Zoltan Pozsar may be one of the most prominent macroeconomic analysts in the past decade. Since 2019, his "War Quintet" series of research reports, particularly the "Bretton Woods System III" theoretical framework, has rapidly made this former Credit Suisse analyst a star in the global macro realm. He also served as a senior advisor to the U.S. Treasury, providing consulting for the Debt Management Office and the Office of Financial Research. In 2023, he founded an independent research company after leaving UBS.
This article is a transcript of an interview conducted in July 2023 for a podcast, mainly involving topics such as currency, gold, and the new economic order. Especially against the backdrop of the current "tariff storm," it holds significant reference value for understanding the current situation and judging future trends.
Ronnie Stöferle: Zoltan, thank you very much for taking the time for this interview. It’s a great pleasure. With me is my dear friend Niko Jilch, who is a very well-known podcaster.
Niko Gierke: Hi, Zoltan, nice to meet you. I've been reading all your stuff lately.
Zoltan Posar: Nice to meet you both. Thank you for the invitation.
Ronnie Stoeffler: Niko has been responsible for the de-dollarization chapter in our In Gold We Trust report for many years. This discussion will revolve around that topic. But there are many things to talk about now.
Zoltan, you come from Hungary, and I would like to ask you a personal question. After World War II, Hungary's pengő suffered the highest recorded hyperinflation rate in human history. The hyperinflation in Hungary was so out of control that at one point prices doubled in about 15 hours, while the pengő lost about 90% of its value in roughly 4 days. Like the Germans and Austrians, do you think Hungarians are particularly concerned about inflation due to their experience with hyperinflation in history? Are they especially interested in the topic of gold? What are your thoughts on this?
Zoltan Pozsar: I heard many stories about the pengő from my grandmother. But you know, since then we have had the forint in Hungary, and I think many instances of hyperinflation are about standing on the wrong side of the outcome of World War II. I don't think the ordinary people of Hungary or the decision-making circles still think based on the post-World War II experiences of the pengő or base policy decisions on them. However, you could ask the same question to anyone in Germany, and you would get the same answer. This is a special phase in history, and I think they have learned from it.
Ronnie Stöferle: I'm referring to this because many people our age used to receive small coins from our grandparents. Due to our grandparents' experiences, it exists in our monetary DNA. For example, if you look at the amount of gold purchased in Germany, you will find that the amount of gold purchased is significantly higher than in most other countries. I think this is related to our attitude towards inflation. In contrast, everyone in the United States is still afraid of the deflationary Great Depression.
Zoltan Pozsar: Yes. We are all afraid of different things, but among the ordinary people in Hungary, it is not as strong as in Germany. However, the Hungarian central bank has been one of the central banks that started buying gold very early.
Niko Jilch**: ** Yes. Let's start discussing a very viable issue. You mentioned that Hungary is buying gold. I believe the Hungarian central bank is one of the European central banks that has recently purchased gold. Europe already has a lot of gold. Why do you think central banks are hoarding gold, and do you think this situation will accelerate? What are your views on this?
Zoltan Pozsar:Yes, I think it will accelerate. I believe that reserve management practices, that is, the way central banks manage foreign exchange reserves, will undergo transformation in the next five to ten years. There are many reasons for this. One reason is that geopolitics has once again become a major theme; we are living in a time of "great power" conflict.
We can mention these major powers: China, the United States, and Russia along with their various proxies. However, I must be careful how I express this— the dollar will still be used as a reserve currency in certain parts of the world, but it will no longer be the case in other areas. The dollar will not disappear overnight; it will still be a reserve currency used for invoicing and trade, as well as for all this work in parts of the world.
But other parts of the world will not be so dependent on the US dollar. Russia is an example. Russia's foreign exchange reserves have been frozen. This means that their assets in US dollars, euros, and Japanese yen have become unusable.
There are legal risks, sanctions risks, and geopolitical risks. If you look at the world from the perspective of the two camps—aligned and non-aligned, East and West, etc.—I think that in some regions, the Global East, the Global South, non-aligned regions, and areas with diplomatic policy conflicts or divergences with the United States are unlikely to use the dollar as a reserve asset.
There are many secondary plots. They will look for other reserve assets as alternatives. I believe gold will occupy a very prominent position there. In fact, since the outbreak of hostilities in Ukraine and the freezing of Russia's foreign exchange reserves, foreign central banks have significantly accelerated their pace of buying gold.
We see this in the data from the International Monetary Fund; we see this in the data released by the World Gold Council; you read about it every day in financial media. The difference between gold and the US dollar as reserve assets is that the textbook refers to the latter as "internal currency," while gold is referred to as "external currency."
This means that when you hold gold and actually have it in your country, in the basement of your central bank, you essentially control the currency base. However, when you hold foreign exchange reserves in the form of dollars, you ultimately store those reserves in bank deposits that are ultimately controlled by the state, or in a central bank controlled by the state, or in U.S. government securities or other sovereign debt assets that are ultimately controlled by the state. Therefore, you do not really control that money; you are essentially always subject to someone giving you access, fundamentally undermining that access and that commitment.
This is one of the reasons the world is looking for alternatives. I would like to add two more things that will change the practices of reserve management. Foreigners hold dollars as foreign exchange reserves because, after all, you need to hold some currency as a country that you can use to import necessities. When people consider why central banks hold foreign exchange reserves, there are only a few reasons:
You need to import oil and wheat as well as any products that are not produced domestically, with prices of goods quoted in US dollars and invoices issued in US dollars. There is no other way. The essentials you import are priced in US dollars.
When the local banking system has dollar liabilities and a crisis occurs, you must provide some support for it; or, if your company has borrowed too much in dollars overseas and encounters problems, you will have to bear the costs.
There is a new theme, in addition to gold, foreign central banks will begin to stockpile currencies other than the dollar, as more oil will be invoiced in RMB and other currencies. Now, countries are no longer solely reliant on the dollar to import the necessities they need.
Niko Jilch: You wrote an article about the birth of the petrodollar, and Europe often tries to use the euro for energy transactions. In a multipolar world, will there be a single reserve currency, or must we let go of that idea? Do you think the euro is essentially just a "streamlined dollar" at this point, or is it an alternative? From the perspective of reserve currencies, it is still in second place.
Zoltan Pozsar:I think there will be three dominant currencies: the US dollar, the Chinese yuan, and then the euro will be like a third wheel. The euro is a very important creation in many ways. One reason it is so important is that it allows Europe to pay for its goods imports in its own currency. If you will, it gives Europe sovereignty over the currency for importing goods. They do not have to hustle to earn dollars to import the oil and gas they need because OPEC countries and Russia take euros from them.
Clearly, the world will change, and you will rely more on energy imports from North America. The United States will require payment in dollars for its energy exports. Another thing about the euro is that China is reducing the weight of the dollar in its basket, but it is increasing the weight of the euro. This question is difficult to answer because Europe is a major prize in this "Great Game" of the 21st century. Where the gravitational pull of things will fall is a big question concerning Europe's future regarding the euro's status as a reserve currency and whether their share is rising or falling.
But I think it is helpful to construct your views on the macro, monetary, interest rate markets, and the global economy for the next five to ten years as follows: with the "Belt and Road" and the Eurasian continent; including all of Asia, all of Europe and the Middle East, Russia, North Africa, and all of Africa. It can be said to be the island of the world.
