We Have Entered the "Speculation" Phase of the Market Cycle | Michael Howell
Summary
Zero interest rates didn’t exist for 4000 years of recorded history. Now CrossBorder Capital founder Michael Howell believes we’re …
Transcript
In actual fact, the Fed is losing control of the rate system at the moment. That's really an inconvenience for them rather than a serious problem. But they're clearly worried because these can get out of hand. No politician really has the balls to cut back spending, so they're just having to fund it through the short end of the market because it is easy, and that's his printing money and we know that doesn't end. With stocks, gold and houses all hovering around all time highs. Many investors are nervous and they're asking what comes next. My guest this week might have the answer. Michael Howell is the founder of Global Liquidity Indexes and author of the Substack Capital Wars. He focuses on the relationship between global. Liquidity and debt, and as you'll hear today, his research is predicting big changes for the markets. I'm Ed D'Agostino and this is Global Macro Update. Michael Howell, it's great to have you first time being on our podcast. So welcome, it's a real pleasure. I've watched many, many interviews with you and always wanted to have a chance to, to speak with you directly. Well, thank you, Ed. It's very good to be here. Your whole Framework is based, if I understand, on global liquidity. Uh, and, and I don't wanna spend too, too much time on it. But, um, for those out there who aren't like me and just spend my nights and weekends watching YouTube videos about finance, um, maybe, maybe you could. Give us a quick summary of sort of how you, I know it's a complex topic, but how you generally approach liquidity and, and how liquidity forms your, your framework for how you look at the markets. The genesis of it all, uh, basically came when I worked at Sama Brothers. The, uh, the former US Investment Bank, which is now part of Citi Group and s Brothers, uh, when I worked for it was the, uh, you know, the world's biggest bond trader and, you know, very big in fixed income markets. Basically Salon used to organize its offices around the world with, uh, centered around a huge trading floor. And that trading floor was, uh, you know, clearly visible, uh, to everybody. You could just look and watch and you could watch money flow around the world. And that was pretty much the, the whole idea behind. Global liquidity because it was very clear that in financial markets, and this was very much a mantra of Sonomo brothers at the time, uh, there was no unrelated event. So if you saw one particular desk suddenly get lots of, uh, lots of business, it was probably likely that that was shifting from another desk somewhere else. It could have been the US treasurers were getting a lot of money, but it may have been that US equity or Japanese equity were losing funds. So you can actually see how money was moving, uh, physically, almost, or tangibly around the world just by looking at these desks. So that was really the, uh, genesis of the whole idea of global liquidity. Um, what it is in terms of, of our measurement is clearly not measuring what happens on an individual trading floor, but it's much more aggregative than that. And what we do is we look at the flows of money, uh, that are traveling through world financial markets. So it's not a measure. That economists are familiar with like M two. In fact, in many ways we say that our definitions of global liquidity pretty much start where traditional measures of M two kind of end. And the reason for that is that we are looking at things like repo markets. We're looking at shadow bank activity, we're looking at cross-border flows. These are the things that really matter when it comes to driving financial asset prices. And the third thing, which I think is, is worth spelling out, is that that financial markets no longer work in the way that. Sort of textbooks describe, I mean, there's, you know, you can look at the maths of, uh, of, you know, how you discount a, uh, uh, a flow of earnings and why that's supposed to sort of drive an asset price. But in reality, it, it's very different from that because capital markets are no longer about. Um, raising money for new capital investments, they're much more about rolling over existing debts. And you know, what we, what we're sitting on in the world economy now is something like $350 trillion of debt of all of all stripes, uh, you know, government debt, corporate debt, household debt, et cetera. Uh, and that debt is not infinite, and it doesn't last forever. It's gotta be refinanced. And the role that financial markets increasingly take is that basically debt refinancing mechanisms, and that debt has to be rolled. So if you've got an average five year maturity on a bond, uh, and you've got $350 trillion of debt out there, you need to roll 70 trillion of of debt every year. So that's a big, big ask, uh, because it's. Basically what we're talking about, we're talking about three quarters of world GDP being rolled in financial markets from debt transactions, and that requires balance sheet capacity. And that balance sheet capacity is what we think of as global liquidity. So that's really the both the genesis and the definitions of what we're talking about. How does global liquidity and debt factor into public markets? Of all types, like how do you, how do you leverage that as a framework for informing investment decisions? The first thing to say is that liquidity, uh, tends to be fungible. In other words, it moves and it can shift from place to place. Uh, particularly when you're outside of crises in crises, liquidity tends not to move. It tends to be stuck. People, you know, freezes. People sit on it, never, then don't move it. But generally it's fungible, so it will shift around. So if you have situations where there's too much liquidity in a financial system, what you'll basically start to see is that, that that liquidity will. Uh, we'll go into where the vent will probably be asset, higher asset prices. If there are defi, if there's deficient liquidity, then you're gonna see, um. Periods of financial crisis more likely now we can probably show that, and I can show you that in a diagram and I'll come back, uh, sort of, uh, onto something a little bit more, uh, maybe more, uh, interesting about current developments in a second. But if we start maybe with this slide, which. A little bit daunting 'cause it's, uh, it's a schematic diagram and there's, there's quite a lot of words on that. But let me just sort of focus in on what, what this is really about and why it matters. And this is saying that if you look at the global financial system, um, really post. Uh, GFC in 2008, nine. What you've got at the heart of it is a debt refinancing system that has a debt liquidity nexus, uh, right in the center. And what that really means is that, uh, debt needs to be refinanced and to refinanced debt, you need liquidity. But the paradox in the financial system is. The liquidity is increasingly collateralized and it requires existing debt, uh, as its backstop or its collateral. So you'll see written on the, uh, in red, uh, lettering on the top, uh, left of this 77% of global lending is now collateral base. Well, that. Actually not our figure. That's a World Bank figure. And what it's saying is that, you know, people can think of a very straightforward example like their home mortgage. Uh, you know, domestic real estate, if you've got a mortgage, is essentially a collateralized loan. But if you extend that out to financial markets. If hedge funds are borrowing, um, to do a, something let's say called the basis trade, where they're, uh, effectively buying cash bonds and they're shorting futures, they will actually be borrowing from dealer banks and they'll be using. Um, US treasury bonds, uh, as their collateral, so they'd be borrowing against that. So most borrowing in financial markets is backed by collateral, and that collateral tends to be government bonds, uh, in some form. It may be bills, it may be notes, but whatever it tends to be, you know, it may be US treasuries, may be maybe German buns, but it tends to be basically, uh, some form of, uh, of solid financial instrument. Now. That's at the heart of the system. And what you see are two wings here. One is on the right where it says refinancing, so that's turning, um, liquidity into debt, helping to roll the debt over. And then you've got the other wing on the left, which is the repo collateral wing, which basically says that, uh, in order to to get liquidity, you need debt. Now, those, either of those two sides can break down, but what tends to break down is the collateral repo side first. Now just to show what this means, and I'll pause after this slide. Uh, 'cause there's a lot of, yeah. Obviously a lot of ground to cover here. What this shows is the ratio between debt and liquidity in the world economy. Now the big problem we've got as a society, uh, as a western economy is there's this way too much debt in the system. Uh, and I know you guys have written about this in the past because I know I've read it and, uh, I've been very impressed with the analysis. But what this is basically illustrating. Is that what is really critical is the ratio between debt and liquidity, not necessarily debt and GDP. Um, debt to GDP just tends to trend up this particular data series. Debt to Liquidity is a stationary or sideways moving, uh, series that tends to see, uh, very clear cycles when you have strong. Or very high debt relative to liquidity. So a high or strong debt to liquidity ratio, which you can see on the chart, is really well above the 200% dotted line. There. You tend to find there are refinancing crises, and what we've done is we've illustrated with the, uh, with the annotation where you get financial crisis and it tends to be. When you've got an elevated or stretched debt to liquidity ratio, the counterside of that is that if you've got, uh, a very low debt to liquidity ratio, in other words, bucket force of liquidity, not much debt to refinance, you then tend to get asset bubbles. And that's what we've illustrated with the annotations on the bottom. Now you'll see in that lower right hand corner, uh, what we've denoted there is the everything bubble. And the everything bubble is clearly what we've. Been through, uh, or experiencing right now where the debt to liquidity ratio was very low, and that was because in the wake of the GFC and in the, uh, during the COVID crisis, policy makers just address the problem by throwing lots of liquidity into the system. And what's more they. Slashed interest rates in near zero lev, near, near zero rates. So you basically encourage a lot of refinancing or terming outta debt into the latter years of, of this decade. And as you can see from the projection what you, what we show there, the orange line that, uh, that ratio is slated to not only just move up. Uh, to the dotted line, the normal equilibrium, but actually shoots through it. And that's because there's a lot of debt coming back into the system now that was termed out during the COVID years that needs to be refinanced. And what's more, the growth rate of liquidity, particularly coming out of the Federal Reserve now is slowing down quite noticeably. So we may be moving into an era of, uh. Uh, of more repo or refinancing tensions, which is exactly what the repo markets are currently telling us. And that sets us up perfectly for today. So thank you for that, that backdrop and that, that is the question, right? Where, where are we today and where do your models show us going? 'cause. You could, you could make the argument that liquidity is going to increase a little bit, um, at least from the Fed, right? And they, they've, they've announced that they're stopping tightening, they're not gonna let their balance sheet run off. And then shortly after that, it sort of hinted that they might be not, not EAs. But easing, I think is how you put it in, in a note that you sent on your capital war Substack, uh, uh, this week. So what, like, what, which is it? How can you be easing without easing and why, why is that? How does the repo market fit into that? I think there are maybe three questions there, so let me just try and do each one in turn. The first. Is where, where are we now in the cycle? This chart here, which is really the centerpiece of what we do, is looking at the global liquidity cycle. This is for the advanced economies. Uh, so it's pretty much everything apart from China is in there or China and emerging markets. But China is the, is the dominant missing, uh, economy. And we've taken China out really because China. Uh, is at the moment quite erratic in terms of its, uh, its liquidity, which we can dig into later. But, uh, for the, for the best part, this is showing, uh, the, the, the major advanced economies. Now what this illustrates is a cycle that goes right back to the 1960s, and this is looking at the momentum, uh, not the level, let me stress the momentum of liquidity through, uh, world financial markets. Now. That cycle is a refinancing cycle, and what we've done is we've put on top of that aine wave. Now that's sine wave. We estimated using something called RIA analysis back in year 2000, so 25 years ago. And we haven't altered the, uh, the frequency of that since that time. So what you see is what you get, and it seems to be lining up pretty well with a 65 month cycle now independently. Uh, an organization called the Foundation for the Study of Cycles contacted us. Uh, earlier this year and said, could we have your data? Because we do a lot of very rigorous cyclical analysis and we like to test out, uh, your