Zoltan Pozsar and Perry Mehrling Debate Bretton Woods 3.0

the dollar. It's gonna blow up, people are gonna stop using it whatever. I still don't even know what the question means. And it's like, what is a post dollar future? What? I don't even understand the top of completely. But we have people who actually do well. 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 Sultan Posar, strategist at Credit Swiss, and Perry Maryland, Boston University professor and also the author of the forthcoming book Money and Empire, Charles P. Kindle Burger 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 Joe kind of go zumped 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? What is the dollar? Is the dollar? Well, so that's actually a very interesting first question as a matter of fact, because there's a lot of different kinds of dollars um and the we already know there's the dollars that that are printed by the government, their little green pieces of paper. Is the dollars of the liability

of the FAID that over bank reserves. That 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 your dollar system UM, where there are liabilities of banks that that are not American banks, um and the assets of people who are not American

systems UM. And 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. It's alt I agree with that. UM, what is the dollar? I think I would let me add some some things to that. There is there's all this offshore dollar which is not only in the balance sheet of non American banks, but then those balances are held by UM countries that are either aligned or not

aligned with UM a certain view of the world. And so that's an extra dimension that I think we have learned about when we when we think about the dollar. There's also the dollar in in in the context of price stability, where you basically have a unipol or world where UM there is one Hedgemen and basically the commodity

trade is UM in the control of that Hedgemen. But then there's also a dollar in the world where the commodity market is becoming more dura political resource national nationalism is creeping into the picture, and and that has an impact on the price level, that has an impact on on inflation. So so I would say that the dollar is a project. Well, let me ask you this. You've been writing about this, this Brenton Wood's three idea, the shift and course we've been talking about it a lot.

Like I guess my question is like, what is the testable hypothesis of whether you're right? What does something look different either now or a few years time. They would say, yes, we entered into some sort of new global regime. Yes. So the first time we talked about Breton Woods three, Um, I think we we said that this is going to be a a long term journey, but it has started. Um. What are some of the markers since we have first talked about Bretonwoods three that that would support the thesis?

I think I think a number of things. Um, we know that the commodity market is no longer exclusively priced in U S dollars. We know that certain countries are getting heavily discounted UM Russian commodities UM for example China, for example India. We know that those countries are paying uh remman b and rupees for those commodities. We know that, you know, Europe stopped paying certain countries stopped paying euros

for for gas and they paid rubles. Now there is gas flow issues, obviously, but but again I think on the margin, it's no longer the case that commodities equal dollars. Okay, that's that's um. That's um. That's number one. What is also obvious that in the Western world we have inflationary impulses that we are dealing with which we haven't really had to deal with in in several decades. UM. Whether UH this cycle of inflation will be successfully um uh halted or not, is I think going to have an

impact on certain currencies status in reserve portfolio. I'm not talking just about the US DADA, but basically G seven currencies, the Sterling euros, dollars, UM. I think, UM, I think there's a lot of work that needs to be done still to basically maintain confidence in UH in these currencies.

When Paul Walker 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 with which we're doing it. So to me again, it's it's a working hypothesis. UM. I have been writing about aspects of this Breton Woods

three idea. You know that the war in interest rates PIACE, war industrial policy Um, all of these things I think are just you know, trying to look at the concept from many different angles, stress testing it. So far, I think I'm internally consistent. So I'm building up the narrative around it. It's a way of kind of stress testing whether you makes sense. But again, if if it fits together, it fits together, and they'll see. But let me just say we are six months into this. I mean, Rome

wasn't built in one day. God didn't create the world in one day either. Um, probably not in that order. But I think it's a work in progress. But can I just press on? I guess, like, what do you look at to judge the dollar's dominance? Is a pure exchange rate? Because on that basis the dollar has done pretty well over the past six months. Is it? Central bank reserves? Those have been diversifying for some time now, Trade financing, invoice, bond issuance, Like what are you looking at?

What am I looking at? Um? So I would say two things. The the the the big picture conclusion I have arrived at and I think I'm articulating this, uh piece by piece in in in my pieces, is that when you think about the dollar, And again, let me let me just use Peri's work workhorse, which is that money has for prices. There's far interest for an exchange

and the price level. So my working 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 it's an exchange rate, it's a nominal thing, right, But versus the Euro and a end, 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 on their exchange rates. Uh. What I what I think about in terms of dollar weakness is basically the dollar getting devalued versus commodities. UM. Because again, if you take a step back and look at everything that's happening in terms of East and West, you know, the G seven versus the Eurasian land mass, resource nationalism, all these things. I think what we are learning is that um, that the West is exposed to the East.

