Why the Desire to Move Away From the Dollar Is Getting Real

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1:24Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway. And I'm Joe Weisenthal. Joe, do you remember what we were doing this time last year? What? No. Oh, no, no, I have no idea. That feels like ages ago. So no, I have no idea. We were actually talking to Zoltan Pozar about his vision of a Bretton Woods 3. Do you remember that? Okay. Yes. Yes, absolutely. I do remember that conversation very specifically. Setting aside that sort of Bretton Woods 3 framework specifically, I do think like overall, like he sort of anticipated extremely well a lot of the discussions that people are having like over the course of the next year.

2:10And so in some respects, I think that's held up well. Right. So there were a lot of different themes in that note, including this idea of more of an emphasis on real assets or commodities. But one of the big ideas that was in there was this theme of a more multipolar world and possible challenges to U.S. hegemony in the financial system, including the dollar's very unique role in that system. And while it is true that the dollar spent most of the past year being really strong, and we put out a couple episodes on that, I think, we have seen efforts at de-dollarization, or at least we've seen a lot of discussion of de-dollarization.

2:54That has really increased in the same time period. Yeah, there's sort of a few interesting dimensions here. So for one, of course, like price does what it's going to do in the short term. And ultimately, I don't think like price is the ultimate arbiter, but, you know, late last year or middle of last year, the dollar rallied a lot. The other thing is, you know, you get these headlines about de-dollarization or the rise of the U.N. or some barrel of oil somewhere in the world was not priced in dollars. Everyone starts to flip out about whatever that means. And on the one hand, OK, that's interesting.

3:29But on the other hand, like, again, you and I, like how many times have we heard this story? People love talking about this possibility. Yeah. Yeah. Oh, suddenly some benchmark barrel of oil somewhere is going to be priced at something and that's the end of dollar hegemony. But I will say like there's a couple of things like I don't want to say it's different. Well, why I think it's still worth having this conversation because obviously a lot of things have changed. You know, one of my theses that I talk a lot about all the time is how like the 2020s are sort of the inverse 2010s. And so I do think to some extent it's a good time to revisit our assumptions.

4:07And when you do start to see, you know, expanding China trade and so forth, the talk of decoupling and the rising role of the UN, I think it is worth having that conversation again, even if sometimes it seems like some of these end of the dollar stories are a little bit overcooked. Or premature. Or premature. On that note, one of the things that has been happening is we've heard a lot of noise from the BRICS group of countries. So that's Brazil, Russia, India, China, and South Africa about possibly creating some sort of alternative to the dollar. So we really need to dive into the de-dollarization story from an emerging markets perspective.

4:47And who better to do that with than with Paul McNamara? He's an investment director over at GAM. We've had him on the show before, and we are going to do another deep dive with him now. Can't wait. Paul, thanks so much for coming back on All Thoughts. Thanks very much for having me. So maybe just to begin with, give us the state of play when it comes to de-dollarization talks, because I know there have been all these little bits and pieces over the past year or so, but what has jumped out at you the most? I think the thing that we're focused on is we've seen very big current account surpluses, especially in the oil exporters.

5:25So Saudi Arabia in particular, I mean, Russia is obviously another story. I mean, the surpluses in China are not as big as they've been. But what's been interesting is that the Saudis in particular, and I think there's some evidence that Abu Dhabi as well, have not been pushing money straight into US treasuries or US securities markets in particular, But sort of treasuries, I mean, there's been a lot of talk in terms of China for a long time. You know, China has run the Belt and Road program, has clearly been that there is a general drive for those companies which continue to run these big external surpluses.

6:02They're clearly trying to branch out significantly away from, well, let's just stick it in medium duration treasuries. you know, and if they were really adventurous into listed US equities into a more globally diversified basket. It's not just about sanctions and what happened to Russia's reserves in the in the aftermath of the attack on Ukraine. But clearly, that's given it fresh impetus. So, okay, so this is interesting. There is something going on. Like, I think it sounds like from your answer. And as Tracy and I said in the beginning, and I'm sure you've heard it for many years in your long and illustrious career, this, oh, the dollar is over, the dollar is over.