claims that it's 65 months. And I said, yeah, sure. Here's the data. Take a look at it. They came back and they said, well, you know, lo and behold, we find exactly the same result. Uh, all our algorithms are point to the fact that there's a repeating 65 month cycle. So apart from the fact that's reassuring. Real, real question is why, and I think the, the answer that I would give is that that's really the average tenor of global debt. So 65 months between five and six years is the average maturity length of debt in the world economy. So that to me. Sort of fundamentally suggests that this is a debt refinancing cycle in the same way as if you sort of picked up a textbook, an economics textbook, maybe of 40, 50 years ago, they'd be talking about a CapEx cycle. And the CapEx cycle. Bec was really, uh, a ome fact that the depreciation cycle of, uh, a fixed investment was around 10 years. And that's what people thought was, uh, a 10 year decennial cycle. So now we've got a, a cycle, which is. Uh, between five and six years. It's not a CapEx cycle, it's a debt refinancing cycle. And what you can see with the latest data is that this bottomed almost exactly on queue, uh, in October of 2022. It's been rising ever since, but it's just inflecting now. Now that inflection may be a meaningful one. I mean, clearly if you look at the data. Historically, I mean, there have been full storms, so it, it's possible it goes up again. But the question is to try and understand what policy makers are doing. So the key one is really the US Federal Reserve. So let me turn to what the Fed is up to. This is the chart that we really need to look at, which is looking at the growth rate of fed liquidity, which is answering your, uh, second question about what is the Federal Reserve really doing with its balance sheet, or, uh, maybe more generally with interest rate policy. Now let me start with the interest rate policy question. I think in a world where you've got huge amounts of government debt. And where the government is making significant transfer payments into the private sector, it's very unclear to me where the higher interest rates or lower interest rates are stimulatory or not. I think it's a really gray area. So for, in other words, if you are doing a lot of transfer payments from the government and the Federal Reserve decides to cut interest rates, you're actually slowing down transfer payments. Uh, and that is the loss of income. And that should actually be for a large part of the economy, uh, actually an economic drag. 'cause you've got lower income and the fact that you have, you are not using, you're not borrowing money from the banking system for your CapEx, means there's no offsetting, uh, benefit from lower rates. Uh, you know, most, uh, investment these days is, are the government induced. This China, or it comes out cash flow. So that would suggest that maybe interest rates are not necessarily the key variable. And what you need to look at is really the amount of liquidity that policy makers are actually injecting into financial markets. And what this is showing is the liquidity injections of the Federal Reserve. Now, that's not the balance sheet, uh, because every item on the balance sheet is not necessarily liquidity creating. Um, there are elements which subtract liquidity. There are elements that don't create in liquidity. So what we've done here is just to extract. The liquidity, creating parts, the net liquidity, creating parts of the balance sheet, and this is showing the duration in that particular element. Now let me just get a little bit more granular without straying into the weeds Too much. That is things like looking at what you might call fed credit. So it's things like open market operations, traditional ones buying debt, um, for example, or things like, uh, the bank term funding program, which was giving emergency assistance to the banks. It could be discount window lending, et cetera. So those are forms of Fed credit that go into the system and coming, subtracting from that would be things like, uh, security issuance by the Fed that absorb liquidity. We'll think of that as a reverse repo program or think of as well, uh, the treasury general account, which is a balance, uh, that the US government keeps at the Federal Reserve, which is, if you like, a, a sort of a, a deposit account that it can build up or run down. And if it builds up that. TGA Treasury of general account. It's taking money outta money markets. So what you've gotta look at is not, the overall balance sheet will be distorted by all those elements, but only looking at the liquidity, creating parts. And that's what we show here now from over 80% growth in 2021. Uh, at the peak, this is six month annualized. We were right down at, uh, negative 40%, uh, by early 2022. And then the cycle began to turn by the end of the year, and you started to go back to positive liquidity growth in the Fed. It's wobbled a couple of times since, uh, but certainly around the beginning of 25, largely because of the debt ceiling, uh, impasse. Uh, and then more recently the government closed down. You've actually seen, uh, liquidity go back into the markets. And, uh, ba uh, basically, uh, sorry. I said the government closed and I meant that was actually a negative. And now what you've seen is the rebuild of the TGA and the government closed down has caused that, uh, withdrawal of liquidity, uh, sort of up until that sort of gray forecast period that we've got there. So. Effectively fed liquidity is negative, but you're projecting that it will start to go up based on this chart. Yes. I'm predicting it's gonna go up. It's not gonna go up very much, but it's gonna go up. And the reason it goes up is that we factored in here $250 billion. In other words, 20 billion a month. Of qe, not the end of, not just the end of qt, but actually a positive qe. Now, I think the Fed is gearing itself up to doing that, uh, because even, um, you know, those members of the FOMC that have been historically very much against, uh, any balance sheet manipulation, uh, such as John Williams and now talking about the need to actually put the quality back into the system, I think my, my reading of it is. Is, you've got likely got three camps within the FOMC. You've got those that are, let's say, experts or monetary plumbing, uh, like Lori Logan, uh, uh, Dallas Fed, who's very much I think in favor of expanding liquidity into, uh, into the system. Uh, for plumbing reasons. You've got more orthodox, uh, central bankers, uh, like Jay Powell and probably John Williams, who. Uh, are much more inclined to think in terms of interest rates and not balance sheet, and see the balance sheet as a distortion. And then you've got the Trumpites. So let's say that's headed by Steven Miran, uh, maybe Governor Waller as well. And what they want to do is to shrink the balance sheet, but cut interest rates. Now I think there's an agenda there, which we can come onto later, but I think that particular power balance in the Fed says that you've got. Uh, three votes. Let's say three constituencies, two are against balance sheet expansion, one's pro. So what you may get is a slim increase, and that's what we've, we've factored in here. Can I ask you how issuance treasury issuance factors into this? Because, uh, someone pointed out to me recently that the recent stable coin regulations have. Had a meaningful impact on the issuance of short-term treasuries, and my understanding is that stable coins need to be backed solely by short-term US treasuries, and that that was sort of a stealthy way for the treasury to be able to issue vastly more. Debt essentially. So how does that factor into this? It's a very good point. I mean, there's, there needs to be a lot more debate about the whole stablecoin issue because I think it's, it's a big, big one and I think it matters not just for the US financial system and this monetary plumbing, but it also matters in particular for the world economy, the international monetary system, and really the role of the dollar in the long term where I think there's a, a compelling case to argue. That rather than de dollarization, which is the sort of media cred core, uh, you're actually gonna get a re dollarization, paradoxically, uh, because of stable crime. That, that's another question. Now on the question of domestic, uh, issue or domestic issuance. The, uh, the policy under Janet Yellen was very much the focus on the short end of the market and do a lot of bill issuance and, uh, secretary treasury, secretary. Uh, Scott Bessant has railed against that and said that sort of he is bad economics, bad finance, whatever, but sadly, he's sort of going down the same route, uh, probably because he can. It's a very easy funding mechanism. Now, as you rightly say, uh, if you've got stable coin and stable coin. Are clearly very big buyers of treasuries. They tend to prefer, or they tend to skew into, uh, the very short dated, uh, end of the market. So bills and short dated notes, and that's what the treasury is definitely starting to issue. The problem with doing that is you kind of create a rod for your own back because one of the things that has. Jumped up in recent quarters has been the size of the Treasury General account, this balance at the Fed. Now, without getting too much stuck in the weeds here, uh, if you were doing a lot of, uh, long dated issuance, you don't have to roll debt very often. And the Treasury general account was set up with a notion that it would basically be a balance that would tend to correspond to about five days spending by the government. Now, if the government is mainly spending its money on. Um, on, let's say this fiscal program, normal fiscal programs, it doesn't really need to have a lot, a bigger balance there because you've got tax revenues coming in, you've got spending going out. You kind of need a small cushion. But if you are rolling, uh, which is now the case, 500 billion of treasury bills every week, plus about another 150 billion. Of short dated debt and other coupons, you need a big balance in that treasury general account. So although they're going down the route of, uh, issuing issuing bills and short dated notes, one of the costs of that is they've gotta run a higher tga. A and a higher TGA is taking money, liquidity out of the system. So it may seem as if you are winning by doing bills, but there's a cost to that. Now, one of the. Offsetting factors could be, and I say I don't wanna get too stuck in the weeds here because it gets very wonkish, but the people that tend to have the biggest appetite for bills and short dated debt are banks and of course, other credit providers and let's row in their money market funds. And stable coin issuers. Now, uh, they tend to be big buyers of the short end of the market, and the fact that you've got repo problems coming through would suggest that they're not really buying enough. And that may suggest that you've got to incentivize the banks to do more, which may mean you have to change bank regulations, and that may be the next shoe to drop. So watch this space. But I think the fact is that what they're, what the administration seems to be very focused on is this window of how you actually, uh, or the window of money, market liquidity. What is going in and what is coming out through coupon issuance. But they seem to be trying to get the banks to do a lot more. And if you get the banks to, I mean, the important point ultimately is if you get the banks to buy government debt, you are monetizing, uh, you are not using existing savings. You're using the, an expanding bank balance sheet to fund the government. Now we know that's not, that's not good finance, but it's happening. And it's gonna happen more. And that's the reality. Is it inflation? When it's definitely monetary inflation, does it feed through to the price level? I think it's got to because history shows it always does. Without getting too wonky, I guess what I would say is if we pull back a little bit and look at your framework and everything that you've said so far, what would you, as, as a, as an individual investor, what would your takeaway be? Are you preaching caution at this point? Are you, yes. I think the question most people are asking is, when do I take cover and where do I hide? Let me just illustrate what the, what the problem is. This is the problem, and this derives from the very first chart I showed, which was the. Debt liquidity nexus, if you like, in the middle of the, of the schematic diagram. And what it says is that if you get imbalances between debt and liquidity, in other words, let me just go back and show that. So that's the slide problems on the left hand side, repo collateral, what do you start to see? You start to see sofa spread. Uh, which are effectively, uh, spreads in the repo market starting to blow out. And that's really, uh, uh, the first sign of problems. And that is what you would get if you see that orange line moving closer to the Dottie or broken line at 200%. And that's clearly where we're move. We are moving up in that direction. Now that, by the way, is the amount of debt that's coming forward to be refinanced. So I didn't show that before, but that just illustrates. The upcoming problems. This is the increment each year, and you can see the bite out of the chart in 20 21, 22, 23, which is basically when a lot of debt was termed out because policy makers, for whatever reason, they, they obviously thought they knew best, but they slashed interest rates to near zero, and what you got was a situation where. A lot of borrowers termed out their debt to the back end of this decade. Now, I always remember the, the sort of solitary lesson that when I was at Salman