Brad Setser on the War in Iran and the Future of the US Dollar

It's possible that the war in Iran could reshape financial flows in significant ways. Perhaps the Gulf states will end up as less desirable places to do business. Perhaps Iran will have a tollbooth at the Strait of Hormuz. Perhaps this episode will accelerate the world's shift away from oil. It's impossible to say. But given the uncertainty, fresh questions are being raised about the existing financial world order, upon the top of which the US dollar sits. On this episode, we speak once again with Brad Setser, the Whitney Shepardson senior fellow at the Council on Foreign Relations. We discuss how the war is already creating new global imbalances, and the degree to which this episode parallels past energy shocks. We also talk about broader trends in reserve management, other factors driving financial flows, and the unique situation facing East Asia, which is seeing a surge in its energy import bills at the same time its making making a fortune selling chips for the AI boom. Read more:US Probes Suspicious Oil Trades Made Before Trump PivotsChina’s $51 Trillion Savings Help Bonds to Outperform During War Only http://Bloomberg.com subscribers can get the Odd Lots newsletter in their inbox each week, plus unlimited access to the site and app. Subscribe at bloomberg.com/subscriptions/oddlots Subscribe to the Odd Lots NewsletterJoin the conversation: discord.gg/oddlotsSee omnystudio.com/listener for privacy information.

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Joe Weisenthal?

  There are some market stories where you want every detail. Tracy and I have made quite a few podcasts on that basis, but sometimes you've only got 10 minutes and need to know what's moving markets and why. That's the Barclays Brief Podcast. Every week, experts from Barclays Markets and research get you up to speed on what matters and what to watch next, about the time it takes to grab a coffee. So, search Barclays Brief wherever you get your podcasts.

• 0:26Speaker 01

  This is the Bloomberg Tech Minute brought to you by ChatGPT. I'm Carol Muster. Getting hired at SpaceX requires exceptional ability and may include having Elon Musk review a candidate's resume. So writes Bloomberg Business Week's Lauren Grush. She reports that the company culture is defined by Musk, and job candidates must understand that a commitment to SpaceX means adhering to this culture and exhibiting loyalty to Elon Musk. To get hired, candidates must demonstrate their achievements from past jobs, and hands-on experience matters more to recruiters than advanced degrees, with the company looking for people with raw, innate intelligence. A spokesperson for SpaceX didn't respond to a request for comment on its recruiting and hiring practices, but according to recruiters, advisors,

• 1:11Speaker 01

  and those who've interviewed for jobs there, it's the space exploration dream that draws people to the company, and Musk invokes that dream regularly to remind workers why they're there. Prospective hires are told that the job will require stamina, including in job ads that candidates, quote, "must be willing to work extended hours and weekends as needed." One major perk for all that hard work? Employees' access to equity, either the right to buy shares or payment in the form of restricted stock units that vest over time. That's the Bloomberg Tech Minute brought to you by ChatGPT. Get started at chatgpt.com.

• 1:51Speaker 01

  Bloomberg Audio Studios, podcasts, radio, news.

• 2:07Tracy Alloway?

  Hello and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

• 2:11Joe Weisenthal?

  And I'm Joe Weisenthal.

• 2:12Tracy Alloway?

  Joe, it is April 15th.

• 2:14Joe Weisenthal?

  Yes.

• 2:15Tracy Alloway?

  Happy Tax Day to all who observe.

• 2:18Joe Weisenthal?

  I'm so annoyed. I'm just speaking of taxes. I'm pro taxes, but I just had an email with my accountant. Anyway, I'm in a bad mood.

• 2:25Tracy Alloway?

  I'm pro taxes. I resent the fact that we have to like actually file them in this massive bureaucratic exercise every year. But anyway.

• 2:32Joe Weisenthal?

  This has nothing to do with what we're talking about.

• 2:34Tracy Alloway?

  Well, okay, taxes, you know, financial flows of a sort.

• 2:38Joe Weisenthal?

  Well, taxes create demand for currency, core MMT principle, right?

• 2:42Tracy Alloway?

  There we go. Okay. Well, let's see. It is April 15th. The situation in Iran, still highly uncertain, very fluid, but you know, we have seen higher oil prices in general. We've seen people getting oil from new sources, new parts of the world. And we've seen a lot of people reaching back to the 1970s oil shock as a sort of historic analogy for what we might be experiencing now.

• 3:07Joe Weisenthal?

  Right. Absolutely. I mean, obviously, again, in the context of like today, April 15th versus like, say, a version of this conversation that we might've even had like two weeks ago, things are a little bit calmer right now. But we absolutely do not know that they're gonna actually have a durable ceasefire and so forth. Obviously, oil prices have come down. Nonetheless, it's a pretty big oil jump from where we were, say, in the middle of February. Even at that point, oil prices might have been pricing in some sort of Iran war premiums. It's even further jump from that. And so, yes, we've had this really big oil shock. And in addition, we might have some sort of shift in the global balance of power, particularly if Iran is a toll keeper in some way with the straightforward moves.

• 3:52Tracy Alloway?

  So this is exactly it. And one of the reasons I mentioned the 1970s oil shock is because that moment is very intertwined with financial history and the development of the financial system itself. And we've done a number of episodes on the history of petrodollars and eurodollars. We had a great series with Josh Younger before. And so I think when you have a moment like this, where people are bringing up those analogies and we can get into whether or not those are the correct analogies to make.

• 4:21Joe Weisenthal?

  Yeah.

• 4:21Tracy Alloway?

  It kind of generates this longer term discussion about what the financial system is actually going to look like and where financial flows are actually going to go to.

• 4:32Joe Weisenthal?

  Totally right. And you know, one of the things that I'm thinking about, like some of our old conversations, like we used to have with Zoltan Posar, for example, and it was like, you know, one of the things that connected dollar dominance was this idea of, well, the US Navy is what policed the high seas and made global trade flow and stuff like that. If that is under question of whether the US actually can keep ships going in the way they were, how does that change the equation? What if it happens to be the case that to go from one place to another, you need to pay in Chinese yuan instead of dollars? All kinds of interesting things that arise about the relationship between power and currencies at a moment of crisis.

