Howell: Speculation Ending, Turbulence Ahead, Money Moving Real Economy, & Why Fed Could Hike
Summary
Michael Howell, CEO of CrossBorder Capital, an investment advisory firm, and author of Capital Wars, returns to The Julia La …
Transcript
Our view is that looking at the data, you're seeing a significant move of money out of financial markets into the real economy that is fueling what we perceive as a robust or even strong US economy. But generally speaking, money is leaving uh the financial sector and going into the real economy. We're now at the phase where main street is getting the benefits after Wall Street's had three or four years of excellent gains. And it's that transition which is always an awkward one. And that's why I'm saying you got to think more about real assets uh than maybe financial assets. >> Hey everyone, welcome to a special in-person episode of the Julia Lar Ro Show where we have a fan favorite. Joining us today is Michael How, CEO of Crossborder Capital, author of Capital Wars on Substack. Michael, it is so wonderful to welcome you in person for the very first time. We talk quite often, but thrilled to have you here today. >> Oh, great to be here, Julius. It's it's going to be fun. >> So fun. and this audience absolutely loves you and so again just so happy to have you in studio. So we just spoke back in April and at the time you were talking about how we were at an inflection point in the liquidity cycle. Now I was reading your latest Substack where you were talking about global liquidity hitting a new high built on narrow foundations. walk us through where we are right now in the liquidity cycle and this narrow foundation that you're seeing this base that has you concerned. >> Okay, I think the thing to do is to try and put this into a context and to try and understand where we are in the cycle. Okay, so the phase that we uh we believe markets are at is what we call a speculation phase. Okay. And that probably sounds kind of real because markets are racing or certain areas of markets are racing. But the point is that's kind of lowquality returns. So in a speculation phase, you can make money, but you're going to see high volatility as well. And it may be a very narrow market, which kind of ticks all those boxes in many ways. Doesn't mean to say in speculation that markets won't go up, but they're going to deliver lower quality returns. And you got to try and fix the position of where we are in the cycle. for the simple reason is what comes next is probably a more ugly phase. So you're likely to see a sort of turbulent phase where liquidity gets drained more quickly and the direction of markets is more likely down. Now when I say put this in context, you got to look around and see what else is happening. And at this state of the cycle where liquidity is beginning to top out uh and I fully understand what you've just said about it reaching an absolute high but it's much more the rate of change that we look at which is the critical thing and the rate of change is beginning to slow down and it has done over the last few months. Okay. Now I'll come on to a couple of caveats but the broad uh sweep is this that at that stage of the cycle this if you like topping phase you normally see commodity markets doing really well. Okay, tick that box. We definitely got it. The other thing you start to see is that yield curves or bond markets, yield curves for bond markets are beginning to see a bearish flattening. In other words, what does that mean? That means that although long yields are going up, shorter term yields are actually going up much faster and the curve is basically flattening and you've got that phenomena, too. Now, that in particular was a very non-consensual view. January 1, okay, January 1, the consensus, the vast consensus was that what you'd be seeing is steepening yield curves, higher yields, lower rates of the at the front end. That definitely hasn't happened. You've had the almost the reverse, a bearish flattening, and that basically lines us up with the speculation phase. So strong commodities, liquidity rolling over and a bearish flattening are three boxes to tick. And maybe you can do a fourth which is maybe a narrower focus on the market. >> Now we can go on and say why is liquidity going down which I can I can develop but that's really the the background. >> I think it's a good point you make that it's lowquality returns. >> We're in the speculation phase. The next one is turbulence and I guess that's when things get ugly as you put it. Can you elaborate a little bit more on the evidence too like around lowquality returns because I imagine a lot of folks might still look at the markets and think oh things are going up they might get that FOMO but you're a seasoned experienced investor you think lowquality returns explain that. Yeah, I think well what we're really saying there is that uh there are certain securities that are going to race ahead and do very well and you've seen uh you a lot a lot in the in the robotic space uh in the AI space in the semiconductor space which have clearly delivered uh doubledigit gains uh almost every week for the past few weeks. I mean that doesn't go on forever. Trees don't grow don't grow to the sky. Uh so we got to get some you know put this into perspective. There's also a lot of other securities in the market that haven't moved very much or even have gone down. So, we've got to put that into context. So, although the general market's gone up, and I accept that. Um, what I'm saying is that this is built on narrower foundations, uh, it doesn't mean to say the gains in those securities are not real. They clearly are real. Uh, but it's a very narrow focus and you got a lot of volatility potentially behind it, uh, in various errors. So, stocks might go up, you know, 10% in one week, they might be down 8% another week. I mean all I'm saying is that volatility is beginning to pick up and that's typically a late cycle sign. Now in terms of asset allocation which is really what we're talking about here. Uh it's not a really a binary decision of saying all in all out of the market. I think one's got to treat this sensibly and say okay we're in a speculation phase. You don't want to devote all your capital to uh stocks right now. Uh you want to have a portion that you have uh let's say in a trading portfolio. uh and you want to have a a core portfolio where you're going to be more conservatively positioned. Now, in that conservative core, what you got to be thinking about are long-term hedges, particularly against monetary inflation, because that's what the trend is basically telling us. There's huge amounts of debt out there. That debt has to be somehow uh afforded or more correctly rolled over. And so a what you're going to see is more and more money printing and that's going on in the background. So monetary inflation hedges like precious metals probably like some crypto some some element in crypto uh prime residential real estate and good quality equities should be in the core and then you've got a trading portfolio which may be 20% depending on people's risk tolerance where you can play around in the markets and by all means jump on momentum by all means be a trader if you I'm sure you can do it better than I can but um those are the sort of things to think about but it's all about context and understanding if you like which season we're in. >> Mhm. Okay, let's talk about where liquidity is going right now. It's going down. Is that right? >> Well, it's the Let me be 100% clear here. The absolute level of liquidity is still inching higher. Okay. So, I think our latest print was maybe about 193 trillion globally. So, this is clearly a big number, but the rate of change is beginning to slow down and at the margin markets price off rates of change. So that's really the critical thing. If you start to get inflections in the rate of change, that's when you got to be worried in terms of risk assets. And that's what we're saying. Now, it doesn't mean to say that the party is over tomorrow, but it's saying you've got to start positioning yourself for this next phase. So liquidity is beginning to roll over. Now, the interesting question is why is that happening? >> It is not categorically not because central banks are tightening. They're not tightening. Okay? There may be one or two instances of that occurring but generally the major sweep of central banks are still uh running loose policies. So it's kind of head scratching. Why is liquidity going down? And the reason is that all money that's anywhere must be somewhere. Okay. So if it's going into the real economy, it's not in the financial markets. And our view is that looking at the data, you're seeing a significant move of money out of financial markets into the real economy. that is fueling what we perceive as a robust or even strong US economy. Uh there seems to be a lot of evidence here. I mean certainly from my experience of economic strength but also a lot of inflation. Um so nominal GDP is probably racing ahead way above most people's forecasts. Um we can come back to that the implications for fixed income but generally speaking money is leaving uh the financial sector and going into the real economy. Now, is that a good thing for certain asset classes? For sure. It's very good for commodities. I mean, that's backing uh this whole commodity story. Uh it's probably good for earnings in a certain number of areas, but it isn't necessarily good for price formation in financial markets. In other words, the E may be going up, but the P multiple may be coming down. And that's the critical thing to kind of understand in this whole equation. It's often hard to see why stocks don't do well when earnings are good. But what I'm saying is we're now at the phase where Main Street is getting the benefits after Wall Street's had three or four years of excellent gains. And it's that transition which is always an awkward one. And that's why I'm saying you got to think more about real assets uh than maybe financial assets. >> Mhm. As you know, um money can only be in one place at a time. You have the financial economy, the real economy. I think sometimes it might feel counterintuitive because a lot of folks might assume that a strong economy that strong real economy would be good for markets, but that's not necessarily the case, is it? >> Well, it's not. I mean, I think one of the, you know, one of the errors that investors often make is to basically say that uh the security prices uh always respond to fundamentals. Now, that may be the case in certain times, but you've also got to accept the fact that capital often gets there first. Money moves quickly. And our view is that it's money that moves markets. Economics is downstream of markets and geopolitics happens to be downstream of economics. So, you've got this sort of sequence and it's money working out where the money flow is. That's really the critical thing. And the two points about the money flow is that one is it's driven by central banks or policy makers uh and that could be leveraged up by the by the private sector but the