In terms of commodities. UM, we have a number of issues in the commodity markets which we can 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 isn't there in

the nineteen thirties. You know, central banks when we had a we had a commodity based money system, they raised the price of money in terms of commodities because they's just that when you devalue versus the goal, that's what happens UM. Today, I would say we will have a version of this in the sense that the geopolitical realities of commodities shift away from your control and you basically are dealing a bit much higher commodity markets UM and

the valuation of the daughter in that sense. But everything is relative. So Perry obviously want to bring you in what do you I mean, like when you think about okay, the last two years or anything you're seeing now and obviously in the sweep of history, like do you see anything fund do you see regime change of sorts, whether you'd call it Breton which three or is it? Yeah, we have inflation that happens sometimes our commodities are scarce.

We commodities were expensive in the early two thousand's too, Like have we been here before? Um? Well, many people are trying to draw analogy between the present situation and the immediate poste um when there was inflation in the seventies and so forth, and when Nixon basically tried to say, you know, we we we don't want to be the top dollar anymore because it constrains us too much. UM. And I think those analogies are misplaced. UM. And also

don't draw the right lessons in the seventies. UM. I do take a longer historical perspective. UM. And you sort of in your introductory remarks you were saying, we've been here many times. The dollars you know, going away? Yes, okay, And I've just written a book basically about it. So about the construction of the dollar system. Um. After the death of Sterling, basically you could you could you could say, um, And it took a while before we were able to

reorganize the global trading system around around the dollar. And that's sort of what the Breton Woods meeting was there to basically acknowledge, like the future is going to be a dollar 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 seventy one

turned out in retrospect to be growing pains. That what happened after seventy one was not the end of the dollar system, but the offshoring of the dollar system UM and 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 of the dollar system

to the global South. UM. Really for the first time when when UM, the national champions in the Global South are able to borrow in dollar capital markets basically because interest rates are zero in the in the North UM. And so there's a win win here that the pension funds want to want to lend the money UM 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 which people said,

oh the dollars are gonner. You know, obviously it was like it was a crisis of the very core it emerged stronger than ever. Um. And uh 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, different view because I can take a longer view. I'm not I'm not I'm not working for credit squeeze. Um. And I've a couple of weeks versus a book every ten years. Yes, yes, the book every ten years. I

try to I try to. Uh, I try to write them more fast than that, but they do take they do take time. Um. The I think the thing that I would like to throw into the mix here is the pandemic. Okay, not you know, the war in Ukraine or tensions in Taiwan or something. But what came before that, which is two years of of extremely loose monetary policy throughout the entire world, involvement of the state. You know,

this was war finance, this was wartime, 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. Um. And that is a rocky road Okay. So that I would analogize all of this to like immediately after World War Two, you know, when um, the the reigns of the monetary system in the United States had been in the treasury, the FED. The Fed's job was simply to finance the

government whatever it took, you know. And if the 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. That's how pandemic finance worked, you know. And that work not just that way in our country, but in every country around around the world. That's how it worked. Okay. You may remember that just before the pandemic um there was an attempt to begin raining 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 have we were, We've been in a period of elasticity. Now we're moving into a period of discipline, and that period of discipline will re establish the dollar. Um I I believe that's that's what I think is happening. Actually, So just on this topic, and I'm kind of hoping

that you'll you'll channel Kindle Burger here. But what are the benefits of a dollar system outside of the US? I think everyone is fairly familiar with what the U S gots from it, But what are other countries, especially at a time when the U S is tightening monetary policy, when some economies, notably emerging markets, probably don't necessarily want to see a tightening of financial conditions. So I will give you Charlie's answer, Um, Charlie kimno Burger's answer. Everyone

called him Charlie, so I will call him Charlie. I call him Charlie throughout the book. And UM, I actually did know him as a matter of fact, and and and used to visit him. But but everyone called him Charlie even if they didn't know him the his 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. UM in the United States.

And what did the Federal Reserve system do united these disparate little regions into a par clearing area inside the United States. Okay, Um, 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 the and this is a big achievement. What Charlie wants to do starting in graduate school of

Columbia is do the same thing for the world. The logic of why it's a good thing to have one currency for for the whole country, okay, and part 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. Um. And that's what people get out of it is that it it makes it makes it easier to do trade, to do calculations, to do to 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 bi s appreciating that we really live in a unified world. This notion of separate nation states with separate currencies, this is something that was that was inherited in our minds from World War Two when when that system had all broken down. But that's not the world we live in now. It's a 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 and that's and that's US dollar monetary policy that 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 um and we're already seeing where the weak points are in the in the global system, and those are going to be managed in the next

couple of years. So 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, are already setting some commodities price outside of dollars or an increase in the commodities price outside of dollars, Like, what are going to be the costs to the world economy if your sort of vision

or your sort of characterization proves out. Yes, Well, perhaps before before I answered that question, I mean listening to Perry, you know, Charlie Kindleberger grew up in a certain period, right, which is you know, 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 where very basically have one hegement. Right, that's a unipolar world order and it has a currency

for it um. But I think everywhere I look today we basically have that unipolar world order being challenged. I mean, I wrote about this, so so we can we can 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 fex reserves.

