level, this inflation crisis, is a very different ballgame. It's not as simple as raising rates because the world doesn't work like that. It's not as simple as doing QT because the world doesn't work like that. So I think this is a real test. And so I think this is a very particular moment in time. You know, this notion that, you know, the, the Fed can deliver 2% price stability, is probably the reason why FX reserve managers over long periods of time, started to diversify away from bills to two-year Treasuries, five-year Treasuries, 10-year Treasuries, because it's a good store of value. And it's an idea, and we will see if that's indeed the case or whether we are going to settle in a period where 2% is not attainable. And maybe 4% at some point is the new target. Or maybe we're just going to be bouncing around between five and 10. I don't know.
Tracy: (32:18)
I have a point of clarification. So when we're talking about be Bretton Woods 3.0, so part of the dollar decline idea is geopolitical. People are worried that their reserves are gonna be seized by the US. We've seen that happen with Russia and Afghanistan. And then part of it has to do with commodities. But if you look at the US from a pure commodities perspective, it's not in a bad place, right? It’s exporting oil and gas. I mean, I have coal in my basement. It came with the house, like, it's a resource rich nation. So how does that aspect of it fit in with the dollar demise idea?
Zoltan: (32:54)
Let's think about this step by step. Okay. So peak eurodollar, yes or no? Inflection point, yes or no. I mean, that's how it starts. My sense would be yes, peak eurodollar because if on the margin, the commodity market is starting to invoice things in currencies other than the US dollar, I think that's something.
And again, you know, the perspective from which I am trying to understand this is, okay, I work as a strategist. I have a job which is to talk to investors and try to figure out the future. This is going to have an implication on commodity prices. This will have an implication on inflation. This will have an implication for the level of interest rates. And this is going to have an implication on swap spreads. Cash Treasuries versus OIS. What's the demand?
And as I said on the podcast before, and let's just take two countries, okay. Let's take Russia and let's take China. Okay. What is the incentive of Russia, for example, to recycle revenues from commodity sales into G7 assets? Zero, right? I mean, you are invoicing things in different currencies. Take note, because that was a $500 billion stash of liquidity that went into the FX swap market, that went at some point into US Treasuries. And again, you know, look at China. I mean, you know, they accumulated Treasuries and then it's flatlined and now it's falling. So on the margin, these things matter. And I think this is how it starts, how it's going to, you know, don't think about this as, you know, next summer it's going to be like this, and it's going to be like that.
It doesn't work like that. But I think on the margin, things have changed and this is going to change things. This is going to change flows on the margin and we are going to be trading and kind of living with those every day as you guys write about it, as I write about it, as others in the audience trade it. So yes, the US is commodity self-sufficient. Other parts of the world are not. But again, as I said, I think the thing that we need to factor in is basically what this means for the price of commodities, which are priced in US dollars. So you can have a devaluation of the global eurodollar in terms of commodities. And then what that means in terms of euro-yen, euro-dollar, dollar-yen exchange rates?
Joe: (35:44)
Perry, you know, obviously Russia and China are continuing to trade more for obvious reasons, perhaps some invoicing of commodities not in dollars, maybe that's picking up. Intuitively, it seems like the renminbi should become a bigger deal. And China is a big trading partner and it seems likely that there are going to be some countries for whom its a partnership gets even stronger. That makes sense to me. Why wouldn't the renminbi become a much more significant global currency, just because China is a big country and a big trading partner?
Perry (36:21)
Well they're a big country and they produce a lot of stuff. And that's right. And they buy a lot of stuff. But that's not what makes for a global currency. I think the notion that inflation is some sign that people are revolted by the dollar, you know, that this is about depreciation of the dollar — that's sort of in the air here — I think that's just not right. That's not what's driving inflation. What's driving inflation are these wartime dislocations. We had a pandemic in which we all shifted to goods. And then the pandemic is over and we shifted back to services and the people to produce those services had all moved out in New York. And so wages are pressured.