other is that liquidity is then drained into a real economy uh that begins to pick up and this is sequential. So the cycle in liquidity precedes the cycle in the real economy and our view is that as the liquidity cycle is dropping off now that is really uh a signal that the real economy is beginning to pick up. So our view is that the underlying momentum in the US economy is pretty good. You know, part what you're getting in the Iran tensions and the oil markets which may well derail it or cause a problem, but the underlying momentum still seems to be good in the economy. >> Gold has been one of the few standout assets of the last few years, reaching new record highs as investors respond to rising fiscal deficits, geopolitical uncertainties, and growing demand from central banks worldwide. But here's something most people still overlook. Price appreciation isn't the only way to benefit from owning gold. What if your gold didn't just sit in a vault, but actually generated a return? With monetary metals, you can earn a yield on gold paid in gold without having to sell. Instead of earning in dollars that can be eroded by inflation or policy changes, you can earn more ounces of gold. That means your gold holdings are growing in real terms, not just nominal ones. Earning gold offers a fundamentally different approach. You're not just preserving wealth, you're increasing your exposure to a hard asset over time. So, you're earning additional ounces of gold while still benefiting from any potential price appreciation. It's a way to make gold a productive asset, not just a defensive one. As more investors turn to gold for wealth preservation and portfolio diversification, a natural question follows. If you're going to own gold, why not earn gold while you own it? Thousands of investors are already earning a yield in physical gold and silver through monetary medals. You can learn more at monetary-medals.com/julia. Now, back to the rest of the episode. Yeah, it's an it's sometimes for me I I I sometimes I'm like I can't quite wrap my head around it, but I I exa I hear exactly what you're saying though and I think it's fascinating. And it's just I think maybe a lot of us we almost misinterpret it then I don't know exactly what I'm >> Yeah I mean look stock markets are leading indicators for a very good reason. Uh so stocks go up before the earnings appear right >> why is why are the stocks going up because capital flow has already moved there. The capital has moved quickly into the into the stocks and that's pushing them up. Now as you get that migration of money into the real economy whether it's through wealth effects or money just spills over then the real economy starts to get traction and as the real economy gets traction it justifies um the uh the increase in the P beforehand. So the P multiple has already gone up and now the E the earnings are starting to come through. >> One of the other things you and I have talked about is the debt refinancing especially in the financial markets. Where do we stand as it relates to that phenomenon? Um the capital moving into financial markets but also needing to kind of service debt or roll over debt. >> Yeah, I think this is a this is a big question. This is a big question that everyone has to face not just in the US but worldwide and that is that capital markets today have transformed from being what the textbooks tell us they are which is mechanisms for raising new money for capex uh into debt refinancing mechanisms. So what you're looking at is something like four out of every five primary transactions now in a financial market worldwide is a debt rollover in some way. Okay? It's all about rolling over the debt that we've taken on historically. It's not about uh not only about taking on new debt. This is just talking about the old debt. And so this is the process the financial markets are really doing. They're rolling over refinancing debt. And the linkage between liquidity and debt is really a key one. And liquidity is necessary because it defines the balance sheet capacity that is available to roll over the debt. If the liquidity is not there, you can't roll the debt over and you get a financial crisis. Now, the paradox that we sit in is one that liquidity also needs debt because most liquidity creation now is collateralized. Oh, >> so something like 75 to 80% of all lending worldwide, that's a World Bank figure, uh is that that lending is collateralized lending. That may be collateralized on a real estate purchase or it may be collateralized against the US Treasury uh bond or note uh in the financial sector, but it's collateralized lending. So the value of collateral is important. So if you get disruptions in the debt markets, the liquidity liquidity can spiral out of control downwards. Are we That's an interesting dynamic too. Are we getting to the point where it's almost too much debt or do we have still more? >> Unquestionably. >> Okay. >> Unquestionably there is there's way too much debt in the system and the system is struggling under that debt. Now the thing to recall is that if you look back at history and history is always a great guide for these things. Every time that any economy is taking on more debt, the only route out is monetization, printing money. Now the reason for that is that debt is integral to the credit system and you can't default massive amounts of debt particularly government debt. So what you got to do is effectively dilute it by printing money creating inflation and that's what happens in every single example historically. Now the problem we've got right now in the world economy is it's not just one economy that has too much debt. The world overall has yeah everybody has because of aging demographics. So the welfare commitments that are being undertaken are you know are significant and you know what's more you've also got legacy debt out there in places like China. So China's had this real this real estate boom a lot of it debt financed and that's struggling under the weight of debt. So China has to monetize and that's what it's been doing. >> They're already monetizing. >> Yeah they're that's why the gold price is going up. This is not just about what's happening in the west. >> Wait a second. Can you explain what's going on with gold and China then? And yeah, this and tie it back to this monetization then. >> Well, China is basically in a very similar situation to what uh Japan was in uh maybe let's say 15 years ago or so. And if you recall what happened in Japan after the Japanese bubble, uh there was basically a lot of legacy debt. Now the Japanese took a long time to sort of realize what was going on, let's say, or to address the problem. But abonomics which started about what 10 years or so ago uh addressed the problem by restructuring the economy and then essentially printing money by getting the Bank of Japan to buy Japanese government bonds. So they hoovered up all the the bulk of the stock of existing Japanese government debt, put it onto its balance sheet, but that meant the balance sheet expanded and as the balance sheet of the Bank of Japan expanded, they effectively printed money, which is the other side of that balance sheet. And so there was a tremendous monetary expansion in Japan. And what has happened to the yen? It's collapsed. Well, that's not any surprise. If you print lots of money, the value of money is going to go down. And so the Japanese have devalued the yen significantly. And the yen is still a very weak currency today. Okay. Now move on 15 years and say, well, okay, haven't we got the same in China? We have. Exactly. Because China went through uh after the GFC a huge real estate boom. Uh they've got legacy debt because of that. >> Can they default that debt? No. U they've got to effectively get over that printing money. >> Now the advantage that China has got in this whole equation is that China has capital controls. So if it prints money, it stays within the system. It doesn't effectively move out. Um unless it does, but that may be another question. But ultimately, uh China is is got this capital control. So they're printing money. So what assets do people buy in China traditionally if they want to protect paper against paper money devaluation? Gold. >> Gold. >> And there's tremendous buying in gold. What is moving in the gold price now as the Shanghai exchange, not uh Comx or the London market? >> Do you will you do you think we'll continue to see that dynamic then with gold? Yes, >> they'll be the primary driver. >> Absolutely. We we're going to see that. uh it's paused right now because if you look at the latest data from the people's bank uh they put their foot on the brake quite quickly uh in the last uh let's say four to four to 6 weeks probably and I don't know the reason for this but I'm I'm speculating probably because there was a lot of speculation in the Chinese markets and so they wanted to quell that short term but we'll see what happens when they start to renew liquidity injections which I think they must do. >> Mhm. And that would be the next leg higher. >> Very bullish for gold. very bullish for gold >> and also other commodities. >> Okay. Um on the monetization, is that the is that the path we're headed on here in the US? Are we headed toward that scenario? >> Uh it it's already happening. Spoiler alert, it's already here. I mean, the fact is that if you look at what um uh Treasury Secretary Besson's doing, he's issuing lots of very short-term paper treasury bills, okay, to fund the deficit. uh he's replacing a lot of existing debt, longer maturity debt with bills. Okay. So, whatever the figure is now, you've got something like uh um I think that in in maybe is it 50% of US debt is now under two years, but it's a you know, a phenomenal uh change in in the dynamics, the average maturity of debt. Uh a lot of bill issuance going is going on. Uh bills obviously by definition are very short term. So, they got to be refinanced uh in a very short-term window. So I think the Treasury now um refinances 600 billion a week of US debt. So this is a big big ask. So effectively what is what why is that monetization? Because when they're issuing so many bills and if you got a big amount of debt to reissue, it's easier to do bills because there's demand. The banks love bills and shortdated debt. And the reason being is if the US is running a fiscal deficit of sizable proportions, which it is, you know, we're talking about 6 7% of GDP, people's bank deposit accounts are being filled up because the Treasury is writing checks. >> Bank deposit accounts are rising. So the banks need an asset on the other side of their ledger to balance the deposit growth. And what better than a short-term government bill? And that's why they buy the bills with elacrity. Now the problem is from an economic point of view is that if a financial intermediary like a bank buys um government debt, it monetizes the debt. It's monetization. That is what you know you've heard of Milton Friedman. Milton Friedman, the arch montorist in the 1970s would be turning in his grave looking at what's happening here. So there's a