Brothers, the, the book that we always encouraged to read, uh, was a book, which was, uh, a sort of, uh, uh, you know, an antidote to sort of, uh, sleepless nights, but it's a history of interest rates by Sydney Homer, and that book covers 4,000 years of world history of interest rates. Nowhere in those pages, is there any reference to zero interest rates. Uh, so what we've had in the last 10 years is an absolutely unique period in world history, and what we've got is, as a result of that, uh, accumulating debt problems, it not only incentivized debt, but it turned out a lot of debt and that debt is coming back as you can see, and that's one reason why that, uh, line starts to shoot up on the right hand side. But the other reason is you've got problems in repo. Uh, beginning to emerge as liquidity is, uh, is, um, slowing down. And as I said, fed liquidity is slowing down. So what you can see here is the spread between sofa rates, which is system overnight funding rates, which are basically repo rates. Uh, I'm sure people are familiar with repo, but repo is basically the main borrowing vehicle, uh, post the GFC, where a lot of, uh. Financial funding used to be done through the interbank market on trust between banks. That market has now virtually disappeared and most lending is done collateralized using government securities, let's say treasuries. And in other words, what you do is you post a treasury, uh, to a dealer bank. And effectively, uh, you'll, you will promise to buy that back in a certain period, maybe overnight, maybe seven days. Uh, but you get a loan, uh, against that and they will lend you. For argument's sake, 95% of the collateral value, uh, to borrow. So that's how it works. And this is the rates that you are charged for that, just to make sure we're, we're keeping everyone with us. That's essentially what you were, were talking about when you talk about the plumbing of, of the system. Correct. Exactly Right. Yeah. That's really the underlying plumbing and the plumbing. The point being is that the plumbing has changed radically, uh, since the global financial crisis. Okay. Uh, and that's what we need to remember. So it, it may sound wonkish. And it may be, you know, uh, uh, somewhat obscure because it is not really written up in textbooks, but that's 'cause the textbooks are sort of somewhat out of date and the world has moved on a lot. And so you need to understand this plumbing backdrop. Now what this is saying is that you can see there's a normal zone there that we show where, uh, spreads against fed funds. This is sofa, minus fed funds, uh, are at a small discount. You kind of expect that because. SFA rates are collateralized. Fed funds is not collateralized. So you'd expect actually that uh, in normal circumstances, sofa would be a cheaper way borrow. Uh, but as you can see here, it's not, and you've seen these big spikes. Now, I put a dotted line notionally at where you get a danger zone, but you can see that we've spiked well above that. Now, given the fact that the Fed recently cut rates by 25 basis points, you can see just by eyeballing the chart. Uh, there, ed, that the, uh, that the interest rate cut, uh, at one stage in the last, uh, two weeks was actually, uh, more than a, more than eroded by that spike in, uh, in repo rates. So in actual fact, the Fed is losing control of the rate system. Now, at the moment, that's really an inconvenience for them rather than a serious problem, but they're clearly worried because these things can get out of hand. Uh, this what happened in 2019 where you've got a repo crisis. So that's really the issue, and I'll give you an illustration of what could go wrong is shown here. And this is looking at the excess reserves of US banks. Uh, which is the orange line, uh, they're deficient because fed liquidity is deficient. And what the black line is showing is the number of failed trades among primary dealers, shown as an inverted seers on the right hand side. Now, if you've got a failed trade, uh, it doesn't sound good and it's not good, and you can basically see, uh, increasing volatility. Uh, in the, um, uh, in the collateral markets or the treasury market really because of that. And if you get increasing volatility, the hedge funds who have been whopping great buyers of treasuries, uh, will start to close down their, their trades. Uh, last year, according to the Federal Reserve, they bought in excess, have one and a half trillion dollars of treasuries. And given the fact that new issuance was 2 trillion. That is a lot. Um, and that's his hedge funds. We know they're flighting and capricious, but you know, don't give them any excuse to stop trading and this is a good reason. So you don't wanna do it. That's really problem number one there. And the other question is just about, you were saying about what should people do, and I was gonna say, well, just let's this come back to look at the cycle. And the cycle is around a peak. So how should you view that? Well, I do that in two ways. One is to say, look, here is the normal track of a liquidity cycle as a dotted line shown there as the average, uh, over the 1970 to 2025 period with zero in the middle of the page being of the trough and months being calibrated either side to the left or to the right, before or after. The red line is the current cycle. So it looks as if we're getting. Very late in that cycle. And how do you operate in terms of an asset allocation? Well, we say, look, you've got, uh, on the left hand side a notional liquidity cycle on the right hand side. We dovetail that with the asset allocation cycle. There's some overlapping, uh, if you're in the upswing of the liquidity cycle, you are risk, risk on, you want more equities around the peak. You want to be thinking about commodities in the downswings. You want to be risk off and moving more towards cash. And then by the trough, you want a lot of government, uh, long duration bonds. So that's how the asset allocation tends to work. And in terms of simple traffic lights, that's pretty much how we view it on this, on this diagram. So in our view, to put, you know, to, to nail our, our sort of call to the mast, I mean, we think the US market. Currently is in speculation. Uh, therefore you would've have that kind of asset allocation. Other markets, you know, Asia emerging, Asia, Europe are probably late calm, but that's maybe dancing on the head of a pin a bit. Uh, but we think we've, we are very late cycle. But if you then look at how this has evolved over the last three years, you can see that it's almost been. Uh, you know, a, a perfect or, uh, very normal, at least liquidity cycle, investment cycle, but it's been a very abnormal economic cycle. And it may be that the economic cycle is distorted by the overhang of debt or excessive government spending. I don't know. But if you just run through this, you'll see in rebound that we were from. Late 2022. You wanted, uh, you know, some risk on, but you know, as the, as the amber traffic light says, proceed with caution, go, but proceed with caution equities, credits, green lights. So go fully into those commodities. Bond duration. Don't try that. Uh, calm phase, which is really, let's say for the last 18 months, you want equities, you want probably, you know, bit of credits. Proceed with caution, uh, commodities definitely picking up. Uh, and then when you get to speculation, you wanna be moving more into commodities, less into equities, uh, probably taking out your credit position, maybe putting a toe in the water of bond duration. Uh, and then when you get to turbulence, you want to be out of the risk. Assets are much more into the safety of bond duration. And then if you look at industry groups, same analysis on the right, uh, you want cyclicals on the way up. You want defensives on the way down? Uh, you know, note the fact that, you know, some of the, a lot of the, um, consumer staples in the US have had very bad relative performance over the last two to three years. Uh, that's not surprising. Uh, technology has been a real winner until recently, but that may say that we are in the speculation phase. Uh, you've got financials, which have had a stunning 18 months, uh, are now probably just coming to the end of their, their term energy commodities. Picking up, certainly mining stocks have been very strong this year. So you kind of get the idea. And I should say this is not, I mean this, the traffic lights have not been adaptive for the current cycle. This is what we always use. Uh, they change, you know, they may change over decades, but they certainly don't change from cycle to cycle. So this is sort of a long based on our long history of returns. How do. Things like, uh, like the price of gold, which is, you know, uh, e even though it's rolled off a little bit from, its from, its recent, all time high, still very high. As you mentioned, miners, gold miners, uh, as we record this, they're having an absolutely epic day. Um, how, what, what signals do, does something like extremely high. Precious metal price send to you? Well, I think it's a, it's a very interesting point. I think the thing is, is that you've, what you've seen is, um, and I'm sure you're familiar with the normal charts, which look at things like gold prices against real interest rates. And historically that's always been a, a, you know, a very nice inverse correlation. So when you get very high, real interest rates, gold prices are low and vice versa. So gold, the, you know, the, the cost of carry of gold tends to be, uh, a, a sort of negative drag on the price, but that, that broke in 2022. So what you saw with gold prices going up significantly, uh, even though real interest rates were going up. And that was an anomaly. Now you could argue, and I think many people did, that was all to do with the sequestration of Russian assets and the fact that, uh, uh, the Russians et al decided that gold was a better, a better place to hold your reserves. I think that's partly true, but I think that was also the beginning of sort of. Let's call it monetary recklessness by a lot of policy makers. It was when there was increasing evidence of what I call sort of omics of this, sort of using bills, doing a lot of financing through bills. Uh, it was when you saw as well China starting to reject a lot of liquidity into the system. And, you know, maybe China was a very good. Sort of example of what's going on and why the gold market's going up. Let me just try and shift to what is going on in China. If I can, I should just stop at this job. 'cause I think I didn't tackle this one, but this was also an important point on route to explain the asset allocation for US investors. This is showing, uh, in red the aggregate I spoke of, which is fed liquidity. So that's shown in billions of dollars on the right hand scale, and the projection into 26 is shown as by the broken red line. So, you know, we think it bounces but doesn't bounce much. It's sort of, you know, a bit of a sort of belly flop and whatever. And if you look at the orange line, that's the, uh, that's the s and p 500, but it's lagged by. 25 weeks. In other words, six months. So we've done that to try and give a sense that when you see strong fed liquidity, the market tends to be buoyant. And when you see, uh, fed liquidity coming off, uh, it's often when you see or leads to a correction in the s and p. And that's what we've historically seen. Maybe this time is no different. So it's worth sort of thinking about this chart. You really want to see fed liquidity moving up a lot more. What I actually find most striking about that chart is, is the behavior or the amount of fed liquidity prior to the Lehman crisis. Uh, just. S relative to post great financial crisis. It, it just really illustrates just how much our financial system has changed. That's a really good point because, you know, basically that was the period when you had an active interbank market. And what really has happened in another way of putting it, is that the interbank market, the old interbank market has been put on the fed balance sheet. Uh, and that may be, is the best way to think about it. So, uh. It was, um, uh, you know, the period before that, before Lehman, I mean you Sure. Most liquidity was created certainly in our terms by things like shadow banks, um, and post Lehman. It wasn't the quantitative, easing by policy makers has been really important in goofing the system or slowing the system down. Has it impacted your work? I mean, has, has, has that changed? Been, um, I think, I think it's probably irrefutable, right? That it's changed the, the market cycle, the economic cycle, um, has, has it, and it's, has it impacted the liquidity cycle in the same way you raise a really important point because I think it's had a much bigger effect on the economic cycle because it's basically opened the door to much more active government. Okay. Um. And, you know, fiscal spending has been a, has been a much bigger driver of economies since the GFC. That's, that's for sure. With all the consequences like debt, it hasn't affected the liquidity cycle per se. Uh, it's affected the composition of the liquidity cycle enormously. So central banks are way, way more important, uh, in terms of the drivers of liquidity than they were before. So that's, you know, intuitively I think that that's sounds right. Now one of the things that we need to understand as well is this point, which is, uh, maybe I'll start with this one, which is just before I get to China, this is the other thing I need, we need to say is that. If you do a lot of bill issuance, which is what the treasury is doing, one of the reasons they're doing that is it's easy to sell bills. And the reason it's easy to sell