A Credite Suisse analyst predicts a new world order of money. In it, raw materials play a greater role, and the balance of power shifts to the east. The West, on the other hand, expects inflation and crises.
Zoltan Pozsar, an analyst at Credite Suisse, predicts that the Ukraine crisis will lead to a new world order of money. Bretton Woods III, as he calls it, will be “based on currencies of the East” backed by commodities. The new order will weaken the Eurodollar system and drive inflation in the West.
The short paper explains how some mechanisms of the financial markets will lead to what many suspect and fear: an epochal financial crisis that will change the global monetary system forever.
As in 1973 – only “considerably worse”
Commodities and their “financialization” are at the heart of the crisis we are currently slipping into. Financialization means the tendency for the financial markets to overlay and dominate the real markets. The turnover in trading futures, options and derivatives based on commodities is many times higher than trading in the commodities themselves.
Commodities are “collateral” in finance: They are collateral that you can deposit to get money. Through loans, through derivatives, through leverage. The raw material is money. It is “external money”: money that gets its value from “outside” – from raw materials that are subject to it.
The classic coin money was an external money. So were the dollars in the Bretton Woods system, since they were backed by gold. In 1971, when Nixon went gold-backing, the dollar became, for the most part, “inside money”: money created from “inside” – out of debt. The net of inside money is always zero. This system – Bretton Woods II – currently prevails. Still.
Because the moment the West decided to freeze Russia’s currency reserves, the foundations of Bretton Woods II crumbled. The transition to Bretton Woods III begins.
“The Perfect Storm”
The sanctions against Russia are provoking a crisis in the commodity markets. That’s obvious. The world, predicts Pozsar, is heading into a repeat of the 1973 oil price shock – albeit “much worse” this time.
The extent of the crisis can be seen on the financial markets. There the prices lose their parity. Under normal circumstances, commodity prices have a small spread: they are pretty much the same across different exchanges. When they diverge too much, traders skim off arbitrage – buying cheap here and selling high there at the same time. The prices are equal. The market works.
However, the war and sanctions have made the market dysfunctional: “There are Russian commodities whose prices are collapsing, and there are non-Russian commodities whose prices are skyrocketing.” Russia is being disconnected from demand, the West from supply.
Because of this turbulence, the demand for “cash” is increasing: for liquid dollars or euros that the banks lend. Because when prices are dancing, traders need liquidity. To take positions, futures and options, and to be liquid to service margin calls. “Everyone in the commodity world experiences a perfect storm […] It’s never good. But that is exactly what happens when the West sanctions the largest percentage of raw materials.”
Because commodities are money, and when the price of money tears apart, that’s not a good sign.
In short: “It’s scary”
Pozsar predicts that this crisis, which has not even really begun, will not be like 1973. It will be more painful for the financial markets. Because: “The commodity market is much more financialized and leveraged today than it was during the OPEC crisis in 1973. And the Russian supply crisis is much larger, much broader and much more correlated.” In short: “It’s scary.”
A marrow that tight is like a minefield. What happens when collateral for margin calls runs dry? What happens to the futures exchanges when the players collapse? Is the Commodity Derivatives Market the Pink Elephant Nobody Wants to Talk About? For an analyst trying to be somehow rational, the environment is a nightmare, with something lurking around every corner that could trigger a crisis of the century.
It’s 2008 again. Only more serious. epoch-making.
Who has the doorstop?
There is only one way to cut the knot: by allowing commodity prices to get back to par. But who can? Who has the doorstop?
Western banks are eliminated. They cannot – or are not allowed to – because their governments have imposed sanctions. You can only try to clean up the mess and keep the inflation of the resource base as low as possible. Commodity traders, such as the Swiss company Glencore, who actually ensure price stability, cannot do this either because they need the banks. When commodity prices are unstable and go up, it’s like a bottom: it pushes everything up.
All actors in the West have their hands tied. Therefore, Pozsar sees only one party that can move the doorstop: the Chinese central bank PBoC.
The PBoC’s options – and the price the West is paying for them
The PBoC has two “geo-strategic” i.e. “geo-financial” options to close the price gap:
First, the PBoC can sell government bonds to pay for cargo ships and through them take advantage of the discount on Russian commodities. If I understand correctly – the wording is a bit nebulous – it would either act as a commodity trader itself or support Chinese commodity traders. Although this would damage long-term interest rates for government bonds, it would stabilize the commodity base. It would also give the PBoC control over inflation. Because whoever controls the collateral controls the money.
Second, the PBoC can expand the money supply to buy Russian commodities. This would boost the money supply in China, but keep commodity prices – and everything else – stable. China would thus create a euro-renminbi market and challenge the hegemony of the eurodollar market.
Either option would fuel inflation in the West. Both lead to a recession and rising interest rates. It’s going to hurt either way. According to Pozsar, anyone who believes that the West can design sanctions in a way that maximizes Russia’s pain but minimizes the financial risks for the West also believes in unicorns.
Bretton Woods III begins
The coming inflation in the West is written in capital letters on every wall. “The crisis is like nothing we have seen since President Nixon detached the dollar from gold in 1971, ending the era of commodity-backed money.” When the current crisis is over and the war is over, ” the US dollar should be much weaker and, on the other hand, the renminbi should be much stronger as it is backed by a basket of commodities.”
Bretton Woods I was backed by gold. Bretton Woods II by “inside money”. Bretton Woods III, which is now beginning, again through “foreign money”: through gold and other commodities. Money will never be the same again and the global balance of power is shifting east.
And Bitcoin? Bitcoin, Pozsar whispers, is very likely to benefit from all of this. As long as he still exists.
