🎧PODCAST NOTES
Zoltan Pozsar and Perry Mehrling debate Bretton Woods 3.0
I have become a huge fan of podcasts. I listen to them when driving, travelling, walking around or doing a low-intensity workout. In order to capture the core ideas and takeaways of each conversation, I started taking notes while listening to them. As most of the podcasts which provide valuable information and insights are usually pretty lengthy, reading only my notes can be helpful to get an overview of the topics covered in the episodes.
The latest podcast I listened to is
“Zoltan Pozsar and Perry Mehrling debate Bretton Woods 3.0”
on Bloomberg’s Odd Lots podcast.
I hope you enjoy these notes.
Podcast’s main topic, guests and their background:
Credit Suisse strategist Zoltan Pozsar argues that we are witnessing the birth of a new currency regime that he calls "Bretton Woods 3.0". In this new era, the centrality of the dollar will fade, in favor of commodities or commodity-backed currencies. But not everyone is convinced. Perry Mehrling, a professor at Boston University goes strongly against this thesis.
Here are my 6 key takeaways:
on inflation:
There is still an ongoing debate on whether the current inflationary period is a cyclical phenomenon caused mostly by the pandemic stimulus or rather a more structural problem of the changing geopolitical landscape and de-globalization.
Pozsar: there are 2 views in the market regarding the roots of inflation.
it is a reopening phenomenon after we have overdone the stimulus (he believes that this is part of the problem, but not the major one)
the economic war and geopolitical tensions messing up supply chains which can stay for longer making inflation long-lasting (he believes that this aspect is still underappreciated and not priced in by the market)
Depending on which scenario will play out, the next 5 years are about whether the dollar will stay strong vs commodities or commodity prices go through the roof and we are going to deal with recurring rounds of inflation. He believes that inflation is not transitory (certainly the reopening can be a one-time factor in the inflation issue) but the geopolitical aspects are getting scarier —and those account for the bigger part in inflation.
on the role of the dollar:
Mehrling: the dollar is a project which was created to unify the monetary system in a country which was divided (the USA). According to Mehrling the globalization of the dollar system was led by the same motivation: to unify the world on a global scale by having one currency —this makes trade and financial transactions easier and more efficient.
Pozsar: from an exchange rate perspective, the dollar versus the euro or the yen is always going to be strong in the present context. But Pozsar sees a dollar weakness against commodities: the dollar is getting devalued versus commodities because the political West is exposed to the political East in commodities (mostly in terms of energy). Given the evolving geopolitical tension between those two blocks this exposure can grow even bigger and commodity prices can go much higher from current levels.
According to Mehrling, what happened in 1971 (the end of the dollar-gold peg) was not the end of the dollar system but a growth pain that made the dollar offshore: extension of the dollar system to the global South and East, so they could start borrowing money.
Pozsar believes that this unipolar, dollar-dominated world is being challenged now. We can clearly see the fragmentation of the physical world (the blockade of Europe from an energy perspective, the blockade of Taiwan from a geopolitical perspective, the blockade of a big pile of foreign exchange reserves from a financial perspective, the blockade of China from a chip sufficiency perspective etc.). If the physical world is becoming fragmented we can not take the world as a unified whole anymore.
Mehrling doesn’t see the trend of a de-globalization. He do believes that supply chains truly got disrupted by the pandemic and even more by geopolitical events but it will get reconstructed, this is not a pivot point to shift to a non-dollar based system.
on the role of the pandemic in the inflation equation:
Mehrling believes that inflation is the result of 2 years of extremely loose monetary policy which can be considered as a “war finance”. After 2 years of war finance now we are shifting back to “peace finance”, similarly to the period after World War II. During times of war finance the Federal Reserve’s role was only to finance the government: if the government wanted to issue bonds and no one wanted to buy them the FED bought them —that’s how war finance works and that’s also how pandemic finance worked too. Before the outbreak of the pandemic there were attempts to bring discipline back into the system after a period of a decade of loose and elastic monetary policy. What the FED is doing now with the rate hikes is the reestablishment of a more disciplinary system which will reestablish the role of the dollar too.
Mehrling: lot of things has changed during the pandemic, lot of technologies had been developed, we changed how we live, how we work, a lots of dislocation happened. Like during the WW2, when new technologies and trends had been created which dominated the following decades, the same happened during the pandemic and that could boost the economy for the coming decades like it did after WW2. For Mehrling it is not obvious that we are entering into a gloomy period — disagrees with Pozsar.
on quantitative tightening:
Merling: quantitative tightening (QT) is the shrinking of the FEDs (Federal Reserve) balance sheet and moving it to the private sector. Quantitative easing (QE) is the opposite when the FED buys up bonds and treasuries etc.