bills is that banks and credit providers already like them. Uh, because if you think about the mechanism, if the, if fiscal spending is very loose. Uh, people's or government workers and government contractors, bank balances are going up. Their deposit accounts are going up. Now, from a bank point of view, what you need is an asset on the other side of the balance sheet to balance your increase in deposits of a similar duration. And what has a similar duration to a bank deposit is a short dated government debt. And so if you've got increasing bank deposits. The banks buy government short dated government debted bills with alacrity. So you can get, if you like, a self-feeding spiral here, which is actually what you're getting. And so if they're doing a lot of funding at the short end, what you're getting is the bulk of monetary growth. And we see here in red the growth rate of traditional M two money weekly. Uh, the main driver of that is the orange line. Which is basically a treasury and agency security holdings by commercial banks. So in other words, they're the main contributor to monetary growth. Right now, it's not traditional bank lending that's picking up. It's basically this component. Now, if you look at this globally, a. This is what's going on and this is what we, this term, global monetization. Now it may not sound like it's a meaningful percentage at sort of 12, 13%, but this is doubled, uh, you know, since the GFC and what you're getting is more and more governments worldwide. Turning to monetization to basically fund themselves. And that's not a good thing. I mean, we're on the wrong side of the Laffer curve for sure, in many countries. So taxation is really out. Uh, no politician really has the balls to cut back spending, so they're just having to fund it. And what's happening is they're funding it through the short end of the market because it is easy. And that's his printing money. And we know that doesn't end well. So this is a global phenomenon that we're seeing now of monetization. So I, my view is that investors have gotta be really alert in 2026 to the risk of inflation signing to come through as a. But that's another question, but it neatly fits into the gold picture. So let me go onto, onto gold and what is happening in China now. If you look at this chart, this is the debt liquidity ratios of Japan and China. This is very similar to the chart. In fact, it's the same, uh, ratio that we saw earlier for the advanced economies, but the advanced economies are probably dominated by America. And you saw that that ratio was very low. But here the ratios have been high and Japan, uh, which has shown they're in black, uh, has we as we know or had a big debt problem and. Japan was really tackling that debt problem bizarrely by tightening monetary policy, uh, through the early nineties. So what you were seeing was debt starting to go up because they were using fiscal policy a lot and they weren't printing money or using monetary. Tools. So the debt to liquidity ratio was starting to shoot up, and that was creating a real problem for the Japanese economy because it was very difficult to roll that debt over, and you were creating a lot of refinancing tensions. So what they did is they did the opposite policy, which is omics and got the Bank of Japan to buy lots of jbs. So they create liquidity and they bring the debt liquidity ratio down, not by reducing debt, by just expanding liquidity dramatically. What's the cost of that? Collapse in the end. Okay. What is China doing now? Well, China's got the same problem. It's looks very similar. It's about 15 years later than Japan. They've got a big debt problem. They've been tightening monetary policy to keep up with what has been up to recently, a very strong dollar, and the debt liquidity ratio is kind of sky high. They're trying to get that down. And what they're doing is they're printing money, they're injecting a lot of liquidity into their financial markets vis this. Which is showing, uh, injections of liquidity by the People's Bank of China. This is a six month, uh, uh, change, but it shows that there was a big increase in early 2025. But generally the trend in this data is upwards. So China, like Japan is monetizing, and what they're trying to do is to get the value of the Chinese yuan down. But what are they trying to devalue against? Well, in my view, they're trying to devalue against real assets. And, uh, they want effectively paper money, uh, to be, uh, devalued against the value of real estate generally in their economy. That's where the problems are. But another real asset is gold. So if you look at this chart, this is the yuan gold price, and this is what I think they're targeting. And I think that it's China that is driving the gold price. And I think the main reason that you saw this decoupling in 2022 was really because China. Uh, started to accumulate gold aggressively, but also has started this process increasingly of monetization. So this is the process that they're going through. And what's more neatly dovetails into the view that, uh, if China is reifying its economy and trying to get growth up, that's also gonna be positive for commodity prices, which is what this chart is trying to show, which illustrates, uh, Chinese liquidity injections in orange, going back a lot further shown as an index. Uh, to make this, uh, sort of comparable and the black line is, is the CRB commodity index. Dotted line is without energy. Solid line is with energy prices. But you get the idea that more Chinese liquidity tends to be positive for commodity prices, simply because the PBOC controls the Chinese economy. And the Chinese economy has a big industrial footprint. So it sucks in commodities and we think that you're gonna get, uh, continual con commodity price. Uh, appreciation, and that's after all what we suggested right back here in the cycle. Uh, when you look at, um, this diagram, we're at the peak of the liquidity cycle. So happens China's also adding fuel, but commodity markets should be, uh, you know, the place to be. I have a good friend who is, uh, a capital allocator, um, very, very active in Asian markets and in China, and he would say two things. He would say China's debt doesn't matter all that much because it's mostly internal, and he would argue that. The Chinese government is trying to push savers fr from focusing so much on real estate, which was their traditional way of, of saving and trying to push them into the stock market. So his theory is that there is going to be, uh, a continued boom in Chinese stocks. Curious what, what your thoughts are on those two points that would follow as well from our view. Because, you know, the way that we, that we see it is maybe through a slightly different lens, but I think you get the same result. And that is that China is trying to, to, uh, monetize or reify its economy in the same way that Japan did through Aeronomics, uh, or the BOJ being more active. You're gonna get a lot of liquidity thrown at the system, and that will spill over into many asset markets, including equities. Uh, and therefore you're gonna get the same end result. Uh, and I think that's what we've seen this year with, um, you know, some big gains in the Shanghai, uh, composite index. So I think that I, I think the, the result is the same. I still think they probably have to get real estate prices up. So I think the, the legacy you've got in China is, I mean, the. The great paradox that, you know, no one seems to focus on here is that, you know, China is not by any means a a socialist economy. I mean, they've got a, a, a very regressive tax system and they've got no welfare spending. So I dunno what socialist about that. It's just basically a, a, a sort of planned economy, uh, or, uh, you know, um, uh, a strong, a strong, uh, command economy, uh, if you like, from that perspective. But it's certainly not a socialist economy and the fact they haven't got a welfare system means. The people have gone into real estate for their pensions. And so, you know, unless you're gonna disenfranchise pensioners and notional pensioners in the future, you've gotta get real estate prices up in some form. You made a almost an aside comment about Japan and, and what they're doing and how it's, it's ultimately gonna result in collapse. Did I, did I hear that properly? I don't think it necessarily results in collapse. I think the thing is that what they, what it certainly results in the collapses of the yen. I think that's for sure because they've basically re liquified so much, they've gotta get outta their debt problems. And the only way that you get outta debt problems is by printing money. You, you, you can't do any other way, unless of course you get growth. But I mean, the ability of governments to choose growth is, is, is, it just doesn't exist. Um, you know, I mean, certainly the policies that all western governments run are just not conducive to growth right now. So the only way you can do it is basically by. Printing money and hoping for the best, trying to get, uh, you know, your, your currency devalued against something, uh, probably gold. Uh, and so our view is you've gotta have monetary inflation hedges, generally. Japan is just one example of that. China will be another. Um, the west, you know, in some ways the West has made great progress in terms of, uh, of getting its debt. Contained. But the problem is, is that if you look at the public sectors in many economies, the welfare commitments are so great that that debt problem starts to acce reaccelerate once again. And that's the problem we've got looking forward. So, you know, we did a little exercise which said, you know, if you, um, if you look, uh, over the next. 25 years, it's quite likely, and this is actually, you know, not a particularly controversial point, but you'll get a debt GDP ratio in the US of over 250% of GDP. Okay? Now that's actually pretty similar to what the Congressional Budget Office comes out with, which is a bipartisan, you know, supposedly independent body. So they're thinking about very similar figures. Now, if you take that 250% of GDP and say, well, actually, what does that mean? Well, if you said that the value of debt in the US federal debt we're talking about here, not general debt, federal debt, and we assume that that federal debt stays constant in real gold terms. What would the gold price have to be by 2050, uh, to keep the real value of debt stable? And the answer is, the gold price would've to be $25,000 an ounce, uh, which is actually quite a high watering figure. Uh, it would have to be $10,000 an ounce by the mid 2030s. So you kind of get the idea. Now people say, oh, that's fancy. It's never gonna happen. But actually look back over the previous 25 years, the value of federal debt went up tenfold. The s and p went up barely five times. Okay. And gold went up 12 times. So gold more than outpaced the increase in federal debt in the last 25 years. And all we're saying here is to match it, uh, you've got huge gains in gold, but what is true of gold is gonna be true of bitcoin, uh, and maybe cryptocurrencies. And one of the things that we often do is to sort of share this perspective. Which is looking at the growth rate weekly of global liquidity and changes in the price of Bitcoin. Now this particular index that you see here is called BES, which is an average of Bitcoin, Ethereum, and Solana. So it's an aggregate of crypto, but the same thing applies. Now, that's not a one for one correlation, but it's not bad. And global liquidity here has been advanced by 13 weeks. So three months, and it's predicting what will happen in terms of the movement of the, of, uh, of those, the crypto market. Now, the point we make here, which is that the most sensitive, liquidity sensitive asset probably on the planet is crypto, or let's say Bitcoin for argument's. What does that tell us? Does it tell us that Bitcoin is a canary and a coal mine? And the recent sell off in Bitcoin is an omen for other asset, other risk assets in the next few months? And I think the answer is it could well be simply because, uh, we are seeing fed liquidity under a lot of downward pressure. I am absolutely fascinated by your work. I I could extend this interview with you another two hours, uh, at time, allowing, but I'll, I'll give you a reprieve. I, I, I'd like to, uh, ask you and I know, but I want all of our viewers to know where can they learn more about you and your, your fascinating work. The best way is through a substack. So we've got a substack called Capital Wars, um, that is the title of a book I wrote about five years ago, which was explaining all the stuff about global liquidity and the challenges ahead. Uh, it's called capital wars. No, not trade wars. Trade wars are the veneer on top. But what we're really talking about is the struggle for capital and capital dominance and who is gonna be the dominant currency. Uh, you know, in the 21st century. And you know, our hope is it's the dollar, but, you know, there are clearly challenges out there. Uh, but capital wars is the best route I think. We have an institu institutional service that you can get from, uh, cross border capital.com. And we provide a lot of data, uh, for quant funds or whatever. Uh, but capital wars or cross-border capital.com are the best vehicles, I think. Fascinating conversation. I hope we can get you back on a, on a regular basis. Michael, I appreciate your time. Well, that's very kind. Enjoyed it enormously. Thank you. Thanks for watching. And make sure to sign up for our global Macro update weekly email where we send you a link to the latest podcast, a transcript, and a roundup of our latest thoughts on markets, geopolitics, and the economy.