From a financial perspective, You've had a week long blockade on an island in the South China Sea. And we are designing a blockade of of China from from a chip sufficiency perspective, not even sufficiency, but you know, be able to make chips with a SML machines, be able to upgrade machines that make memory chips. You know, that's the news about UM memory chip manufacturers with facilities in China.

The latest iteration is and video which makes AI chips, as as the experts of the media on chip matters. Uh no, So you basically have a very complex kind of chess game. I thought you're going to insinuate that the chips we're going to replace what I mean, it's problem again like but but but but the significance of this is that you know, the the E, C, N, Y and and everything. You know, China is about AI and there's a lot of AI infrastructure being done. It's

probably the one sovereign that you associate with AI. And so you know, the the end video, the video news is significant from that perspective. So you have these multiple blockades. Okay, So if the physical world, okay, is becoming fragmented, I don't think it's no longer appropriate to think about, you know, 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. Um, you know you you I didn't mention this before, but but you did ask like what markers am I looking for in terms of look, as I said, the invoicing of flows in different currencies in commodities is one thing. But also when you look

at the stocks of f X reserves, um. You know, the fact that you know, uh, China for example, is letting its treasury portfolio run down since the beginning of the war is another important little 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 um um. And so these are all you know, little bits of pieces that people follow for the next six months, twelve months, five years, and I

think the world is going to look very different. You know. The the I think the historical analog here is I remember, I mean I was, you know, trying to get an internship in Washington, d C. In the year two thousand. I was like writing emails from Hungary to Congressman. You know, China just got um admitted to the w t O,

and like, what the hell does this mean for the world. Well, you know, give eight years and you have three trillion dollars of treasuries, right, you know what is the next five You're going to look like I have no idea. But you know, if the weight at average maturity of these treasuries in fex reserve portfolios is like five years, I mean, the world could look very different, you know,

five five years from now. So so again it's it's it's a it's a glacial progress, but it's it's it's a progress, and I think it's 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. So Perry, just on that reserves point, I mean, it is true if you look at FX reserves over the past decade or beyond, actually you can

see central banks diversifying. So renmand B reserves have gone up, reserves of 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? Like, what is the rationale for doing that? Um, well, diversification but there but this is small potatoes. The numbers you're talking about are are are really quite small. Um the evidence of dollar of dollar dominance is is still

pretty overwhelming. I think now Sultan says, wait five years, so maybe, but wait five years, other things could happen to you know that. Um, it's not it's not obvious to me that all of the long that the trend is your friend. UM in this, in in this, in this regard. Um. Well, remember that wars are hot houses in many ways. UM. And I mean now I'm talking about the pandemic, um, not not not Ukraine. UM. A

lot of things have changed in the pandemic. UM. A lot of a lot 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. It's changed. There's a lot of dislocation that has happened. Okay, and that's what you're seeing in supply chains as. But it's also even local inside the United States, you know people. Um, And that hasn't yet sort of all settled down by

any means. Remember what happened in World War Two. There were separate spheres, right, and the and the effect was that Germany, you know, invented a lot of whole chemical industry, you know, and we developed atomic energy and we know all there was a lot of stuff developed in World War Two that we then rode that wave basically for the next thirty years, the thirty glorious years. You know, we're building on those developments. So it's not obvious to

me that we're entering into a gloomy period. Deglobalization. We haven't used that word yet here, but Salton uses it all the time in his writing, and he is a I wouldn't say fan advocate. He sees de globalization. Um, I'm not sure. I'm not sure. Um. I I think China has its own problems, Russia has its own problems. Um. Where he mentions in some of his his I don't know where you get this factor wide, but that's sort of because of our of the us UH anti immigrant

two million jobs have left those and the people have left. Okay, 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. But that's going to take a little while. UM. So we the whole supply chain stuff was all disrupted by the pandemic. Um 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 to gemin a okay, is not because the US, because it's a uniportly world. In fact, the US doesn't really want to do this. You know, this is a public good the US is providing the rest of the world.

