Insights from Michael Howe on Global Liquidity

is there seems to be some sort of rollover now whereby despite you know a lot of these assets making all-time highs the actual positioning of investors is actually beginning to come down so they're buying more safe assets now all that's really saying is that probably the highs that you're seeing in asset classes where they're occurring is being done on very low volume which is not a great point It's an important point to think about from a risk standpoint. But investors, in terms of their money flows, are seemingly reducing their risk exposure, which I think is an important point to make. And all these things add up to a not happy picture. But I would be particularly concerned right now on a short term basis. By number one, the dollar keep going up. And number two, the U.S. treasury market, particularly the term premium, continuing to rise. Then. they're not bullish indicators on this episode of what the finance podcast so the pleasure welcome back michael howe uh so michael is a regular guest he's been on quite a few times now and he's also the founder and managing director of cross-border capital uh really the you know from my opinion uh at the forefront of sort of analyzing global liquidity and what's happening in the world and it's interrelationship between markets economies everything else as well so Michael, thanks so much for coming on the podcast. Great pleasure, Anthony. Good to be here. Yeah, looking forward to the conversation because we're sort of doing it on the 13th of January. There's been a bit of a market pullback. I think everyone's freaking out. And, you know, at the start of this year, there's been some interesting movements in the bond markets as well. But maybe before we get to those sort of points, I'd really be interested to hear what is your current outlook for global liquidity? What are you seeing? Well, I think the outlook is. sort of fair to middling, but it's certainly not as bullish as it was, you know, this time last year. I think unambiguously, you know, in January 2024, the outlook looked to be pretty good at a time when there was actually quite widespread pessimism among many advisors. And so it was a relatively straightforward call. It obviously never is a straightforward call. It was a relatively straightforward call to say that markets were likely underpriced and they'd go up. And that was true generally across risk assets. You know, including the sort of celebrated crypto and Bitcoin. So a lot of those assets did look, you know, undervalued against liquidity a year ago. That's not really true today. And what they're really dependent on is greater momentum for liquidity. That momentum doesn't really seem to be coming through and it's not coming through from the US, you know, partly because you've got uncertainty over the funding program when the new administration comes in. And a lot of the. juice, if you like, in liquidity in the US last year was really because of the funding change, where Janet Yellen managed to skew US Treasury funding very much towards the short end. Now, I know that's a sort of fairly wonkish idea, but it did actually add significance to the liquidity in the US markets. And allied to that, the Federal Reserve was doing what we sort of somewhat flippantly called not QEQE, which was adding liquidity despite the fact it's headline policy. was actually a QT policy, quantitative tightening, but they were actually adding liquidity. And they managed to add substantially last year, maybe as much as about a trillion US dollars, basically secretively or in a hidden easing. So those factors are really beginning to wane. Now, if you want to illustrate that process, which I think is an important thing to kick off with, if you take a look at a slide that I've got, which is actually well into the presentation about slide 17. It shows the chart there, which is looking at our calibration or a measure of what we call not QEQE. So in other words, the hidden quantitative easing and also the not yield curve control, yield curve control, which is the hidden easing coming from the Treasury when they're doing a yield curve control, not really fessing up to it. And basically what that illustrates is that there is an impetus in U.S. markets last year. of upwards of about $6 trillion or very close to that of actually additional, let's say, hidden stimulus. And that was one of the main reasons that the S&P went up 25% last year, and why crypto was good, etc., why gold went up. All these features are really phenomena of more monetary liquidity. What you're seeing lately is a fairly sharp decline in that stimulus, that impetus. It's come right down to under a trillion. and it looks like it's fading very fast as we head into deeper into 2025. So that's one thing I think one's got to be pretty cognizant of. And the other thing that you've got in the background. is basically what's going on in China. And the situation in China just isn't good. And that comes back to debt. It comes back to debt, I suppose, as well, the US dollar. And that combination is really proving a poisonous cocktail for the Chinese economy. And, you know, just to sort of refresh kind of what's happening there, we know that China's got a huge, huge debt burden. And the economy is really struggling under the weight of that debt. The only way you get out of debt, and particularly debt deflation, which is what China is suffering right now, is to create an offsetting monetary inflation. Now, if you create a monetary inflation, by definition, you're going to destroy the value of your paper money. In other words, you're thinking about currency devaluation. And China is really insistent on maintaining as close a parity to the U.S. dollar as it can. So it's trying to hold the yuan cross against the U.S. dollar. as near as, damn it, on about 7.3 yuan to the US dollar. And that's proving extremely, an extremely difficult exercise. Now, in order to do that, what they're doing is they're tightening monetary conditions. And that tightening of monetary conditions is basically causing both the Chinese economy to slow down. And we would suspect as well, in looking at sort of upcoming data, it will be showing a decline in the world economy. And if you want to look at that, there's a slide again a little bit deeper in the presentation around slide 11, which is showing that correspondence between PBOC, People's Bank of China, liquidity injections or actually, as we speak, liquidity withdrawals and the tempo of the world economy, as gauged by a now cast, a daily now cast that we put together. And the correlation between those two series is pretty decent with the. Chinese liquidity leading by about three months. So if you look at that chart, the omens are clearly not very good for what's going on. So basically, the strong dollar against the background of debt in China is causing China to withdraw liquidity. And then that comes on top of this declining impetus that we're seeing in the US. So generally, the outlook is, as I say, not great. If you take a look at a slide early on in slide three, we actually track our estimates of global liquidity growth in dollar terms against the performance of all world asset markets. The black line on that chart is all world asset markets. And the orange line is looking at our estimates of global liquidity. And we push that forward to the end of 2025. And you can see at best, there's a flat lining going on. And, you know, worse, that probably could trigger some market correction, given the fact the markets are you know, often price off the margin. And if they see a lot of momentum coming through, that's clearly a dangerous feature. And then if you want to maybe just before I stop, the other thing to think about is the, you know, everyone's favorite risk asset now, which is Bitcoin. We show on the following charts like slide four, the very close correlation between movements in Bitcoin and movements in global liquidity. where we pushed global liquidity here forwards by three months to show that it's a predictor. And again, if you look closely at that chart, the black line here is looking at liquidity growth. And what that's showing is a fairly noticeable decline after what had been a decent third quarter. But because liquidity leads, that obviously explains why Bitcoin has been strong in the period up to December, end December, and maybe why it's coming under some pressure now. Okay. Yeah, a lot to unpack there, and I'll make sure all the slides are up so the viewers can see. But I'd be interested in not QE, QE, and not yield control, yield control. It sort of looks like it peaked in around 2024, and it had a bit of a drop since then. So I guess what was driving that? You've mentioned moving bond issuance to the front of the curve. What else? And I guess why has it continued just to decrease over 2024 and into 2025? Well, I think if you look at that chart, and bearing in mind that liquidity leads... markets, the peak in that chart occurred early in 2024. So it was really having its effect, both on markets and more particularly on the economy, you know, around the time of the election. And, you know, it's true that, you know, incoming Treasury Secretary Scott Besson has already, you