We Have Entered the "Speculation" Phase of the Market Cycle | Michael Howell
Summary
Zero interest rates didn’t exist for 4000 years of recorded history. Now CrossBorder Capital founder Michael Howell believes we’re …Transcript
In actual fact, the Fed is losing control of the rate system at the moment. That's really an inconvenience for them rather than a serious problem. But they're clearly worried because these can get out of hand. No politician really has the balls to cut back spending, so they're just having to fund it through the short end of the market because it is easy, and that's his printing money and we know that doesn't end. With stocks, gold and houses all hovering around all time highs. Many investors are nervous and they're asking what comes next. My guest this week might have the answer. Michael Howell is the founder of Global Liquidity Indexes and author of the Substack Capital Wars. He focuses on the relationship between global. Liquidity and debt, and as you'll hear today, his research is predicting big changes for the markets. I'm Ed D'Agostino and this is Global Macro Update. Michael Howell, it's great to have you first time being on our podcast. So welcome, it's a real pleasure. I've watched many, many interviews with you and always wanted to have a chance to, to speak with you directly. Well, thank you, Ed. It's very good to be here. Your whole Framework is based, if I understand, on global liquidity. Uh, and, and I don't wanna spend too, too much time on it. But, um, for those out there who aren't like me and just spend my nights and weekends watching YouTube videos about finance, um, maybe, maybe you could. Give us a quick summary of sort of how you, I know it's a complex topic, but how you generally approach liquidity and, and how liquidity forms your, your framework for how you look at the markets. The genesis of it all, uh, basically came when I worked at Sama Brothers. The, uh, the former US Investment Bank, which is now part of Citi Group and s Brothers, uh, when I worked for it was the, uh, you know, the world's biggest bond trader and, you know, very big in fixed income markets. Basically Salon used to organize its offices around the world with, uh, centered around a huge trading floor. And that trading floor was, uh, you know, clearly visible, uh, to everybody. You could just look and watch and you could watch money flow around the world. And that was pretty much the, the whole idea behind. Global liquidity because it was very clear that in financial markets, and this was very much a mantra of Sonomo brothers at the time, uh, there was no unrelated event. So if you saw one particular desk suddenly get lots of, uh, lots of business, it was probably likely that that was shifting from another desk somewhere else. It could have been the US treasurers were getting a lot of money, but it may have been that US equity or Japanese equity were losing funds. So you can actually see how money was moving, uh, physically, almost, or tangibly around the world just by looking at these desks. So that was really the, uh, genesis of the whole idea of global liquidity. Um, what it is in terms of, of our measurement is clearly not measuring what happens on an individual trading floor, but it's much more aggregative than that. And what we do is we look at the flows of money, uh, that are traveling through world financial markets. So it's not a measure. That economists are familiar with like M two. In fact, in many ways we say that our definitions of global liquidity pretty much start where traditional measures of M two kind of end. And the reason for that is that we are looking at things like repo markets. We're looking at shadow bank activity, we're looking at cross-border flows. These are the things that really matter when it comes to driving financial asset prices. And the third thing, which I think is, is worth spelling out, is that that financial markets no longer work in the way that. Sort of textbooks describe, I mean, there's, you know, you can look at the maths of, uh, of, you know, how you discount a, uh, uh, a flow of earnings and why that's supposed to sort of drive an asset price. But in reality, it, it's very different from that because capital markets are no longer about. Um, raising money for new capital investments, they're much more about rolling over existing debts. And you know, what we, what we're sitting on in the world economy now is something like $350 trillion of debt of all of all stripes, uh, you know, government debt, corporate debt, household debt, et cetera. Uh, and that debt is not infinite, and it doesn't last forever. It's gotta be refinanced. And the role that financial markets increasingly take is that basically debt refinancing mechanisms, and that debt has to be rolled. So if you've got an average five year maturity on a bond, uh, and you've got $350 trillion of debt out there, you need to roll 70 trillion of of debt every year. So that's a big, big ask, uh, because it's. Basically what we're talking about, we're talking about three quarters of world GDP being rolled in financial markets from debt transactions, and that requires balance sheet capacity. And that balance sheet capacity is what we think of as global liquidity. So that's really the both the genesis and the definitions of what we're talking about. How does global liquidity and debt factor into public markets? Of all types, like how do you, how do you leverage that as a framework for informing investment decisions? The first thing to say is that liquidity, uh, tends to be fungible. In other words, it moves and it can shift from place to place. Uh, particularly when you're outside of crises in crises, liquidity tends not to move. It tends to be stuck. People, you know, freezes. People sit on it, never, then don't move it. But generally it's fungible, so it will shift around. So if you have situations where there's too much liquidity in a financial system, what you'll basically start to see is that, that that liquidity will. Uh, we'll go into where the vent will probably be asset, higher asset prices. If there are defi, if there's deficient liquidity, then you're gonna see, um. Periods of financial crisis more likely now we can probably show that, and I can show you that in a diagram and I'll come back, uh, sort of, uh, onto something a little bit more, uh, maybe more, uh, interesting about current developments in a second. But if we start maybe with this slide, which. A little bit daunting 'cause it's, uh, it's a schematic diagram and there's, there's quite a lot of words on that. But let me just sort of focus in on what, what this is really about and why it matters. And this is saying that if you look at the global financial system, um, really post. Uh, GFC in 2008, nine. What you've got at the heart of it is a debt refinancing system that has a debt liquidity nexus, uh, right in the center. And what that really means is that, uh, debt needs to be refinanced and to refinanced debt, you need liquidity. But the paradox in the financial system is. The liquidity is increasingly collateralized and it requires existing debt, uh, as its backstop or its collateral. So you'll see written on the, uh, in red, uh, lettering on the top, uh, left of this 77% of global lending is now collateral base. Well, that. Actually not our figure. That's a World Bank figure. And what it's saying is that, you know, people can think of a very straightforward example like their home mortgage. Uh, you know, domestic real estate, if you've got a mortgage, is essentially a collateralized loan. But if you extend that out to financial markets. If hedge funds are borrowing, um, to do a, something let's say called the basis trade, where they're, uh, effectively buying cash bonds and they're shorting futures, they will actually be borrowing from dealer banks and they'll be using. Um, US treasury bonds, uh, as their collateral, so they'd be borrowing against that. So most borrowing in financial markets is backed by collateral, and that collateral tends to be government bonds, uh, in some form. It may be bills, it may be notes, but whatever it tends to be, you know, it may be US treasuries, may be maybe German buns, but it tends to be basically, uh, some form of, uh, of solid financial instrument. Now. That's at the heart of the system. And what you see are two wings here. One is on the right where it says refinancing, so that's turning, um, liquidity into debt, helping to roll the debt over. And then you've got the other wing on the left, which is the repo collateral wing, which basically says that, uh, in order to to get liquidity, you need debt. Now, those, either of those two sides can break down, but what tends to break down is the collateral repo side first. Now just to show what this means, and I'll pause after this slide. Uh, 'cause there's a lot of, yeah. Obviously a lot of ground to cover here. What this shows is the ratio between debt and liquidity in the world economy. Now the big problem we've got as a society, uh, as a western economy is there's this way too much debt in the system. Uh, and I know you guys have written about this in the past because I know I've read it and, uh, I've been very impressed with the analysis. But what this is basically illustrating. Is that what is really critical is the ratio between debt and liquidity, not necessarily debt and GDP. Um, debt to GDP just tends to trend up this particular data series. Debt to Liquidity is a stationary or sideways moving, uh, series that tends to see, uh, very clear cycles when you have strong. Or very high debt relative to liquidity. So a high or strong debt to liquidity ratio, which you can see on the chart, is really well above the 200% dotted line. There. You tend to find there are refinancing crises, and what we've done is we've illustrated with the, uh, with the annotation where you get financial crisis and it tends to be. When you've got an elevated or stretched debt to liquidity ratio, the counterside of that is that if you've got, uh, a very low debt to liquidity ratio, in other words, bucket force of liquidity, not much debt to refinance, you then tend to get asset bubbles. And that's what we've illustrated with the annotations on the bottom. Now you'll see in that lower right hand corner, uh, what we've denoted there is the everything bubble. And the everything bubble is clearly what we've. Been through, uh, or experiencing right now where the debt to liquidity ratio was very low, and that was because in the wake of the GFC and in the, uh, during the COVID crisis, policy makers just address the problem by throwing lots of liquidity into the system. And what's more they. Slashed interest rates in near zero lev, near, near zero rates. So you basically encourage a lot of refinancing or terming outta debt into the latter years of, of this decade. And as you can see from the projection what you, what we show there, the orange line that, uh, that ratio is slated to not only just move up. Uh, to the dotted line, the normal equilibrium, but actually shoots through it. And that's because there's a lot of debt coming back into the system now that was termed out during the COVID years that needs to be refinanced. And what's more, the growth rate of liquidity, particularly coming out of the Federal Reserve now is slowing down quite noticeably. So we may be moving into an era of, uh. Uh, of more repo or refinancing tensions, which is exactly what the repo markets are currently telling us. And that sets us up perfectly for today. So thank you for that, that backdrop and that, that is the question, right? Where, where are we today and where do your models show us going? 