So that I wanted to ask about this because you mentioned, okay that if you look at past crisis 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 exorbitant privilege, Like it's a good thing, but like there's also a talk that especially pre pandemic, when a lot of the issues were like in sufficient demand, and there was an argument of the dollar is too strong, and that's probably like is there good for the US that these series of crises where the dollar keeps getting stronger? So maybe not?

Maybe not. You know that it is 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 really, you know, it rebounds on on the

United States. The reason I titled my book Money and Empire is precisely because of this, to to really highlight the kind of contradiction between our political reality, which is nation states, okay, and our monetary reality, which is global okay. And how do you manage that? Um? It's it is

managed right now by central bank cooperation mainly UM. And the backstop of the global system is this intricate system of central bank backstops, liquidity swaps and so forth, and these new female repo facilities and things that extend it further to the global south. UM. But it's 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 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 they're ratcheting up in their own time. UM. And that's that's what is 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 geo strategic stuff says

maybe not. Yes, I mean I would say that you know that the data being the the issuer custodian of the reserve currency, I guess it comes with responsibilities and you know, backagenes to if you will, But let me let me just have a comment about you know, the dollar bouncing back every stronger again like my formative years were, I don't know, and onward right, that's when I took my first macro class and so yes, the Asian financial crisis was was a formative period um for me at least.

And then that was the first financial crisis that I followed as a as a as a student, first year macro student. And so yes, that was a crisis where it was an offshore dollar crisis, uh, and a certain part of the world got weaker, um and then the Washington Consensus came in and kind of cleaned things up. And so that was one episode. You know, oh eight was a domestic crisis. That's when we get into the QE habits. Uh. Then you know we've been having um,

you know, smaller crisis since then. I mean, we we we'll be discussed. You know, the treasury cash futures crisis, the report crisis, what do we do about that? Um? 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 a liquid to be able to provide all those credit lines to all this corporation. If something like that would happen, today 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, um is a crisis that we haven't had since the nineteen seventies. So I think there are UM, I don't know. It feels to me like that the dollar crisis are coming closer and closer to home. UM. 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 and I think and I think that we are learning that you know, can the Fed uh deliver price stability just by hiking interest rates? Or are there kind of forces in the real world, whether it's uh, you know, a shortage of cheap goods, cheap energy, labor, all these things, you know, is it is it? Is it as easy as raising interest rates from zero to five percent to slow inflation down? Is it as easy as as drinking um the balance

ship to display intation? Let me let me just offer one one observation, which is that, you know, everybody likes to talk about the fact that, well, maybe we are in the bond bear market and we have you know, lall Street is so young. Nobody has seen rising interest rates, so we don't know how to trade it. A version of that, a version of that is that we haven't seen an inflation episode, so we don't know how to

think about inflation. Um, we have seen something like what happened in the seventies, but we haven't seen anything that you know, happened a hundred years ago, nineteen fourteen, nineteen forty and 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 be thinking about crisis because we had crisis of basis, you know, a pack de x rate and a market rate across currency basis a library OI as a cash treasury future basis um triple a c d os versus triple A 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, this crisis of the price level, this inflation crisis, is a

very different ball game. It's not as simple as raising grades because the world doesn't work like that. It's not as simple as doing QT because the world doesn't work like that. UM, so I think this is a real test, and so and so I think this is a this is a very particular moment in time. You know this, This notion that you know the fat can deliver two percent 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. Ten. Your treasure is 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 two is not attainable. Um and maybe four at some point is the new target, or maybe if you're just going to be bouncing around between five and ten, I don't know. I have a point of clarification,

so when we're talking about that, breton Wood's three. So part of the dollar decline idea is geopolitical people are worried that their reserves are going to 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 where 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 how does that aspect of it fit in with the dollar demise idea? Let's think about this step by step. Okay, so peakuro dollar yes or no? Inflection point? Yes or no? I mean that's how it starts. My sense would be yes, speak your dollar, because if if um 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'm trying to understand this is Okay, Um, I work as a strategist, you know, I have 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. You know, cash treasuries versus OI s. What's the demand And as I said on this on on on on the podcast before, um and let's just take two countries. Okay, let's take let's take Russia and let's take China. Okay, what is the incentive of Russia, for example, to recycle revenues from commodity sales in G seven uh into G seven assets zero? Right,

I mean you're invoicing things in different currencies. Take note, because that was a five hundred billion dollars stash of liquidity that went into the FIC swap market, that went at some point into US treasuries. Uh. And again you know, look at 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, um. And I think this is 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. Um uh. This is going to change flows on the margin, and we are going to be treading and kind of living with those um um uh every day as you guys write about it, as I write about it, as as as others in the audience. Um traded. So yes, the US is commodity is self sufficient. Other parts of the world are not. Um. But again, as I said, I think the thing that we need to factor in is basically what this means for for the price of commodities, which are priced in

US dollars. So you can have a devaluation of the of the of the global euro dollar in terms of commodities, and then you know what that means in terms of euro yen uh euro dollar dollar yen exchange rates um weaker verry um. You know, obviously Russia and China continuing to trade more for obvious reasons, perhaps some invoicing of commodities not in dollars. Maybe that's picking up. Like intuitively, it seems like the Redman b should become a bigger deal.