So there's a lot of dislocation that in a market economy shows up as price movements. So we were talking about this in the green room a little bit before. I think what we might be seeing here is a shift to a higher price level. Okay. But whether this is the beginning of a kind of inflationary period, I still remain in team transitory. Okay. And let me say a more inflammatory thing than that. Okay. Which is that Powell, remember he wanted to tighten before the pandemic. Okay. When there was no inflation, right? It was just time to put some discipline into the system. He wanted to tighten as soon as he could after the pandemic. He didn't think there was gonna be inflation. He wanted to tighten anyway.
Inflation has made it much easier for Powell to do what he wants to do because now everyone is scared about inflation. So it's this. And what does that mean? That mean that's positive for the dollar. That's strengthening the dollar. So I think that the politics are working in favor of a stronger dollar in the future. Not the other way around. And as long as the anchoring of the new price level happens. And it doesn't get unanchored, but I don't see any particular particular sign that that's happened yet.
Zoltan: (38:32)
So this is very interesting because I sense some talking past each other. So the dollar can be weak and strong at the same time. This is like qubits, you know, like zero and one. The dollar can be very, very strong versus other G-7 currencies, which we see. But again, I think the next five years is a story of whether the dollar is going to stay strong versus commodities or commodity prices go through the roof.
And then we are going to be dealing with, you know, recurring rounds of inflation. So let me again, just emphasize, I mean, there's two views in the market: that this is a massive reopening and that we over did fiscal and monetary stimulus. And that's a view. I'm sure that is part of the picture. What I guess I have been trying to articulate and highlight and put on the table is that I think the economic war aspect of all this is underappreciated.
And if the economic war is indeed a theme that is going to be with us for the next five years, the way we should think about inflation is not that, you know, there's all this bad stuff that happened over the past 12 months. It pushed the price level higher, and the base effects are going to take care of the rate of inflation over time. I think we also need to be mindful of all the potential bad things that can happen over the next 12 months to five years. And again, when you read the news and I started to read the news where I could just pick up the paper and I look at commodities, I look at the war, I look at tech stuff, you know, Chris Miller, chip war. That, that type of stuff. And I just try to understand the way Russia and Europe is evolving as a relationship and the way China and the US are evolving as a relationship and things are not getting better. You know?
So do I think that bad stuff can happen in the future that are going to mess up supply chains even more? Yes. Do I see risks in all the demand construction policies that Europe is doing in the face of rising gas and electricity prices? Yes. It's fanning shortages. Do I see risks in the fact that, you know, I mean, OPEC is effectively telling us that they want to see a hundred dollar floor under oil. That's about where it's right. We know that the drift down in oil prices came partly because we have released a lot of oil from the SPR, and we know that every inventory is finite. And then we also know that the physical market where oil gets produced is super tight. You know, you can't ramp stuff up.
There is still a view in the market, which I believe, that commodity prices, especially for, you know, oil, gas, I mean can go vertical. Gas prices and electricity prices in Europe are going vertical. Can it happen in the oil market too? Yes. I mean we basically had, you know, I think you're upset about that, but, you know, I think this is basically the world that you live in. And so these level shifts up in the price level, I think can happen, you know, every six months. There's reasons to believe that that, there's risks like that. And so from that perspective, I don't think that inflation is transitory. Certainly the reopening bit might be like a one time thing, but I think the geopolitical aspects are just getting more complicated and more scary, I would say.
Tracy: (42:00)
So Zoltan just on the price level crisis idea — and this is something that came out from our last conversation with you. And I think we wrote it up in a post, this idea of problems that money can't solve. So physical commodities, supply chains, that sort of thing. In that world, what is the role of a central bank? Because on the one hand, yes. Raise interest rates to fight inflation because you don't have enough of the real stuff to go around. But on the other hand, if what's required to solve that problem is more investment, maybe you don't necessarily want rates going up that much?