know, labelled Jay Powell and Janet Yellen at Fed and Treasury, respectively, kind of cheats in trying to, you know, bolster the markets to get Biden reelected. And, you know, that that's a pretty. in a cute spot by him, but it's evident in the data. And the way that we look at it is to say that if you look at the Fed and what the Fed is doing or what the Fed is doing sort of sous la table in terms of hidden policy, this not QEQE, as we sort of flippantly call it, is basically saying that what they're doing is that they're purportedly doing QT, quantitative tightening, but actually they're injecting liquidity. Now, how can they do that? How can we square that circle? And that is because they define their QT in terms of the overall balance sheet size. So the overall balance sheet of the Federal Reserve is definitely shrinking. That's not a that's not a question. But not all items on the balance sheet actually create liquidity. So even though the overall balance sheet is shrinking, the non-liquidity creating parts are falling much faster. And the liquidity creating parts are actually expanding. And specifically things like. The reverse repo facility is being wound down quite dramatically. You've got fluctuations which are occurring in the Treasury General Account, which is an account that the Treasury holds at the Fed. It's like a cash deposit account. They can run that down or build that up. And that's been a source of liquidity at different times. You've got the Bank Term Funding Program, which was a support program put in place during the Silicon Valley bank turmoil. That's now run off, but it was adding liquidity through the year. And you've also got the operating losses that the Federal Reserve is suffering because it's paying up more interest to coupon holders than it is taking in. Or it's paying up more on the, I shouldn't say the coupon holders, it's basically paying up more on the reverse repo facility than it's taking in. And that basically is a source of loss, but it's actually an injection of liquidity for markets. So all these factors add up. And you can see on slide 15, we calibrate that in what we call not QEQE. Now, that's one source of impetus that people haven't really figured with. And that's a way of directly injecting liquidity into money markets. But there's another way of actually assessing liquidity, which is really looking at the duration impact of treasury issuance. Now, if you're issuing a long dated coupon bond, let's say a 10 year bond or. there or thereabouts, a longer dated tenor, in other words, that will absorb balance sheet capacity among financial institutions and will basically take liquidity out of the system. And that is clearly a negative. And the more funding of a long end there is, the more that you get that liquidity being, if you like, soaked up by this issuance sponge, this coupon issuance sponge. Now, what Janet Yellen very cleverly did is change the parameters of how the. how the US Treasury issues debt. She skewed a lot of issuance into Treasury bills, which are non-coupon paying securities with up to one year of maturity. And the reason they're very attractive is that the banks tend to hoover those up because with a very active fiscal spending program going on, banks are getting a lot of bank deposits built up and they need an asset on the other side of their balance sheet that duration matches. those deposits and what better than a short-dated treasury bill so the banks are very keen buyers of that stuff and the other thing that janet did was she also skewed the calendar of coupon issuance very much towards very short-dated coupons two three five year coupons away from longer end coupons like 10 or 20 or even 30 year so she took about a year and a quarter at least out of the average maturity of the calendar of issuance by the treasury uh since the end of 22. so these things are really important and the slide 16 basically calibrates that effect and if you look at it you'll see that actually uh that sort of uh uh liquidity impulse uh measured in terms of uh of dollar duration was equivalent to what we saw during the covert time so you know this is additionally one should say on top of the fiscal spending stimulus you're seeing this is purely by changing the dial or whatever on the maturity of Treasury funding. So it's very important. Now, you can also see, while I'm on this subject, the impact of that on yields. And if you take a look at slide 18, what that's showing is the difference between the stated or headline, or actual, I suppose it's better to say, Treasury yield of the 10-year tenor. So what US government bonds that? actually yielding the market, which is shown as the orange line and a bootstrapped version of that data, which has come from the agency mortgage market. Now, the agency mortgage market. is a risk-free securities, very much like treasuries. They're held by central banks, even by the Federal Reserve. They're taken as risk-free instruments. And they should align exactly with the treasury market once you've made a little bit of an adjustment mathematically for duration differences and convexity differences. But that's getting into the weeds of bond speak. But generally, they should line up. And if you look at that graph, what you can see is that they haven't lined up during this period of so-called cheating by the Treasury or this big skew towards the short end of the issuance curve. And what that shows is it's basically about 100 basis points of difference in spread. So the Treasury market, the actual bond deal in the US, has been artificially suppressed by about 100 basis points. Now, what does that really mean? to market participants. What it means is that number one, I mean, obviously yields are lower than they should be, but it means that the yield curve is artificially depressed and was actually forced or was magically inverted when it shouldn't really have been. So how do you use the agency mortgage market to queue as a queue for your yield curve calculation? You'd have seen that actually the curve was more likely upward sloping, indicating a strong economy. rather than negatively sloped, indicating potential recession. And that clearly upset calculations of a lot of economists who didn't quite see that point. The other thing which is important, and it's particularly important in the light of recent data, is that it also means that the TIPS market, the Treasury Inflation Securities Market, is biased by about 100 basis points. So in other words, breakeven inflation rates in America, stated breakeven the long term, or underlying inflation that the treasury market is discounting is again distorted by 100 basis points. So it looks as if underlying inflation in America is about two percentage points over the next 10 years, 2% per annum. Actually, in reality, it's over 3%. So the Fed is already sort of distorting people's perceptions here. There's more inflation and there's a more robust economy than we've been led to believe. And that clearly is going to be an issue. that Scott Besant has to tackle when he gets in to Treasury on 20th of January. Yeah. So is that what we're seeing in the bond market? It's not that they're blowing out. It's just that they're sort of normalised and probably the place where they should have been on the longer end. Yes, exactly. So if you take a look at slide 13, what you'll see there is a chart of the bond market in America, the 10-year Treasury, which is the orange line. And the black line is basically implied term premium. Now, implied term premium are picking up. But you can see if you look at that yield curve. Sorry, if you look at that yield chart, the orange line, that's heading towards five and a half percent treasury yield. Now, I'm not sure whether we're going to actually get there. The economy may feel the pain first. But generally, that's what the trend seems to suggest. and it's being driven by term premium. Now, a more exaggerated view of that is in the next slide 14, which shows a much shorter term window of that term premium. And what it illustrates is a very clear breakout in term premium. Now, just for those that don't know, term premium are effectively the risk premium that the treasury market or government bond markets have, which is a compensation against interest rate risk. over the term of the bond. And it's the key way that you measure or value a bond. So if you've got rising term premium, that's saying that there's more and more risk in the bond. And this is exactly what we're getting right now. So risk premium in the US are starting to blow out. Now, that's important in the context of what's going on, for the simple reason that if you go back a couple of slides to slide 12. you'll see exactly the opposite going on in the Chinese bond market. Now, this is unusual, to say the least, that the two biggest economies and, you know, let's say the two, therefore, most important bond markets in the world, the U.S. Treasury market and the Chinese government bond market, are actually moving in completely opposite directions. The U.S. Treasury market is selling off. Prices are going down. Yields are going up. But in the Chinese bond market, you've got the reverse. Yields are plunging and bond prices are going up. And what that's