Then there is what we call the G7. North America, Australia, and small islands and peninsulas are everywhere. Essentially, these are two "economic groups." If you consider the macro discourse, we are talking about allied countries and non-aligned countries. Everything you see in terms of supply chains and globalization will happen in the monetary world, because supply chains are the opposite of payment chains.
If you realign the supply chain along political lines—who your friends are and who they are not—you will also realign the currencies you use to invoice some of those supply chains and trade relationships. The Eurasian continent looks like a yuan diagonal gold block. So what we call the G7 looks like a dollar block.
I think Europe is a question mark there. This will be a battle for dominance.
Ronnie Stöferle: Isn't it important to distinguish between reserve currencies and trade currencies? I think it is very easy for the Renminbi to become the trade currency for oil and gas transactions. But to become a reserve currency?
Zoltan Pozsar **: ** I am often asked this question. I usually respond by saying: babies are not born walking, talking, and trading interest rates; it is a journey of 20 years. They stumble after birth; then they form sentences; then they make their own arguments and decide what they want to do in life, and then they go on to do it. Then they encounter a midlife crisis.
The US dollar has gone through all this. After World War II, when we read history books, it became the reserve currency, but it still took a journey to get there. The reconstruction of post-war Europe and Japan and the Marshall Plan. The US had a current account surplus at the time, much like China's current account surplus today. The US financed Germany, the UK, and Japan, importing everything they needed from American companies to develop their industries.
I was surprised when people said that China and the Renminbi are becoming major powers, but they cannot become a reserve currency because they have a current account surplus. The United States became a reserve currency with a current account surplus. It was only later that the situation changed, and then they turned to a deficit.
The younger generation of traders and market participants conceptually understands the US dollar as a reserve currency, but they do not know that this status stems from surplus positions.
Ronnie Stöferle:The United States also has over 20,000 tons of gold, which is very important for establishing trust in the US dollar.
Zoltan Pozsar: Yes, that's right. All the gold flows there; that's its starting point. The fact that China has a current account surplus is good. There is also a mechanism through which China will provide the world with the renminbi that is not available but needed, in order to import things from China; this is the swap quota. It won't be like the Marshall Plan, but China will inject funds into the system through some mechanisms.
The second thing is that China has reopened the gold window in Shanghai with the Shanghai Gold Exchange. If someone is willing, offshore Renminbi can be exchanged for gold; this is another important function. Renminbi oil invoices have been happening for many years, and now it will happen with Saudi Arabia and Gulf Cooperation Council (GCC) countries. We are starting to see copper trades with Brazil priced in Renminbi. When you read these statements and listen to the speeches of BRICS leaders, they have an agenda. They are all busy achieving de-dollarization of cross-border trade flows; they accept Renminbi as a means of payment; they are launching central bank digital currencies, which essentially means they will bypass the Western banking system, reasons we will discuss.
Your funds in the Western banking system only belong to you if these banks ultimately report or the political processes allow you to use this money. When this trust is broken, you begin to build your alternative payment and clearing systems.
China and the BRICS countries are basically doing all these steps with the renminbi. When you read them in isolation, these steps may not seem like much; however, when you look at them as a whole, and when you consider what they have been building over the past decade, it adds up to something quite substantial.
Another thing I want to mention is that there is capital flight from China. I think it's important to point out that China has not prevented this capital outflow through capital controls.
Capital outflow from China means that foreign exchange reserves are being depleted, and I believe China itself does not mind this. If capital is fleeing because some wealthy individuals domestically think their money is better off in an apartment in New York and they want to deplete foreign exchange reserves to buy things, then that's fine... that's his problem, no longer the country's problem.
Depending on how you view these matters and the perspective you want to take, things are heading in a direction where a significant portion of the world's population will increasingly use the Renminbi. This is a path towards a major trade and reserve currency.
Regarding the issue of reserve currencies, another thing I want to say is: people hold a lot of dollars because they need them during a crisis. If you are a central bank, this idea and body language were formed in an era without dollar swap lines. Because you know that if you short the dollar, what you need to do next is go to the International Monetary Fund, which will be very difficult and painful. China has swap lines with everyone. Therefore, no one needs to hoard renminbi to trade with China. If these swap lines had existed in the 1980s, Southeast Asia would have faced a different financial crisis than in 1997 — this was a liquidity crisis. Today, we handle liquidity crises through swap lines.
I mention this point because I do not believe that the process of the renminbi becoming a reserve currency is for countries to start accumulating it; it will be managed through swap quotas. I keep rereading President Xi's speech to the leaders of the Gulf Cooperation Council; there is much to interpret. He said, "We will trade with each other more, and we will invoice everything in renminbi," "You will have a surplus, I will have a deficit; or I will have a surplus, you will have a deficit, and then how will we recover and manage the interstate means of surplus and deficit?"
In my view, from a monetary perspective, the Eastern vision of the Eurasian continent under the "Belt and Road" initiative is that there will be inter-state mechanisms to recycle surpluses and deficits. Moreover, it will not be driven by the private sector like the dollar system; it will be a more managed system. This is my perspective on China and the renminbi as a reserve currency, more like a trading and invoicing service, or something similar.
Niko Jilch**: **I have two brief questions. The first is a political question. You described how we have seen the first steps towards de-dollarization over the years; now, everything has greatly accelerated since Russia's invasion of Ukraine. It has now become public—Saudis are talking about it. Has Russia essentially reset the global financial system through this invasion?
Zoltan Pozsar **: ** I have just observed that I think the news flow regarding de-dollarization and central bank digital currencies has gained new momentum. If the freezing of Russia's foreign exchange reserves was triggered by the Ukraine war, then yes, I believe the world has changed. Things that were unapproachable or unimaginable before that invasion have become a reality. This is a game changer. The situation is changing rapidly, and countries are adapting.
Niko Jilch: How is the reaction in the U.S. now? A few days ago, Yellen made a statement where she talked about the dangers of the dollar possibly losing its reserve currency status due to sanctions. But that's about it. Others are discussing this issue, but the U.S. has said nothing.
Zoltan Pozsar *: ** I think in 2015,Lutnick was one of the first to say that you could weaponize the dollar and use it as a tool of war. But remember, the more frequently you do this, the higher the risk that other parts of the world will adapt to this pattern. Christine Lagarde gave a compelling speech last week that conveyed the same message. A year ago, Secretary Yellen vetoed the Bretton Woods System III plan I proposed, but recently, the tone of Yellen's speeches has been quite different.
Things are changing. What has been done is done; trust is easily lost and nearly impossible to regain. The defense mechanisms are there. Especially if you read the Financial Times every day, you will sense that the BRICS have their own narrative, and the G7 has its own narrative.
Which countries are developing CBDCs? Those that are de-dollarizing and accumulating gold are joining the mBridge project. When you are at odds with the United States in terms of foreign policy or geopolitics, you are forced to take defensive measures to carve out a domain where you have monetary sovereignty and can control things. The analogy I often bring up is that just as the U.S. does not have Huawei phone signal towers for obvious reasons, China does not want to internationalize the renminbi through networks it does not control (i.e., Western banks).