'cause. You could, you could make the argument that liquidity is going to increase a little bit, um, at least from the Fed, right? And they, they've, they've announced that they're stopping tightening, they're not gonna let their balance sheet run off. And then shortly after that, it sort of hinted that they might be not, not EAs. But easing, I think is how you put it in, in a note that you sent on your capital war Substack, uh, uh, this week. So what, like, what, which is it? How can you be easing without easing and why, why is that? How does the repo market fit into that? I think there are maybe three questions there, so let me just try and do each one in turn. The first. Is where, where are we now in the cycle? This chart here, which is really the centerpiece of what we do, is looking at the global liquidity cycle. This is for the advanced economies. Uh, so it's pretty much everything apart from China is in there or China and emerging markets. But China is the, is the dominant missing, uh, economy. And we've taken China out really because China. Uh, is at the moment quite erratic in terms of its, uh, its liquidity, which we can dig into later. But, uh, for the, for the best part, this is showing, uh, the, the, the major advanced economies. Now what this illustrates is a cycle that goes right back to the 1960s, and this is looking at the momentum, uh, not the level, let me stress the momentum of liquidity through, uh, world financial markets. Now. That cycle is a refinancing cycle, and what we've done is we've put on top of that aine wave. Now that's sine wave. We estimated using something called RIA analysis back in year 2000, so 25 years ago. And we haven't altered the, uh, the frequency of that since that time. So what you see is what you get, and it seems to be lining up pretty well with a 65 month cycle now independently. Uh, an organization called the Foundation for the Study of Cycles contacted us. Uh, earlier this year and said, could we have your data? Because we do a lot of very rigorous cyclical analysis and we like to test out, uh, your claims that it's 65 months. And I said, yeah, sure. Here's the data. Take a look at it. They came back and they said, well, you know, lo and behold, we find exactly the same result. Uh, all our algorithms are point to the fact that there's a repeating 65 month cycle. So apart from the fact that's reassuring. Real, real question is why, and I think the, the answer that I would give is that that's really the average tenor of global debt. So 65 months between five and six years is the average maturity length of debt in the world economy. So that to me. Sort of fundamentally suggests that this is a debt refinancing cycle in the same way as if you sort of picked up a textbook, an economics textbook, maybe of 40, 50 years ago, they'd be talking about a CapEx cycle. And the CapEx cycle. Bec was really, uh, a ome fact that the depreciation cycle of, uh, a fixed investment was around 10 years. And that's what people thought was, uh, a 10 year decennial cycle. So now we've got a, a cycle, which is. Uh, between five and six years. It's not a CapEx cycle, it's a debt refinancing cycle. And what you can see with the latest data is that this bottomed almost exactly on queue, uh, in October of 2022. It's been rising ever since, but it's just inflecting now. Now that inflection may be a meaningful one. I mean, clearly if you look at the data. Historically, I mean, there have been full storms, so it, it's possible it goes up again. But the question is to try and understand what policy makers are doing. So the key one is really the US Federal Reserve. So let me turn to what the Fed is up to. This is the chart that we really need to look at, which is looking at the growth rate of fed liquidity, which is answering your, uh, second question about what is the Federal Reserve really doing with its balance sheet, or, uh, maybe more generally with interest rate policy. Now let me start with the interest rate policy question. I think in a world where you've got huge amounts of government debt. And where the government is making significant transfer payments into the private sector, it's very unclear to me where the higher interest rates or lower interest rates are stimulatory or not. I think it's a really gray area. So for, in other words, if you are doing a lot of transfer payments from the government and the Federal Reserve decides to cut interest rates, you're actually slowing down transfer payments. Uh, and that is the loss of income. And that should actually be for a large part of the economy, uh, actually an economic drag. 'cause you've got lower income and the fact that you have, you are not using, you're not borrowing money from the banking system for your CapEx, means there's no offsetting, uh, benefit from lower rates. Uh, you know, most, uh, investment these days is, are the government induced. This China, or it comes out cash flow. So that would suggest that maybe interest rates are not necessarily the key variable. And what you need to look at is really the amount of liquidity that policy makers are actually injecting into financial markets. And what this is showing is the liquidity injections of the Federal Reserve. Now, that's not the balance sheet, uh, because every item on the balance sheet is not necessarily liquidity creating. Um, there are elements which subtract liquidity. There are elements that don't create in liquidity. So what we've done here is just to extract. The liquidity, creating parts, the net liquidity, creating parts of the balance sheet, and this is showing the duration in that particular element. Now let me just get a little bit more granular without straying into the weeds Too much. That is things like looking at what you might call fed credit. So it's things like open market operations, traditional ones buying debt, um, for example, or things like, uh, the bank term funding program, which was giving emergency assistance to the banks. It could be discount window lending, et cetera. So those are forms of Fed credit that go into the system and coming, subtracting from that would be things like, uh, security issuance by the Fed that absorb liquidity. We'll think of that as a reverse repo program or think of as well, uh, the treasury general account, which is a balance, uh, that the US government keeps at the Federal Reserve, which is, if you like, a, a sort of a, a deposit account that it can build up or run down. And if it builds up that. TGA Treasury of general account. It's taking money outta money markets. So what you've gotta look at is not, the overall balance sheet will be distorted by all those elements, but only looking at the liquidity, creating parts. And that's what we show here now from over 80% growth in 2021. Uh, at the peak, this is six month annualized. We were right down at, uh, negative 40%, uh, by early 2022. And then the cycle began to turn by the end of the year, and you started to go back to positive liquidity growth in the Fed. It's wobbled a couple of times since, uh, but certainly around the beginning of 25, largely because of the debt ceiling, uh, impasse. Uh, and then more recently the government closed down. You've actually seen, uh, liquidity go back into the markets. And, uh, ba uh, basically, uh, sorry. I said the government closed and I meant that was actually a negative. And now what you've seen is the rebuild of the TGA and the government closed down has caused that, uh, withdrawal of liquidity, uh, sort of up until that sort of gray forecast period that we've got there. So. Effectively fed liquidity is negative, but you're projecting that it will start to go up based on this chart. Yes. I'm predicting it's gonna go up. It's not gonna go up very much, but it's gonna go up. And the reason it goes up is that we factored in here $250 billion. In other words, 20 billion a month. Of qe, not the end of, not just the end of qt, but actually a positive qe. Now, I think the Fed is gearing itself up to doing that, uh, because even, um, you know, those members of the FOMC that have been historically very much against, uh, any balance sheet manipulation, uh, such as John Williams and now talking about the need to actually put the quality back into the system, I think my, my reading of it is. Is, you've got likely got three camps within the FOMC. You've got those that are, let's say, experts or monetary plumbing, uh, like Lori Logan, uh, uh, Dallas Fed, who's very much I think in favor of expanding liquidity into, uh, into the system. Uh, for plumbing reasons. You've got more orthodox, uh, central bankers, uh, like Jay Powell and probably John Williams, who. Uh, are much more inclined to think in terms of interest rates and not balance sheet, and see the balance sheet as a distortion. And then you've got the Trumpites. So let's say that's headed by Steven Miran, uh, maybe Governor Waller as well. And what they want to do is to shrink the balance sheet, but cut interest rates. Now I think there's an agenda there, which we can come onto later, but I think that particular power balance in the Fed says that you've got. Uh, three votes. Let's say three constituencies, two are against balance sheet expansion, one's pro. So what you may get is a slim increase, and that's what we've, we've factored in here. Can I ask you how issuance treasury issuance factors into this? Because, uh, someone pointed out to me recently that the recent stable coin regulations have. Had a meaningful impact on the issuance of short-term treasuries, and my understanding is that stable coins need to be backed solely by short-term US treasuries, and that that was sort of a stealthy way for the treasury to be able to issue vastly more. Debt essentially. So how does that factor into this? It's a very good point. I mean, there's, there needs to be a lot more debate about the whole stablecoin issue because I think it's, it's a big, big one and I think it matters not just for the US financial system and this monetary plumbing, but it also matters in particular for the world economy, the international monetary system, and really the role of the dollar in the long term where I think there's a, a compelling case to argue. That rather than de dollarization, which is the sort of media cred core, uh, you're actually gonna get a re dollarization, paradoxically, uh, because of stable crime. That, that's another question. Now on the question of domestic, uh, issue or domestic issuance. The, uh, the policy under Janet Yellen was very much the focus on the short end of the market and do a lot of bill issuance and, uh, secretary treasury, secretary. Uh, Scott Bessant has railed against that and said that sort of he is bad economics, bad finance, whatever, but sadly, he's sort of going down the same route, uh, probably because he can. It's a very easy funding mechanism. Now, as you rightly say, uh, if you've got stable coin and stable coin. Are clearly very big buyers of treasuries. They tend to prefer, or they tend to skew into, uh, the very short dated, uh, end of the market. So bills and short dated notes, and that's what the treasury is definitely starting to issue. The problem with doing that is you kind of create a rod for your own back because one of the things that has. Jumped up in recent quarters has been the size of the Treasury General account, this balance at the Fed. Now, without getting too much stuck in the weeds here, uh, if you were doing a lot of, uh, long dated issuance, you don't have to roll debt very often. And the Treasury general account was set up with a notion that it would basically be a balance that would tend to correspond to about five days spending by the government. Now, if the government is mainly spending its money on. Um, on, let's say this fiscal program, normal fiscal programs, it doesn't really need to have a lot, a bigger balance there because you've got tax revenues coming in, you've got spending going out. You kind of need a small cushion. But if you are rolling, uh, which is now the case, 500 billion of treasury bills every week, plus about another 150 billion. Of short dated debt and other coupons, you need a big balance in that treasury general account. So although they're going down the route of, uh, issuing issuing bills and short dated notes, one of the costs of that is they've gotta run a higher tga. A and a higher TGA is taking money, liquidity out of the system. So it may seem as if you are winning by doing bills, but there's a cost to that. Now, one of the. Offsetting factors could be, and I say I don't wanna get too stuck in the weeds here because it gets very wonkish, but the people that tend to have the biggest appetite for bills and short dated debt are banks and of course, other credit providers and let's row in their money market funds. And stable coin issuers. Now, uh, they tend to be big buyers of the short end of the market, and the fact that you've got repo problems coming through would suggest that they're not really buying enough. And that may suggest that you've got to incentivize the banks to do more, which may mean you have to change bank regulations, and that may be the next shoe to drop. So watch this space. But I think the fact is that what they're, what the administration seems to be very focused on is this window of how you actually, uh, or the window of money, market liquidity. What is going in and what is coming out through coupon issuance. But they seem to be trying to get the banks to do a lot more. And if you get the banks to, I mean, the important point ultimately is if you get the banks to buy government debt, you are monetizing, uh, you are not using existing savings. You're using the, an expanding bank balance sheet to fund the government. Now we know that's not, that's not good finance, but it's happening. And it's gonna happen more. And that's the reality. Is it inflation? When it's definitely monetary inflation, does it feed through to the price level? I think it's got to because history shows it always does. Without getting too wonky, I guess what I would say is if we pull back a little bit and look at your framework and everything that you've said so far, what would you, as, as a, as an individual investor, what would your takeaway be? Are you preaching caution at this point? Are you, yes. I think the question most people are asking is, when do I take cover and where do I hide? Let me just illustrate what the, what the problem is. This is the problem, and this derives from the very first chart I showed, which was the. Debt liquidity nexus, if you like, in the middle of the, of the schematic diagram. And what it says is that if you get imbalances between debt and liquidity, in other words, let me just go back and show that. So that's the slide problems on the left hand side, repo collateral, what do you start to see? You start to see sofa spread. Uh, which are effectively, uh, spreads in the repo market starting to blow out. And that's really, uh, uh, the first sign of problems. And that is what you would get if you see that orange line moving closer to the Dottie or broken line at 200%. And that's clearly where we're move. We are moving up in that direction. Now that, by the way, is the amount of debt that's coming forward to be refinanced. So I didn't show that before, but that just illustrates. The upcoming problems. This is the increment each year, and you can see the bite out of the chart in 20 21, 22, 23, which is basically when a lot of debt was termed out because policy makers, for whatever reason, they, they obviously thought they knew best, but they slashed interest rates to near zero, and what you got was a situation where. A lot of borrowers termed out their debt to the back end of this