telling you is that the U.S. is seeing. underlying inflation pressures pick up and the unwillingness of maybe the bond vigilantes, to name them, who seem to be unwilling to buy US treasuries at these yields. They want higher yields. As you say, the bond market is normalizing in America, whereas in China, you've got the reverse, whereas people are just fleeing for safety into the safety of government bonds. They don't want to hold any risk assets. And that's because of this plight that China's got with debt deflation. and potentially a slowing economy as the PBOC tightens aggressively. So these are the two major anomalies you're seeing in world markets. Yeah, I'd love to go into China a little bit more because it seems, you know, a little bit counterintuitive. Is this to do with, I guess, you know, financial limitations in the market or is there anything else driving it? Well, it's basically that, you know, I mean, China knows what it has to do. OK, it's got a huge debt burden. The only way you get out of debt and debt deflation and the bond market is confirming that we've got debt deflation going on. This very sudden move down in yields is underscores that fact. But China knows what it needs to do, which is basically to offset debt deflation by monetary inflation. That's what they've got to do. But that will entail devaluing their currency. And the issue is that. They don't want to suffer the loss of face of seeing the yuan devalue significantly against the U.S. dollar. And at the moment, you've got a strong dollar. And part of my view really over the last five years or more has been that that dollar rise has been, if you like, in part, a deliberate weaponization of the dollar against the Chinese yuan. And if you look at the trend in the dollar, which is illustrated on slide nine, you'll see there that the trend, and this is our preferred measure of the dollar, which is the real trade weighted exchange rate. If you look at that, it's very clear that the real trade weighted exchange rate of the US dollar has broken higher ever since the global financial crisis. There's a new trend forming. That trend looks remarkably robust. And if you flip to slide 10, the next slide. you'll see that that dollar upswing is underpinned by strong capital inflows. Now, those capital inflows may well have lost a tad of momentum, but they're still positive and they're still driving the dollar higher. And I think that part of this move upwards in the dollar, or if you like, weaponization of the dollar against the Chinese yuan, has been reinforced by deliberate devaluation of the Japanese yen. which is putting even more pressure on the Chinese yuan to devalue. And basically what I think the US wants is a China that has a reset. And that reset is basically a major devaluation of the currency in some form. Now, while we're on that subject, the issue really to think about is what does the Chinese yuan devalue against? And everyone immediately thinks that they've got to devalue against the US dollar. But that's not necessarily the case. And the reason that it's not necessarily the case is that China doesn't really have a competitiveness problem against the US dollar. What it has is a debt problem. And that debt problem needs the paper money of China to devalue against real assets. What that really means is that the yuan has to rise against gold or the yuan gold price in other words has to go up. Now, clearly, if you've got a static dollar gold price and the yuan gold price rises, then by definition, the arbitrage must mean that the yuan dollar equally weakens. But I think maybe there is scope here for a deal. And maybe just maybe. And I've got no insight, but it's pure conjecture that maybe what the Trump and the incoming Trump administration is looking to do is to do some deal with China. And. I think they've definitely got to do a deal. It's in the interest of both economies to do one. And that deal may be to solve everyone's problems is an easing in China, coincident with an easing in the US, a little bit like, you know, we saw back in the mid 1980s with the Plaza Accord in 1985, when then the problem was Europe and America, not America and China. And then it was a strong dollar, which the dollar had to come down. And ultimately what that meant was that the US eased aggressively ahead of the 1987 stock market crash two years before that. And ultimately, the Europeans also joined in as the dollar began to go down. So it may be that that's what we're leading up to. But, you know, note the fact in a sidebar that the yuan gold price is near an all time high. I think it's going to go higher. That's what we should be looking at. Yeah, I guess the risk is, you know, the dollar as it's sort of been, it seems like a liquidity vacuum. You know, all dollar assets have sort of been attracting a lot of the global. You know, money, money, at least. And it seems like the risk is that they could, you know, it's a wrecking ball, but it could not just affect China. It could affect all, you know, basically the whole of Europe, Japan, Australia, every other country as well. It seems like that's that's the way it's moving. Yeah, I think that's right. And I think, you know, I mean, the issue that one's got to try and tackle in all this is, you know, what is the what are the dynamics that are sort of driving markets in the world economy underneath the bottom? Sort of all the. the noise that we get from a day-to-day basis. And what's driving this whole process is basically debt and the impact of debt on the world economy. Now, our conjecture is that all this talk about looking at debt-GDP ratios is wrong. It's misguided. The talk about financial repression, I don't buy into particularly. I don't think that's the world we're in. I think we're in a world where... you've basically got you've got to try and align debt to the pool of liquidity. That means that to effectively devalue debt against liquidity, you need monetary inflation, not financial repression. And what monetary inflation ultimately leads to is a continuation of this, what people have called financial nihilism, which actually is a term coined by Dimitri Kofinas in the US. which I think very neatly summarizes the sort of plight that many people are in, particularly, you know, Generation Z, where, you know, houses are unaffordable. People seem alienated from society. If you haven't got assets, you're in a really difficult position, because what this is really saying is it's not necessarily high street inflation that we're getting. It's actually asset price inflation. If you're not on the asset price in America around, you've really got a big problem. And that's really the issue. Now, if you come back to why is it that this is why is debt a problem and why? Why are we in this mess? If you look a little bit further in the presentation on slide 19, what I've tried to articulate there is really the underlying problem. And if you think about it, I mean, there's nothing wrong with debt per se. I mean, debt is the lifeblood of capitalism. If you don't have. debt, you can't expand economies. So it really is a critical factor. And, you know, most growth is really underpinned by debt and credit. So it's not necessarily a bad thing. What is a bad thing is unproductive debt. And that's the issue that we've got. Now, what slide 19 illustrates is our estimates of the underlying return on capital in the US economy. And what I've tried to show on that chart is there have really been It really looks like a staircase of or descending staircase of returns. And if you look at the back into the 1950s and 60s, you had rates of 12, 13, 14 percent or so for return on capital. And then you see the oil crisis in the early 1970s where all those returns on capital sort of hit an air pocket and they drop by about 40 percent. So you see. those rates going right down to about 8% or maybe even lower. And that's clearly a problem. Now, in that environment, what you need to happen is you need a debt restructuring because a lot of debt has been taken on at the old or expected returns on capital. And so once you've got this air pocket and returns and this new world of higher energy prices, you need to devalue a lot of debt or restructure it. And that's why you need a monetary inflation. And that's exactly what we got through the 1970s until we didn't when Paul Volcker came in to the Fed at the end of the 70s. But basically, debt was devalued. There's a second step down that I've highlighted, which was around 2001, which is China's entry into WTO, the World Trade Organization. And that is an equally large hit to returns on capital. And what it basically means is that U.S. returns on capital dropped by another 40% down to these lowest levels that we're seeing now. That requires another debt restructuring, another debt monetization, if you like, devaluation of paper money, rather like what we saw in the 70s. And that is what this monetary inflation is all about. To get out of bad debt, to get out of unproductive debt, you need to print money. And that's exactly what's happening. So the U.S. is in this process of actually monetizing debt or the world economy, one would say, is in that process. Now. What has added a twist to that is shown on the next slide. And what that