6:42And usually it is sort of overcooked. But just based on even just your preliminary answer, it sounds like there is something going on, that maybe there is some impulse to try something new. I think there is. And I think you mentioned Zoltan Posa, this idea of a multipolar world. I mean, we have moved away from, you know, the US being by far the globally dominant economy to China, You know, the Chinese economy is now about the same size as the US. So, I mean, clearly there's got to be some sort of rebalancing in terms of finance to match the economic dominance and the political movement that goes with it.

7:20Absolutely. I mean, the two people you've always hear spoken about in this context is obviously number one is Zoltan. Number two would be Michael Pettis and his co-author, Matthew Klein, who would make the point that, OK, if you've got these big surpluses being generated, then they have to end up somewhere else. And the only place they can end up is the US because the US is the only economic block which is generating these big deficits to soak up the surpluses. historically I think it's not clear that it's as simple as that but I think as long as the policy in China relies the whole framework of economic policy in China relies on running very big external surpluses they invest a lot but they save even more those excess savings you know they have to end up somewhere and it is going to be very difficult to put them somewhere else the question that comes up is historically, you know, difficult is not the same as impossible.

8:18You know, that before the US dollar, you know, the you had the sterling zone, and okay, it was linked to gold. But you did have a reserve currency, which wasn't the dissaver of last resort. You know, so I mean, there are two things which are not the same, which I think have been confused, which is one, the rise of China being an economy of similar importance to the US, which I think is indisputable. And two, does China or the global non-Western bloc have as many options if they don't want to change the policy mix, which has been very reliant on running very large external surpluses? So I definitely want to get into more of the challenges of moving away from treasuries and into other assets.

8:59But before we do that, you mentioned the idea that there are some emerging market economies that have been buying fewer treasuries recently. And I guess my question is, what is driving that? And is it the case that they're definitely trying to move away from U.S. exposure? Or is it the case that maybe in an environment of high rates and inflation and general uncertainty, maybe it doesn't make a lot of sense to buy U.S. Treasuries at that particular moment? There's a bunch of things. I mean, we have more assertive politics in pretty much every large country. We talk a lot about the BRICS, which I think is problematic in this context because sort of Russia and South Africa and Brazil really don't matter that much in a global context, whereas, for example, Saudi Arabia, which has very nearly a trillion dollars of assets abroad, clearly does.

9:55They have different reasons, but if it's MBS in Saudi Arabia, if it's Modi in India, as you go to countries, there is more and more pushback against US hegemony, however you want to describe it. I think politics is part of it. The other is, one, you probably want to diversify a bit more generally. Two, you're very dependent on Fed policy. Last year was a horrible year for pretty much any asset. I mean, clearly, you might want to look a bit beyond that. You know, so that, you know, there's, I wouldn't say it's just one reason, but it really is striking, you know, that, for example, just how big the surplus is, especially in the OPEC countries have been over the last year, and how little we've seen a tick up, you know, not just in holdings of treasuries, but in, you know, specifically US securities themselves, you know, I mean, part of the problem is that it really is quite hard to put large amounts of money, you end up putting it in stuff like the Vision Fund or Credit Suisse or, you know, stuff like that.

10:55All the soft bank investments, right. Oh, you already said Vision Fund, right. Yeah, yeah. I mean, there's a whole rabbit hole here and it's always tricky, but, you know, it's very difficult. There aren't a lot of places to put large chunks of money like this, and especially where you could expect you won't be the dominant investor, which, yes, It brings some perks, but it also brings some, you know, some very significant problems with it as well. You could build like, what is it, like a hundred mile long city in the middle of the desert and have it be a blockchain capital of the universe. Anyway, I'm digressing a little bit.