Zoltan: (42:34)
Yes. I think a central bank's job at the moment — and I think that job is going to evolve over time — at the moment, the way I think about the Fed's role for example is, you know, you've gone from being a central bank that is generating wealth via QE portfolio balance channel, to push the demand curve outward because there's all this cheap stuff that's coming and what we are afraid of is deflation. Okay. So we've had 15 years of that. And then all of a sudden the supply curves have ricocheted back in, you know, commodities, labor, cheap goods, inflation is coming in large part from that. So to deal with that inflationary impulse and to kind of take it off a bit, I think you need to generate a massive level shift down in demand, such that things are more in line with supply.
And I think Jay Powell kind of articulated something similar to that, that we are going to need a period of below trend growth. So think about this as nominal GDP targeting in reverse. Whereas, you know, we wanted to catch up with the pre-GFC trend. Now we need to kind of catch down to where the realities of supply is second. Again, the underlying environment in which we will be, I think will be inflationary. So the job of a central bank is to make sure that at least real interest rates are not falling, not going more negative, but they are kind of heading in a positive territory. Then two things come from this. You know, as I said in my most recent piece, where I think, you know, we will have to spend a lot of money.
It's kind of like war finance again, it's just to kind of rebuild the world order or something. You know, so we fought the virus. Now we are going to fight supply chains falling apart or something like that. So the whole re-arm, reshore, restock, continue on with energy transition. That's going to require a lot of capital. That's going to require some reasonable rates at which we can fund them. And so I think yield curve control is in the picture in the context of that. But it's a very different yield curve control. It's not yield curve control to keep rates at 1% so that you juice asset prices up. It's basically to make sure that yields don't go through the roof, but there is a back stop to that. So like what we did in the Second World War, where you had a price for short-term money, you had a price for long-term money and you basically had a yield curve and then go and win the war.
You know, if we had World War III, that's what we would do. Hopefully this is just going to be an economic war, where we have to retool and finance that whole process. But I definitely see the central bank kind of be engaged in the bond market and provide the yield curve cap, but with much higher interest rates. And then in the case of, you know, Japan, Europe, the UK, I mean you have a currency crisis in those places. And again, this is back to Perry's earlier, about the dollar and there's one monetary policy, which is the Fed’s monetary policy. And everybody has to kind of go in that direction, otherwise your currency is going to suffer. I think in Europe and all the commodity not self-sufficient parts of the world, monetary policy is going to be relegated to making sure that the level of exchange rate is within the bounds of normalcy and, you know, where you can basically afford to import your basic commodities.
Joe: (46:24)
So I think we can go to the [audience] questions, in part because we just got a question that was going to be kind of my last question. So it seems like a good segue. We both of you on in March 2020, so right at the beginning of the pandemic, but a few months before that we had spoken to you (Zoltan) because that's when there were all the questions about like running out of reserves. So we just got a question about this, which is, you know, obviously you just mentioned quantitative tightening. This is kind of a simple question, it almost seems old-fashioned, but how much space do you think they have and is it going to be another thing where they have to cut it short early because of the amount of reserves demanded in the system?
Zoltan: (47:03)
Is it a question for me?
Joe: (47:04)
Yeah. Both you, but I'll start with you. This question is from the Cameron Dyer.
Zoltan: (47:20)
QT. I don't think that there is a lot of room. I don't think that there's a lot of room to do QT. First I think this is going to be ultimately a question about demand for Treasuries. Not the system's ability to fund those Treasuries, right, because there's a lot of money in the RRP facility. But it feels like everybody just wants to be in the front end, right? Because the front end, you get the benefit of rates are going up. You get higher rates every two, every three months.
I think we are also going from a period where the market was a big believer in this idea that we are at peak inflation, peak hawkishness. And so whatever three months of QT we had so far, first of all, the, the amounts were not that big on like 60 billion per month. You know, the market just absorbed assuming that we are at peak hawkishness. So all you're going to do is rally from here. I mean, that's the whole, let's go along bonds and let's go along duration view.
If we are going to go into a world where inflation hasn't peaked, I mean Europe is in a very different position again, I think this energy crisis that Europe is having now is not only going to have a liquidity event around it, but also it's going to impact industry supply chains. You know, what does it mean for inflation elsewhere?