Rony Stoeffler: Your recent articles are "War and Interest Rates," "War and Industrial Policy," "War and Commodity Burden," "War and Currency Governance Strategies," and "War and Peace." I really enjoyed reading them. I just received a report from Marko Papic at Clocktower Group. This piece is titled "War is Good," which sounds counterintuitive; but he points out that investors should avoid extrapolating geopolitical imbalances as global conflicts. He says that, as we have seen in history before, this kind of multipolarity has also led to a lot of technological innovation over decades or even centuries. He also believes that multipolarity will inject a surge in capital expenditures, which may result in higher inflation in the short term, but in the long run, this should be deflationary. Do you agree that we should not be too afraid of global conflicts or wars, as they may also have positive effects, such as innovation and increased productivity?
Zoltan Posar: Certain types of wars may be good. We are in an era of unrestricted warfare, where it's not just about shooting at each other on land, in the air, and at sea. If war is about the control of technology, money, and commodities, then there is no bloodshed. But in any case, it is a war. Ultimately, it comes down to rare earths, oil, and natural gas—commodity resources and real physical goods. You really don't want to view history as completely outdated.
We need to be cautious here, as we do not want to reimagine history and move forward. The Napoleonic Wars, the Crimean War, World War I and II, material resources, land, and industry are all things you fight for. It is hard to imagine that all future conflicts will be related to bits, bytes, data, spreadsheets, and balance sheets. There are risks here. I believe war is bad because it is a very risky game. Now, it usually occurs in the realms of trade, technology, and currency, and then it spills over into uglier forms.
The catalyst for everything we are talking about is a very tragic hot war in Ukraine, which has a very tragic civilian aspect. I do not think war is good. Yes, it will become a catalyst for change, which will mean more investment. As I have elaborated in my paper, we will invest heavily in reorganization, repatriation, friend-sourcing, and energy transition. But similarly, all these topics will be very commodity-intensive and labor-intensive. It will be "my commodities" and "my industry" and "my workforce" versus yours.
This is not just a matter between the United States and China, it is also a matter between the United States and Europe, so it will be very political. These issues will not be sensitive to interest rates. The Federal Reserve can raise interest rates to 10%; we still need to rearm; we still need to friend-shore; we still need to pursue energy transition because these are all considerations of national security, and national security does not care about the price of currency, namely interest rates. Perhaps in 5 to 10 years we will be more self-sufficient, but I think the next 5 years will become complicated from the perspective of exchange rates, inflation, and interest rates. My "war" newsletter is not a "happy" article.
Ronnie Stoeffler: I think this title is deliberately provocative. Marko Papic is from Yugoslavia, so he knows what war is about. He refers to the competition and innovation that can occur when new powers emerge. I want to ask you, about the topic of inflation, until last year, central bank governors around the world were telling us that it was temporary, there was no stagflation, and "it looks like a hump" (Christine Lagarde).
Then, especially the Federal Reserve, made a very, very aggressive response. Now we see what Gavekal calls the "pessimistic bulls," investors hoping that the inflation rate will decline, which will affect the Federal Reserve; this will lead us back to the old regime, when the Federal Reserve surprises unexpectedly, they only surprise in one direction, and that direction is upwards. One of our views is that we will see greater inflation volatility. "The Great Moderation" is over; forget about that. We are seeing impending inflation volatility in the wave of inflation.
Would you say that the first wave of inflation has ended, and should we expect more waves of inflation? Currently, there is very close cooperation between monetary and fiscal policies. We are seeing issues related to demographic structure, labor market, de-globalization, and so on. Do you think we (the United States) will return to the era where 2% is the inflation cap?
Zoltan Pozsar: With a 2% inflation rate, returning to the old world, I believe there is no chance of it snowballing in hell. The era of low inflation is over, and we will not go back. There are many reasons for this:
Inflation has been a topic for three years.
We started fighting it a year ago, but it's been a part of our lives for a long time. I think since the pandemic, CPI has risen by 20% and wages have risen by about 10%. In contrast to the statistical artifact of CPI, there is still a deficit in what your money buys. Everyone has their own shopping basket. There is a saying that "when no one is talking about inflation, inflation expectations are well anchored". Now, it's getting harder and harder to talk to any investor without talking about inflation. As a result, inflation expectations are no longer well anchored.
2. Wall Street and investors are very young.
This is an industry different from physics, and we all stand on the shoulders of early giants—physics is a science of knowledge accumulation. Finance is cyclical; you make money in this industry, then retire and roast tomatoes. Then, others have to relearn everything you know and exit that knowledge again in their process. If you are young, say 35-45 years old, you haven't really seen anything other than lower interest rates and low inflation. In terms of how you view inflation, this is a new skill you must master because it is not a variable you had to consider in the past.
In fact, this means that people tend to view inflation as another fundamental on Bloomberg screens, and then it explodes, and it will be mean reversion. What does this mean? At our age, our experience in the formation of financial markets includes the Asian Financial Crisis of 2008, some spread explosions since 2015, and the COVID-19 pandemic; all of these were the fundamental crises that broke foreign exchange spreads, and then AAA CDOs and AAA government bonds proved to be not the same thing. There is a basis between the two, and the cash/U.S. Treasury futures basis collapsed in March 2020 when the pandemic hit, and before the Federal Reserve intervened, we had a few days without a truly risk-free curve.
These are all simple matters, because to solve these misalignments, all you need to do is throw the balance sheet at the problem. In English, this means that someone must provide emergency loans, or you must engage in quantitative easing and inject funds into the system; then, once the money is in place, the base misalignment disappears.
Just as the UK has this mini-budget issue, we also have the Silicon Valley Bank problem. What we need to say is, "Here, we give you money, we guarantee deposits, problem solved." So, these are all simple issues. Inflation has a clear distinction. I think we like the idea of Paul Volcker being a national hero because he raised interest rates to 20%, "that’s all it takes to reduce inflation." Well, not really. Paul Volcker is a legendary policymaker, but he was lucky. I want to mention two reasons.
The OPEC price shock that triggered inflation issues occurred in the early 1970s. As prices rose, people began to drill more; during the decade following the OPEC price shock, supply increased. This was the period of the North Sea oilfield development, with Norway starting to extract in the North Sea, Canada drilling more, and Texas drilling more; we were just swimming in oil. Then Paul Volcker came to power in the early 1980s, raised interest rates, and caused a deep recession, leading to a collapse in demand for oil and oil prices. It was great. More oil, less demand. That's the way to reduce inflation.
The second thing is the labor force during the Volcker era. With the arrival of the baby boomer generation, there were more people working, and the participation rate of women in the labor force was also rising, so a lot of labor entered the market. In addition, the politics surrounding wages was changing, as in 1981, President Reagan fired the famous air traffic controllers for daring to strike. Therefore, when energy and labor decline for fundamental reasons, it becomes easier to reduce inflation. More supply, political support.
Today, oil prices are high, and we haven't invested in oil and gas for ten years. Geopolitics will only get worse. For Volcker, the situation worsened ten years ago when he was fighting inflation; he was dealing with a very stable geopolitical environment.
Currently, the oil market and all other commodities are very tight, and geopolitical situations are getting worse—just look at OPEC's production cuts. OPEC+ aims for a target of $100 per barrel; we are below that level. They may cut more to reach their desired goals. The SPR has never been this low in history.
Labor? It is completely different from Volcker's background. The baby boomer generation is retiring, while the millennial generation is no longer as busy as the baby boomers. The older millennials and today's younger generation have all gone to college; however, they do not have to rely on marginal jobs to pay for their college education, because student loans are flowing like water, and their parents are wealthier, so their parents support them through school. When you look at the baby boomer generation, their parents were not wealthy, and their student loans were not so easily available, so they had to work part-time in restaurants, God knows where else to earn money to finish college.