next slide highlights is the more recent plight of China. And China, through this, if you like, weaponization of the dollar, through increasing trade sanctions, technology bans, whatever, the return on capital in China drawn it. equivalently, but over a shorter time period, is actually collapsing. So whereas it took America something like 75 years to go from a rate of return on capital of about 14% to about 4%, the Chinese have managed it in barely 10 years. So what you're seeing here is a very significant collapse in Chinese returns on capital. I mean, you can see from the chart that America's return on capital is beginning to pick up a little bit. I mean, it's actually probably higher now than what you're seeing in China. Germany is in a bad situation, but let's not go there. And that's probably symptomatic of the rest of Europe. But it's that return on capital in China, which is collapsed. Therefore, China needs a debt restructuring. It needs a big monetization. And that's what we're talking about. And if you work out the maths of that, which is shown on the following slide, slide 21, what that is comparing is debt to liquidity ratios, not... debt to GDP ratios. Now, what that chart basically, or those charts suggest, is that there is an underlying equilibrium between debt and liquidity. And that underlying equilibrium has to be honoured. And you can see, you know, those different ratios of different countries. But if you start to look at China, China probably needs something like a 30% expansion in its liquidity base to devalue existing debt. And that's a... benchmark as to what the yuan should devalue again that that's how much it should devalue against gold now the black lines on those charts are debt gdp ratios and debt gdp ratios are just completely meaningless as far as i can see i mean academics have told us or they warned us you know whatever it was 15 years ago that 90 was the critical threshold and the world would end after 90 well here we are at sort of you know sky high levels in japan china Singapore and other Asian countries, you've got much higher than 90% rates in most of the West generally, and the world still goes to work every day. So debt GDP is not really the bogey or the hurdle that we need to think about, it's debt to liquidity. And if you look at slide 22, that illustrates the average for the world economy. These actually are the advanced economies worldwide, but notwithstanding. So what this basically tells us is this is the debt to liquidity ratio going back to 1980. And we projected what will happen in the next two or three years. Now, the reason for citing this chart is that if you look at how it's drawn, there's a dotted line going through the middle, which is an equilibrium that effectively the economies are adjusting back to. So a little bit like a sort of a wobbly man. You knock him one way and he comes back to the middle. That's how this debt GDP ratio kind of works. Now, as you can see, when you're significantly above that dotted line, the median level, you tend to find that there are financial crises quite often. And we've labeled those on the chart. And that's why looking at debt to liquidity is so important. So you get financial crises or more specifically refinancing crises when that ratio is high. significantly below the dotted line, you get asset booms or asset bubbles because there's a lot of surplus liquidity in the system relative to debt refinancing needs. And this comes back to my sort of central point that I've made probably many times before, Anthony, and that is to say, look, modern capital markets are no longer mechanisms for raising new investment or new capital spending. They're mechanisms or systems for refinancing. this huge pile of debt. And in a world where you're raising new capital, interest rates are important. But in a world where you're refinancing debt, it's balance sheet, balance sheet capacity, which is critical. And that's global liquidity. And that's what we need to understand. Now, if you look at that chart closely, you'll see that in the projection window on the far right, that ratio of debt to liquidity starts to go move strongly upwards through 2025, 26, 27. And the reason that's happening is that what's coming back into the frame is something called the debt maturity wall, which is the. debt that was taken out or termed out in the COVID years at very low interest rates, that's got to be refinanced. And that refinancing begins about the middle of 2025. So central banks are going to have to pay a lot of attention to that if we want to avoid another financial crisis. And they've got a lot on their plate. What happens to China? What happens to this debt maturity wall? And how... the US government is funded? Is it funded at the short end or the long end? These are big, big questions to pose. At the end of the day, we think you're getting monetary inflation over the long term. And that's how portfolios have got to be structured. Therefore, you know, the 60-40 portfolios we've long said is dead. And you need to do something different. And that means taking in more explicit monetary inflation hedges into portfolios. Yeah, it's a really interesting way to look at it, and I guess the trend that we've experienced over the past 15 years or so. If I look at that chart, it does seem that sort of after 2010, you know, really the time of QE infinity, when they just sort of would inject as much as liquidity as possible into the markets, it's been a very obvious downwards trend that even during COVID sort of continued down. So do you think that now with, you know, the cat's out of the hat, you can't really put infinite QE back in? Do you think there's a... Will it ever get to that point or will the central banks just keep pumping money back in? I know there's talk about deregulation in the banking system as well. Do you see that as a potential? Yeah, because I think that, you know, we've set ourselves up to kick the can down the road. And we being collectively Western governments, that is, that's what's going to happen. So, you know, they're going to find some way of sneaking QE back into the system. Whether they label that QE or something. You know, the acronym Department of the Fed is going to be working overtime to come up with something like a QS, quantitative support. But they're going to have to do it. They're going to have to find some way. Otherwise, it'd be a financial crisis. And I think we're getting close to I don't want to say close to a crisis, but we're getting close to, you know, tensions in markets becoming more apparent. Just look at the repo markets in the US. These are important markets. They're the money markets. They're really the anchor rates in the whole financial system. And if you look at spikes in repo rates in America through last year, 85 percent of the spikes, and there are an increasing number, have occurred since July of last year. So you're looking at a real concentration of tensions beginning to come through into the money markets in the second half of 2024. So this is a warning sign that the Fed's got to pay attention to. On top of that, as I said, we've got, you know, obviously serious tensions in China. which is what the bond markets there are telling us yeah so what actions do you think scott besson can take when he cut when he comes in because i know he's talked a lot about wanting you know more longer dated bonds but it seems like uh that would potentially exacerbate the current issue yeah well it will i mean if he steps further away from issuing bills um you're going to get the uh not yield curve control yield curve controller we labeled it going to reverse So you're actually going to have a big liquidity squeeze. And I guess, you know, his boss, Donald Trump, is not going to like that very much because the market will come off sharply. So that may or may not be an option, but it's certainly an attractive option to think about. So he's got to be a little bit more innovative. And I rather think he's boxed in and he's going to have to, you know, bite the bullet and accept the fact that Treasury bills are, at least in the short term, an important part of the funding equation. I mean, why upset the apple cart now? I think the other thing that one's got to think about is what happens to the dollar and currency. And, you know, it's been my certainly my view for many months now that the strong dollar is really a deliberate policy, because if you're going to do a trade deal or even a Forex deal of reorganizing the international monetary system, it's much better to do that against the background of a strong dollar than a weak dollar. because you're holding all the, well, excuse the pun, trump cards. But you are in that environment. The strong dollar really matters. And so I think that's certainly in the interest of America. And I can absolutely understand why it's being done. So, you know, you've got that. Now, the problem is, is, as we know, and you highlighted it at the beginning, the dollar is a wrecking ball and it's starting to wreak havoc across the world. You know, the problems with sterling and the problems with the UK gilt market are not unconnected to the strong dollar. I mean, that clearly a lot to do with the incumbent chancellor. Rachel