Pozsar's Bretton Woods III: Three Years Later [2/2]

Start by reading Pozsar’s Bretton Woods III: The Framework [1/2]

Part 1 explains Zoltan Pozsar’s Bretton Woods III framework. This Part 2 uses evidence available by October 26, 2025, and flags later full-year 2025 figures where they appear.

Bretton Woods III after three years

1. Foreign central bank Treasury holdings fell from peaks above $7.5 trillion to below $7 trillion, a gradual but steady move away from dollar assets. US Treasuries are debt securities issued by the federal government. That decline is reserve diversification, which shifts official holdings across currencies and assets.

2. Gold rose from roughly $1'900/oz when Pozsar published his dispatches to peaks above $4'000/oz by the evidence cutoff. That move is consistent with central bank buying and demand for “outside money.” Physical gold is outside money because it is not another institution’s liability.

3. Several countries continue to build infrastructure for non-dollar trade settlement. Some systems operate in limited roles, but as full substitutes for dollar correspondent banking they are still preliminary. Correspondent banking lets banks make cross-border payments through accounts at other banks. The Society for Worldwide Interbank Financial Telecommunication (SWIFT) is principally a financial-messaging network. Further reserve freezes or financial sanctions could accelerate the development of the alternatives.

4. In 2024 the dollar had its best performance against a basket of major currencies since 2015. The US Dollar Index (DXY) tracks a fixed basket of six currencies, with the euro carrying the largest weight. By October 26, the index had fallen about 11% year to date, interrupting the decade-long rally.

5. Research on commodities as collateral studies investors who face collateral constraints and capital controls, which restrict transfers of money across borders. Collateral is an asset that secures financing. These investors import commodities and pledge them for financing. Higher collateral demand raises commodity prices and changes the relationship between inventories and convenience yield, the non-cash benefit of holding physical inventory.

China’s Strategic Options in Bretton Woods III

One of Pozsar’s more provocative arguments concerns China’s strategic options. Foreign exchange reserves are external assets that support a country’s currency and payments. China holds approximately $3 trillion, with a heavy weight in dollars and Treasuries. It therefore faces the same question as any large dollar holder: could another government freeze these assets?

Pozsar described two theoretical paths:

1. China could sell Treasuries and buy commodities directly, especially discounted Russian commodities. This would convert financial claims into physical resources.

2. China could print renminbi and buy commodities. This could create a “eurorenminbi” market parallel to the eurodollar system, the offshore market for US-dollar deposits and credit.

The first option could help China control inflation by securing physical resources. Treasury sales could also raise yields in the Treasury market. The second option would challenge dollar dominance more directly. It would create an offshore currency market backed by commodity reserves rather than financial reserves.

By October 26, 2025, the evidence showed elements of both. China had substantially increased commodity imports from Russia. Renminbi internationalization had progressed, though more slowly than some expected. China’s capital controls and less-developed financial markets constrained it relative to dollar markets.

Durable Insights from the Bretton Woods III Framework

Several insights look durable even if Bretton Woods III does not emerge exactly as Pozsar described it.

1. Central banks control the nominal domain of money, prices, and financial claims. They do not control the real domain of resources, infrastructure, and production. Monetary policy can influence demand, manage liquidity, and stabilize financial markets. It cannot conjure physical resources, and rate increases do little to resolve an underlying commodity shortage.

2. Very large crude carriers (VLCCs), Suez Canal capacity, and port efficiency constrain financial flows, so the infrastructure behind commodity movements helps explain funding-market dynamics.

3. Commodity-backed finance, warehouse-receipt systems, and physical collateral reflect better monitoring and verification, as well as a strategic move away from pure financial claims. The Financial Stability Board (FSB) noted in 2023 that banks provide credit, clearing services, and intermediation between commodity firms and central counterparties in the commodities ecosystem. A central counterparty stands between buyers and sellers in a cleared trade.

4. The weaponization of reserve assets changes every reserve holder’s risk calculation, however justified in a specific case. The changed calculation implies persistent, gradual reserve diversification, not immediate de-dollarization.

Practical Implications for Funding Markets and Monetary Policy

At the October 26, 2025 cutoff, these insights had four practical implications.

1. Less efficient trade routes can prolong funding-market stress. Funding markets provide the financing that keeps trade and financial positions running. Those routes can make commodity traders borrow more and for longer. Banks may also face balance-sheet constraints from regulation or from quantitative tightening (QT), which reduces a central bank’s balance sheet. The term funding premium, the extra cost of borrowing beyond overnight maturities, may therefore remain high relative to overnight rates.

The spread between forward-rate agreement and overnight indexed swap rates (FRA-OIS) compares an unsecured interbank borrowing rate with a maturity-matched OIS rate. It primarily indicates bank credit and liquidity stress, so its connection to de-dollarization or commodity finance is indirect.

2. Cross-currency basis swaps exchange funding cash flows in two currencies. Covered interest parity is the condition that forward exchange rates offset interest-rate differences. Persistent deviations from it can reflect structural forces, including trade reconfiguration, reserve diversification, and a changing geography of dollar demand. The deviations may become lasting features of a new monetary system, not temporary arbitrage opportunities.

3. A supply disruption can raise prices without strong demand. Central banks then face an ugly tradeoff. They can tighten policy to try to control headline inflation, at the risk of recession. Or they can accommodate the shock and accept higher inflation. Supply-driven commodity inflation does not respond well to rate increases.

4. Year-end constraints on global systemically important banks (G-SIBs) affect money-market functioning. Shipping limits and logistical bottlenecks also affect commodity prices and inflation. Monitoring the “real plumbing,” including freight rates, port congestion, and pipeline capacity, provides early warning of inflation pressure.

Bretton Woods III as an Analytical Framework

Perhaps Bretton Woods III is more useful as a framework than as a prediction to validate or refute. It links geopolitics, commodity markets, and funding markets into a coherent account of how the global financial system works, and it raises four questions:

• How do physical constraints on commodity flows affect financial-market plumbing?
• What reserve-holder risks escape traditional financial-risk measures?
• Where does central-bank power end and military, diplomatic, or infrastructure power begin?
• How do the “real” and “nominal” domains interact under stress?

The evidence available by October 26, 2025, contains elements consistent with the framework: gradual reserve diversification, persistent commodity volatility, term-financing stress in commodity markets, and an increased focus on supply-chain resilience over pure efficiency.

Other evidence cuts against it: the dollar remained strong through 2024, alternative payment systems developed slowly, and dollar-based financial infrastructure remained resilient.

Still, several Bretton Woods II assumptions face questions that looked less urgent five years earlier: that dollar reserves are nearly risk-free, that global supply chains optimize cost above all else, and that central banks can manage every monetary disturbance.

Pozsar’s full Money Notes series is available through his website. Perry Mehrling’s course Economics of Money and Banking provides excellent background on the “money view” behind this analysis.