@CreditSuisse strategist tells Bloomberg's Odd Lots podcast that the U.S. dollar has reached a critical inflection point.
Russia’s invasion of Ukraine could mark the beginning of a turning point for the U.S. dollar, according to money market guru Zoltan Pozsar.
Speaking on Bloomberg’s Odd Lots podcast, the global head of short-term interest rate strategy at Credit Suisse AG noted that wars tend to turn into major junctures for global currencies, and with Russia losing access to its foreign currency reserves, a message has been sent to all countries that they can’t count on these money stashes to actually be theirs in the event of tension. As such, it may make less and less sense for global reserve managers to hold dollars for safety, given that they could be taken away right when they’re most needed.
Russia isn’t the first country to get this lesson in recent months. The Biden administration’s move to seize Afghanistan’s cash assets and prevent their access by the Taliban was another recent signal that reserves can be frozen.
Pozsar argues that this recognition may encourage central banks to diversify away from the dollar, or try to re-anchor their currencies to assets that are less susceptible to influence from U.S. or European governments. As such, recent tensions could usher in a new monetary order in which countries are far less interconnected through international bank accounts and reserves.
Different kinds of money
At issue are the types of money held by governments, which Pozsar divides into two categories: inside money and outside money. Most of the world’s money is inside money, meaning it’s money that you’re owed. The number you see on your bank account doesn’t represent some kind of cash deposit in a vault somewhere. It’s simply a promise from the bank to you that it will pay you that amount should you need it. The same concept applies at the sovereign scale.
Outside money, on the other hand, isn’t someone else’s liability. For an individual, that could be physical cash or even Bitcoin. For a country, like in Russia’s case, that could be gold. As of January, Russia held over $120 billion worth of gold, more than its actual dollar-denominated holdings. Now, given the loss of access to its dollars and euros, gold is effectively its primary holding. And Pozsar sees a potential for the ruble to become de facto, or literally, backed by gold.
“Most FX reserves that exist in the world today are all forms of inside money, i.e. they are the liabilities of someone,” Pozsar said on Odd Lots. “Whether you hold the sovereign debt of a country, or you keep a deposit at a central bank of a foreign country, or if you keep deposits at Western financial institutions, these are all forms of inside money that you don't control. Someone owes it to you. And these things can be sanctioned.”
“If a central bank is in a situation like this and the currency’s under pressure, would it ever come to having to re-anchor your currency to something? Like gold? I think these are all questions that should be top of mind,” he added. “I don't know if it'll come to that, but if things get worse, you could basically re-anchor the ruble to a pile of gold because you need an anchor in situations like this.”
Pozsar’s not alone in his warnings about the dollar's vulnerability, with others seeing the same forces at play in the fate of the currency’s reserve status. Dylan Grice, the former Societe Generale strategist who’s since founded Calderwood Capital, described the recent moves as a “weaponization” of money. “You only get to play the card once,” he tweeted. “China will make it a priority to need no USD before going for Taiwan. It’s a turning point in monetary history.”
Steven Englander, a Managing Director at Standard Chartered Bank, echoed the idea.
“It’s a very long-term thing, so nothing immediate or even say on a two- to three-year basis, but if what we are seeing is a demonstration of the power of economic and financial force, the logical response if there is a risk that you will be on the receiving end is to see what you can do to immunize yourself,” he said. “Weirdly enough there may be a second response – what essentials is your potential economic foe importing from you and what can you do to have the maximum impact on their economy and least on yours.”
Delinking from the dollar
To some extent, Russia has already recognized and reacted to the ‘inside-outside money’ framework described by Pozsar, working in recent years to reduce its holdings of U.S. dollar-denominated assets — including selling off all of its U.S. Treasuries in 2018 according to official data — and amassing its hefty pile of shiny rocks.
“In a competitive game, where your currency holdings are issued by an adversary and can be frozen or vaporized at that adversary’s discretion… Global trade and the accumulation of FX reserves makes … less sense.”
For years, the fate of dollar dominance has been a popular and contentious source of discussion with repeated warnings and terrible predictions about the currency’s demise. If anything, however, what’s surprised people is the growing strength of the greenback. At the 2019 Jackson Hole Symposium, then-Bank of England-chief Mark Carney delivered a speech on the problematic strength of the dollar, and the fact that while the U.S. accounted for a smaller and smaller share of the global economy, the dollar itself is as significant as when the Bretton Woods arrangement collapsed.
There were also numerous warnings about the dollar’s demise in the aftermath of the 2008 financial crisis, but if anything that period saw a strengthened greenback as the Federal Reserve took on an even more globalized role in helping to bail out the world’s financial systems.
There’s another problem facing countries with large amounts of reserves that no longer want to hold them in dollar-denominated assets: They’ll need to find something else to buy, and the pool of potential suitable assets could be limited. While gold is the obvious candidate, there’s only so much of it available (one reason why the rise of central banks’ collective dollar holdings has easily surpassed those of gold in recent years).
Others have floated the idea of Asian currencies or bonds. However, these markets are far smaller and much less liquid than U.S. or European ones, making it difficult for countries like Russia or China to stash their cash in these assets.
Still, it's hard to compete with the dollar, said Cameron Crise, a macro strategist for Bloomberg. “It’s not clear that anyone other than the United States has both the ability and the will to ‘manufacture’ safe assets and sell them to foreigners as the bedrock of a global financial system.”