Pozsar: since 2000 there has always been a big central bank buying a lot of treasuries: 2000-2008 PBOC (People’s Bank of China), 2008 onwards it was the FED, after the FED stopped the ECB (European Central Bank) and BOJ (Bank of Japan) started doing QE. The moral of this is that big central banks are doing a lot of liquidity injection by buying treasuries —current expectation is that a big central bank is always gonna be a marginal buyer. But today the developing tendency shows that China is not buying anymore, the FED is not buying anymore, Japan is not buying anymore — so we basically expect the private sector to step in and do this job and absorb the treasuries that they push back to the market with QT at times when inflation is uncertain. Now we can watch whether the FED can maintain price stability solely by raising interest rates but maybe there are other external factors like cheap commodities that have an influence on keeping inflation low, which the FED can not control.
Pozsar doesn’t think that there is a lot of room to do QT. We are going from a period where the market is a big believer of the idea of “peak inflation, peak hawkishness, and all we gonna do from here is rally” to a world where inflation hasn’t peaked, the energy crisis Europe is having is not only going to have a liquidity event around it but also gonna impact industries and supply chains.
on the role of the Federal Reserve and central banks:
Pozsar thinks that the job of central banks will evolve with time. They have gone from being a central bank generating wealth via QE to push the demand curve outward because the cheap stuff that was coming and because we were afraid of deflation —we had 15 years of that policy. Then all of a sudden the supply side got disrupted: cheap commodities, cheap labor, cheap goods are now gone— inflation is coming in large part from that, that is the impulse. To deal with it we have to generate a shift down in the demand side so that things are more inline with supply. J. Powell articulated that too: we are going to need a longer period of below trend growth —nominal GDP targeting in reverse. The underlying environment in which we are going to be is inflationary so the job of central banks is to make sure that real interest rates are not falling, not going more negative.
on what does this all mean and how it will affect the system:
Pozsar: Central banks can print money and control the yield curve but they can not print wheat or gas or oil. So countries will have to maintain a structurally bigger allocation to energy, gold and other resources while they are cheap before the economic war escalates even further —which can easily happen. The Bretton Woods 3.0 theory is about that tendency, it is not about establishing a link to gold or to a basket of commodities, it is not about to change the dollar for something else. But the commodity market is going to become a place where things are not exclusively priced in dollar but in other currencies too. Pozsar notes that foreign countries’ dollar reserves are shrinking or flattening —there is a peak in eurodollar. The market is starting to invoice commodities in currencies other than the USD. This will have an implication on commodity prices, inflation, the level of interest rates and on swap spreads. Countries getting heavily discounted in Russian commodities: China and India pay in renminbi and rupees and certain European countries stopped paying for Russian energy in euros and started using rouble. Commodities not equal dollars anymore.
Mehrling: agrees with the core idea of this tendency but doesn’t see it as a threat to the hegemony of the dollar.
Conclusion:
In a previous issue, I introduced you to the basic ideas of Zoltan Pozsar’s concept of a new, commodity-centered monetary system which you can read here.
Mehrling is very ignorant about possibly being wrong about the future dominance of the dollar-based monetary system. He simply doesn’t see a scenario (an alarming one) where the dollar could lose its power and the role of a reserve currency. This gets reflected in the way he is expressing himself during the show by talking quite cynical and deliberately trying to undermine the validity of Pozsar’s approach. He is clearly defending the status quo. On the other hand, Pozsar makes some good arguments based on data which challenges the mainstream view represented by the market.
I find the concept of a commodity-based monetary system very interesting, and it aligns with the thesis of Ray Dalio about the changing world order, which I respect a lot.
Although Mehrling is a respected person in his field of expertise, analyzing the market and writing about it is always easier than actually putting your money where your mouth is. When trying to choose a side to follow, I always stick to people who have a reliable track record and decent skin in the game they are playing. And Ray Dalio with Bridgewater certainly has as they not only successfully forecasted the 2008 financial crisis but also traded it and made money for their clients while other investors and experts were bleeding out. The theory of a Bretton Woods 3.0 represented by Pozsar fits in the mid-term macro forecasts of Bridgewater and the long-term concept of The Changing World Order where the current global leader (the US and its biggest powerhouse, the currency) is being challenged by China as a competitor — this rivalry usually leads to a change in the status quo.