Reeves, you know, seemed, one would have to say, charitably out of her depth. But, you know, the fact is that a lot of these problems, China, UK, Europe, French bonds, I mean, all these things are kind of connected. Yeah, definitely. Maybe a very niche question to the UK sort of QE. I know they do it differently where they actually sell bonds into the markets versus the Fed who sort of allow their... bonds and bills and et cetera to roll off. Does that have a larger effect on liquidity or are they both similar? David Stein The UK has been more aggressive in that regard without question. But to be perfectly truthful, the UK doesn't really matter anymore in the big equation. The big central banks are the Fed and the People's Bank of China. And then you really have to scratch around. The ECB matters to some extent. David Stein boj matters to an extent bank of england matters a little bit but i mean that they don't really affect things that much it's much more about the fed and the pboc they're the big ones okay yep makes sense uh we won't tell the europeans because i'm sure they we all won't be too happy but uh the power yeah there's no initiative going on yeah no definitely uh so what does this mean for markets i know as you said at the start you know you've been quite bullish 2023 2024 yeah what does this mean it doesn't seem too too good especially if we link the liquidity to performance well i mean i mean my view in the short term would be by the two-year two-year bond uh because i think this i think with the world economy potentially slowing down uh i mean if you take a look at slide eight in the presentation um what that shows is um a now cast that we put together of the world economy i mean it's a daily plot but effectively is trying to take the temperature of the world economy on a daily basis. I mean, it seems that that after having sort of chugged along at a fairly constant tempo, suddenly took a dive sometime around mid-December to a lower level. I mean, you took at least one percentage point out of world growth. But, you know, although one percentage point may not sound a lot at the margin, it really matters. You know, the world feels very different if it's growing at 3% compared with 2%. So. um you know the these things are uh are significant and then if you look at the chart just before that on slide seven it looks at the risk exposure of all world investors now um you know that don't read too much into that chart necessarily but it basically tries to identify cycles in risk exposure and what it's looking at is or what it's highlighting is there seems to be some sort of rollover now whereby despite you know a lot of these assets making all-time highs, the actual positioning of investors is actually beginning to come down. So they're buying more safe assets. Now, all that's really saying is that probably the highs that you're seeing in asset classes, where they're occurring, is being done on very low volume, which is not a great point. It's an important point to think about from a risk standpoint, but investors in terms of the... their money flows are seemingly reducing their risk exposure, which I think is an important point to make. And, you know, all these things, you know, add up to a not happy picture. But I would be particularly concerned right now on a short term basis by number one, the dollar keep going up. And number two, the U.S. Treasury market, particularly the term premium, continuing to rise. They're not bullish indicators. so i know in a recent interview you were saying you know sort of be close to the door you're a bit uh yeah you're unsure are you sort of out the door yet or you're still still close to the door i've got to pay a lot of attention to liquidity liquidity if liquidity conditions start to come down then absolutely yes but you know the the point about liquidity cycles is they tend to be you know five years five six year cycles and you know i don't want to be jumping in and out every month so i think i've got to be yeah I'd like to be sure that there's a turn, but all I'm saying is that there's a definitive loss of momentum. and i'm getting worried and a lot of the companion indicators uh like term premier uh like the dollar etc are you know not uh are not signaling uh uh you know a particularly bullish outlook right now things can change for sure you get corrections short-term corrections in markets maybe we're seeing one but i i don't like what i see right now and i'd certainly be you know looking for uh you know some uh shift into into safe assets. I mean, not a dramatic one, maybe, but at least hedging some positions. And as I say, the two-year note is not such a bad thing to be thinking about in terms of an investment. Yeah, that is two-year bonds. I mean, maybe they're an interesting thing to start to contemplate. I mean, not least because if you look at the US term structure, you know, all hopes of major interest rate cuts have pretty much evaporated now. Whereas I think that if things start to get dicey, they're going to come back pretty quickly. Yeah, great point. And do you see the markets, I guess all markets reacting similar to 2022, where it's sort of basically everything goes down in the future? Or is that going to be really dependent on what we see when this cycle shifts? Obviously, as you're saying, it's maybe not now, but potentially in the coming years. Well, I think the thing is, is that, you know, the nature of markets has changed in my view. there's an awful lot more passive or indexed investment, which means there's a lot more correlation of asset classes going on. A lot of this is driven by liquidity, which is the common denominator. So if liquidity goes down, everything goes down. And so I think there is a case for saying that if you get, you know, what follows the everything boom is the everything bust. I think there's a lot in that. And if you sort of drill down into the equity markets, I mean, this cycle is the first one that I've seen in decades. whereby the US market for many advisors is being treated explicitly as the world market. So, you know, whereas traditionally, let's say European or UK advisors would have maybe the largest equity share in their own domestic markets, they're now putting 60 percent into the US. And that's, you know, that's a big sea change. So I think that, you know, that. makes a difference. So it means that if US liquidity goes down, and US liquidity is a major driver of the global picture, then everything kind of goes down together. Yeah, great point. So Michael, thanks so much for sort of going all over the place in liquidity markets, etc. So last question is, what is one message you want people to take away from the conversation? Well, I would, I'd be cautious coming into this year, I don't think it's the end of the party necessarily. But you know, our indicators anyway. been signaling a peak in liquidity uh in late 2025 for a long time now i mean you know we've been suggesting that um you know since 2022 in fact that there'd be a full run up to uh 2025. so this is not this is not really coming out of the blue i think the you know the issue is that you've got a number of uncertainties that are uh that are sort of distracting us slightly in the beginning of the year one being china one being this debt maturity wall And the third one really being, you know, how the incoming administration handles treasury issuance. I think these are big factors to watch. But I'd be focusing on those three, you know, short-term hurdles. But, you know, I mean, maybe as you said, to sort of coin a phrase I used before, you know, enjoy the party while you can, but dance near the door. There's, you know, there is bad news coming down the track. And we just got to be cognizant of when that, you know, when that upsets people. Yeah, great message. And Michael, thanks again. I think you've been on sort of four or five times now. And I'm sure everyone's always really enjoyed your conversation, our conversations. But yeah, if anyone wanted to find out more about your work and what you do, where would the best place for that be? Well, I think the easiest way is the sub stack, which is called Capital Wars. So that's a piece that we write. We write through three of those at least a week. And they basically give data, what's happening to liquidity and give our... give some of our views. That's, you know, really for retail high net worth individuals. And then we have an institutional service, which is much more detailed, includes a lot of data and further analysis. And that is available from our website, which is crossbordercapital.com. Great. I'll pull out the description below, but thanks again for your time. Good, Anthony. Thank you. Hey everyone, thank you for listening. I really appreciate the support. If you got value out of this, I'd really appreciate it if you could like, subscribe or comment, you know, good or bad feedback. I'm always open to that, but it really helps to the channel. As I said before, only about 14% of people actually subscribe to this channel. So if you were to that, it would really help. It could mean we could continue to grow. If not, thanks for watching and see you on the next show. You also might like this video right here. All right. Thanks again.