11:30I want to actually go back to the comment you made about assertive politics, because we could talk economics. We could talk about the rise of trade with China, but obviously a lot of some of these impulses are going to come from domestic political choices. What is going on? Like, what are you seeing specifically? And what is the sort of common thread across multiple countries that you say is driving this sort of like shift in political or global political consideration? I think the sanctions applied to Russia after, you know, after the invasion of Ukraine stand out, because it's usually spoken about in the context of a possible Chinese attack on Taiwan.

12:10But you go around, pretty much every country has reasonably severe disagreements with the US, with the West in various ways. There is a huge amount of resentment, which really is not something I should be trying to diagnose the politics. But I think, you know, just in sheer practical terms, that at least 300 billion, and we think probably a decent chunk more of Russian money was put beyond the use of the Russians simply because it was placed within the US financial system. I think that's given a lot of urgency, you know, even to countries, you know, who might not expect to have a major dispute with the US the way that the Russians have.

12:53It really does become then a question of, well, you know, how do we protect this savings part?

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14:39Visit buyatoyota.com for a great deal on an efficient Toyota today. Vehicle's projected resale value is specific to the 2025 model year. For more information, visit kellybluebookskbb.com. Toyota, let's go places. You know, there is that argument and you touched on it already a little bit, but there is an argument to be made that maybe for reasons of financial stability, this would make sense. So, you know, if you're an emerging market economy, maybe you don't want your country to be tied too closely to what the U.S. is doing because maybe the U.S. is raising rates at a time when you really need financial conditions to loosen.

15:21And we've spoken with Hyun Sung Shin at the Bank for International Settlements a lot about this. He's done a lot of research on the topic. How valid are those concerns and how do you disaggregate the sort of financial conditions, diversification argument versus the political sanctions, concerns about future financial control type thing? I mean it comes back to the old quote I mean I think this is from the 70s that you know a US policymaker said you know it's our currency and your problem that you know that we've seen that US financial conditions just affect anywhere else if you look at I mean you have to disaggregate that we've had a big burst of inflation everywhere and interest rates would have gone up everywhere this has not been the Fed chasing everybody else's interest rates around the last year or so But higher US rates have led to a stronger dollar.

16:12And a stronger dollar does mean significantly tighter financial conditions for anyone who borrows in dollars, the cost of repaying that debt. And this is, I think, a lot of what people are talking about when they say that they want independence from the dollar. Whether you necessarily want the renminbi instead, and if you think the renminbi is going to be much easier, that's another question. But yeah, as long as the borrowing currency of choice. And, you know, and I kind of agree with Joe that, you know, just because somebody invoices a barrel of awesome gas that they bought from Abu Dhabi for dollars and then they sell it to somebody else for renminbi, I'm not sure that's quite the game changer it's being pitched to be.

16:52I mean, you can send me a gas bill in Bitcoin and I will turn my pounds into Bitcoin and I will pay the gas bill. And whoever is, you know, whoever sells me that gas will sell the Bitcoin for sterling. And I'm not really sure that's quite the game changer it's being pitched at. What does matter is, you know, especially these surplus countries. One, are they going to continue to run these surpluses? and to what extent can they immunise themselves from US political influence to the extent that they're still holding a lot of their assets in dollars. My view is, and the impact on markets will be, is it's very, very difficult because the surpluses coming out of China are a fraction of what they were.

17:32I mean, they're down to about 2.5 % of GDP now when they were up at 10 around the time of the financial crisis. But if the renminbi is going to become a reserve currency, then effectively it becomes impossible for China to run surpluses. So at a minimum, you're closing off possible policy options in the future. And really, I mean, does the rest of the world really want to start nominating its debt in that of a currency where they might suddenly start moving to huge surpluses versus the rest of the world? and then that's going to impact the monetary policy everywhere else on earth. Yeah, I mean, it's not simple is never a satisfactory answer.