• 5:13Tracy Alloway?

  Right. And if you're paying for oil in yuan, does that mean that you're going to save that like money in non-dollar reserve assets? Or are you just going to put it like right back into treasuries? All right. There are a lot of questions that we have about this current moment. Obviously, everything's still highly uncertain, but who do we call when we're trying to untangle uncertain global flows? One man, and that is Brad Setser. He is, of course, the Whitney Shepardson Senior Fellow at the Council on Foreign Relations, a man who holds the title of most of All Thoughts appearances, I think, at this point.

• 5:46Joe Weisenthal?

  What we love about Brad is there has never been a crisis in which he doesn't have some relevant expertise to bring to bear.

• 5:52Tracy Alloway?

  That's right. Brad, welcome back to All Thoughts. Thanks so much for coming on.

• 5:56Speaker 03

  No, no, thanks for having me back.

• 5:57Tracy Alloway?

  So why don't we just start with that historic analogy, the 1970s oil shock, lots of ink currently being spilled on whether or not that's the correct parallel for our current crisis experience. But In your view, how much does this particular oil shock resemble that of, I guess, 50 years ago now?

• 6:19Speaker 03

  I mean, not, okay, well, there's the obvious parallel in the sense that the 70s oil shocks, you know, 73 was a function of the Yom Kippur War, Israel, the Arab nations' reactions, this or that. The second oil shock in 1979 was, you know, a function of the Iranian revolution. So same geographic region, different in the sense that the US and Israel are the instigators, and different in the fact that so far at least, the magnitude of the shock is not at all comparable. Now, it's not at all comparable in price terms. In 73 and then in 79, oil doubled or tripled. And by the end of the decade, oil had gone up by

• 7:05Speaker 03

  well, six, seven times in dollar prices, less in real terms. We've only gone up, whatever, 50% max from spot oil. I mean, sort of for Brent and for WTI and the next month's future. It's a little higher for delivery in Asia, but we are not yet at the magnitude of the shock that we were in the 1970s. The obvious point is our economy as a whole for the US and for the world is a little less oil-dependent, but I wouldn't push that too far. So I think the main distinction is, you know, we sort of started it, the US and Israel. We, in theory, can end it, although we would only end it if Iran finds its own equilibrium, which it allows other countries' oil to pass through the strait.

• 7:51Speaker 03

  And at least so far, the market has not anticipated that this will need the same kind of jump in price to balance supply and demand. That could change. If you look at it in terms of physical interruption of the flow of oils, some of your guests who've been on here have noted.

• 8:07Joe Weisenthal?

  Yeah.

• 8:07Speaker 03

  We're similar, maybe even worse. So we're kind of in this weird world where the physical interruption is bigger, the price reaction is smaller.

• 8:16Joe Weisenthal?

  I'm glad you brought this up. I would just love your take on this in particular. You talk to the commodity guys like we do, and they're like, this is crazy. This is the biggest shock ever. Guys like me, I'm an efficient markets guy, like, hey, I just see what's on the screen. It looks like it's not that big of a deal. You be the third-party arbiter here. How do you make sense of the gap between what we see on our screen versus the shortfall in physical barrels, 20 million every single day that aren't coming to the market?

• 8:46Speaker 03

  It's not quite 20.

• 8:48Joe Weisenthal?

  Okay, okay.

• 8:48Speaker 03

  You got the east, west.

• 8:49Joe Weisenthal?

  There's been some route.

• 8:50Speaker 03

  It's somewhere between 10 and 15.

• 8:52Joe Weisenthal?

  Okay.

• 8:53Speaker 03

  Which, which happens to be between 10 and 15% of global supply.

• 8:56Joe Weisenthal?

  Yeah.

• 8:56Speaker 03

  Happens to be between 20 and 30% of global traded oil. It is still a massive, massive, massive shock. And my elasticities would imply a much bigger increase in price if that was a sustained, expected interruption. Look, I think you end up dealing with the reality that oil is close to being a perfectly fungible commodity, but it is not a perfectly fungible commodity. A North Atlantic barrel can only get to China or Japan with a long trek around the world.

• 9:30Joe Weisenthal?

  Yeah.

• 9:30Speaker 03

  So there's an extra shipping cost. A lot of the barrels in the North Atlantic are sweet and light. Light, just as, you know, how vicious, you know, easy to flow, like a measure of the weight of the oil, sweet, less sulfur. And, you know, a lot of the refiners in Asia were set up to refine medium sour. And for some things, you want heavier grades of oil because you get more diesel out of the heavier grades. And, you know, refiners just configured for different grades of oil. So you, when you interrupt the flow, fundamentally the flow from the Gulf countries to Asia, there's no immediate, instantaneous substitution for barrels in the North Atlantic. I think that's first point.

• 10:15Speaker 03

  Second point is what people think of as traded oil is not actually the oil for delivery tomorrow. It is the futures contract for the next month, next month after that. The world could look completely different. The US has, within its ability, the capacity to kind of pull back. And if the US pulls back, and maybe the Iranians insist on a toll, there is no shortage of oil that could come out. Now, it'll take a little longer now because of the physical destruction of some of the export facilities in the Gulf. But if you don't have this particular choke point strangled, the old global oil market was very, very well supplied. So I think the futures market has to balance between

• 10:59Speaker 03

  one possibility, which is that there is plenty of oil two, three months out, and oil is on a trajectory, not immediately because of the damage and everything else, back to 60, and another possibility where this persists, and oil's at 150 or above. And the markets had trouble figuring that one out.

• 11:17Tracy Alloway?