This is part of the labor supply for low-end restaurant and hotel jobs. These things are missing today. Our labor force participation rate is stagnant and is actually declining at the margins; we are facing a serious labor shortage problem that can only be solved by immigration. But this is not an easy solution, and it is quite political. We have a skills gap, and most jobs do not require a college degree, yet every person entering the labor market is over-educated for some of those jobs. This prevents the labor market from clearing.
The U.S. labor market used to be a point of pride for us, setting us apart from Europe. In Europe, due to language barriers, you can't just move around. If you speak German, you can't work in France. This is not an issue in the U.S.; you can put your house up for sale and move to another state. However, when mortgage rates soar and housing is expensive, especially in the hot areas where you can find work, you won't be moving around. So now we have a problem with labor mobility. This is a very different context. What I want to say is that people tend to overthink inflation and get into technical discussions about core inflation.
There are two things to remember. The labor market is incredibly tight. I don't think the unemployment rate will rise much during this interest rate hike cycle. Because, if you are an employer and you are fortunate enough to have the employees you need, you won't let them go because it will be very difficult to rehire them. If the unemployment rate doesn't really rise, then in a very tight labor market, wage dynamics will remain strong; this is important for service sector inflation, which is determined by labor costs.
Then, on the other hand, you need to focus on the prices of food and energy, both of which are random and are involved in geopolitics. So, if you want to take a guess: Do food and energy prices have more upside potential or downside potential?
There may be more upside potential as the situation is tense and geopolitical, mine and yours. This is the essentials — if the prices of essentials rise and the labor market is tight, then a lot of feedback will generate from higher overall inflation to higher wage inflation; and core goods, whatever they may be, are not that important. This is the price of flat-screen TVs and used cars. Frankly, if you are the Federal Reserve, you wouldn't care about the prices of used cars, flat-screen TVs, D-RAM chips, etc., because these are not what determines what people demand in terms of wages.
What I want to say is that people are striking not because of the rising prices of flat-screen TVs, but because of the rising prices of food, fuel, and housing, making it impossible to make a living.
So, I think this is the recent environment, and I believe what we are seeing is that interest rates have risen from 0% to 5%. We have hardly experienced localized fires, and both the Bank of England and the Federal Reserve are very eager to extinguish the fire immediately after it surfaces. The crisis was quickly dealt with. However, for all these interest rate hikes, we have not actually made much progress. Housing is slowing down, demand for cars is slowing down, but the unemployment rate remains very low. When you look at the earnings of essential consumer goods companies like Nestlé, Coca-Cola, or Procter & Gamble, you don't really see the economy slipping off a cliff. People are coping with rising prices, which does not mean they are spending less. This will be a persistent issue, and when the market believes we will cut interest rates before the end of this year, it is just wishful thinking.
Every asset holder and anyone who has grown up as a financial market professional should not forget that we have been implementing quantitative easing for over 10 years. It's like spending a lifetime in the financial world. But this is not the only thing that can happen. Yes, things are painful, but this is in terms of bringing inflation down to target. The unemployment rate is still at 3.5%, so I don't really see the pain in the economy. More is needed.
I think it's important to consider inflation from a short-term cyclical perspective, just like the way interest rate hikes lead to inflation. What I just told you is that inflation may be trickier than you think. Definitely in the next year or two. The labor market is tight, wage inflation is high, and the core inflation rate is well above the target value, around 4% or 5%.
The second thing is the industrial policies we talked about. Restructuring and onshoring as well as energy transition; this will be an upcoming investment renaissance. We can already read that the Inflation Reduction Act has invested billions of dollars in its first year, and there is much more to come. Economic recessions are usually not related to investment booms. The longer inflation persists, if the Federal Reserve cannot manage to push us into a recession with a significant rise in unemployment, I think our time is limited because all these investment themes are poised to take off. As I said, once they are poised, it will require a large workforce and a lot of goods. This will only exacerbate the inflation problem and complicate the Fed's job.
Niko Jilch: This raises a core question that everyone wants to know the answer to. How do you invest in this environment; which assets do you expect to perform well?
Zoltan Pozsar: I think this means various bad things for a 60/40 portfolio, which is the standard portfolio construction. At the very least, you need to do something like 20/20/20/40. That means 20% cash, 20% commodities, 20% bonds, and 40% stocks.
Cash and commodities make sense to me for the following reasons. Cash used to be seen as a dirty asset because it doesn't generate anything. But now, cash yields are substantial. We should not bet on the back end of the 10-year Treasury yield because if the market's view on recession, interest rate cuts, and inflation is wrong, the U.S. 10-year Treasury yield will go up instead of starting to go down from here. When the yield curve inverts, cash is actually a very good asset; it gives you a very nice yield along the highest yield of the curve; it provides you with option value, meaning that if you find some great assets to buy, you can. I think commodities are equally important because, as I said, our investments are insufficient. Commodities are fundamentally tight; geopolitics is messing up commodities, and resource nationalism is on the rise. Even when there is supply, it comes with special terms, which means higher prices instead of lower prices.
In this basket of commodities, I believe that gold will have a very special meaning, simply because gold is returning to the margin as a reserve asset and a settlement medium for interstate capital flows. I think cash and commodities make a very good combination. I also think you can prominently include some commodity-based stocks and some defensive stocks in that portfolio. Both of these will be value stocks and will benefit from this environment. This is because growth stocks have dominated in the past decade, while value stocks will dominate in this decade. I think this is a fairly healthy combination, but I would be very careful about broad stock exposure and would also be very cautious with growth stocks.
Ronnie Stöferle: You used to work at the Federal Reserve Bank of New York, which is the most powerful branch of the Fed, and you encountered many institutional clients. I want to ask you, regarding the topics we are discussing, I know where you come from because I worked at a large bank in Austria, but I started to discover gold and the Austrian School of Economics. At some point, I said, "I feel like a vegetarian in a slaughterhouse." As an institution like the Fed, having different views is not always that easy.
I know that the Federal Reserve is often criticized for its timing and lagging behind the curve. Do you think that within the Federal Reserve and large institutions, these topics we are discussing: de-dollarization, inflation being very tricky in the coming years, more fiscal expansion – you just mentioned lithium, another example – are these topics being discussed, or are they still just topics for outsiders and mavericks like us?
Zoltan Pozsar: Last year, I held nearly 400 client meetings with hedge funds, banks, asset management companies—everyone wanted to talk about these things. Everyone wanted to understand the implications. Some are more advanced in thinking about them, while for others, it's new. I interact regularly with the Fed, and they receive my writings. I publish these ideas and articles for institutional clients, central banks, and others. Christine Lagarde is talking about them, and so is Janet Yellen. Maybe a year ago, I felt like I was sticking my neck out a bit too far, which was risky, because maybe my intuition was completely wrong, and I shouldn't have said what I said about the Bretton Woods System III. But it turns out that argument is becoming increasingly correct.
I am currently riding on Christine Lagarde's ponytail, and her speech is very similar to my war bulletin. She talked about what this means for interest rates, industrial policy, monetary dominance, and so on. If you're a central bank, you don't exist in a vacuum; you have to consider these things. The Fed is undergoing QT, but they haven't really decided how much duration they are putting into the market. It entirely depends on the U.S. Treasury. So, there is cooperation there. Look at the body language around SVB. This is a crisis that cannot happen because the Fed is putting out fires too quickly. When your status as a reserve currency is different from the past in certain parts of the world, the last thing you need is a banking crisis (or a debt default due to the debt ceiling).