And China is a big trading partner, and apparently it seems likely that there are going to be some countries for whom it's a partnership gets even stronger. Like it's that makes sense to me, Like, what the why wouldn't the Redman be become a much more significant global currency just because China is a big country and a big trading partner. Um, well, they're a big country and they produce a lot of stuff and that's right. Um, And I think, and and they buy a lot of stuff.

But that's not what makes for a global currency. Um. I think what we're the notion that inflation is some sign that people are are are revulsed by the dollar. You know that this is about depreciation of the dollar there, that that's sort of in the air here. Um, I think that's just not right. That's not what's driving inflation.

What's driving inflation are these wartime dislocations. Um, we had a pandemic in which we all shifted to two goods, and then the pandemic is over, we shifted back to services and the people to produce those services that all moved out of 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. Um, And I as was let me let me, let me, 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 to put some discipline into the system. He wanted to to to tighten as soon as he could after the pandemic.

He didn't think there was going to 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 means that's positive for the dollar. That's strengthening the dollar. So I think that the politics are working in favor of of a stronger dollar in

the future, not not the other way around. Um. And as long as the the anchoring of the of the of the of the new price level, UM happens and it doesn't get uh, it doesn't get un anchored. But I don't see any particular particular sign that that's happened yet. So so this is very interesting because I send some talking past each other. So the dollar can be weak and strong at the same time. This is like cubits,

you know, like zero and one. You know, the dollar can be very very strong versus other g seven currencies which we see right. But again I think 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, ring rounds of inflation.

So let me let me again just just emphasize. I mean, there's two views in the market that this is a massive reopening and that we over the fiscal and monetary stimulus, and that's a view. I'm sure that is part of the picture. But 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 the theme that

is going to be with us for the next five years. Um, the way we should think about inflation is not that, you know, there's all this bad stuff that happened over the past twelve months. It pushed the price level higher, and the base effects are going to take care of, you know, 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 twelve months

to five years. And again when you read the news, and I started to read the news, where like I just pick up the paper and I look at commodities, I look at the war, I look at text stuff, you know, Chris Miller, Chip War, that type of stuff, and 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 Do I think that bad stuff can happen

in in the 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 phase of rising gas and electricity prices, Yes, it's fanning shortages. Um. Do I see risks in 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 game partly because we have released a lot of oil from the spr and we know that as every infantry that's finite. And then we also know that the physical market where oil gets produced is super tight. You know, you can't tramp stuff up. There is still a view in the market which I believe that that commodity prices, especially for you know, oil gas. I mean it 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 but you know, so I think I think this is basically the world that you live in, UM. And so this 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 there's risks like that, and so from that perspective, I don't think that inflation is

is transitor is. Certainly the reopening bit might be like a one time thing, but but I think the geopolitical aspects are just getting more complicated and more ski area. I would say so result 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. Yes, Um, I think I think a central banks 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 QUEI portfolio balanced gennel um to push the demand kurd outward because there's all this cheap stuff that's coming and what we are afraid of is deflation. Okay, so we've had fifteen years of that and then all of a sudden the supply curves have recotiate 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 linuage supply, And I think J. Powell kind of articulated something similar to that that we've been um. You know, we are going to need a period of below trend growth. So

think about this as nominal GDP targeting and reverse. Whereas you know, we wanted to catch up with the pre pre pre GFC trend, now we need to kind of catch down to where where the realities of supplied. Its second um again like 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 heading in a in

a positive territory. Then two things come from this um, 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. Um. You know, So before the virus, now we're going to you know, find you know, supply chains falling apart or something like that. You know, so the whole rearmed, reshore, restock,

continue on with energy transition. That's going to require a lot of capital. Uh, 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 um. But it's a very different yield curve control. It's it's it's it's not yield curve control to keep rates at one percent so that you use asset prices up. It's basically to make sure that yields

don't go through the roof. But there is a backstop to that's 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. Um. You know, if this is you know, if you have World War three, that's what people do. Hopefully this is just going to be an economic war where we have to retool and and and finance that