  Yeah, so, okay, speaking of oil at 150 potentially, one of the key differences between now and, I guess, the 1970s is that the higher oil price is not necessarily accruing to the petro-states, right? Because if you're the UAE or someone like that, and you can't physically get as much oil out, then you're not generating as much money, and so you're not recycling that money into potentially US bonds, or, I guess nowadays, US stocks and things like that. And if you think back to the 1970s and the birth of the petrodollar market, you know, it was because they were making a lot of money that they had to put somewhere. Just talk to us on a very simplistic basis about who is actually, like, making money?

• 11:59Tracy Alloway?

  Whose current account is benefiting from higher oil prices right now?

• 12:03Speaker 03

  Well, you made the key point, which is that the usual winners, like, the big winners from Russia in '22, the big winners when Libya went offline, big winners with some periods of Iran sanctions, big winners with some of the periods of tighter Venezuela sanctions, are the countries in the Gulf. They have the most oil. And they also have some of the lowest breakeven prices. So any oil above 60 means a big current account surplus. Those countries are not going in a position to capture this windfall. So you've kind of taken Kuwait, Iraq...

• 12:41Speaker 03

  UAE, out of the picture. The Saudis, like, at the margin because they can get some oil out, but they can't get as much oil out. And they actually had a really high breakeven. They're a current account deficit country. They need $100 a barrel oil with 7 million barrels a day of exports in order to breakeven. They're going to get 100, maybe they're going to get a higher price so they can make it up with 5 million. But, you know, the Gulf countries are just not the winners. Russia should win. The Ukrainians are doing their best to kind of limit the amount of Russian oil that gets to the market. The Kazakhs will win. All the stands that can export oil will win. Nigeria will win. Angola will win. All the South American oil exporters will win.

• 13:24Speaker 03

  And then, you know, the biggest locus of production outside of the Gulf, even bigger than the production in, you know, the West Siberian fields of Russia, are the, in the US South, Southwest, Texas, and then in Alberta. So, you know, North America is producing, you know, well over 25 million barrels a day, exporting five to the rest of the world. And while it's mostly a transfer from American consumers to American producers, that is one of the biggest shifts in the global economy. I left out Norway. So Norway really, really, really bends, especially if gas prices go up. It is the Salt Brunei.

• 14:06Speaker 03

  You know, it's the smaller oil exporters who aren't at, don't fit your mental image of the Petro chic.

• 14:13Joe Weisenthal?

  I'm looking at the dollar, how do you pronounce the tengay? Do you know the Kazakhs, the, how do we pronounce the?

• 14:20Speaker 03

  Tengay is good.

• 14:21Joe Weisenthal?

  The tengay? I'm looking at the dollar tengay cross, which is the Kazakh currency. It's been doing very well. And in fact, actually, the tengay, or dollar tengay, which is how I think you're supposed to quote it, hit its low in the very early April, which sort of coincides with the peak of some of these fears, at least in the local terms. So your intuition or your description of who are some of the big winners seems to be matched in the market.

• 14:48Tracy Alloway?

  We need a catchy nickname for dollar tengay, like cable. That's not that catchy, is it?

• 14:53Joe Weisenthal?

  No, you know what we need? We need like an acronym for the non-Gulf state, non-sanctioned oil powerhouse. So we need like- Kazakhstan, Angola, who are, what was another one you said?

• 15:07Speaker 03

  Nigeria, Colombia, Ecuador.

• 15:11Joe Weisenthal?

  The Cankers or something like that. We need, um, this is good. We'll, we'll, we'll workshop this later.

• 15:34Joe Weisenthal?

  There are some market stories where you want every detail. Tracy and I have made quite a few podcasts on that basis, but sometimes you've only got 10 minutes and need to know what's moving markets and why. That's the Barclays Brief Podcast. Every week, experts from Barclays Markets and research get you up to speed on what matters and what to watch next. About the time it takes to grab a coffee. So search Barclays Brief wherever you get your podcasts.

• 16:00Speaker 01

  This is the Bloomberg Tech Minute brought to you by ChatGPT. I'm Carol Muster. Getting hired at SpaceX requires exceptional ability and may include having Elon Musk review a candidate's resume. So writes Bloomberg Business Week's Lauren Grush. She reports that the company culture is defined by Musk and job candidates must understand that a commitment to SpaceX means adhering to this culture and exhibiting loyalty to Elon Musk. To get hired, candidates must demonstrate their achievements from past jobs and hands-on experience matters more to recruiters than advanced degrees, with the company looking for people with raw innate intelligence. A spokesperson for SpaceX didn't respond to a request for comment on its recruiting and hiring practices,

• 16:43Speaker 01

  but according to recruiters, advisors, and those who've interviewed for jobs there, it's the space exploration dream that draws people to the company and Musk invokes that dream regularly to remind workers why they're there. Prospective hires are told that the job will require stamina, including in job ads that candidates, quote, "must be willing to work extended hours and weekends as needed." One major perk for all that hard work? Employees' access to equity, either the right to buy shares or payment in the form of restricted stock units that vest over time. That's the Bloomberg Tech Minute brought to you by ChatGPT. Get started at chatgpt.com.

• 17:23Joe Weisenthal?

  Let's zoom back in time for a second because we brought up the 1970s. But, you know, okay, there's obviously differences. How did the 70s reshape the world? Like fundamentally, okay, you have these oil shocks, et cetera. And people then start talking about these things called petrodollars is a word that comes into existence. But in what senses, you know, did those shocks? What kind of legacy did they leave on the global financial system?

• 17:50Speaker 03

  Well, they had a real legacy. You know, you're going into the 1970s, oil was so bloody cheap, people burned it for electricity.

• 17:58Joe Weisenthal?

  Yeah.

• 17:59Speaker 03

  And going into the 1970s, Americans drove, which we've now have gone back to doing, honking big cars, you know, massive Cadillacs with big fins. So, you know, 15 years later, very little oil is being burned for electricity. You substitute for cheaper forms of fossil fuels, more nuclear.

• 18:17Joe Weisenthal?

  They still burn oil for electricity in New England because they're so anti-climate change that they refuse to build a natural gas pipeline. So they burn oil instead. Anyway, sorry, keep going.