These topics are becoming increasingly mainstream. When I speak with the most mature macro hedge funds and investors, they often say they have never seen such a complex environment. There is a consensus around gold; it's a safe bet while everything else is highly uncertain. This is a very unique environment. I believe we need to take a very, very broad perspective to actively reimagine and rethink our understanding of the world, as things are changing rapidly. The dollar, the renminbi, gold, currencies, and commodities. I think they will all be caught up.
Niko Jilch: Did you just mention that seasoned asset management companies have a consensus on gold?
Zoltan Pozsar: No, only macro investors.
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Bretton Woods System III: Zoltan predicted years ago is unfolding in 2025.
Zoltan Pozsar may be one of the most prominent macroeconomic analysts in the past decade. Since 2019, his "War Quintet" series of research reports, particularly the "Bretton Woods System III" theoretical framework, has rapidly made this former Credit Suisse analyst a star in the global macro realm. He also served as a senior advisor to the U.S. Treasury, providing consulting for the Debt Management Office and the Office of Financial Research. In 2023, he founded an independent research company after leaving UBS.
This article is a transcript of an interview conducted in July 2023 for a podcast, mainly involving topics such as currency, gold, and the new economic order. Especially against the backdrop of the current "tariff storm," it holds significant reference value for understanding the current situation and judging future trends.
Ronnie Stöferle : Zoltan, thank you very much for taking the time for this interview. It’s a great pleasure. With me is my dear friend Niko Jilch, who is a very well-known podcaster.
Niko Gierke: Hi, Zoltan, nice to meet you. I've been reading all your stuff lately.
Zoltan Posar: Nice to meet you both. Thank you for the invitation.
Ronnie Stoeffler: Niko has been responsible for the de-dollarization chapter in our In Gold We Trust report for many years. This discussion will revolve around that topic. But there are many things to talk about now.
Zoltan, you come from Hungary, and I would like to ask you a personal question. After World War II, Hungary's pengő suffered the highest recorded hyperinflation rate in human history. The hyperinflation in Hungary was so out of control that at one point prices doubled in about 15 hours, while the pengő lost about 90% of its value in roughly 4 days. Like the Germans and Austrians, do you think Hungarians are particularly concerned about inflation due to their experience with hyperinflation in history? Are they especially interested in the topic of gold? What are your thoughts on this?
Zoltan Pozsar : I heard many stories about the pengő from my grandmother. But you know, since then we have had the forint in Hungary, and I think many instances of hyperinflation are about standing on the wrong side of the outcome of World War II. I don't think the ordinary people of Hungary or the decision-making circles still think based on the post-World War II experiences of the pengő or base policy decisions on them. However, you could ask the same question to anyone in Germany, and you would get the same answer. This is a special phase in history, and I think they have learned from it.
Ronnie Stöferle : I'm referring to this because many people our age used to receive small coins from our grandparents. Due to our grandparents' experiences, it exists in our monetary DNA. For example, if you look at the amount of gold purchased in Germany, you will find that the amount of gold purchased is significantly higher than in most other countries. I think this is related to our attitude towards inflation. In contrast, everyone in the United States is still afraid of the deflationary Great Depression.
Zoltan Pozsar : Yes. We are all afraid of different things, but among the ordinary people in Hungary, it is not as strong as in Germany. However, the Hungarian central bank has been one of the central banks that started buying gold very early.
Niko Jilch**: ** Yes. Let's start discussing a very viable issue. You mentioned that Hungary is buying gold. I believe the Hungarian central bank is one of the European central banks that has recently purchased gold. Europe already has a lot of gold. Why do you think central banks are hoarding gold, and do you think this situation will accelerate? What are your views on this?
Zoltan Pozsar : Yes, I think it will accelerate. I believe that reserve management practices, that is, the way central banks manage foreign exchange reserves, will undergo transformation in the next five to ten years. There are many reasons for this. One reason is that geopolitics has once again become a major theme; we are living in a time of "great power" conflict.
We can mention these major powers: China, the United States, and Russia along with their various proxies. However, I must be careful how I express this— the dollar will still be used as a reserve currency in certain parts of the world, but it will no longer be the case in other areas. The dollar will not disappear overnight; it will still be a reserve currency used for invoicing and trade, as well as for all this work in parts of the world.
But other parts of the world will not be so dependent on the US dollar. Russia is an example. Russia's foreign exchange reserves have been frozen. This means that their assets in US dollars, euros, and Japanese yen have become unusable.
There are legal risks, sanctions risks, and geopolitical risks. If you look at the world from the perspective of the two camps—aligned and non-aligned, East and West, etc.—I think that in some regions, the Global East, the Global South, non-aligned regions, and areas with diplomatic policy conflicts or divergences with the United States are unlikely to use the dollar as a reserve asset.
There are many secondary plots. They will look for other reserve assets as alternatives. I believe gold will occupy a very prominent position there. In fact, since the outbreak of hostilities in Ukraine and the freezing of Russia's foreign exchange reserves, foreign central banks have significantly accelerated their pace of buying gold.
We see this in the data from the International Monetary Fund; we see this in the data released by the World Gold Council; you read about it every day in financial media. The difference between gold and the US dollar as reserve assets is that the textbook refers to the latter as "internal currency," while gold is referred to as "external currency."
This means that when you hold gold and actually have it in your country, in the basement of your central bank, you essentially control the currency base. However, when you hold foreign exchange reserves in the form of dollars, you ultimately store those reserves in bank deposits that are ultimately controlled by the state, or in a central bank controlled by the state, or in U.S. government securities or other sovereign debt assets that are ultimately controlled by the state. Therefore, you do not really control that money; you are essentially always subject to someone giving you access, fundamentally undermining that access and that commitment.
This is one of the reasons the world is looking for alternatives. I would like to add two more things that will change the practices of reserve management. Foreigners hold dollars as foreign exchange reserves because, after all, you need to hold some currency as a country that you can use to import necessities. When people consider why central banks hold foreign exchange reserves, there are only a few reasons:
Niko Jilch : You wrote an article about the birth of the petrodollar, and Europe often tries to use the euro for energy transactions. In a multipolar world, will there be a single reserve currency, or must we let go of that idea? Do you think the euro is essentially just a "streamlined dollar" at this point, or is it an alternative? From the perspective of reserve currencies, it is still in second place.
Zoltan Pozsar : I think there will be three dominant currencies: the US dollar, the Chinese yuan, and then the euro will be like a third wheel. The euro is a very important creation in many ways. One reason it is so important is that it allows Europe to pay for its goods imports in its own currency. If you will, it gives Europe sovereignty over the currency for importing goods. They do not have to hustle to earn dollars to import the oil and gas they need because OPEC countries and Russia take euros from them.
Clearly, the world will change, and you will rely more on energy imports from North America. The United States will require payment in dollars for its energy exports. Another thing about the euro is that China is reducing the weight of the dollar in its basket, but it is increasing the weight of the euro. This question is difficult to answer because Europe is a major prize in this "Great Game" of the 21st century. Where the gravitational pull of things will fall is a big question concerning Europe's future regarding the euro's status as a reserve currency and whether their share is rising or falling.