But I would be particularly concerned right now on a short term basis. By number one, the dollar keep going up. And number two, the U.S. treasury market, particularly the term premium, continuing to rise.

Then. they're not bullish indicators on this episode of what the finance podcast so the pleasure welcome back michael howe uh so michael is a regular guest he's been on quite a few times now and he's also the founder and managing director of cross-border capital uh really the you know from my opinion uh at the forefront of sort of analyzing global liquidity and what's happening in the world and it's interrelationship between markets economies everything else as well so Michael, thanks so much for coming on the podcast. Great pleasure, Anthony. Good to be here. Yeah, looking forward to the conversation because we're sort of doing it on the 13th of January.

There's been a bit of a market pullback. I think everyone's freaking out. And, you know, at the start of this year, there's been some interesting movements in the bond markets as well.

But maybe before we get to those sort of points, I'd really be interested to hear what is your current outlook for global liquidity? What are you seeing? Well, I think the outlook is. sort of fair to middling, but it's certainly not as bullish as it was, you know, this time last year.

I think unambiguously, you know, in January 2024, the outlook looked to be pretty good at a time when there was actually quite widespread pessimism among many advisors. And so it was a relatively straightforward call. It obviously never is a straightforward call.

It was a relatively straightforward call to say that markets were likely underpriced and they'd go up. And that was true generally across risk assets. You know, including the sort of celebrated crypto and Bitcoin. So a lot of those assets did look, you know, undervalued against liquidity a year ago. That's not really true today.

And what they're really dependent on is greater momentum for liquidity. That momentum doesn't really seem to be coming through and it's not coming through from the US, you know, partly because you've got uncertainty over the funding program when the new administration comes in. And a lot of the. juice, if you like, in liquidity in the US last year was really because of the funding change, where Janet Yellen managed to skew US Treasury funding very much towards the short end. Now, I know that's a sort of fairly wonkish idea, but it did actually add significance to the liquidity in the US markets.

And allied to that, the Federal Reserve was doing what we sort of somewhat flippantly called not QEQE, which was adding liquidity despite the fact it's headline policy. was actually a QT policy, quantitative tightening, but they were actually adding liquidity. And they managed to add substantially last year, maybe as much as about a trillion US dollars, basically secretively or in a hidden easing.

So those factors are really beginning to wane. Now, if you want to illustrate that process, which I think is an important thing to kick off with, if you take a look at a slide that I've got, which is actually well into the presentation about slide 17. It shows the chart there, which is looking at our calibration or a measure of what we call not QEQE. So in other words, the hidden quantitative easing and also the not yield curve control, yield curve control, which is the hidden easing coming from the Treasury when they're doing a yield curve control, not really fessing up to it.