• 18:26Speaker 03

  And for a long time in Puerto Rico. I mean, there's also islands because oil is very energy dense and easy to transport.

• 18:34Joe Weisenthal?

  Yeah.

• 18:35Speaker 03

  And look, we did move to smaller Japanese cars away from the big three massive cars from the 1960s. So there is like a very real set of adaptation in the economy. The economy becomes less oil intense because it was such a huge increase in the price of oil. Americans are very unhappy. If you remember in the 1970s, it was not good for President Carter when the Iranian revolution, you know, there was the hostages. But the oil shock did not help his popularity. And Americans in general are very, very unhappy when oil prices are high. It's one of our national quirks. But then in the short run, at that time, there was this huge windfall into the Gulf States. The Gulf States piled up dollars and there were dollars.

• 19:19Speaker 03

  Most oil, you know, oil was priced in dollars before 1973. It didn't take a deal to price oil in dollars. The US had been the biggest producer of oil in the 1930s. We were the supplier of oil to the Brits and others during World War II, you know, it was only over the course of the 1950s and 1960s do other parts of the world kind of catch up with US oil production. But the US, the oil industry in a deep sense was born in the United States and it was always priced in dollars. And the Gulf countries and Saudi Aramco was originally a joint venture with an American company, or maybe even fully owned by an American company, I forget. So it was natural it was priced in dollars.

• 20:00Speaker 03

  Oil, it wasn't like in the 1970s, you had to do a new deal to price oil in dollars rather than something else. Oil was in dollars. Those dollars piled up and it was a period of difficulty in the international monetary system. The US was going off the gold standard, Bretton Woods was breaking down, inflation was not well-contained after the first oil shock. And there was an effort to convince the Saudis to keep their large stock of new petrodollars in dollars, not by euros, and use them, at least in part, to buy treasuries. Now, even then, the Saudis were a little reluctant to visibly buy treasuries.

• 20:41Speaker 03

  And, you know, some Bloomberg reporters several years ago went through this history and the US started masking who was buying treasuries at the request of the Saudis. Because the Saudis, you know, well, like, you know, you guys are supporting Israel. We don't really want to be buying your bonds directly. Can you hide it? And we agreed. And then because there was still this residual tension between the US and many, many parts of the Arab world, a lot of the dollars did not flow into the treasury market. They flowed into bank accounts in London, offshore, effectively euro dollars originating from petro-states. And then those got recycled and they got lent, in no small part to oil importing emerging economies.

• 21:25Speaker 03

  And that is sort of viewed as the start of the buildup of the vulnerabilities that led to the Latin American debt crisis in the 1980s. Now, there's another part of this whole story that I think people forget, which is sort of what's been on my mind and is irritating me. After 79, 80, Saudis had built up huge, huge, huge, huge stocks of dollars. A great, great decade for the Saudis in the 1970s. In the 80s, in order to keep prices high, they had to cut production. And then eventually, that wasn't enough, and the oil price collapsed. And by the end of the 1980s, and certainly by the middle of the 1990s, all the dollars that had been built up in the 1970s had been spent.

• 22:10Speaker 03

  The Saudi cumulative current account balance went back into basically being neutral or into a deficit by 95, certainly was there by 2000. So in some sense, the petrodollar boom came and it went. By the time of the Asian financial crisis, oil prices were very, very low in the 20s. And there was not, there were no flows of petrodollars, nor was there a very large stock of petrodollars. So there's sometimes a tendency to think the 70s just continued, continued, continued. And the reality is, setting aside the really rich Emirates and Kuwait, the rest of the

• 22:51Speaker 03

  oil exporters were not in a position to continuously build up and save over most of the period after 1980, until we get, you know, the big run-up in oil from '03 to '14.

• 23:05Tracy Alloway?

  The '03 to '14 run-up in oil, then, talk to us about where those dollars actually went, what types of assets? Because my sense is that happens to coincide with the very moment that a lot of the wealthy Gulf states were talking about diversifying into things like tech stocks.

• 23:23Speaker 03

  Equities generally.

• 23:25Tracy Alloway?

  Yeah.

• 23:26Speaker 03

  I think there's two stages. At the very beginning of the run-up in oil prices, there are an awful lot of countries that remember basically being out of money in '98 and '99, when oil prices collapsed, when Russia defaulted. The Saudis were almost out of reserves, too. And so the first stage is, you know, we're rebuilding our precautionary balances. At least. In the biggest, most visible countries, Russia and Saudi Arabia. Now, it's a little different in Abu Dhabi, the biggest emirate, the one with the most oil. And in Kuwait, Kuwait had to make up for the first call for and some of the destruction.

• 24:06Speaker 03

  But in Abu Dhabi, in Qatar with its gas, they, from the beginning, had felt they had a decent precautionary buffer and started doing the sovereign wealth fund style investments, more into alternatives, more into equities. As time goes on, the Saudis build up a bigger buffer and they conclude they have enough reserves. And then they start doing a mix of spending at home and buying equities and taking direct stakes in companies. Over time, the Emiratis, who used to be kind of conservative and behind the scenes, just put the money in Audia, invested in a fairly diversified portfolio, don't take controlling

• 24:48Speaker 03

  stakes, they become very active investors, looking for the home run. The Royals become more involved in the management, is a little bit less of an outpost of London professional fund managers and a bit more of a playground of some of the younger sheiks. And then, you know, it kind of varies across the world. The Norwegians build up a massive professionally run sovereign wealth fund, which is a predictable portfolio balancer, and since equities have gone up over the past four years, all the new flow has gone into bonds because they hit a predictable target. And then the Russians actually started off building up dollars, but then they got worried about, you know, their political relationship with the US, the reset with Obama didn't really work.

• 25:30Speaker 03

  They, even before Crimea and the Donbass, they had taken their reserves, dollar reserve share down to 40 or 50. And then after the Donbass, they took their reserves, dollar reserve share down to, we now know to be basically zero. They certainly took everything out of US custodial accounts. So you do see diversification over time across currencies and then even more so across assets. Now, the last point I make, and this is just sort of to be provocative because I'm tired of people blah, blah, blahing about the dollar as the global reserve currency and how that's the foundation of everything.