18:16But I think, you know, the problems are it's very easy to say that these countries want to be independent of US, of the US dollar. But in almost every case, that's going to involve policy choices, which are going to have difficult policy ramifications. I mean, we got here for a reason. You know, speaking of policy choices, however, and you talk about the sort of assertiveness of some various nations. There's also policy choices happening in the U.S. It appears, I mean, arguably the U.S. itself is becoming more inward looking, and arguably it started under Trump, but there seems to be a lot of continuity with Biden in terms of some of these domestic investments, whether it's semiconductors, whether it's energy, some of these investments, particularly antagonizing allies or friends in Europe who feel we're sort of like pulling away the supply chain from them.

19:12Like how much of this is also like not just a story about US trading partners turning away from the US or turning away from sort of dollar assets, but a US decision to sort of focus more inward and, you know, rely less on the rest of the world. I, yeah, I don't really see that. I mean, the, whatever your objections to the US as a Hedgerman, you know, try somebody else. I mean, the specific example that sticks with me is the dollar swap lines, which were extended to, you know, the big Western ally, Central Bank, you know, and specifically the Western allies that, you know, they weren't extended to certain other countries which could have benefited from them.

19:50While the US does make it clear that monetary policy is not run for the benefit of anybody but Americans, you know, that we had a big push in the 97 Asian crisis and then 98, everybody's saying, well, you know, you can't keep hiking because that's going to screw things up for everybody else, to which the US response was rightly, well, too bad, you know, US monetary policy, you know, the Fed has no mandate to look after anybody who isn't an American. But, you know, the swap lines were absolutely critical in protecting the rest of the world, especially during 2008. But, you know, but also during COVID, we saw we saw the lines rolled out in the past that, you know, however much, you know, the rest of us might, you know, complain or be unkind about, you know, about Donald Trump or anybody else.

20:39The US has always, you know, go back to the Marshall Plan or whatever. But, you know, the U.S. has always at a minimum had a defensible case that of enlightened self-interest. And, you know, and I think there are question marks about whether, you know, the alternatives, whether it's gold, whether it's the renminbi. And let's be honest, those are the only two, you know, the rubles no use to anyone, you know, or Bitcoin or whatever mad scheme you have that, you know, that there are policymakers in the U.S. who are making choices which I think benefit the rest of the world. And it's not clear that the alternatives would be adequate for the rest of us.

21:18So just to kind of crystallize this idea in our minds, walk us through what would need to happen in order to make some other types of reserve assets more viable options than U.S. Treasuries. Like what would make a South African bond a proper replacement for a U.S. tenure? Or what would make, I don't know, a Brazilian bond a replacement? Well, I mean, those two countries, I think, you're making absolute maximum difficulty because... I got to ask the hard questions. Both of those economies rise and fall with commodity prices. You know, Brazil, it's iron ore and soybeans. South Africa, sort of platinum, palladium in particular, also coal, that, you know, as commodity prices rise and fall, that dictates everything for those economies.

22:09It even dictates the credit cycle because Brazil or South Africa are in a much better position to cut interest rates when the external balances are healthy. And commodity prices are overwhelmingly driven by China. I mean, especially Brazil. I think Brazil, you know, comes second after Australia in terms of economies sort of most driven by the Chinese property cycle. So, you know, I don't see scope there. I mean, what you're looking at are, well, one is alternatives to US Treasuries sort of within US financial markets. But, you know, a US investment grade corporate bond doesn't really trade that much.

22:43I mean, an investment grade emerging market debt bond in dollars, you know, does tend to trade very much off the Treasury market. and to the extent it doesn't very much of US dollar denominated corporate credit. It's very, very difficult. I mean, the question is also, is China, and again, it's China, it's not anyone else, maybe the Saudis to a certain extent, doing this in a context where they're continuing to use the external surplus, they're continuing to have massive excess savings for domestic policy means, because deploying 10 % of GDP is a colossally more difficult task than deploying, you know, 2 % of GDP, which is where they are at the moment.