And basically what that illustrates is that there is an impetus in U.S. markets last year. of upwards of about $6 trillion or very close to that of actually additional, let's say, hidden stimulus. And that was one of the main reasons that the S&P went up 25% last year, and why crypto was good, etc., why gold went up. All these features are really phenomena of more monetary liquidity.

What you're seeing lately is a fairly sharp decline in that stimulus, that impetus. It's come right down to under a trillion. and it looks like it's fading very fast as we head into deeper into 2025. So that's one thing I think one's got to be pretty cognizant of. And the other thing that you've got in the background. is basically what's going on in China.

And the situation in China just isn't good. And that comes back to debt. It comes back to debt, I suppose, as well, the US dollar. And that combination is really proving a poisonous cocktail for the Chinese economy.

And, you know, just to sort of refresh kind of what's happening there, we know that China's got a huge, huge debt burden. And the economy is really struggling under the weight of that debt. The only way you get out of debt, and particularly debt deflation, which is what China is suffering right now, is to create an offsetting monetary inflation. Now, if you create a monetary inflation, by definition, you're going to destroy the value of your paper money. In other words, you're thinking about currency devaluation.

And China is really insistent on maintaining as close a parity to the U.S. dollar as it can. So it's trying to hold the yuan cross against the U.S. dollar. as near as, damn it, on about 7.3 yuan to the US dollar.

And that's proving extremely, an extremely difficult exercise. Now, in order to do that, what they're doing is they're tightening monetary conditions. And that tightening of monetary conditions is basically causing both the Chinese economy to slow down.

And we would suspect as well, in looking at sort of upcoming data, it will be showing a decline in the world economy. And if you want to look at that, there's a slide again a little bit deeper in the presentation around slide 11, which is showing that correspondence between PBOC, People's Bank of China, liquidity injections or actually, as we speak, liquidity withdrawals and the tempo of the world economy, as gauged by a now cast, a daily now cast that we put together. And the correlation between those two series is pretty decent with the.

Chinese liquidity leading by about three months. So if you look at that chart, the omens are clearly not very good for what's going on. So basically, the strong dollar against the background of debt in China is causing China to withdraw liquidity.

And then that comes on top of this declining impetus that we're seeing in the US. So generally, the outlook is, as I say, not great. If you take a look at a slide early on in slide three, we actually track our estimates of global liquidity growth in dollar terms against the performance of all world asset markets. The black line on that chart is all world asset markets.

And the orange line is looking at our estimates of global liquidity. And we push that forward to the end of 2025. And you can see at best, there's a flat lining going on. And, you know, worse, that probably could trigger some market correction, given the fact the markets are you know, often price off the margin.

And if they see a lot of momentum coming through, that's clearly a dangerous feature. And then if you want to maybe just before I stop, the other thing to think about is the, you know, everyone's favorite risk asset now, which is Bitcoin. We show on the following charts like slide four, the very close correlation between movements in Bitcoin and movements in global liquidity.

where we pushed global liquidity here forwards by three months to show that it's a predictor. And again, if you look closely at that chart, the black line here is looking at liquidity growth. And what that's showing is a fairly noticeable decline after what had been a decent third quarter.

But because liquidity leads, that obviously explains why Bitcoin has been strong in the period up to December, end December, and maybe why it's coming under some pressure now. Okay. Yeah, a lot to unpack there, and I'll make sure all the slides are up so the viewers can see. But I'd be interested in not QE, QE, and not yield control, yield control. It sort of looks like it peaked in around 2024, and it had a bit of a drop since then.

So I guess what was driving that? You've mentioned moving bond issuance to the front of the curve. What else? And I guess why has it continued just to decrease over 2024 and into 2025?

Well, I think if you look at that chart, and bearing in mind that liquidity leads... markets, the peak in that chart occurred early in 2024. So it was really having its effect, both on markets and more particularly on the economy, you know, around the time of the election. And, you know, it's true that, you know, incoming Treasury Secretary Scott Besson has already, you know, labelled Jay Powell and Janet Yellen at Fed and Treasury, respectively, kind of cheats in trying to, you know, bolster the markets to get Biden reelected. And, you know, that that's a pretty. in a cute spot by him, but it's evident in the data.

And the way that we look at it is to say that if you look at the Fed and what the Fed is doing or what the Fed is doing sort of sous la table in terms of hidden policy, this not QEQE, as we sort of flippantly call it, is basically saying that what they're doing is that they're purportedly doing QT, quantitative tightening, but actually they're injecting liquidity. Now, how can they do that? How can we square that circle?

And that is because they define their QT in terms of the overall balance sheet size. So the overall balance sheet of the Federal Reserve is definitely shrinking. That's not a that's not a question.

But not all items on the balance sheet actually create liquidity. So even though the overall balance sheet is shrinking, the non-liquidity creating parts are falling much faster. And the liquidity creating parts are actually expanding.

And specifically things like. The reverse repo facility is being wound down quite dramatically. You've got fluctuations which are occurring in the Treasury General Account, which is an account that the Treasury holds at the Fed. It's like a cash deposit account. They can run that down or build that up.

And that's been a source of liquidity at different times. You've got the Bank Term Funding Program, which was a support program put in place during the Silicon Valley bank turmoil. That's now run off, but it was adding liquidity through the year. And you've also got the operating losses that the Federal Reserve is suffering because it's paying up more interest to coupon holders than it is taking in. Or it's paying up more on the, I shouldn't say the coupon holders, it's basically paying up more on the reverse repo facility than it's taking in.

And that basically is a source of loss, but it's actually an injection of liquidity for markets. So all these factors add up. And you can see on slide 15, we calibrate that in what we call not QEQE. Now, that's one source of impetus that people haven't really figured with. And that's a way of directly injecting liquidity into money markets.

But there's another way of actually assessing liquidity, which is really looking at the duration impact of treasury issuance. Now, if you're issuing a long dated coupon bond, let's say a 10 year bond or. there or thereabouts, a longer dated tenor, in other words, that will absorb balance sheet capacity among financial institutions and will basically take liquidity out of the system.