decade. Now, I always remember the, the sort of solitary lesson that when I was at Salman Brothers, the, the book that we always encouraged to read, uh, was a book, which was, uh, a sort of, uh, uh, you know, an antidote to sort of, uh, sleepless nights, but it's a history of interest rates by Sydney Homer, and that book covers 4,000 years of world history of interest rates. Nowhere in those pages, is there any reference to zero interest rates. Uh, so what we've had in the last 10 years is an absolutely unique period in world history, and what we've got is, as a result of that, uh, accumulating debt problems, it not only incentivized debt, but it turned out a lot of debt and that debt is coming back as you can see, and that's one reason why that, uh, line starts to shoot up on the right hand side. But the other reason is you've got problems in repo. Uh, beginning to emerge as liquidity is, uh, is, um, slowing down. And as I said, fed liquidity is slowing down. So what you can see here is the spread between sofa rates, which is system overnight funding rates, which are basically repo rates. Uh, I'm sure people are familiar with repo, but repo is basically the main borrowing vehicle, uh, post the GFC, where a lot of, uh. Financial funding used to be done through the interbank market on trust between banks. That market has now virtually disappeared and most lending is done collateralized using government securities, let's say treasuries. And in other words, what you do is you post a treasury, uh, to a dealer bank. And effectively, uh, you'll, you will promise to buy that back in a certain period, maybe overnight, maybe seven days. Uh, but you get a loan, uh, against that and they will lend you. For argument's sake, 95% of the collateral value, uh, to borrow. So that's how it works. And this is the rates that you are charged for that, just to make sure we're, we're keeping everyone with us. That's essentially what you were, were talking about when you talk about the plumbing of, of the system. Correct. Exactly Right. Yeah. That's really the underlying plumbing and the plumbing. The point being is that the plumbing has changed radically, uh, since the global financial crisis. Okay. Uh, and that's what we need to remember. So it, it may sound wonkish. And it may be, you know, uh, uh, somewhat obscure because it is not really written up in textbooks, but that's 'cause the textbooks are sort of somewhat out of date and the world has moved on a lot. And so you need to understand this plumbing backdrop. Now what this is saying is that you can see there's a normal zone there that we show where, uh, spreads against fed funds. This is sofa, minus fed funds, uh, are at a small discount. You kind of expect that because. SFA rates are collateralized. Fed funds is not collateralized. So you'd expect actually that uh, in normal circumstances, sofa would be a cheaper way borrow. Uh, but as you can see here, it's not, and you've seen these big spikes. Now, I put a dotted line notionally at where you get a danger zone, but you can see that we've spiked well above that. Now, given the fact that the Fed recently cut rates by 25 basis points, you can see just by eyeballing the chart. Uh, there, ed, that the, uh, that the interest rate cut, uh, at one stage in the last, uh, two weeks was actually, uh, more than a, more than eroded by that spike in, uh, in repo rates. So in actual fact, the Fed is losing control of the rate system. Now, at the moment, that's really an inconvenience for them rather than a serious problem, but they're clearly worried because these things can get out of hand. Uh, this what happened in 2019 where you've got a repo crisis. So that's really the issue, and I'll give you an illustration of what could go wrong is shown here. And this is looking at the excess reserves of US banks. Uh, which is the orange line, uh, they're deficient because fed liquidity is deficient. And what the black line is showing is the number of failed trades among primary dealers, shown as an inverted seers on the right hand side. Now, if you've got a failed trade, uh, it doesn't sound good and it's not good, and you can basically see, uh, increasing volatility. Uh, in the, um, uh, in the collateral markets or the treasury market really because of that. And if you get increasing volatility, the hedge funds who have been whopping great buyers of treasuries, uh, will start to close down their, their trades. Uh, last year, according to the Federal Reserve, they bought in excess, have one and a half trillion dollars of treasuries. And given the fact that new issuance was 2 trillion. That is a lot. Um, and that's his hedge funds. We know they're flighting and capricious, but you know, don't give them any excuse to stop trading and this is a good reason. So you don't wanna do it. That's really problem number one there. And the other question is just about, you were saying about what should people do, and I was gonna say, well, just let's this come back to look at the cycle. And the cycle is around a peak. So how should you view that? Well, I do that in two ways. One is to say, look, here is the normal track of a liquidity cycle as a dotted line shown there as the average, uh, over the 1970 to 2025 period with zero in the middle of the page being of the trough and months being calibrated either side to the left or to the right, before or after. The red line is the current cycle. So it looks as if we're getting. Very late in that cycle. And how do you operate in terms of an asset allocation? Well, we say, look, you've got, uh, on the left hand side a notional liquidity cycle on the right hand side. We dovetail that with the asset allocation cycle. There's some overlapping, uh, if you're in the upswing of the liquidity cycle, you are risk, risk on, you want more equities around the peak. You want to be thinking about commodities in the downswings. You want to be risk off and moving more towards cash. And then by the trough, you want a lot of government, uh, long duration bonds. So that's how the asset allocation tends to work. And in terms of simple traffic lights, that's pretty much how we view it on this, on this diagram. So in our view, to put, you know, to, to nail our, our sort of call to the mast, I mean, we think the US market. Currently is in speculation. Uh, therefore you would've have that kind of asset allocation. Other markets, you know, Asia emerging, Asia, Europe are probably late calm, but that's maybe dancing on the head of a pin a bit. Uh, but we think we've, we are very late cycle. But if you then look at how this has evolved over the last three years, you can see that it's almost been. Uh, you know, a, a perfect or, uh, very normal, at least liquidity cycle, investment cycle, but it's been a very abnormal economic cycle. And it may be that the economic cycle is distorted by the overhang of debt or excessive government spending. I don't know. But if you just run through this, you'll see in rebound that we were from. Late 2022. You wanted, uh, you know, some risk on, but you know, as the, as the amber traffic light says, proceed with caution, go, but proceed with caution equities, credits, green lights. So go fully into those commodities. Bond duration. Don't try that. Uh, calm phase, which is really, let's say for the last 18 months, you want equities, you want probably, you know, bit of credits. Proceed with caution, uh, commodities definitely picking up. Uh, and then when you get to speculation, you wanna be moving more into commodities, less into equities, uh, probably taking out your credit position, maybe putting a toe in the water of bond duration. Uh, and then when you get to turbulence, you want to be out of the risk. Assets are much more into the safety of bond duration. And then if you look at industry groups, same analysis on the right, uh, you want cyclicals on the way up. You want defensives on the way down? Uh, you know, note the fact that, you know, some of the, a lot of the, um, consumer staples in the US have had very bad relative performance over the last two to three years. Uh, that's not surprising. Uh, technology has been a real winner until recently, but that may say that we are in the speculation phase. Uh, you've got financials, which have had a stunning 18 months, uh, are now probably just coming to the end of their, their term energy commodities. Picking up, certainly mining stocks have been very strong this year. So you kind of get the idea. And I should say this is not, I mean this, the traffic lights have not been adaptive for the current cycle. This is what we always use. Uh, they change, you know, they may change over decades, but they certainly don't change from cycle to cycle. So this is sort of a long based on our long history of returns. How do. Things like, uh, like the price of gold, which is, you know, uh, e even though it's rolled off a little bit from, its from, its recent, all time high, still very high. As you mentioned, miners, gold miners, uh, as we record this, they're having an absolutely epic day. Um, how, what, what signals do, does something like extremely high. Precious metal price send to you? Well, I think it's a, it's a very interesting point. I think the thing is, is that you've, what you've seen is, um, and I'm sure you're familiar with the normal charts, which look at things like gold prices against real interest rates. And historically that's always been a, a, you know, a very nice inverse correlation. So when you get very high, real interest rates, gold prices are low and vice versa. So gold, the, you know, the, the cost of carry of gold tends to be, uh, a, a sort of negative drag on the price, but that, that broke in 2022. So what you saw with gold prices going up significantly, uh, even though real interest rates were going up. And that was an anomaly. Now you could argue, and I think many people did, that was all to do with the sequestration of Russian assets and the fact that, uh, uh, the Russians et al decided that gold was a better, a better place to hold your reserves. I think that's partly true, but I think that was also the beginning of sort of. Let's call it monetary recklessness by a lot of policy makers. It was when there was increasing evidence of what I call sort of omics of this, sort of using bills, doing a lot of financing through bills. Uh, it was when you saw as well China starting to reject a lot of liquidity into the system. And, you know, maybe China was a very good. Sort of example of what's going on and why the gold market's going up. Let me just try and shift to what is going on in China. If I can, I should just stop at this job. 'cause I think I didn't tackle this one, but this was also an important point on route to explain the asset allocation for US investors. This is showing, uh, in red the aggregate I spoke of, which is fed liquidity. So that's shown in billions of dollars on the right hand scale, and the projection into 26 is shown as by the broken red line. So, you know, we think it bounces but doesn't bounce much. It's sort of, you know, a bit of a sort of belly flop and whatever. And if you look at the orange line, that's the, uh, that's the s and p 500, but it's lagged by. 25 weeks. In other words, six months. So we've done that to try and give a sense that when you see strong fed liquidity, the market tends to be buoyant. And when you see, uh, fed liquidity coming off, uh, it's often when you see or leads to a correction in the s and p. And that's what we've historically seen. Maybe this time is no different. So it's worth sort of thinking about this chart. You really want to see fed liquidity moving up a lot more. What I actually find most striking about that chart is, is the behavior or the amount of fed liquidity prior to the Lehman crisis. Uh, just. S relative to post great financial crisis. It, it just really illustrates just how much our financial system has changed. That's a really good point because, you know, basically that was the period when you had an active interbank market. And what really has happened in another way of putting it, is that the interbank market, the old interbank market has been put on the fed balance sheet. Uh, and that may be, is the best way to think about it. So, uh. It was, um, uh, you know, the period before that, before Lehman, I mean you Sure. Most liquidity was created certainly in our terms by things like shadow banks, um, and post Lehman. It wasn't the quantitative, easing by policy makers has been really important in goofing the system or slowing the system down. Has it impacted your work? I mean, has, has, has that changed? Been, um, I think, I think it's probably irrefutable, right? That it's changed the, the market cycle, the economic cycle, um, has, has it, and it's, has it impacted the liquidity cycle in the same way you raise a really important point because I think it's had a much bigger effect on the economic cycle because it's basically opened the door to much more active government. Okay. Um. And, you know, fiscal spending has been a, has been a much bigger driver of economies since the GFC. That's, that's for sure. With all the consequences like debt, it hasn't affected the liquidity cycle per se. Uh, it's affected the composition of the liquidity cycle enormously. So central banks are way, way more important, uh, in terms of the drivers of liquidity than they were before. So that's, you know, intuitively I think that that's sounds right. Now one of the things that we need to understand as well is this point, which is, uh, maybe I'll start with this one, which is just before I get to China, this is the other thing I need, we need to say is that. If you do a lot of bill issuance, which