So again, if you don't think that the Fed is at peak hawkishness, and that there is a risk of, you know, the peak of the hiking cycle, not being 3.5%, but rather say 5%. Again, Powell didn't say anything that should make us think that that's not possible, you know, inflation is the target. He did not mention stocks and asset prices once in that speech. And that omission is very important.
I mean, when you write these speeches at that venue, I mean, you think about what you're going to say. So what you don't say has just as much meaning as what you say, but he doesn't seem to care too much about the growth impact of hikes. It's inflation at 2%. Singular mission. That's what we are going to do. So if we are going to go in a market period where we are going to hike to 5% or 6%, you know, demand for Treasuries is not going to be as good over the next three to six months as it was during the first three months of QT. Mind you QT at the moment is accelerating. So that's another issue.
And again, I think just as we were talking about this, you know, financial blockades of FX reserves, financial, you know, energy blockade of Europe, a blockade of Taiwan, a blockade of chips, China can make things more dynamic as we do QT, because the weird thing to me about QT is that everybody thinks about ‘well, this is what the Fed is doing to do.’ Well, okay, fine. But that's the bare bone minimum, because others are also in a position where you can also start selling Treasures and not show up at auction. So that’s a hundred billion a month that the private sector will have to absorb instead of the Fed, that’s just a minimum, right? Because other central banks can can step away from the market. So basically this means that cash Treasuries can cheapen quite a bit relative to OIS swap spreads, can tighten, there's a certain appetite that the Fed is going to have to tolerate that. But if that becomes an issue, I think the days of QT are numbered
Perry: (50:49)
So what is QT? Okay, let us understand what the balance of the Fed looks like. Okay. The balance of the Fed is money market funding of capital market lending. The Fed is a shadow bank. So QT involves taking those positions and moving them into the private sector. Basically, that's what it is. You're shrinking the balance sheet of the Fed, and you're expanding a balance sheet somewhere else. So it has to become profitable to do money market funding of capital market lending. Okay. Otherwise no one will do it. That's what would make quantitative tapering — QT — possible. Remember quantitative easing was just the opposite, you know, where these collapsing positions on private balance sheets were just dropped onto the public balance sheet. And so we're just moving in the opposite direction.
So mostly that's about prices, right? That's about, is it profitable to do this? Zoltan was sort of saying that, basis spreads and he has all these fancy words, but in the big picture, you're shifting the shadow bank from the public sector to the private sector is what you're is what you're trying to do. And I do think it's possible for interest rates to go considerably higher, what I would add to this, and maybe we have a little dispute about this. What matters a lot in the world is nominal rates. There's a lot of push saying, ‘oh, we still have negative real rates, and you're never gonna get control of inflation.’ Well, I already raise some questions about whether this really is inflation or something.
Higher nominal rates mean that buyers have to pay more money. Okay. And that is a clearing, that's a settlement constraint, you know, so it will put, if you raise interest rates by a couple of percentage points, the outstanding debt is going to get re-priced, and the borrowers are going to be under a lot more pressure, and they're going to have to do something about that. They're going to have to pay their debt instead of doing something else. And that's not just in the United States, that's globally. And the vulnerable borrowers are going to go to the wall. And this is the period that we're in. Okay. So that the quantities will shrink there too, because there will be defaults. What happened to crypto is just the first….
Tracy: (53:12)
Oh, I'm actually really surprised we haven't had a crypto question...
Perry: (53:14)
I was just throwing that in. A little red meat.
Zoltan: (53:17)
Let me add something, I think it's very important. And just reminding everyone since the year 2000, there has always been a big central bank on the margin buying a lot of Treasuries. Okay. From 2000 to 2008, it was the PBOC, and then they flatlined. From ‘08 onwards, it was the Fed. When the Fed stopped, the ECB and the BOJ started to do QE, but then all the yen and euros, they produced on an FX, you know, the pension funds in those jurisdictions swapped those euros and yen for dollars to buy Treasury securities. So what is the moral of this is? It’s either the PBOC doing a lot of liquidity injection, buying Treasuries, or the Fed is doing liquidity injection by buying Treasuries or other central banks are buying their own bonds, that creates a lot of liquidity in euro and yen, which gets swapped for dollars. And then you buy Treasuries with it.