lot of monetization going on already. And a lot of the money supply growth in the US is coming through this mechanism of basically banks buying buying government debt. >> And how far can that go? >> Well, how far can you kick a can down the road? I mean, this is the this is the question. And it it goes on till it doesn't. Now, the point that I would make is this is, you know, we're we're we're saving close to the wind in to to use that expression in in this regard. What I said earlier on was that the US economy looks to be very strong. I mean that's just my anecdotal feel but if you look at the data it's coming starting to come through already and our data on liquidity is showing this shift from the financial sector of the real economy should support that. So if nominal GDP is growing at let's say 7 to 8% peranom okay which is probably not an unrealistic figure particularly given the huge AI capex boom that's going on and the size of the government deficit etc. and probably one would throw in exports of fuel uh you know now that the because of the Iranian tensions all this adds to US export growth US economic growth etc. So you've got this strong dynamic for the economy um 7 to 8% nominal GDP growth is that consistent with a bond market that's yielding circa five or even a tad lower at the 10 10 year level. I don't think that's consistent. That two sprint 200 basis point margin is a big big one. So, normally you'd expect bond yields to go up. Why aren't they going up? And I think that's another question to answer. And the answer the answer is is number one because the treasuries starving the long end of the market of supply because it's issuing so many bills. So, the long-term funds like the insurance companies or the uh pension funds can't get that paper. Uh they they need duration and the government's not supplying it. So, there's an artificial dampening at the long end. And the other thing is they're suppressing volatility in the markets through treasury buybacks. So if you look at the move index, which in my view is the most important statistic to watch right now, it's more important than Fed funds rate. Uh look at what the move index, which is the uh bond market equivalent of the VIX, okay, for stocks. Uh move is a measure of bond volatility. That index is being suppressed in my view and it's being suppressed by Treasury buybacks. Every time you see the move spike up, there's an increase in treasury buybacks, which is the US Treasury basically going into the market and buying stale uh off therun treasuries and replacing them with new shiny new on the run. It's a bit like saying, you know, you don't like a secondhand car, you want to buy a new car, and the market prefers the new car than the secondhand one. >> You had a great piece on this in your Substack around I liked the title whack-a- move, like whack-a-ole. >> Um, all right. Just in plain English for the audience, explain why the bond volatility matters so much, the move, and why is the Treasury again, why are they so desperate to keep a lid on it? Exactly. >> Okay, so let let's say it's important and why they need to keep it down. Okay, so you've really got two two dimensions to think of. One is um who's buying treasuries at the moment and it's predominantly um coming from hedge funds. So hedge funds have been big big buyers. We know that the Federal Reserve itself did a study last year on hedge fund buying and found it was in the trillions. It's they're huge buyers uh of of bonds. Now, what the hedge funds are doing are doing what's called a basis trade. Now, that's getting into the weeds of the bond market, but let me try and explain it. What they're doing is they're basically clipping the margin between a futures contract and a and the cash market. So they're buying in the cash market of you know physical bonds and they're basically shorting in the futures market and they're clipping a little bit of spread each time but they leverage it hugely. That basis trade uh is profitable for them but it depends on low volatility. If volatility in the bond market jumps that trade will unravel because leverage will start to diminish. The other way that that's important is thinking about what we call the collateral multiplier within the credit market or within the credit system. And basically the collateral multiplier comes back to the fact that something like as I said 80% of all lending now in uh in markets is collateralbased. Now dealer banks who lend against collateral will basically give a haircut to the collateral uh depending on the underlying uh quality of the security. Okay. So if you've got let's say US treasuries uh their pristine collateral uh and they will get a small haircut uh maybe 1% maybe even less uh possibly higher in uh in a higher volatile environment. So if volatility increases the collateral is more uncertain for the dealer bank to hold and so they will give a bigger cushion. They want a bigger cushion so they give a bigger haircut which means they're not going to lend so much against that. And if you start to look at the maths of that, you get very big swings in what we call the collateral multiplier. So the move index, if it's low, you get small haircuts, a bigger collateral multiplier, big bigger liquidity inputs. So liquidity is all about a low or good liquidity is all about keeping the move move index low. >> Is there a point where no matter what they do, they can't keep it suppressed? Well, I mean, this is a qu proof of the pudding is going to be in eating and I one would imagine that, you know, new chair Kevin Walsh is going to start shaking the tree at the Fed a bit and the markets will want to test out Walsh as they always do. Uh, let's face it and maybe there's going to be more volatility in the bond market. So, is the Treasury able to do that? I mean, that's really an open question. We don't know. But, you know, what I'm trying to say here is that, you know, they can kick the can down the road until they can't. And it's all about the bond market. You got to look at the bond market. if yields start to break out you there's a problem uh without any question break high I'm talking about the other thing is to think about what the Fed's doing uh in uh in the other part of the markets that's critical which is the repo markets now if you go back to late last year uh the repo markets started to blow out spreads were blowing out in other words interest rates were going up way beyond what the Fed was trying to dictate with Fed funds so the sofa so-called sofa rate which is the overnight funding rate in the repo markets basically spiked relative to Fed funds and that's not a good look. Okay, so they wanted to try and get that down and the reason it was spiking was that banks were short of reserves and the Federal Reserve had began to take or the Fed and the Treasury had basically begun to take money out of the money markets and that was all part of this idea that they can shrink the balance sheet. They can't simple reason they I mean simple fact they can't they can't do that. So what they've done is they've done two things. Number one, they've introduced a new QE measure or what we say not QEQE because they denied um but they've introduced a new QE measure called reserve management purchases uh which have basically added something like 250 billion uh into markets uh over since what mid December early December. So that's that's that's a that's a big injection of cash. On top of that, there's been bank deregulations through the uh changing the uh supplementary liquidity ratio where that has basically again reduce the need for reserves among banks by about 250 billion. So it's been overall if you add little bits on top it's about 600 billion of net injection. That's a big number. >> H when it comes to bonds are they are they attractive at all as a safe haven or Well, I think the I mean the question is is that you've got to start thinking about uh duration and the impact that that would have on a on a portfolio. So >> yes duration sweet spot then >> yeah I mean I think you can I mean my view would be that probably around mid duration let's say between the two five year area at current yields you're probably okay because duration is sufficiently low that you're not really going to lose money on a on a on a on a US treasury. I think once you start to extend along the uh maturity spectrum um you know think about I mean a 10-year bond in practice if you get a 100 basis point increase you're going to lose about 7%. >> Out of that so you know that's that's more than your coupon. >> Yeah. >> So that's not attractive. Uh if you start going out to 30 year then clearly it's uh you're talking about you know maybe 20%. >> Mhm. You mentioned Kevin Walsh new Fed share. I don't know how deep you are into this, but any expectations for him that you want to share? Oh, >> I think high expectations. I think Kevin Wood is a great guy. I think he's got, you know, he he's got a much better vision of what the Federal Reserve should be doing than maybe the uh the the previous chair. Um, and so I I would have great hopes for him. I think the problem is is maybe the Fed uh or the markets have got too big for the Fed. And that that's really the question we've got to we've got to pose. Has the Fed got the firepower now to control the markets? Uh, one would hope it has, but you know, this is really an open question. And you can see that the Fed and the Treasury together are acting acting uh in unison in my view to try and keep the market stable. That's what they they're doing. They're doing success a successful job so far. But there are big challenges out there. And the big challenges are this huge amount of debt. we've got to try and refinance against a backdrop where there are pressures on the fixed income market because the economy seems so strong. >> Should they be like so concerned about the markets, the Fed and the Treasury? >> Well, I mean from the perspective of should they be concerned from a real economy standpoint? I I think the answer is that if you get a shakeout in the markets that's going to be very damaging for the real economy looking forward because basically wealth effects are now so important in the uh in the equation. So absolutely uh if there's a bare market in stocks there'll be a bare market in the economy for sure uh at some later stage but that comes into the future from a perspective of government funding absolutely uh and this is the you know often the first move of the Fed or the Treasury is when you get disruptions in the in the Treasury market they need funding. Um, correct me if I'm wrong on this, but have you evolved your um, views on inflation or how you frame inflation, no longer transitory but now illusionary? Is that how you describe it these days? Well, what I what I was trying to allude to in that is that I was just using and this was a reference to a Substack piece, but what I was saying was to use the the the term transitory >> um was associated with uh with Chair Powell and that label stuck. And as my sort of former boss Henry Calfman said, I think at the time, and Henry used to be the great dion in