Saturday, July 15, 2023

July 3: "Zoltan Pozsar Explains the Coming Monetary ‘Divorce’"

From Bloomberg's Odd Lots - Joe Weisenthal, the hardest working man in show business financial journalism and the brains of the operation, Tracy Alloway.July 3:

The former Credit Suisse strategist founds his own firm to capitalize on a shifting global financial system.

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

Key insights from the pod:
Zoltan reveals his next move — 2:06
The meaning of Ex Uno Plures — 2:31
Is the Bretton Woods III thesis playing out? Plus a new angle on CBDCs— 5:19
Are big macro stories actionable for investostors? — 15:26
Changes in structural demand for US Treasuries — 24:13
The role of commodities financing in Bretton Woods III — 27:21
Thoughts on the recent banking drama — 33:36
Strength of the banking system now — 39:51
CBDCs and central banks a the new shadow banks — 44:02

[Introductory comments and then:]

Zoltan: (02:06)
Well, the next step is I have founded my own macroeconomic consultancy. The name of the firm is Ex Uno Plures. And I will be providing research to institutional investors and consult institutional investors about the plumbing, as I always have.
Joe: (02:25)
Okay. Many questions. Well, let's just start simple. What does Ex Uno Plures mean?
Zoltan: (02:31)
Ex Uno Plures is the opposite of “e pluribus unum,” which is this little motto that we can find on a great seal of the United States and on the dollar bill. It means in English, “out of one, many.”

It's meant to capture two ideas. The first idea is, you know, my retrospective on what I've been doing for a strategist for a decade is basically anticipating moments when prices fall apart in funding and rates markets. So the basic idea is that most of the time things are straight on top of each other, you know, the interest rate structure is orderly. And then when something bad happens, whether it's panic or a pandemic or a balance sheet constraint or liquidity constraint, prices fall apart. So out of one price you are dealing with many prices. And so that's basically the bread and butter of what a rate strategist and a rates trader is doing, anticipating those moments and being on the right side of those moments.

And then the other idea is that, you know, global macro as such, I think it grew up as a concept and an asset class, if you will, in a unipolar moment where globalization was moving forward, the dollar was the undisputed global hegemonic currency. And so we were all kind of trading the global dollar cycle.

And going forward, as we discussed this in the context of Bretton Woods III, that's no longer going to be the case. So it's kind of capturing the zeitgeist in that, you know, China is trying to extract itself from the Western financial system, much like the Western real economy is trying to extract itself out of supply chains that are running through China.

And so we are, I think, at the beginning of this era, the next five to 10 years at least, where we are going to go through this monetary divorce. And you know, the dollar’s hegemony is going to be challenged by some geo-financial moves that China is [doing]. So out of one dominant reserve currency, we'll have a world where we'll have many.
Joe: (04:36)
That's a great name.
Tracy: (04:38)
So, you know, you mentioned moments in macro and I think last year when you released that Bretton Woods III thesis that you talked about on the show and wrote a number of research notes about, it definitely demarcated a thing that seemed to be, you know, floating out there in people's minds. This idea that maybe finally some things were changing around dollar hegemony as you just mentioned. Talk to us about that original thesis a little bit more and whether or not you think it's been borne out over the course of the last, I guess, 12 to 15 months or so.
Zoltan: (05:19)
I think the concept is very healthy and it's alive. I personally see more and more signs that some of these themes that we have discussed on that first show when we talked about Bretton Woods III are coming to fruition.

And also in the conversation with Perry, I think we did a quick temperature check on the idea. And the conclusion I had there was that, you know, Bretton Woods III is a healthy baby boy, so to speak. So it's growing and developing rapidly.

Look. A couple of things to frame that. My answer to that question is, I think it's becoming very obvious that when you talk to policy circles and investors in the West, I think the primary focus is on how do we, so to speak, de-risk supply chains that are running through China? How do we become more, you know, self-sufficient in terms of rare earths, all the capital goods we need for energy transition? Chips and so on and so forth.

