Start by reading Pozsar’s Bretton Woods III: The Framework [1/2]
Now, what actually happened in the three years since Pozsar published this framework? (1) Dollar reserve diversification is happening, but gradual: Foreign central bank Treasury holdings declined from peaks exceeding $7.5 trillion to levels below $7 trillion. This represents steady diversification away from dollar-denominated assets, though not a dramatic collapse. (2) Gold has performed strongly: From roughly $1'900/oz when Pozsar published his dispatches to peaks above $4'000/oz today, gold has appreciated substantially, consistent with increased demand for “outside money.” (3) Alternative payment systems are developing: Various nations continue building infrastructure for non-dollar trade settlement. While these systems remain in preliminary stages rather than fully operational alternatives to SWIFT, development timelines could speed up following specific triggering events. (4) The dollar itself has remained strong: Perhaps surprisingly given predictions of dollar weakness, the dollar achieved its best performance against a basket of major currencies since 2015 in 2024. The DXY index (which tracks the dollar against major trading partners) fell about 11% this year, marking the end of this decade-long rally. (5) Commodity collateral is increasingly important: Research on commodities as collateral shows that under capital controls and collateral constraints, investors import commodities and pledge them as collateral. Higher collateral demands increase commodity prices and affect the inventory-convenience yield relationship.
One of Pozsar’s more provocative arguments concerns China’s strategic options. With approximately $3 trillion in foreign exchange reserves heavily weighted toward dollars and Treasuries, China faces the same calculus as any holder of large dollar reserves: what is the risk these could be frozen? Pozsar outlined two theoretical paths for China: (1) Sell Treasuries to purchase commodities directly (especially discounted Russian commodities), thereby converting financial claims into physical resources. (2) Print renminbi to purchase commodities, creating a “eurorenminbi” market parallel to the eurodollar system.
The first option provides inflation control for China (securing physical resources) while potentially raising yields in Treasury markets. The second option represents a more fundamental challenge to dollar dominance, the birth of an alternative offshore currency market backed by commodity reserves rather than financial reserves. In practice, we’ve seen elements of both. China has increased commodity imports from Russia substantially. The internationalization of the renminbi has progressed, though more slowly than some expected, constrained by China’s capital controls and the relative underdevelopment of its financial markets compared to dollar markets.
Regardless of whether “Bretton Woods III” emerges exactly as described, several insights from Pozsar’s framework appear durable. (1) Central banks control the nominal domain, not the real domain: Monetary policy can influence demand, manage liquidity, and stabilize financial markets. It cannot conjure physical resources, build supply chains, or speed up energy transitions. (2) Physical infrastructure matters for financial markets: The number of VLCCs, the capacity of the Suez Canal, the efficiency of port facilities, these real-world constraints bind financial flows. Understanding the infrastructure underlying commodity movements provides insight into funding market dynamics. (3) Collateralization is changing: The trend toward commodity-backed finance, warehouse receipt systems, and physical collateral reflects both technological improvements (better monitoring and verification) and strategic shifts (diversification away from pure financial claims). As the FSB noted in 2023, banks play a vital role in the commodities ecosystem, providing not just credit but clearing services and intermediation between commodity firms and central counterparties. (4) Geopolitical risk affects monetary arrangements: The weaponization of reserve assets, however justified in specific circumstances, changes the risk calculation for all reserve holders. This doesn’t mean immediate de-dollarization, but it does mean persistent, gradual diversification.
So what can we take from this for today: (1) Funding market stresses may be more persistent: If commodity traders require more financing for longer durations due to less efficient trade routes, and if banks face balance sheet constraints from regulatory requirements or QT, term funding premia may remain elevated relative to overnight rates. The FRA-OIS spread, the spread between forward rate agreements and overnight indexed swaps, becomes a window into these dynamics. (2) Cross-currency basis swaps signal more than rate differentials: Persistent deviations from covered interest parity reflect structural factors: global trade reconfiguration, reserve diversification, and the changing geography of dollar funding demand. These aren’t temporary anomalies to be arbitraged away but potentially persistent features of the new system. (3) Commodity volatility has monetary policy implications that are difficult to manage: When commodity prices surge due to supply disruptions rather than demand strength, central banks face an ugly tradeoff: tighten policy to control inflation headlines while risking recession, or accommodate the price shock and accept higher inflation. Unlike demand-driven inflation, supply-driven commodity inflation doesn’t respond well to rate hikes. (4) Infrastructure bottlenecks matter: Just as G-SIB constraints around year-end affect money market functioning, shipping capacity constraints and logistical bottlenecks affect commodity prices and, through them, inflation. Monitoring the “real plumbing,” freight rates, port congestion, pipeline capacity, provides early warning signals for inflation pressures.
Perhaps the most valuable way to engage with Bretton Woods III is not as a prediction to be validated or refuted, but as a framework for thinking about the intersection of geopolitics, commodities, and money. It forces attention to questions that are easy to overlook: (a) How do physical constraints on commodity flows affect financial market plumbing? (b) What risks do reserve holders face that aren’t captured in traditional financial risk metrics? (c) Where do central bank powers end and other forms of power, military, diplomatic, infrastructural, begin? (d) How do the “real” and “nominal” domains interact during periods of stress?
The current environment shows elements consistent with the framework: gradual reserve diversification, persistent commodity volatility, funding market stresses related to term commodity financing, and increasing focus on supply chain resilience over pure efficiency. It also shows elements inconsistent with it: dollar strength, the slow pace of alternative systems, and the resilience of dollar-based financial infrastructure. What seems clear is that the assumptions underlying Bretton Woods II, that dollar reserves are nearly risk-free, that globalized supply chains should be optimized for cost above all else, that central banks can manage most monetary disturbances, are being questioned in ways they weren’t five years ago. Whether that questioning leads to a new monetary order or simply a modified version of the current one remains to be seen. But Pozsar’s framework provides a useful lens for watching the process unfold, connecting developments in commodity markets, funding markets, and geopolitical arrangements into a coherent story about how the global financial system actually works.
Pozsar’s full Money Notes series is available through his website, and Perry Mehrling’s course Economics of Money and Banking provides excellent background on the “money view” that underpins this analysis.