But I think it is helpful to construct your views on the macro, monetary, interest rate markets, and the global economy for the next five to ten years as follows: with the "Belt and Road" and the Eurasian continent; including all of Asia, all of Europe and the Middle East, Russia, North Africa, and all of Africa. It can be said to be the island of the world.
Then there is what we call the G7. North America, Australia, and small islands and peninsulas are everywhere. Essentially, these are two "economic groups." If you consider the macro discourse, we are talking about allied countries and non-aligned countries. Everything you see in terms of supply chains and globalization will happen in the monetary world, because supply chains are the opposite of payment chains.
If you realign the supply chain along political lines—who your friends are and who they are not—you will also realign the currencies you use to invoice some of those supply chains and trade relationships. The Eurasian continent looks like a yuan diagonal gold block. So what we call the G7 looks like a dollar block.
I think Europe is a question mark there. This will be a battle for dominance.
Ronnie Stöferle : Isn't it important to distinguish between reserve currencies and trade currencies? I think it is very easy for the Renminbi to become the trade currency for oil and gas transactions. But to become a reserve currency?
Zoltan Pozsar **: ** I am often asked this question. I usually respond by saying: babies are not born walking, talking, and trading interest rates; it is a journey of 20 years. They stumble after birth; then they form sentences; then they make their own arguments and decide what they want to do in life, and then they go on to do it. Then they encounter a midlife crisis.
The US dollar has gone through all this. After World War II, when we read history books, it became the reserve currency, but it still took a journey to get there. The reconstruction of post-war Europe and Japan and the Marshall Plan. The US had a current account surplus at the time, much like China's current account surplus today. The US financed Germany, the UK, and Japan, importing everything they needed from American companies to develop their industries.
I was surprised when people said that China and the Renminbi are becoming major powers, but they cannot become a reserve currency because they have a current account surplus. The United States became a reserve currency with a current account surplus. It was only later that the situation changed, and then they turned to a deficit.
The younger generation of traders and market participants conceptually understands the US dollar as a reserve currency, but they do not know that this status stems from surplus positions.
Ronnie Stöferle : The United States also has over 20,000 tons of gold, which is very important for establishing trust in the US dollar.
Zoltan Pozsar : Yes, that's right. All the gold flows there; that's its starting point. The fact that China has a current account surplus is good. There is also a mechanism through which China will provide the world with the renminbi that is not available but needed, in order to import things from China; this is the swap quota. It won't be like the Marshall Plan, but China will inject funds into the system through some mechanisms.
The second thing is that China has reopened the gold window in Shanghai with the Shanghai Gold Exchange. If someone is willing, offshore Renminbi can be exchanged for gold; this is another important function. Renminbi oil invoices have been happening for many years, and now it will happen with Saudi Arabia and Gulf Cooperation Council (GCC) countries. We are starting to see copper trades with Brazil priced in Renminbi. When you read these statements and listen to the speeches of BRICS leaders, they have an agenda. They are all busy achieving de-dollarization of cross-border trade flows; they accept Renminbi as a means of payment; they are launching central bank digital currencies, which essentially means they will bypass the Western banking system, reasons we will discuss.
Your funds in the Western banking system only belong to you if these banks ultimately report or the political processes allow you to use this money. When this trust is broken, you begin to build your alternative payment and clearing systems.
China and the BRICS countries are basically doing all these steps with the renminbi. When you read them in isolation, these steps may not seem like much; however, when you look at them as a whole, and when you consider what they have been building over the past decade, it adds up to something quite substantial.
Another thing I want to mention is that there is capital flight from China. I think it's important to point out that China has not prevented this capital outflow through capital controls.
Capital outflow from China means that foreign exchange reserves are being depleted, and I believe China itself does not mind this. If capital is fleeing because some wealthy individuals domestically think their money is better off in an apartment in New York and they want to deplete foreign exchange reserves to buy things, then that's fine... that's his problem, no longer the country's problem.
Depending on how you view these matters and the perspective you want to take, things are heading in a direction where a significant portion of the world's population will increasingly use the Renminbi. This is a path towards a major trade and reserve currency.
Regarding the issue of reserve currencies, another thing I want to say is: people hold a lot of dollars because they need them during a crisis. If you are a central bank, this idea and body language were formed in an era without dollar swap lines. Because you know that if you short the dollar, what you need to do next is go to the International Monetary Fund, which will be very difficult and painful. China has swap lines with everyone. Therefore, no one needs to hoard renminbi to trade with China. If these swap lines had existed in the 1980s, Southeast Asia would have faced a different financial crisis than in 1997 — this was a liquidity crisis. Today, we handle liquidity crises through swap lines.
I mention this point because I do not believe that the process of the renminbi becoming a reserve currency is for countries to start accumulating it; it will be managed through swap quotas. I keep rereading President Xi's speech to the leaders of the Gulf Cooperation Council; there is much to interpret. He said, "We will trade with each other more, and we will invoice everything in renminbi," "You will have a surplus, I will have a deficit; or I will have a surplus, you will have a deficit, and then how will we recover and manage the interstate means of surplus and deficit?"
In my view, from a monetary perspective, the Eastern vision of the Eurasian continent under the "Belt and Road" initiative is that there will be inter-state mechanisms to recycle surpluses and deficits. Moreover, it will not be driven by the private sector like the dollar system; it will be a more managed system. This is my perspective on China and the renminbi as a reserve currency, more like a trading and invoicing service, or something similar.
Niko Jilch**: **I have two brief questions. The first is a political question. You described how we have seen the first steps towards de-dollarization over the years; now, everything has greatly accelerated since Russia's invasion of Ukraine. It has now become public—Saudis are talking about it. Has Russia essentially reset the global financial system through this invasion?
Zoltan Pozsar **: ** I have just observed that I think the news flow regarding de-dollarization and central bank digital currencies has gained new momentum. If the freezing of Russia's foreign exchange reserves was triggered by the Ukraine war, then yes, I believe the world has changed. Things that were unapproachable or unimaginable before that invasion have become a reality. This is a game changer. The situation is changing rapidly, and countries are adapting.
Niko Jilch : How is the reaction in the U.S. now? A few days ago, Yellen made a statement where she talked about the dangers of the dollar possibly losing its reserve currency status due to sanctions. But that's about it. Others are discussing this issue, but the U.S. has said nothing.
Zoltan Pozsar *: ** I think in 2015, Lutnick was one of the first to say that you could weaponize the dollar and use it as a tool of war. But remember, the more frequently you do this, the higher the risk that other parts of the world will adapt to this pattern. Christine Lagarde gave a compelling speech last week that conveyed the same message. A year ago, Secretary Yellen vetoed the Bretton Woods System III plan I proposed, but recently, the tone of Yellen's speeches has been quite different.
Things are changing. What has been done is done; trust is easily lost and nearly impossible to regain. The defense mechanisms are there. Especially if you read the Financial Times every day, you will sense that the BRICS have their own narrative, and the G7 has its own narrative.
Which countries are developing CBDCs? Those that are de-dollarizing and accumulating gold are joining the mBridge project. When you are at odds with the United States in terms of foreign policy or geopolitics, you are forced to take defensive measures to carve out a domain where you have monetary sovereignty and can control things. The analogy I often bring up is that just as the U.S. does not have Huawei phone signal towers for obvious reasons, China does not want to internationalize the renminbi through networks it does not control (i.e., Western banks).