The big central bank liquidity impulse is always there to be a marginal buyer. So now, okay we talk about this China is not buying anymore. Hedging costs are way too high. The curve is flat, so it doesn't pay anymore to buy anything on an FX-hedged basis anymore. The yen is close to 150. I mean, we are now at levels at which you can expect either FX interventions out of Japan, which is going to involve selling Treasury securities on the margin, or you are going to adjust the yield curve back to basically adjust. If that happens, that doesn't mean anything good for duration. And then basically when we think about the Fed doing QT, we are basically saying that against this 20 year history of who buys Treasuries on the margin, the FX hedged buyer can step away.
China can step away and Fed can step away and it's all going to be okay? We are basically expecting the private sector to step in instead of the public sector in a period where inflation is as uncertain as it has ever been. We have no idea if it's going to go from 10 to five, 10 to 15, or if it's gonna coast at 10, what I'm quite certain of is that it's not going to crash back down to 2%, but basically we are asking the private sector to take down all these Treasuries that we are going to push back into the system without a glitch and without a massive premium.
Tracy: (55:48)
I have a good question from Alex Howlett. He asks, this is for Perry specifically, you know, we all understand that it is possible for an international monetary system to be usurped. We saw that before with things like sterling. What would it take to convince you that the dollar was on its way out? What would have to change in the world?
Perry: (56:12)
Well, that's a good question. Maybe one, I haven't put a lot of energy into because it seems we're pretty far from that, but so let me go back to 1931. What was it that undermined Sterling? There were two things, okay. There was that the Bank of England did not have the capacity to run the global system on its own. And it couldn't get the US to help. Both of those things happened. It can happen that there would be a crisis and the Fed is a little overwhelmed. If everyone refused to help the Fed, okay, this could be a problem, but it would be a problem for everybody. Okay. It was a problem for the United States that the United States did not help the Bank of England, as a matter of fact. We had a global depression and some people thought that was mainly a US thing, you know, but it was actually very, very damaging to the United States. So I think that the cooperation of policy cooperation of the major central banks in the global north, is vital. And if that breaks down, all bets are off.
Zoltan: (57:32)
Can I ask Perry a question? So I don't know the answer to this, but I wonder what your take is on this. I get this question a lot. I don't know what to answer to it. So firs,t the fiat money as a project is fairly young, right. It's like post-Nixon, ‘71, from what I understand. So what do you think about that? Number one? And...
Perry: (57:59)
I think that's not right.
Zoltan: (58:00)
Okay. Very good. And, and, and number two if fiat, if, if the fundamental building block of fiat money is an ability to deliver price stability, and if for, for that reason, there is some risk to that notion what happens to fiat money?
Perry: (58:21)
Well you may have noticed I never used the word fiat money. When I think about the sterling standard, I call it the sterling standard, not the international gold standard. Everyone was using sterling as the international money. And yes, sterling was notionally redeemable in gold, but nobody ever did it. And all of the actual transactions were in sterling. Same with the dollar system. You know, so that when you go off gold, it, I don't know, freaked people out, but in a certain sense, we never were on gold. We were on a dollar standard, and that was there for historical reasons or whatever. And when we got rid of it, when we got rid of that sort of rule, we are now fine. So when you say fiat, okay, and I would say this to anybody, you know, you're thinking that these are green pieces of paper that are printed on a printing press, and that's not correct.
These are liabilities of a bank somewhere. Okay. And there's assets that are on the other side of the balance sheet too. Credit is not a bug. It's a feature. Credit is not a bug. It's a feature. Outside money, which is like inventories of gold or something like that, is never going to be a good money. Inside money is the money that makes the world go around, it's credit money. And so you need credit in order to make that go, creditworthiness, and the best credit is money.
Tracy: (59:54)
So I have a question it's sort of a pushback to Zoltan's pushback on that topic just now. But it's from John Farley. If Bretton Woods III comes to pass, how does pegging of currencies to commodities other than gold actually tame commodity volatility, if the underlying issue of, you know, resource shortages and things like that remains?