whole process. But I definitely see the central bank kind of be engaged in the bond market and provide a yield curve cap but with much higher interest rates. And then in the case of you know, Japan, Europe, the UK, um, I mean you have a currency crisis in those places. Um. And and again this is back back to Perry's earlier uh point 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 recurrency 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 your basic commodities. So I think we can go to the 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 seg but well one we had both of you on in March, so like right at the beginning of the pandemic, but a few months before that we had spoken to you because that's when there was all the questions about like running out of reserves or insufficient. So we just got a question about this, which is like, you know, obviously you just mentioned quantitative tightening. This is kind of a simple question. Almost seems like it almost seems old fashioned. But how

much space do you think they have? And is it gonna be another thing where they have to cut it short early because of the amount of reserves demanded in the system. Is a question from me about you, But I'll start with you. Are we saying who the questions are from? I don't know. Yeah, this is ok. You can if you send it, If you send a message and you don't want your name from Cameron dire I sort of stole okay questions. Qut. I don't think that there's a lot of room I don't think that there's

a lot of room to do QUT. First, I think this is going to be ultimately a question about demand for treasuries, not not the systems a bit into the 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. Um. 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 QTV we had so far, First of all, that the amounts were not that big on the sixty billion dollars per month, um. You know, the market just absorbed assuming that we are at peak hawkishness. So all

you're gonna do is raelly 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 if you have further um, you know, I mean Europe is in a very different uh 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

for inflation elsewhere? So again, if 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 three and a half but rather say five percent, Again, Powell didn't say anything that should make us think that that's not possible. You know, inflation is the target. He'd did not mentioned stocks and as surprises 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 gonna say, So what you don't say has just as much meaning as what you say. But you know, it doesn't seem to care too much about the growth impact of hikes. He does not mention as surprises one bit. It's inflation singular mission,

that's what we're going to do. So if we are going to go in a in a in a in a market period where um, we're going to hike the five or six percent, 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. My new QT at the moment is accelerating.

So that's another that that's that's another issue. And and again UM, I think, um, just as we were talking about this, you know, financial blockades of of FX reserves, financial energy blockade of Europe, a blockade of Taiwan, a blockade of chips, um China, can you know, make things more dynamic as we do QT. Because the only the weird thing to me about QTS that everybody thinks about it, Well,

this is what the FED is going to do. Well, okay, fine, but that's the parable and minimum because others are also in a position where you can also start selling treasures and not show up at auctions. At a hundred billion a month that the private sector will have to absorb instead of the FED is just a minimum, right because other central banks can can step away from the market. So basically this means that you know, cash treasuries can cheapen quite a bit relative to our I has swap

spreads can tighten. There's a certain appetites um uh that that the FET is going to have to tolerate that. But if if that becomes an issue, I think I think the days of QT are numbered. 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 limiting. The FIT is a show a 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, Um, otherwise no one will do it. That's what That's what

would make quantitative tapering QT um uh possible. Um. Remember why how quantity of 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. Um. And I think that So, so mostly that's about prices, right, That's that's about is

it is it profitable to to do this? Zoltan was sort of saying that with these business spreads, and he has all these fancy words, but in the in the big picture, you're shifting the shadow bank from the public sector to the to the private sector. Is what you're is what you're trying to do, um and I do think it's possible for interest rates to go um 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 a lot of push saying, oh, we still have negative real rates and you're never going to get control of inflation. Well, I already raise some questions about whether your measure of inflation, whether this really is inflation or something. Higher nomin rates mean that buyers have to pay more money, okay, and that that is a clearing that's a settlement constraint, you know.

So it will put if you raise interest rates by by a couple of percentage points, the outstanding debt is going to get re repriced and and the borrowers are going to be under a lot more pressure and they're gonna have to do something about that. They're going to have to pay their their debt instead of doing something else. So there will be a there will and that's not just in the United States. That's that's globally, and the

vulnerable borrowers are going to go to the wall. And this is this is the period that we're in, Okay, so that the quantities will shrink there too because there will be defaults. Um. What happened to crypto is just the first. I'm actually really surprised we haven't had a crypto question. I was just throwing that red meat for you. Let me let me add something to cute I think.