Rony Stoeffler: Your recent articles are "War and Interest Rates," "War and Industrial Policy," "War and Commodity Burden," "War and Currency Governance Strategies," and "War and Peace." I really enjoyed reading them. I just received a report from Marko Papic at Clocktower Group. This piece is titled "War is Good," which sounds counterintuitive; but he points out that investors should avoid extrapolating geopolitical imbalances as global conflicts. He says that, as we have seen in history before, this kind of multipolarity has also led to a lot of technological innovation over decades or even centuries. He also believes that multipolarity will inject a surge in capital expenditures, which may result in higher inflation in the short term, but in the long run, this should be deflationary. Do you agree that we should not be too afraid of global conflicts or wars, as they may also have positive effects, such as innovation and increased productivity?
Zoltan Posar: Certain types of wars may be good. We are in an era of unrestricted warfare, where it's not just about shooting at each other on land, in the air, and at sea. If war is about the control of technology, money, and commodities, then there is no bloodshed. But in any case, it is a war. Ultimately, it comes down to rare earths, oil, and natural gas—commodity resources and real physical goods. You really don't want to view history as completely outdated.
We need to be cautious here, as we do not want to reimagine history and move forward. The Napoleonic Wars, the Crimean War, World War I and II, material resources, land, and industry are all things you fight for. It is hard to imagine that all future conflicts will be related to bits, bytes, data, spreadsheets, and balance sheets. There are risks here. I believe war is bad because it is a very risky game. Now, it usually occurs in the realms of trade, technology, and currency, and then it spills over into uglier forms.
The catalyst for everything we are talking about is a very tragic hot war in Ukraine, which has a very tragic civilian aspect. I do not think war is good. Yes, it will become a catalyst for change, which will mean more investment. As I have elaborated in my paper, we will invest heavily in reorganization, repatriation, friend-sourcing, and energy transition. But similarly, all these topics will be very commodity-intensive and labor-intensive. It will be "my commodities" and "my industry" and "my workforce" versus yours.
This is not just a matter between the United States and China, it is also a matter between the United States and Europe, so it will be very political. These issues will not be sensitive to interest rates. The Federal Reserve can raise interest rates to 10%; we still need to rearm; we still need to friend-shore; we still need to pursue energy transition because these are all considerations of national security, and national security does not care about the price of currency, namely interest rates. Perhaps in 5 to 10 years we will be more self-sufficient, but I think the next 5 years will become complicated from the perspective of exchange rates, inflation, and interest rates. My "war" newsletter is not a "happy" article.
Ronnie Stoeffler: I think this title is deliberately provocative. Marko Papic is from Yugoslavia, so he knows what war is about. He refers to the competition and innovation that can occur when new powers emerge. I want to ask you, about the topic of inflation, until last year, central bank governors around the world were telling us that it was temporary, there was no stagflation, and "it looks like a hump" (Christine Lagarde).
Then, especially the Federal Reserve, made a very, very aggressive response. Now we see what Gavekal calls the "pessimistic bulls," investors hoping that the inflation rate will decline, which will affect the Federal Reserve; this will lead us back to the old regime, when the Federal Reserve surprises unexpectedly, they only surprise in one direction, and that direction is upwards. One of our views is that we will see greater inflation volatility. "The Great Moderation" is over; forget about that. We are seeing impending inflation volatility in the wave of inflation.
Would you say that the first wave of inflation has ended, and should we expect more waves of inflation? Currently, there is very close cooperation between monetary and fiscal policies. We are seeing issues related to demographic structure, labor market, de-globalization, and so on. Do you think we (the United States) will return to the era where 2% is the inflation cap?
Zoltan Pozsar: With a 2% inflation rate, returning to the old world, I believe there is no chance of it snowballing in hell. The era of low inflation is over, and we will not go back. There are many reasons for this:
We started fighting it a year ago, but it's been a part of our lives for a long time. I think since the pandemic, CPI has risen by 20% and wages have risen by about 10%. In contrast to the statistical artifact of CPI, there is still a deficit in what your money buys. Everyone has their own shopping basket. There is a saying that "when no one is talking about inflation, inflation expectations are well anchored". Now, it's getting harder and harder to talk to any investor without talking about inflation. As a result, inflation expectations are no longer well anchored. 2. Wall Street and investors are very young.
This is an industry different from physics, and we all stand on the shoulders of early giants—physics is a science of knowledge accumulation. Finance is cyclical; you make money in this industry, then retire and roast tomatoes. Then, others have to relearn everything you know and exit that knowledge again in their process. If you are young, say 35-45 years old, you haven't really seen anything other than lower interest rates and low inflation. In terms of how you view inflation, this is a new skill you must master because it is not a variable you had to consider in the past.
In fact, this means that people tend to view inflation as another fundamental on Bloomberg screens, and then it explodes, and it will be mean reversion. What does this mean? At our age, our experience in the formation of financial markets includes the Asian Financial Crisis of 2008, some spread explosions since 2015, and the COVID-19 pandemic; all of these were the fundamental crises that broke foreign exchange spreads, and then AAA CDOs and AAA government bonds proved to be not the same thing. There is a basis between the two, and the cash/U.S. Treasury futures basis collapsed in March 2020 when the pandemic hit, and before the Federal Reserve intervened, we had a few days without a truly risk-free curve.
These are all simple matters, because to solve these misalignments, all you need to do is throw the balance sheet at the problem. In English, this means that someone must provide emergency loans, or you must engage in quantitative easing and inject funds into the system; then, once the money is in place, the base misalignment disappears.
Just as the UK has this mini-budget issue, we also have the Silicon Valley Bank problem. What we need to say is, "Here, we give you money, we guarantee deposits, problem solved." So, these are all simple issues. Inflation has a clear distinction. I think we like the idea of Paul Volcker being a national hero because he raised interest rates to 20%, "that’s all it takes to reduce inflation." Well, not really. Paul Volcker is a legendary policymaker, but he was lucky. I want to mention two reasons.
Today, oil prices are high, and we haven't invested in oil and gas for ten years. Geopolitics will only get worse. For Volcker, the situation worsened ten years ago when he was fighting inflation; he was dealing with a very stable geopolitical environment.
Currently, the oil market and all other commodities are very tight, and geopolitical situations are getting worse—just look at OPEC's production cuts. OPEC+ aims for a target of $100 per barrel; we are below that level. They may cut more to reach their desired goals. The SPR has never been this low in history.
Labor? It is completely different from Volcker's background. The baby boomer generation is retiring, while the millennial generation is no longer as busy as the baby boomers. The older millennials and today's younger generation have all gone to college; however, they do not have to rely on marginal jobs to pay for their college education, because student loans are flowing like water, and their parents are wealthier, so their parents support them through school. When you look at the baby boomer generation, their parents were not wealthy, and their student loans were not so easily available, so they had to work part-time in restaurants, God knows where else to earn money to finish college.
This is part of the labor supply for low-end restaurant and hotel jobs. These things are missing today. Our labor force participation rate is stagnant and is actually declining at the margins; we are facing a serious labor shortage problem that can only be solved by immigration. But this is not an easy solution, and it is quite political. We have a skills gap, and most jobs do not require a college degree, yet every person entering the labor market is over-educated for some of those jobs. This prevents the labor market from clearing.
The U.S. labor market used to be a point of pride for us, setting us apart from Europe. In Europe, due to language barriers, you can't just move around. If you speak German, you can't work in France. This is not an issue in the U.S.; you can put your house up for sale and move to another state. However, when mortgage rates soar and housing is expensive, especially in the hot areas where you can find work, you won't be moving around. So now we have a problem with labor mobility. This is a very different context. What I want to say is that people tend to overthink inflation and get into technical discussions about core inflation.