• 26:07Speaker 03

  Remember this, an international large cap equity portfolio will have a US share of roughly two thirds, 65, 70%.

• 26:20Speaker 03

  The Saudi Public Investment Fund, my friend Alex Ettra has done some work on it. Its international portfolio has a dollar share of 80. And that's probably typical because most private equity funds are going to be mostly pretty dollar-heavy. A typical global reserve portfolio is now at 57% dollars. So the notion that reserves are the source of inflows into dollars is a bit dated. A reserve portfolio will typically have a lower dollar share than a standard return-seeking equities fund, which just because of the outperformance of US large caps, will be more overweight dollars.

• 26:58Tracy Alloway?

  Joe, mildly annoyed Brad is the best Brad, I think. We should ask a question about the IMF report on global imbalances. No, no, we have a lot to talk about.

• 27:08Joe Weisenthal?

  Well, I mean, actually, could you just expand on this further? So we look around the world and we see that actually, reserve portfolios are arguably, or all things equal, maybe underweight dollars. Was that always the case? Is there a structural reason for that? Like, what's the story behind this mismatch? I didn't actually realize that.

• 27:28Speaker 03

  Well, reserves can be managed for safety and liquidity and not for return.

• 27:34Joe Weisenthal?

  I see.

• 27:35Speaker 03

  And so the pressure to get the most returns is weaker. So you don't have to chase the tech stocks. You don't have to match an index. And if you don't have the tech stocks, you're underperforming the index, you're underperforming your benchmark. Your benchmark as a reserve manager will be more bespoke, higher priority on safety and liquidity. That's observation one. Observation two, and this is where things get funky. A quarter of global reserves, to the first approximation, are in China. Now, China still manages its currency against the dollar, but China, as a matter of policy, brought its reserves, formal reserve, dollar reserve share, down, last disclosed number,

• 28:15Speaker 03

  down to 55% from 79% in 2005. They did not like the optics of financing their strategic rival and holding a lot of treasuries in visible ways. Now, that's a bit misleading because the dollar share of the portfolios of the state banks, which now have a very large share of the total state portfolio, is much higher, 70%. And if you actually net out the offshore liabilities of the state banks and just look at the net. Oh, yeah. The euro offshore portfolio is matched by euro offshore liabilities. So that nets

• 28:57Speaker 03

  out. The dollar offshore are matched by dollars onshore. So in a sense, the BOP flow through the state banks was almost, setting aside some of the CNY lending, which has gone up, was like 100% dollars. Like a Taiwanese lifer portfolio, one of my other favorite topics, would be 95% dollars. You remember, central banks are holding reserves as an asset against liabilities, money that don't pay interest. Some have to sterilize. So they don't have the same pressure to generate returns. And so therefore, they can hold lower yielding, safer assets. And a couple of big players, China and Russia, just didn't want to be too heavy dollars.

• 29:38Joe Weisenthal?

  God, there are so many things now that I'm thinking about. We could like, different avenues I want to ask Brad about. But just since you mentioned Taiwanese life insurance companies, it got me to think about East Asia a little bit. I'm just curious, like, have you ever seen anything like what's going on with South Korea right now?

• 29:58Speaker 03

  No.

• 29:59Joe Weisenthal?

  I only think because of East Asia, where it's just like this insane, I mean, this is a real, obviously, like a big, generally rich, developed economy by and large, and it's just having this insane growth spurt, both in the stock market and actually the real economy, because of how the incredible margins and sales it's getting on essentially memory chips right now. Like, is there any analogy that comes to mind for what we're witnessing here right now?

• 30:23Speaker 03

  I'm not that comes to immediately to mind. I mean, Huge growth in exports.

• 30:29Joe Weisenthal?

  Yeah.

• 30:30Speaker 03

  Very rapid real growth, particularly in Taiwan, actually. But narrow, one sector expanding.

• 30:36Joe Weisenthal?

  Right.

• 30:37Speaker 03

  And then weakening currency. You know, you have growth outperformance, you have a terms of trade positive shock from the semiconductor prices, and then you have a weak currency. And then you have an econ, like last year, all the outflow from Korea that matched the current account surplus was into equities. A third of that was from their national pension fund, so a policy flow. Two thirds of it was just retail, and retail decided, even though Samsung is making money hand over fist, that they preferred to hold US tech stocks. So now I haven't seen anything like it. I mean, what is also interesting right now is that Korea is a very petroleum intensive economy, a lot of petrochems, energy intensive industries, in addition to the memory chips.

• 31:22Speaker 03

  And so, and it's energy poor, fossil fuel poor. So it is, on the one hand, benefiting from this giant positive shock, memory chip surge in price, surge in demand, AI is helping Samsung print money hand over fist. And then the economy's on the receiving end of a pretty big negative shock.

• 31:43Joe Weisenthal?

  Yeah.

• 31:44Speaker 03

  Because of the loss of oil flow. And so, you know, we've sort of stayed in a, that mix has kept the won weak. The, the interesting thing to me is that the Koreans are now starting to complain that the won is too weak, despite being a country that historically likes a weak currency for exports. And the National Pension Service has just announced they're going to expand their hedging program. I hope they succeed. The world economy does not benefit from won at 1,500 and an even bigger Korean surplus over time.

• 32:15Tracy Alloway?

  Well, we'll have to bring back former Odd Lots guest Hyun Sung Shin to talk about all of this.

• 32:21Speaker 03

  Good luck. I mean, he's got a promotion.

• 32:23Joe Weisenthal?

  He has a good job these days, yeah.

• 32:25Tracy Alloway?

  I just refer to him as former Odd Lots guest from now on and forever.

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• 35:06Tracy Alloway?