the bond markets in the 70s and 80s, uh he said very correctly, this is the word used when you got a Federal Reserve that doesn't want to raise interest rates. And I think that was very well put. Now what I'm trying to say right now is that Kevin Walsh is basically uh saying that maybe inflation is running a lot cooler than we think uh if it's measured properly. Now my view would be this is trying to create the illusion of low inflation because I think the reality is and you know tell me I'm wrong here but there's a lot of evidence of inflation out there in the system uh particularly for you know food prices or whatever. I mean it's self-evident to me. >> Yeah. go out to eat or grocery store. It's Yeah, it's Yeah, >> it's it's real. There is inflation. >> Feels it. I guess speaking of inflation, because you've also talked about this that >> gold is not a hedge against, as y'all call it in the UK, high street inflation, which is our version of main street, right? >> Um, but it is a hedge against monetary inflation. Could you explain the distinction there between the different types of inflation? And I guess this channel we talk about gold quite often and so I want to hear the gold side too. >> Yeah. I mean in actual fact gold has easily beaten high street inflation uh over the long term. So by definition it's done is it done better than high than main street inflation. That's for sure. It's giving you a much better return. But what I'm saying is that what gold is a hedge against uh is monetary inflation. Now let's sort of unpack that idea. So if you look at prices in Main Street, they're really composed of two elements. one is the costs that go into a product. So that might be things like oil prices, it may be productivity, maybe technology, all these elements. But you've also got uh another effect which is to do with the paper money, the denomination that you're looking at. So it's priced in a paper dollar. So the price can go up if the Federal Reserve prints too many dollars and it can go down if the Federal Reserve happened to, and it never does, reduce the money supply. Okay? So that's the monetary inflation bit and you got to align that or add to that the cost inflation bit and the two together give you main street inflation. Now what's happened over the long term is that you haven't had cost inflation, you've had cost deflation. Okay? And the cost deflation has come because of technology, because of higher productivity, because up to recently relatively low oil prices, uh because of cheap Chinese goods, uh all these things have depressed costs and caused um main street inflation to be well below monetary inflation. That's another way of saying that the basket, the CPI basket has done a lot worse than Wall Street. Okay, Wall Street is an asset price that responds to monetary inflation. Gold has bested Wall Street. Okay, so I think the figure is that maybe since uh year 2000, Wall Street's up six, seven times, gold is up maybe 15 times. Okay. So, it's done much much better over that period of time because what it's responding to is monetary inflation and there's been a lot of monetary creation over that period because there's been a lot of federal debt and in order to fund the debt you need to create liquidity and that's money growth. So, essentially you've got these different components. If you want to protect against monetary inflation, uh you're protecting your wealth. If you want to protect against CPI inflation, you're protecting your income. Most people think >> mean and that's interesting. wealth and income. >> Yeah. So, what you've got to do is to think about the two things differently. If you want to protect your income, think about CPI. If you want to protect your wealth, think about monetary inflation because that's what matters. And therefore, if monetary inflation is running hot over the medium-term of let's say 7 to 8%. Because that's the the pace of growth of US debt according to the Congressional Budget Office in the future. Okay? 7 to 8% a year. That's the hurdle that you've got to clear for your wealth to stand still. And so going forward, more we more debt we issue, the more monetary inflation, hence wanting to own gold. >> Yep. Or monetary inflation hedges. >> And as I said, monetary inflation hedges traditionally precious metals. >> Mhm. >> Um prime residential real estate, good quality stocks, and possibly well certainly in the last 15 years, crypto. >> Where where in crypto specifically, Bitcoin, or what are you thinking? Well, I'm not an expert, so I'm I'm not I'm not going to put my head on the block on that, but I mean, Bitcoin is so comfy in the comments. >> Yeah. Okay. So, again, to recap, the current phase we're in, the speculation regime, turbulence is next. Um, but right now, the the markers that you flagged earlier, the high volatility, that low quality returns or that late cycle equity action that we've seen, commodity strength, that bearish flattening of the yield curve. Um again just reemphasize where you want to be exactly allocated and is there anything that you want to avoid right now in this environment? >> Well, I think I mean okay let let's start thinking about what to what to own. I think that what I would do is first of all I would be thinking about diversifying portfolios because clearly in an environment where you've got more uncertainty and potential turbulence you want protection. So I would be diversifying um and that that's a general thing. So it mean also means buying international stocks. It means putting money into international markets. Uh it means thinking about holding fixed income. Think about holding commodities, real estate, etc. So having a a broader portfolio where I would be right now is I'd be in commodities. I would still have positions in equities, but I'd be thinking more of late cycle areas. So energy stocks to my mind look pretty attractive right now. Uh resource stocks, gold miners probably a decent area to be in. These are the sort of areas I'd be thinking about. Uh if you look at the commodity space, uh I don't think you've really started a bull market yet in a lot of these food commodities. I think they're just beginning to lift off. And traditionally, if you look at how um the commodity markets work, gold and silver are leading indicators of other commodities. And it typically moves. I mean things can they're not always symmetric like this but you typically see precious metals first uh then base metals then food commodities starting to move. Uh and I think you've basically had that uh that process. Oil I think looks cheap. Uh I think the oil price is going up. I mean you may have heard me say before or even write in Substack that one of the metrics I look at and looked at for a long time is the gold oil ratio. The gold oil ratio simply measures uh the ratio between an ounce of gold and a barrel of price of a barrel of oil. That traditionally has been about 20 times. And that data goes right back to you 60 years or so. And it shows that the ratio is 20. Now just do the math. If you got 4,000ish or between 4,000 and $5,000 an ounce for gold, divide that by 20, what's the oil price? Over 200 bucks a barrel. Now, every single time that I make that statement uh to clients or in presentations, people react hugely negatively and say that is impossible. That's never going to happen. This is so insane. Um that push back is interesting because it's such a contrarian view. But let's never say never because that can happen. And I'm not don't hold me to the 200 bucks, but the direction is really the point to make. Oil looks pretty cheap here. uh energy stocks therefore look attractive in my view and if you've got a strong economy uh that's got to be something to think about looking forward >> would in that event would the liquidity move into the real economy or the financial markets or >> oh it would go into it would definitively go into uh the real economy uh that's for sure because oil is very liquidity uh very sensitive liquidity it takes a lot absorbs a lot of liquidity you need that I mean gifts are given the just think of the the the sort of logistics of moving all around the world. It's very credit intensive. So, it needs liquidity. So, you know, a lot of it's held in inventory. It's in tankers. All this stuff is high finance. So, what I would say is that that's a situation where that would be negative. And what's more, central banks typically react to higher oil prices because they see that feeding through to inflation expectations very quickly. >> Well, you may have answered my final question, but it was going to be the following. It was going to be um what is a contrarian call or prediction that you have right now that would seem it would definitely not be consensus and then if you and I were sitting down maybe a year from now maybe give it a longer time frame if you'd like that would be much more widely accepted. What would that be? Well, I think that the contrarian one would be that the Federal Reserve has to raise interest rates in the next 12 months because everyone seems to be believing they won't and it may be shorter than that, but I think that the US economy is so strong right now and certainly the anecdote that I I pick up and the data I'm looking at that inflation is going to be more of a problem. >> They're going to have to move. Uh but, you know, it's good for jobs, good for Main Street, may not be so good for Wall Street. So that's why I'm saying you've got to migrate in terms of the cycle and think about where we are and just look at the evidence the the the context. So what you've got uh as I say is strong economy booming commodity markets. If you see any loss of momentum in commodity markets then we're going to have to rethink. Look at the fixed income markets. What you're getting is a bearish flattening of the curve. Right? Okay. This was, as I say, completely non- consensus uh four or five months ago, and now it's happening before our eyes. If that changes, I'm going to rethink. But at the moment, we're still going with it. The 102 spread is each day. I mean, each day I've been in New York has inch lower. >> Michael, I have to say, I always enjoy our conversations. You are absolutely brilliant. I always learn from you. I I can't keep up with you intellectually. You are just absolutely brilliant. Before I let you go, let folks know where they can find you, support your work, subscribe to your work, learn more about what you're doing. Um, you know, whether they're retail or institutional. >> Okay. The the the best way I think is through capital wars, which is Substack. Uh, we have a website as well, uh, where we supply data to institutions. That's glindexes.com. >> But capital war subsec is probably the easiest. Michael House, CEO of Crossber Capital, author of Capital Wars. Thank you so much for being a friend of this show, for being so generous with your time, all of your knowledge, your wisdom, helping all of us learn and get better and just teaching us. So, I really appreciate you and it's been so lovely meeting you in person. >> Well, great, great fun, Julia. Enjoyed it enormously. Thank you.