There are two things to remember. The labor market is incredibly tight. I don't think the unemployment rate will rise much during this interest rate hike cycle. Because, if you are an employer and you are fortunate enough to have the employees you need, you won't let them go because it will be very difficult to rehire them. If the unemployment rate doesn't really rise, then in a very tight labor market, wage dynamics will remain strong; this is important for service sector inflation, which is determined by labor costs.
Then, on the other hand, you need to focus on the prices of food and energy, both of which are random and are involved in geopolitics. So, if you want to take a guess: Do food and energy prices have more upside potential or downside potential?
There may be more upside potential as the situation is tense and geopolitical, mine and yours. This is the essentials — if the prices of essentials rise and the labor market is tight, then a lot of feedback will generate from higher overall inflation to higher wage inflation; and core goods, whatever they may be, are not that important. This is the price of flat-screen TVs and used cars. Frankly, if you are the Federal Reserve, you wouldn't care about the prices of used cars, flat-screen TVs, D-RAM chips, etc., because these are not what determines what people demand in terms of wages.
What I want to say is that people are striking not because of the rising prices of flat-screen TVs, but because of the rising prices of food, fuel, and housing, making it impossible to make a living.
So, I think this is the recent environment, and I believe what we are seeing is that interest rates have risen from 0% to 5%. We have hardly experienced localized fires, and both the Bank of England and the Federal Reserve are very eager to extinguish the fire immediately after it surfaces. The crisis was quickly dealt with. However, for all these interest rate hikes, we have not actually made much progress. Housing is slowing down, demand for cars is slowing down, but the unemployment rate remains very low. When you look at the earnings of essential consumer goods companies like Nestlé, Coca-Cola, or Procter & Gamble, you don't really see the economy slipping off a cliff. People are coping with rising prices, which does not mean they are spending less. This will be a persistent issue, and when the market believes we will cut interest rates before the end of this year, it is just wishful thinking.
Every asset holder and anyone who has grown up as a financial market professional should not forget that we have been implementing quantitative easing for over 10 years. It's like spending a lifetime in the financial world. But this is not the only thing that can happen. Yes, things are painful, but this is in terms of bringing inflation down to target. The unemployment rate is still at 3.5%, so I don't really see the pain in the economy. More is needed.
I think it's important to consider inflation from a short-term cyclical perspective, just like the way interest rate hikes lead to inflation. What I just told you is that inflation may be trickier than you think. Definitely in the next year or two. The labor market is tight, wage inflation is high, and the core inflation rate is well above the target value, around 4% or 5%.
The second thing is the industrial policies we talked about. Restructuring and onshoring as well as energy transition; this will be an upcoming investment renaissance. We can already read that the Inflation Reduction Act has invested billions of dollars in its first year, and there is much more to come. Economic recessions are usually not related to investment booms. The longer inflation persists, if the Federal Reserve cannot manage to push us into a recession with a significant rise in unemployment, I think our time is limited because all these investment themes are poised to take off. As I said, once they are poised, it will require a large workforce and a lot of goods. This will only exacerbate the inflation problem and complicate the Fed's job.
Niko Jilch: This raises a core question that everyone wants to know the answer to. How do you invest in this environment; which assets do you expect to perform well?
Zoltan Pozsar: I think this means various bad things for a 60/40 portfolio, which is the standard portfolio construction. At the very least, you need to do something like 20/20/20/40. That means 20% cash, 20% commodities, 20% bonds, and 40% stocks.
Cash and commodities make sense to me for the following reasons. Cash used to be seen as a dirty asset because it doesn't generate anything. But now, cash yields are substantial. We should not bet on the back end of the 10-year Treasury yield because if the market's view on recession, interest rate cuts, and inflation is wrong, the U.S. 10-year Treasury yield will go up instead of starting to go down from here. When the yield curve inverts, cash is actually a very good asset; it gives you a very nice yield along the highest yield of the curve; it provides you with option value, meaning that if you find some great assets to buy, you can. I think commodities are equally important because, as I said, our investments are insufficient. Commodities are fundamentally tight; geopolitics is messing up commodities, and resource nationalism is on the rise. Even when there is supply, it comes with special terms, which means higher prices instead of lower prices.
In this basket of commodities, I believe that gold will have a very special meaning, simply because gold is returning to the margin as a reserve asset and a settlement medium for interstate capital flows. I think cash and commodities make a very good combination. I also think you can prominently include some commodity-based stocks and some defensive stocks in that portfolio. Both of these will be value stocks and will benefit from this environment. This is because growth stocks have dominated in the past decade, while value stocks will dominate in this decade. I think this is a fairly healthy combination, but I would be very careful about broad stock exposure and would also be very cautious with growth stocks.
Ronnie Stöferle: You used to work at the Federal Reserve Bank of New York, which is the most powerful branch of the Fed, and you encountered many institutional clients. I want to ask you, regarding the topics we are discussing, I know where you come from because I worked at a large bank in Austria, but I started to discover gold and the Austrian School of Economics. At some point, I said, "I feel like a vegetarian in a slaughterhouse." As an institution like the Fed, having different views is not always that easy.
I know that the Federal Reserve is often criticized for its timing and lagging behind the curve. Do you think that within the Federal Reserve and large institutions, these topics we are discussing: de-dollarization, inflation being very tricky in the coming years, more fiscal expansion – you just mentioned lithium, another example – are these topics being discussed, or are they still just topics for outsiders and mavericks like us?
Zoltan Pozsar: Last year, I held nearly 400 client meetings with hedge funds, banks, asset management companies—everyone wanted to talk about these things. Everyone wanted to understand the implications. Some are more advanced in thinking about them, while for others, it's new. I interact regularly with the Fed, and they receive my writings. I publish these ideas and articles for institutional clients, central banks, and others. Christine Lagarde is talking about them, and so is Janet Yellen. Maybe a year ago, I felt like I was sticking my neck out a bit too far, which was risky, because maybe my intuition was completely wrong, and I shouldn't have said what I said about the Bretton Woods System III. But it turns out that argument is becoming increasingly correct.
I am currently riding on Christine Lagarde's ponytail, and her speech is very similar to my war bulletin. She talked about what this means for interest rates, industrial policy, monetary dominance, and so on. If you're a central bank, you don't exist in a vacuum; you have to consider these things. The Fed is undergoing QT, but they haven't really decided how much duration they are putting into the market. It entirely depends on the U.S. Treasury. So, there is cooperation there. Look at the body language around SVB. This is a crisis that cannot happen because the Fed is putting out fires too quickly. When your status as a reserve currency is different from the past in certain parts of the world, the last thing you need is a banking crisis (or a debt default due to the debt ceiling).
These topics are becoming increasingly mainstream. When I speak with the most mature macro hedge funds and investors, they often say they have never seen such a complex environment. There is a consensus around gold; it's a safe bet while everything else is highly uncertain. This is a very unique environment. I believe we need to take a very, very broad perspective to actively reimagine and rethink our understanding of the world, as things are changing rapidly. The dollar, the renminbi, gold, currencies, and commodities. I think they will all be caught up.
Niko Jilch: Did you just mention that seasoned asset management companies have a consensus on gold?
Zoltan Pozsar: No, only macro investors.