  Just going back to the de-dollarization idea. As you point out, there's a lot of nuance with reserve portfolios. And then one of the things you always see when a headline comes out saying that, you know, foreign countries reduce their share of US treasuries is this idea of the custodial accounts. And maybe we're not getting a full picture of exactly what they're buying. When it comes to gauging de-dollarization, I'm doing air quotes. No one can see me because this is a podcast. But like, what are you actually looking at to score and gauge whether that's a real trend and whether or not it's accelerating over the past five weeks or so?

• 35:41Speaker 03

  It's hard to track in real time. I mean, the obvious indicator is if the world is de-dollarizing, they're going to be buying fewer dollars and the dollar should be falling in value, which it generally is not. So, I mean, I think that's, that's the simple, high-frequency metric. To me, it is very difficult to have a credible story around de-dollarization when the dollar is strong, not weak, relative to history. And when the total dollar claims on the US, including dollar-denominated equity claims, have continued to increase. And so in 2025, the world was longer dollars than it was in 2024, despite all the hot air spent talking about de-dollarization.

• 36:26Speaker 03

  Function of the fact that we have a current account deficit of over a trillion dollars, so we have to sell a trillion of financial assets, and we are not selling euro or yen or yuan-denominated claims to the world. So last year was sort of financed 50/50 with dollar debt and US equities, which implicitly settle in dollars. So in that sense, I find it a silly discussion. In order to de-dollarize, the world has to stop funding the US in dollars. Now, there's a whole bunch of other things that can happen around the world, and there is a small sub-trend where some emerging market borrowers are borrowing in yuan to save money. And so I think that is an interesting cross-current, but it is a modest cross-current.

• 37:08Speaker 03

  The sanctioned countries, of course, don't use dollars or euros to settle payments because they cannot. Now, in general, they seem to want to get rid of the sanctions. They're not saying, "Oh, this has been great. We are so lucky that we have to settle payment in yuan and sell our oil to China at a discount." They generally would like to say, "Well, we would love to be unsanctioned, to sell in dollars and to have a competitive market for our oil, not just some monopsony buyer in China." But, look, you look for indicators of changes in hedge ratios. You look for individual countries or individual institutions that have changed their portfolio allocation in a meaningful

• 37:51Speaker 03

  way. And I think over the past nine months, there was decent evidence that some of the Scandinavian pension funds, institutional investors hedged or reduced their dollar bond holdings, partially in response to some overheated rhetoric around Greenland.

• 38:10Speaker 04

  Yeah.

• 38:10Speaker 03

  On the other hand, unambiguous evidence, because of some silly changes in regulation that had a big impact, that the Taiwanese lifers reduced their hedge ratio by a really big number. And the Japanese lifers continue to see, like, they let their hedge ratios slip because hedging is costly in Taiwan. It's costly in Japan. And you haven't been rewarded for hedging because the currencies have stayed weak. And in fact, in Taiwan, when you reduce the hedge ratio, that works as a bid for the dollar, and it pushes the dollar back up and pushes the Taiwan dollar down. So you, it becomes self-reinforcing circular Soros reflexivity. So you see parts of the global economy that are hedging. You

• 38:54Speaker 03

  see parts of the global economy that have really reduced their hedge ratio, just gone all-in, long-dollar fixed income. And you see parts of the global economy that are less comfortable holding dollar-fixed income, but they are absolutely unwilling to be underweight U.S. equities. And so what you really end up seeing is not de-dollarization. It's just more a little bit of a rotation towards holding U.S. equities and a little less bonds.

• 39:20Joe Weisenthal?

  Going back to sovereign wealth funds and just thinking about them abstractly, you know, countries, particularly big commodity exporters, have various good reasons to have sovereign wealth funds. Their revenues are going to be very volatile and cyclical, and so you want to smooth them out. In some instances, though, one factor is that you have these countries that get incredible dollar inflows but don't really have big domestic industries, and so you can't spend it all domestically without creating a lot of inflation. But now we see, in the Gulf countries in particular, that there is just a lot more domestic economic activity happening, period. We know that sort of Abu Dhabi and

• 40:03Joe Weisenthal?

  Dubai are just growing bustling cities in their own right, and so there is actually opportunity, there might be domestic capacity. We know that Saudi, you know, they're trying all kinds of stuff from, we've talked about this in the past, from soccer teams to mile-long, multi-mile-long cities in a vertical, in a horizontal line, or whatever. But just generally, does the growth of some of these countries, just in terms of domestic economic activity, change the calculus about how some of these revenues are used? It's like, oh, we can actually deploy this domestically in a productive way, maybe by building data centers and so forth, that it won't just be, we're going to add to inflation?

• 40:46Speaker 03

  Well, we can debate about whether yet another data center is going to truly prove productive. Our AI tech barons certainly believe it to be. But there is a scenario where they've kind of drunk their own Kool-Aid and are overbuilding data centers. You know, Saudi Arabia is a great example. The line looks like it's not going to be a line at scale back. The desert ski resort with artificial snow is no more. That's been canceled. Everything was sort of getting pulled back in. Well, not everything. The big cube in Riyadh, I guess, is still going forward. But yes, it did fundamentally change Saudi Arabia when MBS came and said, I am going to throw a ton of money into domestic development, basically

• 41:31Speaker 03

  real estate, but also sports, entertainment, dah dah dah dah, combined with some social liberalization around women's role in society.