Howell: Speculation Ending, Turbulence Ahead, Money Moving Real Economy, & Why Fed Could Hike
Summary
Michael Howell, CEO of CrossBorder Capital, an investment advisory firm, and author of Capital Wars, returns to The Julia La …Transcript
Our view is that looking at the data, you're seeing a significant move of money out of financial markets into the real economy that is fueling what we perceive as a robust or even strong US economy. But generally speaking, money is leaving uh the financial sector and going into the real economy. We're now at the phase where main street is getting the benefits after Wall Street's had three or four years of excellent gains. And it's that transition which is always an awkward one. And that's why I'm saying you got to think more about real assets uh than maybe financial assets. >> Hey everyone, welcome to a special in-person episode of the Julia Lar Ro Show where we have a fan favorite. Joining us today is Michael How, CEO of Crossborder Capital, author of Capital Wars on Substack. Michael, it is so wonderful to welcome you in person for the very first time. We talk quite often, but thrilled to have you here today. >> Oh, great to be here, Julius. It's it's going to be fun. >> So fun. and this audience absolutely loves you and so again just so happy to have you in studio. So we just spoke back in April and at the time you were talking about how we were at an inflection point in the liquidity cycle. Now I was reading your latest Substack where you were talking about global liquidity hitting a new high built on narrow foundations. walk us through where we are right now in the liquidity cycle and this narrow foundation that you're seeing this base that has you concerned. >> Okay, I think the thing to do is to try and put this into a context and to try and understand where we are in the cycle. Okay, so the phase that we uh we believe markets are at is what we call a speculation phase. Okay. And that probably sounds kind of real because markets are racing or certain areas of markets are racing. But the point is that's kind of lowquality returns. So in a speculation phase, you can make money, but you're going to see high volatility as well. And it may be a very narrow market, which kind of ticks all those boxes in many ways. Doesn't mean to say in speculation that markets won't go up, but they're going to deliver lower quality returns. And you got to try and fix the position of where we are in the cycle. for the simple reason is what comes next is probably a more ugly phase. So you're likely to see a sort of turbulent phase where liquidity gets drained more quickly and the direction of markets is more likely down. Now when I say put this in context, you got to look around and see what else is happening. And at this state of the cycle where liquidity is beginning to top out uh and I fully understand what you've just said about it reaching an absolute high but it's much more the rate of change that we look at which is the critical thing and the rate of change is beginning to slow down and it has done over the last few months. Okay. Now I'll come on to a couple of caveats but the broad uh sweep is this that at that stage of the cycle this if you like topping phase you normally see commodity markets doing really well. Okay, tick that box. We definitely got it. The other thing you start to see is that yield curves or bond markets, yield curves for bond markets are beginning to see a bearish flattening. In other words, what does that mean? That means that although long yields are going up, shorter term yields are actually going up much faster and the curve is basically flattening and you've got that phenomena, too. Now, that in particular was a very non-consensual view. January 1, okay, January 1, the consensus, the vast consensus was that what you'd be seeing is steepening yield curves, higher yields, lower rates of the at the front end. That definitely hasn't happened. You've had the almost the reverse, a bearish flattening, and that basically lines us up with the speculation phase. So strong commodities, liquidity rolling over and a bearish flattening are three boxes to tick. And maybe you can do a fourth which is maybe a narrower focus on the market. >> Now we can go on and say why is liquidity going down which I can I can develop but that's really the the background. >> I think it's a good point you make that it's lowquality returns. >> We're in the speculation phase. The next one is turbulence and I guess that's when things get ugly as you put it. Can you elaborate a little bit more on the evidence too like around lowquality returns because I imagine a lot of folks might still look at the markets and think oh things are going up they might get that FOMO but you're a seasoned experienced investor you think lowquality returns explain that. Yeah, I think well what we're really saying there is that uh there are certain securities that are going to race ahead and do very well and you've seen uh you a lot a lot in the in the robotic space uh in the AI space in the semiconductor space which have clearly delivered uh doubledigit gains uh almost every week for the past few weeks. I mean that doesn't go on forever. Trees don't grow don't grow to the sky. Uh so we got to get some you know put this into perspective. There's also a lot of other securities in the market that haven't moved very much or even have gone down. So, we've got to put that into context. So, although the general market's gone up, and I accept that. Um, what I'm saying is that this is built on narrower foundations, uh, it doesn't mean to say the gains in those securities are not real. They clearly are real. Uh, but it's a very narrow focus and you got a lot of volatility potentially behind it, uh, in various errors. So, stocks might go up, you know, 10% in one week, they might be down 8% another week. I mean all I'm saying is that volatility is beginning to pick up and that's typically a late cycle sign. Now in terms of asset allocation which is really what we're talking about here. Uh it's not a really a binary decision of saying all in all out of the market. I think one's got to treat this sensibly and say okay we're in a speculation phase. You don't want to devote all your capital to uh stocks right now. Uh you want to have a portion that you have uh let's say in a trading portfolio. uh and you want to have a a core portfolio where you're going to be more conservatively positioned. Now, in that conservative core, what you got to be thinking about are long-term hedges, particularly against monetary inflation, because that's what the trend is basically telling us. There's huge amounts of debt out there. That debt has to be somehow uh afforded or more correctly rolled over. And so a what you're going to see is more and more money printing and that's going on in the background. So monetary inflation hedges like precious metals probably like some crypto some some element in crypto uh prime residential real estate and good quality equities should be in the core and then you've got a trading portfolio which may be 20% depending on people's risk tolerance where you can play around in the markets and by all means jump on momentum by all means be a trader if you I'm sure you can do it better than I can but um those are the sort of things to think about but it's all about context and understanding if you like which season we're in. >> Mhm. Okay, let's talk about where liquidity is going right now. It's going down. Is that right? >> Well, it's the Let me be 100% clear here. The absolute level of liquidity is still inching higher. Okay. So, I think our latest print was maybe about 193 trillion globally. So, this is clearly a big number, but the rate of change is beginning to slow down and at the margin markets price off rates of change. So that's really the critical thing. If you start to get inflections in the rate of change, that's when you got to be worried in terms of risk assets. And that's what we're saying. Now, it doesn't mean to say that the party is over tomorrow, but it's saying you've got to start positioning yourself for this next phase. So liquidity is beginning to roll over. Now, the interesting question is why is that happening? >> It is not categorically not because central banks are tightening. They're not tightening. Okay? There may be one or two instances of that occurring but generally the major sweep of central banks are still uh running loose policies. So it's kind of head scratching. Why is liquidity going down? And the reason is that all money that's anywhere must be somewhere. Okay. So if it's going into the real economy, it's not in the financial markets. And our view is that looking at the data, you're seeing a significant move of money out of financial markets into the real economy. that is fueling what we perceive as a robust or even strong US economy. Uh there seems to be a lot of evidence here. I mean certainly from my experience of economic strength but also a lot of inflation. Um so nominal GDP is probably racing ahead way above most people's forecasts. Um we can come back to that the implications for fixed income but generally speaking money is leaving uh the financial sector and going into the real economy. Now, is that a good thing for certain asset classes? For sure. It's very good for commodities. I mean, that's backing uh this whole commodity story. Uh it's probably good for earnings in a certain number of areas, but it isn't necessarily good for price formation in financial markets. In other words, the E may be going up, but the P multiple may be coming down. And that's the critical thing to kind of understand in this whole equation. It's often hard to see why stocks don't do well when earnings are good. But what I'm saying is we're now at the phase where Main Street is getting the benefits after Wall Street's had three or four years of excellent gains. And it's that transition which is always an awkward one. And that's why I'm saying you got to think more about real assets uh than maybe financial assets. >> Mhm. As you know, um money can only be in one place at a time. You have the financial economy, the real economy. I think sometimes it might feel counterintuitive because a lot of folks might assume that a strong economy that strong real economy would be good for markets, but that's not necessarily the case, is it? >> Well, it's not. I mean, I think one of the, you know, one of the errors that investors often make is to basically say that uh the security prices uh always respond to fundamentals. Now, that may be the case in certain times, but you've also got to accept the fact that capital often gets there first. Money moves quickly. And our view is that it's money that moves markets. Economics is downstream of markets and geopolitics happens to be downstream of economics. So, you've got this sort of sequence and it's money working out where the money flow is. That's really the critical thing. And the two points about the money flow is that one is it's driven by central banks or policy makers uh and that could be leveraged up by the by the private sector but the other