Zoltan: (01:00:19)
Okay. This is a very important question. I don't think I ever said in any of my pieces that we are going to go to a world where things are pegged to commodities, or they are pegged to gold. What I said was this, what you think of as reserves at the level of a nation state is evolving, right? As we talked about this before, you know, you can't print oil to heat, or wheat to eat, right? You know, there are problems that central banks cannot solve. We have grown up, I have grown up in a world, right, where Southeast Asia got into trouble because they didn't have dollar liquidity. The binding constraint was that as a country, you didn't have the dollars to import the stuff you needed. What came out of that was a particular kind of solution, medicine, which is that we need to have a lot of FX reserves.
And as a prudent country, we need to cover two years’ worth of current account deficits with reserves. This is all pre-dollar spot stuff. Okay. So the emphasis was on, you know, we need to build a big pile of reserves because that's, you know, like as individuals, we have a pile of savings and that's how it's prudent to live. We are now basically, as I said in my pieces, if you go back and read it carefully, what I said, not what, you know, was interpreted, was at a nation's level, okay, I'm sitting on all these reserves, it's dollar liquidity. Great. But I need gas. I need electricity. I need wheat. I need whatever stuff for my, you know, I need to build chip foundries and all these things. So basically what is a reserve? The notion of it is changing.
Okay. Maybe some countries have way too much dollar liquidity and not enough commodity reserves. So I think over the next five years, as these countries are sitting there looking at their pile of Treasuries in a context of rising commodity prices, maybe you are going to reevaluate what it means to have a comfortable and prudent amount of reserves. What should that consist of? Should it only be Treasury securities, which you can repo and liquidate and sell to raise dollars to buy what? Okay, should it be Treasury securities? When, you know, inflation is running structurally at 8% and Treasury coupons pay, I don't know, 4%, 5%? If real terms, those Treasuries — five- or 10-year Treasuries — are buying less, should I be only in Treasuries? Should I have a structurally bigger allocation to gold?
Should I, as a sovereign, sell some of my Treasuries, get dollar liquidity and cut the $200 billion check and establish a commodity resource company at the sovereign level? Go out and buy commodities when it's cheap? Before we end up into an even deeper economic war, where resource national nationalism is a bigger issue. Can it happen that reserve management practices and countries thinking about what is reserves changes in that direction? Yes, for me, that is what Bretton Woods III is about. It's not establishing a link to gold. It's not establishing a link to a basket of commodities. It's not to unseat the dollar and kind of elevate, you know, something else on a pedestal. These things, I think over the next five years are going to happen on the margin again, as I said, like to understand this and again like nursing a baby, you know, that baby is changing all the time, but you know, it's going to become something else over time.
And I think that the best approach to look at Bretton Woods III is to just kind of look at these things and whether they are happening again, I can list you a number of headlines. You know, India instructing its states to cover three years' worth of residential and industrial coal needs to basically hedge itself for the winter. News like this is all over the place, but I think that this theme is happening, and it's going to grow in size. And over the next five years, when we look at FX reserves and central bank balance sheets, and what states’ balance sheets look like, commodities and gold are going to play a bigger role. I think Treasuries are going to play a smaller role.
And the commodity market is going to be a market where it's not just exclusively dollars that we invoice things in, but also other currencies. And if that happens to a half a trillion, or a trillion dollar scale, I think that's going to be meaningful enough that they are going to have implications in rates markets at the level of price level of commodities inflation and all these things. So to me, that's what Bretton Woods III is. Maybe it's a bad term and it kind of sends you off. I mean, Adam Tooze said that it's a bad term. So maybe it's a bad term, but it pushes you to think about things a certain way, but I think these are the practical implications of everything that we’re talking about.