• 41:41Speaker 03

  Huge change. And what it in practical terms meant, I keep, some people use the fiscal break even. I think fiscal spending, some things can be kept off budget. I prefer to just look at the good old fashioned balance of payments. The balance of payments break even of Saudi went from 60 to 90 to 100. So in order to have a current account surplus that needs to be invested abroad, the Saudis now need an oil price of roughly 95. They did not get that last year. So they are running budget deficits. They are running a current account deficit, which was financed by borrowing from the world. And since MBS not only wanted to do all these domestic economic developments, he wanted to play in the big boy league with

• 42:26Speaker 03

  the Emiratis and do big investments in the US and be chums with Donald Trump. The Saudis, in order to do all that, buy equities, da, da, da, da, as well as build all the domestic projects, they borrowed 100 billion last year. They were the biggest borrower in the emerging world. So if you don't have the level of wealth that the Emiratis or the Qataris have, you will find yourself in a position where you are no longer a source of petrodollars. You're a drain on the world's euro dollar system. And the Saudis have flipped and become a drain on euro dollars. The Emiratis can do whatever the hell they want. I mean, the

• 43:06Speaker 03

  Emiratis just have so much money and so few people, so few people as in Emirati born residents who have a claim on the oil surplus, not the high end, I know Tracy, you were a high end guest worker when you were looking to buy, and the low end guest workers who don't have a claim on the oil. And so the Emiratis are just in a position, you know, in some sense, the Emiratis can, they are, they are like the Rockefellers if they had not given their money away. They wouldn't actually need to run an oil field in order to invest in all sorts of things, just because they'd made so much money from oil over the past 50 years, that they can just become investors.

• 43:49Tracy Alloway?

  The Rockefellers, if they hadn't donated to the Council on Foreign Relations, right, and spent all the money.

• 43:54Speaker 03

  I'm very happy that they gave some money.

• 43:56Tracy Alloway?

  We all are very happy. Okay. So I realize in this conversation, we haven't talked at all about Europe yet. And it feels like lately, whenever we do talk about Europe, the only certainty is always that like it's going to come out in a worse position than it was before. If you're looking at Europe right now with the additional burden of higher energy, with all the focus on AI, with China's export boom, is Europe just inevitably in a structurally weaker place than it was before?

• 44:26Speaker 03

  Not enormously. At the margin, losing Qatari gas means they're going to become more dependent on American gas. They're not thrilled with that. They're, of course, not thrilled with any increase in oil price. But where we are now, this is a manageable shock. This is a much, much smaller shock than the loss of Russian pipeline gas in 22, which I think we underestimate how big of a shock that was to the European economy. So I don't know that this particular shock is enormously negative to Europe. It is modestly negative because Europe's a net importer of 12 million barrels of oil. So, you know, every $10, lose 40 billion on the current account.

• 45:10Speaker 03

  Europe is wealthy enough, it can afford that. It's not going to impinge them. It causes political problems. When gas prices go up, the Germans want to cut fuel taxes to offset that, like, you know, as rich countries sometimes do. I don't think it fundamentally changes much about Europe. It does highlight fossil fuel dependence because Europe is fossil fuel light. It does add to pressure to do more nukes, to be more serious about renewables. And it certainly doesn't help. Europe figure out how to respond to the China shock, which I think is a much bigger shock to Europe than at least this kind of petroleum shock.

• 45:51Speaker 03

  And then the other baseline problem, which we'll see if it's solvable or not solvable, is that, you know, we're going to be in a world where missile interceptors are constrained, and there's going to be a scramble to make missile interceptors. And the US is going to be even less willing to provide missile interceptors to Ukraine. So we're in a world where Europe, its missile defense will have to come from its own production to a much greater degree, which is arguably a positive for long-term development. But it does create a near-term sense of vulnerability. But I think the central shock in this case is going to be much more heavily felt in oil importing Asia.

• 46:31Joe Weisenthal?

  Yeah. So, you know, you talked about the high bar that would have to clear for some meaningful change and, you know, the dollar's role in the global economy, or, you know, the dollar's dominance, et cetera. But setting, like, look, we have, there was a widespread view around the world that the US has become a very reckless nation, right? I mean, like, there's these complaints, why does global policy, the prospect of a war being started by the US depend on what 10,000 voters in Michigan and Wisconsin, other people? You know, this is some quote from some European, how they view things every four years.

• 47:12Joe Weisenthal?

  We have been extremely hostile to formal allies for reasons that most people around the world can't comprehend, the Greenland example.

• 47:22Speaker 03

  Joe, you were not on board with Canada becoming our 51st state. I'm disappointed.

• 47:26Joe Weisenthal?

  Canada is a great example. The Greenland, like, these things just pile up, right? And so, like, even, like, setting aside, and then, of course, now there is this current war, which most countries are clearly not on board with. Hard to understand, most people, most countries don't really understand what the goal was. It may end up being a huge own goal if it permanently gives Iran, it's unclear what's going to happen. Could these things pile up in such a way? Such that, look, setting aside these flows, the US ends up being kind of a trends more towards a global pariah. We know that polls about the US's favorability continue to decline throughout much of the world, et cetera.

• 48:10Joe Weisenthal?

  How sustainable is it to have the dollar as a reserve global currency, the thing that everything priced in, if so much of the world essentially views the US as a rogue state?

• 48:21Speaker 03

  When it's framed in those rhetorical terms, it almost feels like, you know, the only possible answer is that the dollar will become less dominant in global transactions. And as I mentioned, as a share of cross-border financial assets, the equity share is bigger than the reserve share. It's not no longer just the flows. The flows coming from holding safe reserves are nowhere near big enough to have a net international investment position of negative 100, or even a net debt position of negative 50. So you can certainly make that argument.

• 49:01Speaker 03

  I can also make an argument that before the Iran war, China, because it was unwilling to let its currency adjust, was intervening in the foreign exchange market to the tune of $100 billion a month, and that $100 billion was flowing in $2. So unless China changes how it manages its currency, and this is a much bigger flow than anything around petrodollars. And it was hard to track flows, it was going into bank funding markets, so forth and so on. But in some sense, until China, which didn't love the US before, decides that it is willing to change how it manages its currency and how it manages its economy, it is compelled

• 49:45Speaker 03

  to go into the market and buy if its exporters want to convert dollars for yuan. And when its exporters are not converting dollars for yuan, they are still holding dollars. Now, they could hold euros, but if they hold euros, you know, they get less interest. So it hinges on a little bit more than just global perceptions of the US. Okay. The Chinese have not loved the US for a long time. The Chinese have not found a way to really extricate themselves from a world where they often need to really buy a lot of dollars and add dollars to their system. Like, the world doesn't love China, I think. China can be a coercive power.