I think it's very important, UM. And it just remind everyone since the year two thousand, UM, there has always been a big central bank on the margin buying a lot of treasuries. Okay. From two thousand to two thousand and eight it was the PBOC and then they flatlined. Okay, from O eight onwards it was the FED. When the Fed stopped, UM, the e c B and the b O J started to do QUI. But then all the yen and euros they produced on an effex the you know,

the pension funds in those jurisdictions. UM swapped those euros and yen for dollars to buy UH treasury securities. UM. So what is the moral of this is that it's either the PBOC doing a lot of liquidity injection buy treasuries or the FED is doing liquidity injection by buying treasuries or other central banks for 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. A big central bank liquidity impulse is always there to be a marginal buyer. So now okay we talk about this. You know, China is not buying anymore, had you cause your way to byme and the curve is flat, so it doesn't pay anymore to to to buy anything on an f FX heach basis anymore. The

end is close to one fifty. I mean, we are now at levels at which you can expect either FEX interventions out of Japan, which is going to involve you know, selling treasury securities on the margin, or you are going to adjust the guilty curve pact to basically adjust UM. If that happens, that doesn't mean anything good for UH for for duration. And then basically when we think about the FED doing QT are basically saying that against this twenty year history of who buys treasuries on the margin,

the FX help buyer can step away. Uh, you know, China can step away, and the fat can step away and it's all going to be okay. We're 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 ten to five, ten to five, ten to fifteen, or if it's going to cost at ten what. I'm quite certain obviously it's not going to

crash back down to two pc. 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 premier. M Um, I have a good question from Alex Howett. He asks this is for Perry specifically. Um, you know, we all understand that it is possible for an international monetary system to be served. We saw that before 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? Um, Well, the that's a good question, maybe when I haven't put a lot of energy into because that's it seems pretty far from that. But so let me go back to what what was it that undermined sterling? Okay? Um? And it was there was two things. Okay, There was that the Bank of England UM could 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, Um it can happen that there would be a crisis and the FED is is a little overwhelmed. If everyone refused to help the FED, Okay, this would be a problem, but it would be a problem for everybody. It was a problem for the United States that the United States did not help the Bank of England UM. As a matter of fact, we had a global depression if you if you notice, and and some people thought that was mainly a U S thing, you know, but it was. It was actually very very

damaging to the United States. So I think that the cooperation of policy, co operation of the major central banks in the global north um is is vital and if that breaks down, all bets are off. Can I question? So I don't know the answer to this. But but I wonder, um, but your take is on this? I get this question a lot. I don't know what to answer to it. So first, fiat money as a project is fairly young. It's let post Nixon, from what I understand. So what do you think about that? Number one? And

I think that's not right, okay, And and and number two. Um, if the fundamental building block of fiat money is an ability to deliver price stability, and if for for that reason there's some risk to that notion, what happens to fiat money? Well, I you may have noticed I never used the word fiat money, Okay. Um. 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 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, freak 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 or what ever. Um. And when we got rid of it didn't have that. It didn't have that much

when we when we got rid of that sort of rule. Um, we're now fine. So when you say fiat, okay, what you're what 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 of a of a bank somewhere, okay, And there's assets that are on the other side of the balance sheet. To UM, 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. Um is never going to be a good money. Inside money is the money that you that that makes the world go around. It's credit money, okay, And so you need credit, okay in order to make that go Um credit worthiness and the best credit is money. So I have a question. It's sort of a push back to Sultan's push back on that topic just now.

But um, it's from John Farley. If bretton Wood's three comes to pass, how does pegging of currencies to commodities other than gold actually tame commodity volatility? If the underlying issue of resource shortages and things like that remain. Okay, which is which is 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

packed 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 as used as as we talked about this before. You know, you can't print oil to heat or meat 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

try ball 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 was a particular kind of solution medicine, which is that we need to have a lot of fex reserves and as a prudent country, we need to cover two years worth of chronic and deficits with the results.

This is all pre dollars spotline 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 as I said in my pieces, if you go back you read it carefully. What I said, not what you know was interpreted, was that 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 read I need whatever stuff for my you know, I need to build chip foundries and all these things. Right, So, so basically, what is a reserve? The notion of it is changing. Okay, maybe some countries have way too many dollar liquidity and not enough, not enough commodity reserves. So I think over the next five years, as these countries are sitting there looking at

their at their pile of of of of treasuries. You know, 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 repot

and liquid it and sell to raise dollars to buy what? Okay, Should it be treasury securities when you know inflation is running structurally at eight percent and treasury coupons pay I don't know, four or five percent if in real terms those treasuries five year tenure 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 two hundred billion dollar 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 where need 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 Breton wood Street is about. It's not establishing a link to gold, It's not establishing a link to a basket of commodities. It's not too unseats 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 too and to kind of 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 and I think that the best approach to look at Breton Wood Street is to just kind of look at these things and whether they are happening. Again, Like I can, I can list you a number of headlines. You know, India instructing its states to cover three years worth of residential and industrial Uh call needs to basically head itself for the winter whatever. Uh you know, Uh, I mean, you know the news like this are are

are all over the place. But I think that this team is happening and and and it's going to grow in size and over the next five years. When we look at fex 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 evoice things in, but also other currencies.