is that liquidity is then drained into a real economy uh that begins to pick up and this is sequential. So the cycle in liquidity precedes the cycle in the real economy and our view is that as the liquidity cycle is dropping off now that is really uh a signal that the real economy is beginning to pick up. So our view is that the underlying momentum in the US economy is pretty good. You know, part what you're getting in the Iran tensions and the oil markets which may well derail it or cause a problem, but the underlying momentum still seems to be good in the economy. >> Gold has been one of the few standout assets of the last few years, reaching new record highs as investors respond to rising fiscal deficits, geopolitical uncertainties, and growing demand from central banks worldwide. But here's something most people still overlook. Price appreciation isn't the only way to benefit from owning gold. What if your gold didn't just sit in a vault, but actually generated a return? With monetary metals, you can earn a yield on gold paid in gold without having to sell. Instead of earning in dollars that can be eroded by inflation or policy changes, you can earn more ounces of gold. That means your gold holdings are growing in real terms, not just nominal ones. Earning gold offers a fundamentally different approach. You're not just preserving wealth, you're increasing your exposure to a hard asset over time. So, you're earning additional ounces of gold while still benefiting from any potential price appreciation. It's a way to make gold a productive asset, not just a defensive one. As more investors turn to gold for wealth preservation and portfolio diversification, a natural question follows. If you're going to own gold, why not earn gold while you own it? Thousands of investors are already earning a yield in physical gold and silver through monetary medals. You can learn more at monetary-medals.com/julia. Now, back to the rest of the episode. Yeah, it's an it's sometimes for me I I I sometimes I'm like I can't quite wrap my head around it, but I I exa I hear exactly what you're saying though and I think it's fascinating. And it's just I think maybe a lot of us we almost misinterpret it then I don't know exactly what I'm >> Yeah I mean look stock markets are leading indicators for a very good reason. Uh so stocks go up before the earnings appear right >> why is why are the stocks going up because capital flow has already moved there. The capital has moved quickly into the into the stocks and that's pushing them up. Now as you get that migration of money into the real economy whether it's through wealth effects or money just spills over then the real economy starts to get traction and as the real economy gets traction it justifies um the uh the increase in the P beforehand. So the P multiple has already gone up and now the E the earnings are starting to come through. >> One of the other things you and I have talked about is the debt refinancing especially in the financial markets. Where do we stand as it relates to that phenomenon? Um the capital moving into financial markets but also needing to kind of service debt or roll over debt. >> Yeah, I think this is a this is a big question. This is a big question that everyone has to face not just in the US but worldwide and that is that capital markets today have transformed from being what the textbooks tell us they are which is mechanisms for raising new money for capex uh into debt refinancing mechanisms. So what you're looking at is something like four out of every five primary transactions now in a financial market worldwide is a debt rollover in some way. Okay? It's all about rolling over the debt that we've taken on historically. It's not about uh not only about taking on new debt. This is just talking about the old debt. And so this is the process the financial markets are really doing. They're rolling over refinancing debt. And the linkage between liquidity and debt is really a key one. And liquidity is necessary because it defines the balance sheet capacity that is available to roll over the debt. If the liquidity is not there, you can't roll the debt over and you get a financial crisis. Now, the paradox that we sit in is one that liquidity also needs debt because most liquidity creation now is collateralized. Oh, >> so something like 75 to 80% of all lending worldwide, that's a World Bank figure, uh is that that lending is collateralized lending. That may be collateralized on a real estate purchase or it may be collateralized against the US Treasury uh bond or note uh in the financial sector, but it's collateralized lending. So the value of collateral is important. So if you get disruptions in the debt markets, the liquidity liquidity can spiral out of control downwards. Are we That's an interesting dynamic too. Are we getting to the point where it's almost too much debt or do we have still more? >> Unquestionably. >> Okay. >> Unquestionably there is there's way too much debt in the system and the system is struggling under that debt. Now the thing to recall is that if you look back at history and history is always a great guide for these things. Every time that any economy is taking on more debt, the only route out is monetization, printing money. Now the reason for that is that debt is integral to the credit system and you can't default massive amounts of debt particularly government debt. So what you got to do is effectively dilute it by printing money creating inflation and that's what happens in every single example historically. Now the problem we've got right now in the world economy is it's not just one economy that has too much debt. The world overall has yeah everybody has because of aging demographics. So the welfare commitments that are being undertaken are you know are significant and you know what's more you've also got legacy debt out there in places like China. So China's had this real this real estate boom a lot of it debt financed and that's struggling under the weight of debt. So China has to monetize and that's what it's been doing. >> They're already monetizing. >> Yeah they're that's why the gold price is going up. This is not just about what's happening in the west. >> Wait a second. Can you explain what's going on with gold and China then? And yeah, this and tie it back to this monetization then. >> Well, China is basically in a very similar situation to what uh Japan was in uh maybe let's say 15 years ago or so. And if you recall what happened in Japan after the Japanese bubble, uh there was basically a lot of legacy debt. Now the Japanese took a long time to sort of realize what was going on, let's say, or to address the problem. But abonomics which started about what 10 years or so ago uh addressed the problem by restructuring the economy and then essentially printing money by getting the Bank of Japan to buy Japanese government bonds. So they hoovered up all the the bulk of the stock of existing Japanese government debt, put it onto its balance sheet, but that meant the balance sheet expanded and as the balance sheet of the Bank of Japan expanded, they effectively printed money, which is the other side of that balance sheet. And so there was a tremendous monetary expansion in Japan. And what has happened to the yen? It's collapsed. Well, that's not any surprise. If you print lots of money, the value of money is going to go down. And so the Japanese have devalued the yen significantly. And the yen is still a very weak currency today. Okay. Now move on 15 years and say, well, okay, haven't we got the same in China? We have. Exactly. Because China went through uh after the GFC a huge real estate boom. Uh they've got legacy debt because of that. >> Can they default that debt? No. U they've got to effectively get over that printing money. >> Now the advantage that China has got in this whole equation is that China has capital controls. So if it prints money, it stays within the system. It doesn't effectively move out. Um unless it does, but that may be another question. But ultimately, uh China is is got this capital control. So they're printing money. So what assets do people buy in China traditionally if they want to protect paper against paper money devaluation? Gold. >> Gold. >> And there's tremendous buying in gold. What is moving in the gold price now as the Shanghai exchange, not uh Comx or the London market? >> Do you will you do you think we'll continue to see that dynamic then with gold? Yes, >> they'll be the primary driver. >> Absolutely. We we're going to see that. uh it's paused right now because if you look at the latest data from the people's bank uh they put their foot on the brake quite quickly uh in the last uh let's say four to four to 6 weeks probably and I don't know the reason for this but I'm I'm speculating probably because there was a lot of speculation in the Chinese markets and so they wanted to quell that short term but we'll see what happens when they start to renew liquidity injections which I think they must do. >> Mhm. And that would be the next leg higher. >> Very bullish for gold. very bullish for gold >> and also other commodities. >> Okay. Um on the monetization, is that the is that the path we're headed on here in the US? Are we headed toward that scenario? >> Uh it it's already happening. Spoiler alert, it's already here. I mean, the fact is that if you look at what um uh Treasury Secretary Besson's doing, he's issuing lots of very short-term paper treasury bills, okay, to fund the deficit. uh he's replacing a lot of existing debt, longer maturity debt with bills. Okay. So, whatever the figure is now, you've got something like uh um I think that in in maybe is it 50% of US debt is now under two years, but it's a you know, a phenomenal uh change in in the dynamics, the average maturity of debt. Uh a lot of bill issuance going is going on. Uh bills obviously by definition are very short term. So, they got to be refinanced uh in a very short-term window. So I think the Treasury now um refinances 600 billion a week of US debt. So this is a big big ask. So effectively what is what why is that monetization? Because when they're issuing so many bills and if you got a big amount of debt to reissue, it's easier to do bills because there's demand. The banks love bills and shortdated debt. And the reason being is if the US is running a fiscal deficit of sizable proportions, which it is, you know, we're talking about 6 7% of GDP, people's bank deposit accounts are being filled up because the Treasury is writing checks. >> Bank deposit accounts are rising. So the banks need an asset on the other side of their ledger to balance the deposit growth. And what better than a short-term government bill? And that's why they buy the bills with elacrity. Now the problem is from an economic point of view is that if a financial intermediary like a bank buys um government debt, it monetizes the debt. It's monetization. That is what you know you've heard of Milton Friedman. Milton Friedman, the arch montorist in the 1970s would be turning in his grave looking at what's happening here. So there's a