Perry: (01:05:27)
So I think it's probably right, that we have learned that our supply chains are way too fragile and that they need to have more redundancy in them, more inventories along the way. That for geopolitical reasons, maybe it would be a good idea to be a little more independent, you know, have your energy security, and so forth. All of those things seem to me, right. I just don't think they have any implications for the future of the dollar. I think that people will be accumulating, you know, more reserves of commodities, and worrying about safe food safety and all that sort of thing. I don't see that that's about converting your Treasury bills into grain stores or something. I think you're still going to have Treasury bills. So it's not a substitute. I don't see any of that as any threat to the dollar.
Joe: (01:06:22)
Well, here's a question, and it very closely fits with this. The question is from Gianni at Blue Line Futures. So one project that's been in the works since even before the pandemic, but which has become much more acute, is the attempt by the US to become a natural gas export powerhouse. We see the creation of these terminals. Europe would take all the gas that it could possibly get right now. And there's no global price for gas right now, but is there a possibility that Henry Hub, at some point in this evolution becomes the global benchmark, if everyone wants US gas. And does that then have a cementing role in terms of the dollar status as once again, back to invoicing, the dollar, US sets the price, etc.
Zoltan: (01:07:15)
I mean, I would say, sure. Why not? I mean, we are heading in that direction, right? I guess, I don't know what the answer there is. Maybe I ask Perry, I pass the hot potato onto you, but I mean, in my mind, like the US became the dollar, became the reserve currency, in large part because of the petrol dollar trade. But that was basically a situation where the US had to import and pay others with US dollars.
Perry: (01:07:44)
Talking about the seventies.
Zoltan: (01:07:45)
Yeah. Yeah. But I guess if you start to export commodities yourself and then, so you're no longer, you're running at it from a current account surplus perspective, not a current account deficit perspective. What does that mean for the amount of dollars out there? You're not broadcasting those dollars to the rest of the world. You're basically absorbing those dollars, because someone is paying from the rest of the world to you for your commodities.
Perry: (01:08:12)
I don't know what Henry Hub is.
Zoltan: (01:08:14)
Henry Hub is a natural...
Joe: (01:08:17)
A natural gas benchmark price in Louisiana.
Perry: (01:08:19)
I shouldn't be answering this.
Zoltan: (01:08:22)
But I guess the question is if the US is a net commodity exporter, oil and gas, instead of a net commodity importer, right? So the whole petrol dollar idea was we don't have the oil, but we have the dollars. So we pay for the oil, the dollars, and then others recycle those dollars in Treasuries….
Perry: (01:08:43)
The Petrodollar was really about the US banking system recycling the surpluses that were being accumulated by the oil exporters into lending to the oil importers, not just the United States, but everyone else in the world too. And that is part of the offshoring of the US dollar. That was the that part that I talked about, the offshoring of the US dollar after the collapse of Bretton Woods in ‘71. That mechanism was quite important for getting those balances up really fast. And it was definitely pushed by the US government. They were trying to solve a problem, big imbalances, you know, this isn't the first time that we're having today, where we have global imbalances. There were those big imbalances there. And if there had been better cooperation, you know, but in the global north, probably it wouldn't have happened if the European countries had helped each other use their gas reserves, you know, they could have fought off OPEC, but they did not.
They were each, each one was running for themselves. And so this is what happened, that it was solved by the private market. I think there's a more general lesson here, which is when the central bank is doing a lot. Okay. It's a bad sign. You really, you know, the industrial policy, which is what you're pushing with your rearm, restock, rewire, reshore industrial policy, that doesn't necessarily involve the central bank in doing much of anything. You know, this is a job for the Treasury, for the fiscal side of the government. And all the Fed has to do is, you know, make sure that there's a market for their bonds or something like that, but it's not QE, you know, they're not trying to stimulate the economy. I think one thing we learned is that, you know, QE as a way of stimulating the economy, it doesn't really work very well. As a way of catching the falling knife, it works great.
Tracy: (01:10:44)
Well Joe, I really hate to ask this question. But we've gone on for an hour and 20 minutes. Shall we leave it there?
Joe: (01:10:50)
Let's leave it there.
You can follow Perry Mehrling on Twitter at @PMehrling (Unfortunately, Zoltan isn’t on the platform.)