Joe Weisenthal: Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal.

Tracy Alloway: and I'm Joe Weisenthal. Joe, it is April 15th.

Joe Weisenthal: Yes. Happy tax day to all who observe.

Tracy Alloway: I'm so annoyed. I just speaking of taxes, I'm pro taxes, but I just had an email with my accountant and anyway, I'm...

Joe Weisenthal: Well, okay. Taxes, you know, financial flows of a sort. Well, taxes create demand for currency. Core MMT principle right there.

Tracy 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.

Joe 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 have even had like two weeks ago, things are a little bit calmer right now, but we absolutely do not know that they're going to actually have a durable ceasefire and so forth. Obviously, oil prices have come down. Nonetheless, it's a pretty big oil jump from when we were say in the middle of February. Even at that point, oil prices might have been pricing in some sort of around war premium. So, 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 toller in some way of the Hormuz.

Tracy Alloway: So, this is exactly it. 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 petro dollars and euro dollars. 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. 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.

Joe 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 Pozsar 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, right?

Tracy 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. Uh, a man who holds the title of most Odd Lots appearances, I think, at this point.

Joe Weisenthal: Brad, welcome back to Odd Lots. Thanks so much for coming on. 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 uh I guess 50 years ago now?

Brad Setser: Oh, no. Thanks for having me back. 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 to that. The second oil shock in 1979 was, you know, a function of the Iranian revolution. Uh 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 well six seven times in dollar prices less in real terms we've only gone up whatever 50% max from uh spot oil.

Brad Setser: 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 straight 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 oil. some of your guests who've been on here have noted we're similar, maybe even worse.

Joe Weisenthal: So, in the we're kind of in this weird world where the physical interruption is bigger, the price reaction is smaller. 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 a 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?

Brad Setser: It's not quite 20. It's somewhere between 10 and 15. Okay. Which happens to be between 10 and 15% of global supply. 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. So, there's an extra shipping cost. A lot of the barrels in the North Atlantic are sweet and light... and a lot of the refiners in Asia were set up to refine medium sour.

Brad Setser: The 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. So, I think the futures market has to balance between one possibility, which is that there is plenty of oil 2 3 months out and oil is on a trajectory back to 60. And another possibility where this persists and oils at 150 or above and the markets had trouble figuring that one out.

Tracy 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 pro 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 petro dollar 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, whose current account is benefiting from higher oil prices right now.

Brad Setser: Well, you made the key point which is that the usual winners like the big winners... are the countries in the Gulf. Those countries are not going in a position to capture this windfall. So you've kind of taken Kuwait, Iraq, UAE out of the picture. The Saudis actually had a really high break even. They're current account deficit country. They need a $100 a barrel oil with 7 million barrels a day of exports in order to break even. Russia should win. The Kazaks will win. Nigeria will win. Angola will win. All the South American oil exporters will win.

Brad Setser: And then, you know, the biggest locust of production outside of the Gulf... are 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. I left out Norway. So, Norway really, really, really bends, especially if gas prices go up. It is the salt brunei.

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

Brad Setser: Well they had a real legacy you know going into the 1970s oil was so bloody cheap people burned it for electricity. The economy becomes less oil intense because it was such a huge increase in the price of oil. Most oil was priced in dollars before 1973. Oil was in dollars. Those dollars piled up and... a lot of the dollars did not flow into the Treasury market. They flowed into bank accounts in London, offshored effectively euro dollars originating from pro states and then those got recycled and they got lent in no small part to oil importing emerging economies 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.

Brad Setser: After 79 80 Saudis had built up huge stocks of dollars... In the 80s the oil price collapsed. And by the end of the 1980s all the dollars that had been built up in the 1970s had been spent. So in some sense the petro dollar boom came and it went. until we get, you know, the big run up in oil from 03 to 14.

Joe Weisenthal: The 03 to 14 run up in oil. Then talk to us about where those dollars actually went. What types of assets? ...reserve portfolios are arguably or all things equal maybe underweight dollars. Was that always the case? Is there a structural reason for that?

Brad Setser: Well, reserves can be managed for safety and liquidity and not for return. A reserve portfolio will typically have a lower dollar share than a standard return seeking equities fund which just because of the outperformance of the US large caps will be more overweight dollars.

Brad Setser: It's hard to track in real time. I mean, the the obvious indicator is if the world is ddollarizing, they're going to be buying fewer dollars and the dollar should be falling in value, which it generally is not. To me it is very difficult to have a credible story around ddollarization when the dollar is strong not weak relative to history and when the total dollar claims on the US... have continued to increase. 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.

Tracy Alloway: Got it. There are so many things now that I'm thinking about... But just since you mentioned Taiwanese life insurance companies that got me thinking about East Asia a little bit.

Brad Setser: Um not that comes to immediately to mind. Korea is a very petroleum intensive economy... benefiting from this giant positive shock memory chip surge... and then the economy is on the receiving end of a pretty big negative shock because of the loss of oil flow. twothirds of it was just retail and retail decided even though Samsung is making money handover fist that they preferred to hold US tech stocks.

Joe 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?

Brad Setser: It hinges on a little bit more than just global perceptions of the US. 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. Countries may not respect the US... 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 efficient way of getting something done.

Brad Setser: 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.

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

Joe Weisenthal: Thanks, Brad. That was fantastic.