And if that happens to half a trillion and 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 the price level of commodities, and faction and all these things. And to me, that's what Breton Bostree is. Maybe it's a bad term and it kind of sends you off. I mean, Adam two said that it's a bad term. So maybe it's a bad term, but because it pushes you down to think

about things a certain way. But I think these are the practical implications of everything that you're talking about. So I 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. UM that, for geopolitical reasons, maybe be a good idea to be a little more independent, you know, have your energy, energy security and so forth. All of

those things seemed to me right. I just don't think they have any implications for the future of the dollar. Um that there. I think that people will be accumulating, you know, more more reserves of commodity reason and 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. Um. I think you're still

gonna have treasure. So there it's it's not either, it's not it's not as substitute, okay, um, And I don't I don't see any of that as any threat to the dollar. Well, here's a question, and it's very closely fits with this from Janic's Blue Line futures uh one store. One project that's been in the work 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. And we see the creation of these terminals, and we know that you know, Europe would take all the gas it could possibly get right now, is Henry Hub that price? And you know, we know that 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 MOBAL benchmark if everyone wants US gas, and does that then have a cementing role in terms of the dollars status as once again back to invoicing

the dollar US, that's the price etcetera. Yeah, I mean I would say, sure, why not. I mean, we're heading in that direction, right, um um, guests from here, guests guests from there. Um. I guess I don't know what the answer there is. Maybe I asked Perry up, I passed the hot potato onto you. But I mean, in my mind, like the US became the daughter became the reserve currency in large part because of the petrol Dotter trade.

But that was basically a situation where the US had to important pay others with US dollars with yeah, yeah, but but but I guess if you start to export commodities yourself and then so so you're no longer you're you're running at it from a from a cronic and surplus perspective, not a cronic and 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 command. I don't know what Henry Hubby is Henry Hubby is. It is a natural guess I should answer this benchmark in Louisiana. No, no, but but but but I guess the question is if the US is a net commodity

exporter oiling as instead of a net commodity importer. Right, So the whole petrol dollar idea was they don't have the they don't have the oil, but we have the dollars, so we pay for the oil the dollars, and then others recycled those dollars in treasury. No, I don't think

if it's a curne on surplus question. Now, the petrol dollar was was really about the US banking system recycling the surpluses that were being accumulated by the oil exporters um into lending to the 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 U. S dollar. That that was the that that was that part that I talked about the off shoing of the US dollar as a after after the collapse of Breton

Woods in seventy one. That mechanism was quite important for getting those balances really up, really fast, um. And it was definitely pushed by the US government. They were trying to solve a problem big imbalances, you know, global This isn't the first time we're having today, w we have global imbalances. There were those big imbalances there, um, and if there had been better cooperation, you know, but in

the global North, probably it wouldn't have happened. If if, if the European countries had helped each other use their use their gas reserves. You know, they could have fought off, okay, but they did not. They were each each one was was running for themselves. And so this is what this is what happened, Um that it was solved by the

private market. I think through this is there's a more general lesson here, um, which is when the central bank is doing a lot okay, it's bad sign you you really you know, the industrial policy, which is what you're pushing with your rearm restock, rewire, re sure okay, industrial policy, Um, that doesn't necessarily involve the simple bank and doing much

of anything. You know. This is this, this is a this is a job for the for for the treasuring, for for the fiscal side of of the government and all the 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 quee. You know, they're not They're not having they're not trying to stimulate the economy. I think one thing we learned is that, you know, Killey as a as a way of stimulate the economy

doesn't really work very well. As a way of catching the falling NiFe. It works great well, Joe. I really hate to ask this question, um, but we've gone on for you know, an hour and twenty minutes. Shall we leave it there? Let's leave it there. We could go on for another hour and a half, but I think we gotta wrap. So big thank you to our guests. We really could have got. Follow Peri Merrily on Twitter at pre Meryling and check out his book if you're

in the UK. It's not for sale here. Charles Pekin Burger in the dollar system, Salton, I don't know if you lurk secretly on Twitter, but I guess if you want to follow him, maybe become a become a credit sweet client. That's probably a big thanks to our producer Kerman Rodriguez and Dash Bennett helping you uys put it together. And I guess that's it. We'll leave it there. Thanks for listening. Thanks for coming to Heret