is what the treasury is doing, one of the reasons they're doing that is it's easy to sell bills. And the reason it's easy to sell bills is that banks and credit providers already like them. Uh, because if you think about the mechanism, if the, if fiscal spending is very loose. Uh, people's or government workers and government contractors, bank balances are going up. Their deposit accounts are going up. Now, from a bank point of view, what you need is an asset on the other side of the balance sheet to balance your increase in deposits of a similar duration. And what has a similar duration to a bank deposit is a short dated government debt. And so if you've got increasing bank deposits. The banks buy government short dated government debted bills with alacrity. So you can get, if you like, a self-feeding spiral here, which is actually what you're getting. And so if they're doing a lot of funding at the short end, what you're getting is the bulk of monetary growth. And we see here in red the growth rate of traditional M two money weekly. Uh, the main driver of that is the orange line. Which is basically a treasury and agency security holdings by commercial banks. So in other words, they're the main contributor to monetary growth. Right now, it's not traditional bank lending that's picking up. It's basically this component. Now, if you look at this globally, a. This is what's going on and this is what we, this term, global monetization. Now it may not sound like it's a meaningful percentage at sort of 12, 13%, but this is doubled, uh, you know, since the GFC and what you're getting is more and more governments worldwide. Turning to monetization to basically fund themselves. And that's not a good thing. I mean, we're on the wrong side of the Laffer curve for sure, in many countries. So taxation is really out. Uh, no politician really has the balls to cut back spending, so they're just having to fund it. And what's happening is they're funding it through the short end of the market because it is easy. And that's his printing money. And we know that doesn't end well. So this is a global phenomenon that we're seeing now of monetization. So I, my view is that investors have gotta be really alert in 2026 to the risk of inflation signing to come through as a. But that's another question, but it neatly fits into the gold picture. So let me go onto, onto gold and what is happening in China now. If you look at this chart, this is the debt liquidity ratios of Japan and China. This is very similar to the chart. In fact, it's the same, uh, ratio that we saw earlier for the advanced economies, but the advanced economies are probably dominated by America. And you saw that that ratio was very low. But here the ratios have been high and Japan, uh, which has shown they're in black, uh, has we as we know or had a big debt problem and. Japan was really tackling that debt problem bizarrely by tightening monetary policy, uh, through the early nineties. So what you were seeing was debt starting to go up because they were using fiscal policy a lot and they weren't printing money or using monetary. Tools. So the debt to liquidity ratio was starting to shoot up, and that was creating a real problem for the Japanese economy because it was very difficult to roll that debt over, and you were creating a lot of refinancing tensions. So what they did is they did the opposite policy, which is omics and got the Bank of Japan to buy lots of jbs. So they create liquidity and they bring the debt liquidity ratio down, not by reducing debt, by just expanding liquidity dramatically. What's the cost of that? Collapse in the end. Okay. What is China doing now? Well, China's got the same problem. It's looks very similar. It's about 15 years later than Japan. They've got a big debt problem. They've been tightening monetary policy to keep up with what has been up to recently, a very strong dollar, and the debt liquidity ratio is kind of sky high. They're trying to get that down. And what they're doing is they're printing money, they're injecting a lot of liquidity into their financial markets vis this. Which is showing, uh, injections of liquidity by the People's Bank of China. This is a six month, uh, uh, change, but it shows that there was a big increase in early 2025. But generally the trend in this data is upwards. So China, like Japan is monetizing, and what they're trying to do is to get the value of the Chinese yuan down. But what are they trying to devalue against? Well, in my view, they're trying to devalue against real assets. And, uh, they want effectively paper money, uh, to be, uh, devalued against the value of real estate generally in their economy. That's where the problems are. But another real asset is gold. So if you look at this chart, this is the yuan gold price, and this is what I think they're targeting. And I think that it's China that is driving the gold price. And I think the main reason that you saw this decoupling in 2022 was really because China. Uh, started to accumulate gold aggressively, but also has started this process increasingly of monetization. So this is the process that they're going through. And what's more neatly dovetails into the view that, uh, if China is reifying its economy and trying to get growth up, that's also gonna be positive for commodity prices, which is what this chart is trying to show, which illustrates, uh, Chinese liquidity injections in orange, going back a lot further shown as an index. Uh, to make this, uh, sort of comparable and the black line is, is the CRB commodity index. Dotted line is without energy. Solid line is with energy prices. But you get the idea that more Chinese liquidity tends to be positive for commodity prices, simply because the PBOC controls the Chinese economy. And the Chinese economy has a big industrial footprint. So it sucks in commodities and we think that you're gonna get, uh, continual con commodity price. Uh, appreciation, and that's after all what we suggested right back here in the cycle. Uh, when you look at, um, this diagram, we're at the peak of the liquidity cycle. So happens China's also adding fuel, but commodity markets should be, uh, you know, the place to be. I have a good friend who is, uh, a capital allocator, um, very, very active in Asian markets and in China, and he would say two things. He would say China's debt doesn't matter all that much because it's mostly internal, and he would argue that. The Chinese government is trying to push savers fr from focusing so much on real estate, which was their traditional way of, of saving and trying to push them into the stock market. So his theory is that there is going to be, uh, a continued boom in Chinese stocks. Curious what, what your thoughts are on those two points that would follow as well from our view. Because, you know, the way that we, that we see it is maybe through a slightly different lens, but I think you get the same result. And that is that China is trying to, to, uh, monetize or reify its economy in the same way that Japan did through Aeronomics, uh, or the BOJ being more active. You're gonna get a lot of liquidity thrown at the system, and that will spill over into many asset markets, including equities. Uh, and therefore you're gonna get the same end result. Uh, and I think that's what we've seen this year with, um, you know, some big gains in the Shanghai, uh, composite index. So I think that I, I think the, the result is the same. I still think they probably have to get real estate prices up. So I think the, the legacy you've got in China is, I mean, the. The great paradox that, you know, no one seems to focus on here is that, you know, China is not by any means a a socialist economy. I mean, they've got a, a, a very regressive tax system and they've got no welfare spending. So I dunno what socialist about that. It's just basically a, a, a sort of planned economy, uh, or, uh, you know, um, uh, a strong, a strong, uh, command economy, uh, if you like, from that perspective. But it's certainly not a socialist economy and the fact they haven't got a welfare system means. The people have gone into real estate for their pensions. And so, you know, unless you're gonna disenfranchise pensioners and notional pensioners in the future, you've gotta get real estate prices up in some form. You made a almost an aside comment about Japan and, and what they're doing and how it's, it's ultimately gonna result in collapse. Did I, did I hear that properly? I don't think it necessarily results in collapse. I think the thing is that what they, what it certainly results in the collapses of the yen. I think that's for sure because they've basically re liquified so much, they've gotta get outta their debt problems. And the only way that you get outta debt problems is by printing money. You, you, you can't do any other way, unless of course you get growth. But I mean, the ability of governments to choose growth is, is, is, it just doesn't exist. Um, you know, I mean, certainly the policies that all western governments run are just not conducive to growth right now. So the only way you can do it is basically by. Printing money and hoping for the best, trying to get, uh, you know, your, your currency devalued against something, uh, probably gold. Uh, and so our view is you've gotta have monetary inflation hedges, generally. Japan is just one example of that. China will be another. Um, the west, you know, in some ways the West has made great progress in terms of, uh, of getting its debt. Contained. But the problem is, is that if you look at the public sectors in many economies, the welfare commitments are so great that that debt problem starts to acce reaccelerate once again. And that's the problem we've got looking forward. So, you know, we did a little exercise which said, you know, if you, um, if you look, uh, over the next. 25 years, it's quite likely, and this is actually, you know, not a particularly controversial point, but you'll get a debt GDP ratio in the US of over 250% of GDP. Okay? Now that's actually pretty similar to what the Congressional Budget Office comes out with, which is a bipartisan, you know, supposedly independent body. So they're thinking about very similar figures. Now, if you take that 250% of GDP and say, well, actually, what does that mean? Well, if you said that the value of debt in the US federal debt we're talking about here, not general debt, federal debt, and we assume that that federal debt stays constant in real gold terms. What would the gold price have to be by 2050, uh, to keep the real value of debt stable? And the answer is, the gold price would've to be $25,000 an ounce, uh, which is actually quite a high watering figure. Uh, it would have to be $10,000 an ounce by the mid 2030s. So you kind of get the idea. Now people say, oh, that's fancy. It's never gonna happen. But actually look back over the previous 25 years, the value of federal debt went up tenfold. The s and p went up barely five times. Okay. And gold went up 12 times. So gold more than outpaced the increase in federal debt in the last 25 years. And all we're saying here is to match it, uh, you've got huge gains in gold, but what is true of gold is gonna be true of bitcoin, uh, and maybe cryptocurrencies. And one of the things that we often do is to sort of share this perspective. Which is looking at the growth rate weekly of global liquidity and changes in the price of Bitcoin. Now this particular index that you see here is called BES, which is an average of Bitcoin, Ethereum, and Solana. So it's an aggregate of crypto, but the same thing applies. Now, that's not a one for one correlation, but it's not bad. And global liquidity here has been advanced by 13 weeks. So three months, and it's predicting what will happen in terms of the movement of the, of, uh, of those, the crypto market. Now, the point we make here, which is that the most sensitive, liquidity sensitive asset probably on the planet is crypto, or let's say Bitcoin for argument's. What does that tell us? Does it tell us that Bitcoin is a canary and a coal mine? And the recent sell off in Bitcoin is an omen for other asset, other risk assets in the next few months? And I think the answer is it could well be simply because, uh, we are seeing fed liquidity under a lot of downward pressure. I am absolutely fascinated by your work. I I could extend this interview with you another two hours, uh, at time, allowing, but I'll, I'll give you a reprieve. I, I, I'd like to, uh, ask you and I know, but I want all of our viewers to know where can they learn more about you and your, your fascinating work. The best way is through a substack. So we've got a substack called Capital Wars, um, that is the title of a book I wrote about five years ago, which was explaining all the stuff about global liquidity and the challenges ahead. Uh, it's called capital wars. No, not trade wars. Trade wars are the veneer on top. But what we're really talking about is the struggle for capital and capital dominance and who is gonna be the dominant currency. Uh, you know, in the 21st century. And you know, our hope is it's the dollar, but, you know, there are clearly challenges out there. Uh, but capital wars is the best route I think. We have an institu institutional service that you can get from, uh, cross border capital.com. And we provide a lot of data, uh, for quant funds or whatever. Uh, but capital wars or cross-border capital.com are the best vehicles, I think. Fascinating conversation. I hope we can get you back on a, on a regular basis. Michael, I appreciate your time. Well, that's very kind. Enjoyed it enormously. Thank you. 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