In March 2022, when Western countries imposed unprecedented sanctions following Russia’s invasion of Ukraine, Zoltan Pozsar published a series of dispatches that became some of the most discussed in the financial markets that year. The main thesis was clear: we were witnessing the birth of “Bretton Woods III”, a fundamental shift in the operation of the global monetary system. Nearly three years later, with more data on de-dollarization trends, commodity market dynamics, and structural changes in global trade, it is appropriate to revisit this framework.
I first heard about Poser at Credit Suisse during the 2019 repo market disruption and March 2020 funding crisis, when his framework explained market dynamics in a way I had never seen before. Before joining Credit Suisse as a short-term rates strategist, Posser spent years at the Federal Reserve (where he mapped the shadow banking system, which prompted the G20 to initiate regulatory measures in this area) and the US Treasury. His work focuses on what he calls the “plumbing” of financial markets, the often overlooked mechanism by which money actually flows through the system. His intellectual approach is largely inspired by Perry Mehrling’s “Money View”, which treats money as having four distinct prices rather than being a simple unit of account.
Poser’s Bretton Woods III framework is based on a straight differential. “Inside money” refers to claims on institutions: Treasury securities, bank deposits, central bank reserves. “External money” refers to commodities like gold, oil, wheat, metals whose intrinsic value is independent of the promise of any institution.
Bretton Woods I (1944–1971) was backed not only by gold but also by money. The US dollar was convertible into gold at a fixed rate, and other currencies were tied to the dollar. When this system collapsed in 1971, Bretton Woods II emerged: a system where the dollar was backed by in-the-money U.S. Treasury securities. Countries accumulated dollar reserves, primarily in the form of treasuries, to support their currencies and facilitate international trade.
Posser’s argument: The moment Western countries froze Russian foreign exchange reserves, the risk-free nature of these dollar holdings fundamentally changed. What was seen as a negligible credit risk suddenly became a risk of seizure. For any country potentially facing future sanctions, the calculus of holding large dollar reserve positions has changed. Hence Bretton Woods III: a system where countries increasingly prefer to hold reserves in the form of commodities and gold, outside of money that cannot be stopped by the decision of another government.
To understand Posser’s analysis, we need to understand his analytical framework. Perry Mehrling teaches that money has four prices: (1) Par: One-for-one exchangeability of different types of money. Your bank deposits should be converted into cash at par. Money market fund shares must trade at $1. When the par value breaks, as happened in 2008 when money market funds “broke the debt”, the payments system itself is at risk. (2) Interest: The value of future money versus today’s money. This is the domain of overnight rates, term funding rates, and the various “basis” (spreads) between different funding markets. When covered interest parity breaks down and cross-currency basis swaps increase, it signals a strain in the ability to convert one currency into another over time. (3) Exchange rate: Price of foreign money. How many yen or euros does one dollar buy? When countries lack sufficient reserves, fixed exchange rate regimes may collapse, as happened in Southeast Asia in 1997. (4) Price level: Price of goods in money terms. How much is oil, wheat, or copper worth? It not only determines core inflation but also affects the price of almost everything in the economy.
Central banks have powerful tools for managing the first three prices. They can provide liquidity to maintain parity, influence interest rates through policy and intervene in foreign exchange markets. But the fourth price, the price level, is much more difficult to control, especially when the commodity is driven by supply shocks. As Posser says: “You can print money, but not oil for heating or wheat for food.”
Posser’s contribution was to extend Mehrling’s framework to the “real domain”, the physical infrastructure underlying commodity flows. For each of the three non-commodity prices of money, there is an analogy in commodity markets: (1) Foreign currency ↔ foreign cargo: Just as you exchange currencies, you exchange dollars for foreign-sourced commodities. (2) Interest (time value of money) ↔ shipping: Just as lending has a time dimension, moving goods from port A to port B takes time and requires financing. (3) Par (stability) ↔ security: Just as central banks protect the convertibility of various currency forms, military and diplomatic power protects commodity shipping routes.
This mapping reveals something important: Commodity markets have their own “plumbing” that operates in parallel to financial plumbing. And when this real infrastructure is disrupted, it creates tensions that monetary policy alone cannot resolve.
One of the most concrete examples in Poser’s March 2022 dispatch shows this intersection between finance and physical reality. Consider what happens when Russian oil exports to Europe are disrupted and must be rerouted to Asia. Previously, Russian oil traveled about 1–2 weeks from Baltic ports to European refineries on Aframax carriers (ships carrying about 600,000 barrels each). The financing required was relatively short-term, one or two weeks. After sanctions, the same oil should go to Asian buyers. But Baltic ports cannot accommodate very large crude carriers (VLCCs), which carry 2 million barrels. So the oil must first be loaded onto Aframax vessels, sent to a transfer point, transferred ship-to-ship to a VLCC, then shipped to Asia, a journey of about four months.
To move the same amount of oil, the same distance globally, now requires: (a) More ships (Aframax ships for initial transport and VLCCs for longer distances). (b) More time (4 months instead of 1-2 weeks). (c) More financing (commodity traders must borrow for much longer periods). (d) Tying up of more capital by banks (long term loans against volatile commodities).
Possar estimated that this re-routing alone would bring about 80 VLCCs, approximately 10% of the global VLCC capacity, into permanent use. Financial implications: The liquidity coverage ratio (LCR) of banks increases as they are providing more term loans to finance these longer shipping periods. When commodity trading requires more financing for a longer period, it competes with other demands on the bank balance sheet. If this occurs simultaneously with quantitative tightening (QT), when the central bank is removing reserves from the system, funding tensions are likely to be higher. As Possar noted: “In 2019, O/N repo rates rose as banks ran out of LCR and stopped lending reserves. In 2022, term credit for commodity traders may dry up as QT begins soon in an environment where banks’ LCR needs are going up, not down.”
One aspect of the framework that deserves more attention relates to dollar funding for non-US banks. According to recent Dallas Fed research, banks headquartered outside the United States hold approximately $16 trillion of US dollar assets, which is comparable to the $22 trillion of assets held by US-based institutions. Key difference: US banks have access to the Federal Reserve’s emergency liquidity facilities during periods of stress. Foreign banks do not have a US dollar lender of last resort. During the COVID-19 crisis, the Fed expanded dollar swap lines at foreign central banks to precisely address this vulnerability, by about $450 billion, about one-sixth of the Fed’s balance sheet expansion in early 2020. Structural dependence on dollar funding creates persistent vulnerabilities. When dollars become scarce globally, whether due to Fed policy tightening, changes in risk sentiment or disruptions in commodity financing, foreign banks face balance sheet pressures that could exacerbate stress. The covered interest parity violations that Poser frequently discusses reflect these frictions: direct dollar borrowing and borrowing synthetic dollars through FX swaps should theoretically have similar costs, but in practice, significant basis spreads persist.
Continue reading Possesor’s Bretton Woods III: Three Years Later [2/2]