lot of monetization going on already. And a lot of the money supply growth in the US is coming through this mechanism of basically banks buying buying government debt. >> And how far can that go? >> Well, how far can you kick a can down the road? I mean, this is the this is the question. And it it goes on till it doesn't. Now, the point that I would make is this is, you know, we're we're we're saving close to the wind in to to use that expression in in this regard. What I said earlier on was that the US economy looks to be very strong. I mean that's just my anecdotal feel but if you look at the data it's coming starting to come through already and our data on liquidity is showing this shift from the financial sector of the real economy should support that. So if nominal GDP is growing at let's say 7 to 8% peranom okay which is probably not an unrealistic figure particularly given the huge AI capex boom that's going on and the size of the government deficit etc. and probably one would throw in exports of fuel uh you know now that the because of the Iranian tensions all this adds to US export growth US economic growth etc. So you've got this strong dynamic for the economy um 7 to 8% nominal GDP growth is that consistent with a bond market that's yielding circa five or even a tad lower at the 10 10 year level. I don't think that's consistent. That two sprint 200 basis point margin is a big big one. So, normally you'd expect bond yields to go up. Why aren't they going up? And I think that's another question to answer. And the answer the answer is is number one because the treasuries starving the long end of the market of supply because it's issuing so many bills. So, the long-term funds like the insurance companies or the uh pension funds can't get that paper. Uh they they need duration and the government's not supplying it. So, there's an artificial dampening at the long end. And the other thing is they're suppressing volatility in the markets through treasury buybacks. So if you look at the move index, which in my view is the most important statistic to watch right now, it's more important than Fed funds rate. Uh look at what the move index, which is the uh bond market equivalent of the VIX, okay, for stocks. Uh move is a measure of bond volatility. That index is being suppressed in my view and it's being suppressed by Treasury buybacks. Every time you see the move spike up, there's an increase in treasury buybacks, which is the US Treasury basically going into the market and buying stale uh off therun treasuries and replacing them with new shiny new on the run. It's a bit like saying, you know, you don't like a secondhand car, you want to buy a new car, and the market prefers the new car than the secondhand one. >> You had a great piece on this in your Substack around I liked the title whack-a- move, like whack-a-ole. >> Um, all right. Just in plain English for the audience, explain why the bond volatility matters so much, the move, and why is the Treasury again, why are they so desperate to keep a lid on it? Exactly. >> Okay, so let let's say it's important and why they need to keep it down. Okay, so you've really got two two dimensions to think of. One is um who's buying treasuries at the moment and it's predominantly um coming from hedge funds. So hedge funds have been big big buyers. We know that the Federal Reserve itself did a study last year on hedge fund buying and found it was in the trillions. It's they're huge buyers uh of of bonds. Now, what the hedge funds are doing are doing what's called a basis trade. Now, that's getting into the weeds of the bond market, but let me try and explain it. What they're doing is they're basically clipping the margin between a futures contract and a and the cash market. So they're buying in the cash market of you know physical bonds and they're basically shorting in the futures market and they're clipping a little bit of spread each time but they leverage it hugely. That basis trade uh is profitable for them but it depends on low volatility. If volatility in the bond market jumps that trade will unravel because leverage will start to diminish. The other way that that's important is thinking about what we call the collateral multiplier within the credit market or within the credit system. And basically the collateral multiplier comes back to the fact that something like as I said 80% of all lending now in uh in markets is collateralbased. Now dealer banks who lend against collateral will basically give a haircut to the collateral uh depending on the underlying uh quality of the security. Okay. So if you've got let's say US treasuries uh their pristine collateral uh and they will get a small haircut uh maybe 1% maybe even less uh possibly higher in uh in a higher volatile environment. So if volatility increases the collateral is more uncertain for the dealer bank to hold and so they will give a bigger cushion. They want a bigger cushion so they give a bigger haircut which means they're not going to lend so much against that. And if you start to look at the maths of that, you get very big swings in what we call the collateral multiplier. So the move index, if it's low, you get small haircuts, a bigger collateral multiplier, big bigger liquidity inputs. So liquidity is all about a low or good liquidity is all about keeping the move move index low. >> Is there a point where no matter what they do, they can't keep it suppressed? Well, I mean, this is a qu proof of the pudding is going to be in eating and I one would imagine that, you know, new chair Kevin Walsh is going to start shaking the tree at the Fed a bit and the markets will want to test out Walsh as they always do. Uh, let's face it and maybe there's going to be more volatility in the bond market. So, is the Treasury able to do that? I mean, that's really an open question. We don't know. But, you know, what I'm trying to say here is that, you know, they can kick the can down the road until they can't. And it's all about the bond market. You got to look at the bond market. if yields start to break out you there's a problem uh without any question break high I'm talking about the other thing is to think about what the Fed's doing uh in uh in the other part of the markets that's critical which is the repo markets now if you go back to late last year uh the repo markets started to blow out spreads were blowing out in other words interest rates were going up way beyond what the Fed was trying to dictate with Fed funds so the sofa so-called sofa rate which is the overnight funding rate in the repo markets basically spiked relative to Fed funds and that's not a good look. Okay, so they wanted to try and get that down and the reason it was spiking was that banks were short of reserves and the Federal Reserve had began to take or the Fed and the Treasury had basically begun to take money out of the money markets and that was all part of this idea that they can shrink the balance sheet. They can't simple reason they I mean simple fact they can't they can't do that. So what they've done is they've done two things. Number one, they've introduced a new QE measure or what we say not QEQE because they denied um but they've introduced a new QE measure called reserve management purchases uh which have basically added something like 250 billion uh into markets uh over since what mid December early December. So that's that's that's a that's a big injection of cash. On top of that, there's been bank deregulations through the uh changing the uh supplementary liquidity ratio where that has basically again reduce the need for reserves among banks by about 250 billion. So it's been overall if you add little bits on top it's about 600 billion of net injection. That's a big number. >> H when it comes to bonds are they are they attractive at all as a safe haven or Well, I think the I mean the question is is that you've got to start thinking about uh duration and the impact that that would have on a on a portfolio. So >> yes duration sweet spot then >> yeah I mean I think you can I mean my view would be that probably around mid duration let's say between the two five year area at current yields you're probably okay because duration is sufficiently low that you're not really going to lose money on a on a on a on a US treasury. I think once you start to extend along the uh maturity spectrum um you know think about I mean a 10-year bond in practice if you get a 100 basis point increase you're going to lose about 7%. >> Out of that so you know that's that's more than your coupon. >> Yeah. >> So that's not attractive. Uh if you start going out to 30 year then clearly it's uh you're talking about you know maybe 20%. >> Mhm. You mentioned Kevin Walsh new Fed share. I don't know how deep you are into this, but any expectations for him that you want to share? Oh, >> I think high expectations. I think Kevin Wood is a great guy. I think he's got, you know, he he's got a much better vision of what the Federal Reserve should be doing than maybe the uh the the previous chair. Um, and so I I would have great hopes for him. I think the problem is is maybe the Fed uh or the markets have got too big for the Fed. And that that's really the question we've got to we've got to pose. Has the Fed got the firepower now to control the markets? Uh, one would hope it has, but you know, this is really an open question. And you can see that the Fed and the Treasury together are acting acting uh in unison in my view to try and keep the market stable. That's what they they're doing. They're doing success a successful job so far. But there are big challenges out there. And the big challenges are this huge amount of debt. we've got to try and refinance against a backdrop where there are pressures on the fixed income market because the economy seems so strong. >> Should they be like so concerned about the markets, the Fed and the Treasury? >> Well, I mean from the perspective of should they be concerned from a real economy standpoint? I I think the answer is that if you get a shakeout in the markets that's going to be very damaging for the real economy looking forward because basically wealth effects are now so important in the uh in the equation. So absolutely uh if there's a bare market in stocks there'll be a bare market in the economy for sure uh at some later stage but that comes into the future from a perspective of government funding absolutely uh and this is the you know often the first move of the Fed or the Treasury is when you get disruptions in the in the Treasury market they need funding. Um, correct me if I'm wrong on this, but have you evolved your um, views on inflation or how you frame inflation, no longer transitory but now illusionary? Is that how you describe it these days? Well, what I what I was trying to allude to in that is that I was just using and this was a reference to a Substack piece, but what I was saying was to use the the the term transitory >> um was associated with uh with Chair Powell and that label stuck. And as my sort of former boss Henry Calfman said, I think at the time, and Henry used to be the great dion in