23:21You can probably slip 2 % of GDP into emerging markets and venture capital and Europe and whatever else. You can't put 10 % of GDP. I mean, the problem with emerging markets is that they're allocated as a special asset class to people like me because they are different. The legal rules are very difficult. The idea that a minority shareholder should get some benefit from the success of a company in Russia is really regarded as ludicrous by most, you know, by most people of influence within Russia. It's, you know, if you can go through the history, if you, you know, you look at UCOS, you look at the Contacte, you know, sort of, I mean, Russia is a particularly bad example, but it's not out there.

24:07You can look at what's going on with Adani in India. You know, the returns on a long horizon from emerging market investments have been absolutely dismal for a long time. And I think that institutional backdrop, that does narrow the field for profitable investments. So is there a supply of, not necessarily liquid, because there's nothing remotely as liquid as treasuries, but investable with a reasonable chance of positive economic returns in the medium term that isn't plugged into the US or its allies? I think there's quite a big question mark over that. I mean, that's not to say that you can't do what Turkey is doing and sell influence.

24:47And I think that there's a lot of money going into places like Turkey to buy influence rather than for purely economic reasons. I want to ask you a question about China, but can you explain what you mean by influence? What's going on in Turkey? Yeah, I mean, Turkey's an interesting one because you're never sure if this is purely driven by what the current Turkish administration wants to do purely, you know, for its own reasons or whether they're doing it. The Turks are running a very big external deficit. They've pegged the lira effectively to the US dollar for about nine months now, even as they're running sort of double digit credit growth, growing external surplus.

25:25And yet, at the same time, their gross foreign exchange reserves are growing. It's pretty clear that there's Saudi and Qatari money, probably some Abu Dhabi money in as well. At the same time, Turkey is a major conduit for sanctions-busting gas flows out of Russia. They've been instrumental in holding out the expansion of NATO. At the same time, the NATO airbase in Inchilic is still open. And it's it there's a question of whether this is just Turkish pre-electoral politics or whether that there are, you know, they're you they're relying on or they're they're being paid off. Sounds awfully crude.

26:04But, you know, there there are financial flows which which are playing part of that calculation. You know, we've seen it with with Hungary, the promise of cheap gas that doesn't seem seem to have been fulfilled. But, you know, as you go around, even stuff like, you know, Honduras recently took itself off the very short list of countries which recognized Taiwan as an independent country. You know, that's not a huge amount of money in Chinese terms, but certainly there were financial flows involved there. Since you mentioned China there, and I wanted to ask a broader follow up on it, which is that, okay, like Tracy asked the really hard question, the almost impossible question of what does the world look like?

26:44We're a Brazilian or a 10 year or a South African 10 year as a replacement for a treasury. But like, let's ask the less hard question of like, okay, what would it entail for the RMB or Chinese debt to start really becoming a meaningful global reserve asset? What would be the policy choice that China would have to make domestically or the tradeoff that China would have to make beyond just trading globally and expanding its trade position in order for its financial assets to play that role globally? The Chinese would have to stop creating such vast surpluses, which means that all the various incentives in place to create massive excess saving in China or some of them are going to have to be relaxed.

27:29If you're a Chinese person, there's a very weak social safety net. Until recently, you were only allowed one child. So to protect yourself for the future, you had to make much higher levels of financial saving than pretty much anyone else in the world. You know, financial repression, you can't invest abroad. That whole apparatus for creating, you know, savings, 40, 50 percent of GDP has to be at the very least wound back. You probably need to relax capital controls materially. You need to reframe economic policy very seriously. I mean, the thing that makes China so important to the global financial system means that it's actually not a great destination for capital because, you know, to the extent that the Chinese want to get rid of these excess savings, they certainly don't want excess Saudi or Indian or anybody else's savings because that just makes the task that much more difficult.