• 50:26Speaker 03

  You know, President Trump basically had a theory around last year's trade negotiations, which in the, to put it in this year's terms, he wanted other countries to pay a toll for access to the US consumer market. Yeah. They should be giving us things because, you know, this is our world's greatest market. The Chinese have wanted people to pay a political toll, treating China, the great nation, with respect, not criticizing the CCP, various other things, to have access to certain industrial products, rare earths. And it sometimes have suggested, well, you cannot criticize us on trade, you know, show us respect, because otherwise, those permanent magnet licenses won't come.

• 51:11Speaker 03

  So they extract a toll. They are, can be coercive. Think of how they treated Australia after the Australians said some impolite things about China's handling of COVID. Yet, it is very, very difficult for most countries around the world to respond by not trading with China. Right. So I think in the foreseeable future, countries may not respect the US, they may believe the US is a reckless and a rogue power, but you can still use our dollar to transact between Africa and Latin America efficiently. And that will not be viewed as a political statement, it'll just be viewed as the most

• 51:55Speaker 03

  efficient way of getting something done. So that's kind of how I would expect things. Okay. Now, I do think... We are in a world where an enormous share of the world's financial wealth, both people looking for safety, the reserve assets, people looking for a bit more yield than you can get out of a safe G10 government bond, the private credit, CLO world, and then people wanting the equity home runs. All those investors globally are now quite overweight US assets. And as a result, the dollar is quite strong. And so to me, the core question is not really whether the geopolitics will change things. Assuming we don't get into a full-on blow up with Europe,

• 52:40Speaker 03

  which would, I think, accelerate some shifts. I think the real question is, is this intense overweight in the dollar sustainable when we have fairly reckless policies? And the answer so far has been yes.

• 52:57Tracy Alloway?

  Brad Setser, thank you so much for coming back on the show. Really appreciate it.

• 53:01Speaker 03

  Thanks for having me again. Thanks, Brad. That was fantastic. Hopefully, this is like, you know, now every episode is going to get ranked. And I was like, yeah, that was probably one of his worst three. We'll have the community. Nothing like, and I know I'm never going to hit Taiwan Life. Yeah, no, this was a good one. There's a good one. Excellent.

• 53:30Tracy Alloway?

  Joe, always good talking to Brad.

• 53:31Speaker 03

  Always good.

• 53:32Tracy Alloway?

  You know, one thing that struck me in that last answer, he mentioned the word toll quite a lot. You know, the idea of China trying to extract a political toll, now potential tolls in the Strait of Hormuz. And I've been thinking about that a lot because, you know, if we think about the, back in 2022, I wrote a piece called Choke Point Capitalism. And it was the idea that governments around the world were waking up to the importance of strategic supply and this idea that because of COVID, you have to have a certain independency in important things. And I think like, we're starting to see that kind of translate into the geopolitical sphere in terms of like, Power nowadays is basically being able to

• 54:16Tracy Alloway?

  control those choke points, right? And so a lot of diplomacy, a lot of geopolitics is now focused on, you know, Trump is going to affect this, a choke point in semiconductors, or a choke point in the world's oil supply.

• 54:31Joe Weisenthal?

  Yeah.

• 54:31Tracy Alloway?

  I don't know if I'm saying that right, but like, there's something there.

• 54:34Joe Weisenthal?

  Yeah, well, I mean, I thought it was interesting. So Brad talking about, you know, Europe is going to have to spend more money on missile defense, for example. The US is going to be less reliable, stocks are being depleted, et cetera. This is like the phenomenon of our time, which is that every region, every country, or at least every region feels it has to spend on its own, right? That the capacity of another nation that it may have assumed it could trade with will not necessarily be reliable. The other thing I was thinking, that I've been thinking a lot about is, okay, Chinese manufacturing dominance is a very thoroughly discussed issue in the US and Europe, right? But it's not, it doesn't really get as much attention in the rest of the world.

• 55:18Joe Weisenthal?

  So, you know, you don't hear about, for example, the effect of Chinese exports in undermining Mexican exporters nearly as much, or Brazilian exporters, et cetera. These are also countries that are trying to climb-

• 55:31Tracy Alloway?

  You might if we were in Mexico or Brazil, but yeah.

• 55:34Joe Weisenthal?

  Right, I agree. But the, the upshot is, I think because we are in a sort of US, Europe dominated media landscape, we mostly hear about China as a sort of pressure point to rich countries. We are not discussing the fact that also there is going to be this domestic stress that will emerge from manufacturers in these countries. In other words, what I'm saying is, you look at the rest of the world and you say, well, they're going to pivot to China because the US is this reckless rogue state, et cetera. Except that they're all going to be facing the same-

• 56:08Tracy Alloway?

  The same issue.

• 56:08Joe Weisenthal?

  The same issues as the US and Europe are. We're just not talking about them because that's not the center of our conversation. But the idea of like, okay, it's very obvious for Mexico, or Brazil, or any, or Kazakhstan, or whoever else, to quote pivot to China, whatever that means, they're facing all of these same issues in many cases as well.

• 56:27Tracy Alloway?

  Yeah, I think the middle power theory gets really interesting in that context. Anyway, shall we leave it there?

• 56:35Joe Weisenthal?

  Let's leave it there.

• 56:36Tracy Alloway?

  This has been another episode of the All Thoughts Podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.

• 56:41Joe Weisenthal?

  And I'm Joe Weisenthal. You can follow me at the Stalwart. Follow our guest Brad Setzer at Brad underscore Setzer. Follow our producers Carmen Rodriguez at Carmen Armin, Dashoban at Dashbot, and Cale Brooks at CaleBrooks. And for our Odd Lots content, go to Bloomberg.com/oddlots, where we have a daily newsletter and all of our episodes. And you can chat about all these topics 24/7 in our Discord, discord.gg/oddlots.

• 57:06Tracy Alloway?

  And if you enjoy Odd Lots, if you like it when we have mildly annoyed Brad Setzer on the podcast, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad-free. All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.

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