the bond markets in the 70s and 80s, uh he said very correctly, this is the word used when you got a Federal Reserve that doesn't want to raise interest rates. And I think that was very well put. Now what I'm trying to say right now is that Kevin Walsh is basically uh saying that maybe inflation is running a lot cooler than we think uh if it's measured properly. Now my view would be this is trying to create the illusion of low inflation because I think the reality is and you know tell me I'm wrong here but there's a lot of evidence of inflation out there in the system uh particularly for you know food prices or whatever. I mean it's self-evident to me. >> Yeah. go out to eat or grocery store. It's Yeah, it's Yeah, >> it's it's real. There is inflation. >> Feels it. I guess speaking of inflation, because you've also talked about this that >> gold is not a hedge against, as y'all call it in the UK, high street inflation, which is our version of main street, right? >> Um, but it is a hedge against monetary inflation. Could you explain the distinction there between the different types of inflation? And I guess this channel we talk about gold quite often and so I want to hear the gold side too. >> Yeah. I mean in actual fact gold has easily beaten high street inflation uh over the long term. So by definition it's done is it done better than high than main street inflation. That's for sure. It's giving you a much better return. But what I'm saying is that what gold is a hedge against uh is monetary inflation. Now let's sort of unpack that idea. So if you look at prices in Main Street, they're really composed of two elements. one is the costs that go into a product. So that might be things like oil prices, it may be productivity, maybe technology, all these elements. But you've also got uh another effect which is to do with the paper money, the denomination that you're looking at. So it's priced in a paper dollar. So the price can go up if the Federal Reserve prints too many dollars and it can go down if the Federal Reserve happened to, and it never does, reduce the money supply. Okay? So that's the monetary inflation bit and you got to align that or add to that the cost inflation bit and the two together give you main street inflation. Now what's happened over the long term is that you haven't had cost inflation, you've had cost deflation. Okay? And the cost deflation has come because of technology, because of higher productivity, because up to recently relatively low oil prices, uh because of cheap Chinese goods, uh all these things have depressed costs and caused um main street inflation to be well below monetary inflation. That's another way of saying that the basket, the CPI basket has done a lot worse than Wall Street. Okay, Wall Street is an asset price that responds to monetary inflation. Gold has bested Wall Street. Okay, so I think the figure is that maybe since uh year 2000, Wall Street's up six, seven times, gold is up maybe 15 times. Okay. So, it's done much much better over that period of time because what it's responding to is monetary inflation and there's been a lot of monetary creation over that period because there's been a lot of federal debt and in order to fund the debt you need to create liquidity and that's money growth. So, essentially you've got these different components. If you want to protect against monetary inflation, uh you're protecting your wealth. If you want to protect against CPI inflation, you're protecting your income. Most people think >> mean and that's interesting. wealth and income. >> Yeah. So, what you've got to do is to think about the two things differently. If you want to protect your income, think about CPI. If you want to protect your wealth, think about monetary inflation because that's what matters. And therefore, if monetary inflation is running hot over the medium-term of let's say 7 to 8%. Because that's the the pace of growth of US debt according to the Congressional Budget Office in the future. Okay? 7 to 8% a year. That's the hurdle that you've got to clear for your wealth to stand still. And so going forward, more we more debt we issue, the more monetary inflation, hence wanting to own gold. >> Yep. Or monetary inflation hedges. >> And as I said, monetary inflation hedges traditionally precious metals. >> Mhm. >> Um prime residential real estate, good quality stocks, and possibly well certainly in the last 15 years, crypto. >> Where where in crypto specifically, Bitcoin, or what are you thinking? Well, I'm not an expert, so I'm I'm not I'm not going to put my head on the block on that, but I mean, Bitcoin is so comfy in the comments. >> Yeah. Okay. So, again, to recap, the current phase we're in, the speculation regime, turbulence is next. Um, but right now, the the markers that you flagged earlier, the high volatility, that low quality returns or that late cycle equity action that we've seen, commodity strength, that bearish flattening of the yield curve. Um again just reemphasize where you want to be exactly allocated and is there anything that you want to avoid right now in this environment? >> Well, I think I mean okay let let's start thinking about what to what to own. I think that what I would do is first of all I would be thinking about diversifying portfolios because clearly in an environment where you've got more uncertainty and potential turbulence you want protection. So I would be diversifying um and that that's a general thing. So it mean also means buying international stocks. It means putting money into international markets. Uh it means thinking about holding fixed income. Think about holding commodities, real estate, etc. So having a a broader portfolio where I would be right now is I'd be in commodities. I would still have positions in equities, but I'd be thinking more of late cycle areas. So energy stocks to my mind look pretty attractive right now. Uh resource stocks, gold miners probably a decent area to be in. These are the sort of areas I'd be thinking about. Uh if you look at the commodity space, uh I don't think you've really started a bull market yet in a lot of these food commodities. I think they're just beginning to lift off. And traditionally, if you look at how um the commodity markets work, gold and silver are leading indicators of other commodities. And it typically moves. I mean things can they're not always symmetric like this but you typically see precious metals first uh then base metals then food commodities starting to move. Uh and I think you've basically had that uh that process. Oil I think looks cheap. Uh I think the oil price is going up. I mean you may have heard me say before or even write in Substack that one of the metrics I look at and looked at for a long time is the gold oil ratio. The gold oil ratio simply measures uh the ratio between an ounce of gold and a barrel of price of a barrel of oil. That traditionally has been about 20 times. And that data goes right back to you 60 years or so. And it shows that the ratio is 20. Now just do the math. If you got 4,000ish or between 4,000 and $5,000 an ounce for gold, divide that by 20, what's the oil price? Over 200 bucks a barrel. Now, every single time that I make that statement uh to clients or in presentations, people react hugely negatively and say that is impossible. That's never going to happen. This is so insane. Um that push back is interesting because it's such a contrarian view. But let's never say never because that can happen. And I'm not don't hold me to the 200 bucks, but the direction is really the point to make. Oil looks pretty cheap here. uh energy stocks therefore look attractive in my view and if you've got a strong economy uh that's got to be something to think about looking forward >> would in that event would the liquidity move into the real economy or the financial markets or >> oh it would go into it would definitively go into uh the real economy uh that's for sure because oil is very liquidity uh very sensitive liquidity it takes a lot absorbs a lot of liquidity you need that I mean gifts are given the just think of the the the sort of logistics of moving all around the world. It's very credit intensive. So, it needs liquidity. So, you know, a lot of it's held in inventory. It's in tankers. All this stuff is high finance. So, what I would say is that that's a situation where that would be negative. And what's more, central banks typically react to higher oil prices because they see that feeding through to inflation expectations very quickly. >> Well, you may have answered my final question, but it was going to be the following. It was going to be um what is a contrarian call or prediction that you have right now that would seem it would definitely not be consensus and then if you and I were sitting down maybe a year from now maybe give it a longer time frame if you'd like that would be much more widely accepted. What would that be? Well, I think that the contrarian one would be that the Federal Reserve has to raise interest rates in the next 12 months because everyone seems to be believing they won't and it may be shorter than that, but I think that the US economy is so strong right now and certainly the anecdote that I I pick up and the data I'm looking at that inflation is going to be more of a problem. >> They're going to have to move. Uh but, you know, it's good for jobs, good for Main Street, may not be so good for Wall Street. So that's why I'm saying you've got to migrate in terms of the cycle and think about where we are and just look at the evidence the the the context. So what you've got uh as I say is strong economy booming commodity markets. If you see any loss of momentum in commodity markets then we're going to have to rethink. Look at the fixed income markets. What you're getting is a bearish flattening of the curve. Right? Okay. This was, as I say, completely non- consensus uh four or five months ago, and now it's happening before our eyes. If that changes, I'm going to rethink. But at the moment, we're still going with it. The 102 spread is each day. I mean, each day I've been in New York has inch lower. >> Michael, I have to say, I always enjoy our conversations. You are absolutely brilliant. I always learn from you. I I can't keep up with you intellectually. You are just absolutely brilliant. Before I let you go, let folks know where they can find you, support your work, subscribe to your work, learn more about what you're doing. Um, you know, whether they're retail or institutional. >> Okay. The the the best way I think is through capital wars, which is Substack. Uh, we have a website as well, uh, where we supply data to institutions. That's glindexes.com. >> But capital war subsec is probably the easiest. Michael House, CEO of Crossber Capital, author of Capital Wars. Thank you so much for being a friend of this show, for being so generous with your time, all of your knowledge, your wisdom, helping all of us learn and get better and just teaching us. So, I really appreciate you and it's been so lovely meeting you in person. >> Well, great, great fun, Julia. Enjoyed it enormously. Thank you.