From Credit Suisse, March 31:
Credit Suisse research has always prided itself on thought leadership. In today’s environment, where we have to navigate a global conflict between great powers and an unfolding crisis of commodities, thought leadership is more important than ever. The current environment is perhaps more complex than the crises of 1997, 2008, or 2020, for the problem is not only nominal (FX pegs, par, or the great overdraft, respectively), but also real: commodities are real resources (food, energy, metals), and resource inequality cannot be addressed by QE...
...you can print money, but not oil to heat or wheat to eat.
Wars also upend the dominance of currencies and serve as a doula to the birth of new monetary systems. What Deutsche Bank’s Bretton Woods II framework was to the first decade of the new century, and what QE and Basel III then were to the second (post-GFC) decade of the new century, we believe that our Bretton Woods III framework will be to the third decade of the new century......and potentially beyond.
If we are right, our framework will be the right framework to think about how to trade interest rates in coming years: inflation will be higher; the level of rates will be higher too; demand for commodity reserves will be higher, which will naturally replace demand for FX reserves (Treasuries and other G7 claims); demand for dollars will be lower too as more trade will be done in other currencies; and structurally then, the negative cross-currency basis (the dollar premium) will naturally fade away and potentially become a positive cross-currency basis.
Credit Suisse and the House View will be here to guide you through all this, and with that, let’s begin to hash out the details of our Bretton Woods III framework.In today’s dispatch we will expand on Perry Mehrling’s “four prices of money” framework. We have used this framework in our last dispatch from March 7th to show that in every major crisis since 1997, one of the four prices of money came into play, and, by extension, every major crisis is also a crisis of money.
To remind the reader, in Perry Mehrling’s framework, the four prices of money are:
(1) Par
(2) Interest
(3) Foreign exchange
(4) Price level
Par (parity) is the one-for-one price of different types of money: for banks, reserves are convertible into currency at par, and for all non-banks, deposits at one bank are convertible into deposits at another at par, and deposits at banks are convertible into currency at par. Parity between these forms of money ensures that transactions take place seamlessly today. Parity broke in 2008. Had the Fed not stepped in, we could not have been able to transact normally.
Interest is the price of future money (money tomorrow versus money today). Interest is the price at which you part with money for a period of time, that is, the price at which you part with liquidity. Depending on who you lend to, interest rates are different: fed funds is a rate of interest on interbank loans, repo is a rate of interest on loans versus collateral, FX swap implied yields are rates of interest on loans involving the swap of two different currencies. Interest rates depend on the nature of the transaction (unsecured or secured), the quality of the borrower, and the term of the loan. An overnight interest rate (EFFR) is always the anchor, and a swap curve indexed to an overnight anchor (an OIS curve) is the base against which all other interest rates are expressed (the EFFR-SOFR basis for repos and the OIS-OIS basis for FX swaps). Interest is about lending, lending uses balance sheet, and balance sheet costs, together with the type of lending, determine bases. Interest rates basically consist of an OIS part and layers of bases on top of OIS – the proverbial money market cake (sponge, cream, sponge, cream) that we often refer to. STIR traders trade either the OIS curve (the number of hikes up or down), or bases around OIS driven by one-off events like money market fund reform or corporate tax reform, or left-field events like the onset of Covid-19 in March 2020. Had the Fed not stepped in in March 2020, corporations would not have been able to draw on their credit lines and the Treasury couldn’t have funded itself.
Foreign exchange is the price of foreign money – the price of the U.S. dollar versus other currencies, which can be floating or fixed, or managed in between. Fixed exchange rates broke in several countries in Southeast Asia in 1997. Had the IMF not stepped in, we would have had a banking crisis in New York.
Price level is the price of commodities in terms of money. Commodities mean fossil fuels, metals, grains, and rare earths, and through these commodities, the price of everything imaginable. Commodity prices determine food and energy inflation and also core goods inflation. The price level was an afterthought for the past 25 years. Unlike crises related to par, interest (bases), or FX rates, there were no major price-level related crises over the past 25 years. If anything, the problem was persistently low inflation, which central banks tried to counter very hard through aggressive balance sheet policies (QE) with limited success.
Now consider this:....
....MUCH MORE (11 page PDF)
HT: FT Alphaville's Further Reading post