And so the focus in the West is on making sure that the real economy is decoupled from the East, so to speak. And when you speak to market participants and policymakers in the East, the primary focus there — because they have all the supply chains and so they are in control of that part of the equation there — the primary focus is on how do you extract yourself from the Western financial system and how do you de-risk this relationship that you have financially with the US dollar and Western financial institutions and financial centers in general.

And I would say that since we last spoke about this topic, there have been a number of news headlines, you know, readouts from state visits, what have you, where things like the renminbi invoicing of commodities is moving ahead. We are reading about more and more stories where natural gas deals and oil deals are invoiced in renminbi and not the US dollar.

I have not talked about this aspect of Bretton Woods III, but I kind of uncovered the new aspect of it, which is the whole central bank digital currency topic and how all that fits into Bretton Woods III. And you know, when you start digging in that domain, I think you uncover several things that are kind of eye-opening.

So let me just offer one. For example, you know, the real economy analog again is, you know, in the US for example, we don't allow Huawei to build cell phone towers for obvious reasons. You know, there is a risk of eavesdropping and espionage. And you know, the central bank digital currencies are basically the same story. I have been kind of cursorily following CBDCs, but I couldn't really fit it into an overall macro picture as to what are CBDCs about.

But you know, if you think about it, China has been quite busy trying to internationalize the renminbi and use it more for trade settlement purposes since the middle of the last decade. So around 2015 is when they started and then that process somehow stalled. And I think the reason why that process stalled is that they recognize that it's pointless to internationalize their currency through a Western financial system. Through London, through New York and through the balance sheets of Western financial institutions, when you basically do not control that network of institutions that your currency is running through.

For you to do something like that, you basically need a full new correspondent banking system. Okay. And so, you know, this is also the time when Russia annexed Ukraine, sort of financial sanctions became a much more dominant topic in the financial press. So I think that was a wakeup call for China, that if they want to indeed internationalize the renminbi, they need to start from scratch and they need to build a de novo financial network that they control.
And so this is also the time when CBDCs has become a hot topic. You know, CBDCs started in China, you know, the eCNY. And the way I think about CBDCs is, and developments in that space today, is that you basically need to imagine a world where five, 10 years from now we are going to have the renminbi that's far more internationally used than today, but the settlement of international RMB transactions are going to happen on the balance sheets of central banks. So instead of having a network of correspondent banks, we should be thinking about a network of correspondent central banks.

And a world where you have a number of different countries and each of those different countries have their banking systems using the local currency. But when country A wants to trade with country B, you know, Thailand with China for example, the FX needs of those two local banking systems are going to be met by dealings between two central banks.

And so when you reimagine a system like this, it's basically a state to state and a central bank to central bank network that is completely independent of Western financial centers and the dollar. So there's a ton of development — we can devote some time later in the show to talk about this — so there's a ton of development on that front.

And also the context here is that if you want to imagine an alternative to a dollar based system, you know, the single most important thing that makes the dollar so important is that 90% of FX transactions any given day in the world use the US dollar as one leg of the transaction. Okay. So basically, that's because we inherited the system where if you want to settle, you know, if you want to settle a transaction between someone in Hungary and Thailand, okay, the way you would do that today is you would sell your Hungarian forint, buy euros, sell the euro and buy the dollar and sell the US dollar, and buy back.

So that's basically three different currency pairs, three market-makers, three bid-ask spreads. It’s incredibly inefficient. But again, if you go back to this concept of correspondent central banks as opposed to correspondent banks, this transaction just can settle between the local Hungarian banking system and local Thai banking system. You have to do central banks act as dealers of last resort in the FX markets.

And so that's the last, you know, piece I want to mention in this part, which is that, you know, in the West we are talking about this dealer of last resort thing a lot. And the context in which we talk about dealer of last resort in the West and in the US case specifically, is that we need a dealer of last resort for the Treasury market because the Treasury market is not liquid. That's where the focus is.

Of course, we need the dealer of last resort in the repo market and the FX market. But I think it's also time to start thinking about dealers of first resorts in terms of FX market-making for the global East and South, which is the central bank digital currency, central bank correspondent system that I'm describing.....


What's somebody named Zoltan know about the Hungarian forint? It would be like asking a guy named Árpád about paprika. Oh, wait...