And that is clearly a negative. And the more funding of a long end there is, the more that you get that liquidity being, if you like, soaked up by this issuance sponge, this coupon issuance sponge. Now, what Janet Yellen very cleverly did is change the parameters of how the.

how the US Treasury issues debt. She skewed a lot of issuance into Treasury bills, which are non-coupon paying securities with up to one year of maturity. And the reason they're very attractive is that the banks tend to hoover those up because with a very active fiscal spending program going on, banks are getting a lot of bank deposits built up and they need an asset on the other side of their balance sheet that duration matches. those deposits and what better than a short-dated treasury bill so the banks are very keen buyers of that stuff and the other thing that janet did was she also skewed the calendar of coupon issuance very much towards very short-dated coupons two three five year coupons away from longer end coupons like 10 or 20 or even 30 year so she took about a year and a quarter at least out of the average maturity of the calendar of issuance by the treasury uh since the end of 22. so these things are really important and the slide 16 basically calibrates that effect and if you look at it you'll see that actually uh that sort of uh uh liquidity impulse uh measured in terms of uh of dollar duration was equivalent to what we saw during the covert time so you know this is additionally one should say on top of the fiscal spending stimulus you're seeing this is purely by changing the dial or whatever on the maturity of Treasury funding.

So it's very important. Now, you can also see, while I'm on this subject, the impact of that on yields. And if you take a look at slide 18, what that's showing is the difference between the stated or headline, or actual, I suppose it's better to say, Treasury yield of the 10-year tenor.

So what US government bonds that? actually yielding the market, which is shown as the orange line and a bootstrapped version of that data, which has come from the agency mortgage market. Now, the agency mortgage market.

is a risk-free securities, very much like treasuries. They're held by central banks, even by the Federal Reserve. They're taken as risk-free instruments. And they should align exactly with the treasury market once you've made a little bit of an adjustment mathematically for duration differences and convexity differences.

But that's getting into the weeds of bond speak. But generally, they should line up. And if you look at that graph, what you can see is that they haven't lined up during this period of so-called cheating by the Treasury or this big skew towards the short end of the issuance curve.

And what that shows is it's basically about 100 basis points of difference in spread. So the Treasury market, the actual bond deal in the US, has been artificially suppressed by about 100 basis points. Now, what does that really mean?

to market participants. What it means is that number one, I mean, obviously yields are lower than they should be, but it means that the yield curve is artificially depressed and was actually forced or was magically inverted when it shouldn't really have been. So how do you use the agency mortgage market to queue as a queue for your yield curve calculation?

You'd have seen that actually the curve was more likely upward sloping, indicating a strong economy. rather than negatively sloped, indicating potential recession. And that clearly upset calculations of a lot of economists who didn't quite see that point. The other thing which is important, and it's particularly important in the light of recent data, is that it also means that the TIPS market, the Treasury Inflation Securities Market, is biased by about 100 basis points. So in other words, breakeven inflation rates in America, stated breakeven the long term, or underlying inflation that the treasury market is discounting is again distorted by 100 basis points.

So it looks as if underlying inflation in America is about two percentage points over the next 10 years, 2% per annum. Actually, in reality, it's over 3%. So the Fed is already sort of distorting people's perceptions here. There's more inflation and there's a more robust economy than we've been led to believe.

And that clearly is going to be an issue. that Scott Besant has to tackle when he gets in to Treasury on 20th of January. Yeah. So is that what we're seeing in the bond market? It's not that they're blowing out.

It's just that they're sort of normalised and probably the place where they should have been on the longer end. Yes, exactly. So if you take a look at slide 13, what you'll see there is a chart of the bond market in America, the 10-year Treasury, which is the orange line. And the black line is basically implied term premium. Now, implied term premium are picking up.

But you can see if you look at that yield curve. Sorry, if you look at that yield chart, the orange line, that's heading towards five and a half percent treasury yield. Now, I'm not sure whether we're going to actually get there. The economy may feel the pain first. But generally, that's what the trend seems to suggest.

and it's being driven by term premium. Now, a more exaggerated view of that is in the next slide 14, which shows a much shorter term window of that term premium. And what it illustrates is a very clear breakout in term premium. Now, just for those that don't know, term premium are effectively the risk premium that the treasury market or government bond markets have, which is a compensation against interest rate risk. over the term of the bond.

And it's the key way that you measure or value a bond. So if you've got rising term premium, that's saying that there's more and more risk in the bond. And this is exactly what we're getting right now.

So risk premium in the US are starting to blow out. Now, that's important in the context of what's going on, for the simple reason that if you go back a couple of slides to slide 12. you'll see exactly the opposite going on in the Chinese bond market. Now, this is unusual, to say the least, that the two biggest economies and, you know, let's say the two, therefore, most important bond markets in the world, the U.S.

Treasury market and the Chinese government bond market, are actually moving in completely opposite directions. The U.S. Treasury market is selling off. Prices are going down. Yields are going up. But in the Chinese bond market, you've got the reverse.

Yields are plunging and bond prices are going up. And what that's telling you is that the U.S. is seeing. underlying inflation pressures pick up and the unwillingness of maybe the bond vigilantes, to name them, who seem to be unwilling to buy US treasuries at these yields.

They want higher yields. As you say, the bond market is normalizing in America, whereas in China, you've got the reverse, whereas people are just fleeing for safety into the safety of government bonds. They don't want to hold any risk assets.

And that's because of this plight that China's got with debt deflation. and potentially a slowing economy as the PBOC tightens aggressively. So these are the two major anomalies you're seeing in world markets.

Yeah, I'd love to go into China a little bit more because it seems, you know, a little bit counterintuitive. Is this to do with, I guess, you know, financial limitations in the market or is there anything else driving it? Well, it's basically that, you know, I mean, China knows what it has to do.

OK, it's got a huge debt burden. The only way you get out of debt and debt deflation and the bond market is confirming that we've got debt deflation going on. This very sudden move down in yields is underscores that fact. But China knows what it needs to do, which is basically to offset debt deflation by monetary inflation. That's what they've got to do.

But that will entail devaluing their currency. And the issue is that. They don't want to suffer the loss of face of seeing the yuan devalue significantly against the U.S. dollar. And at the moment, you've got a strong dollar. And part of my view really over the last five years or more has been that that dollar rise has been, if you like, in part, a deliberate weaponization of the dollar against the Chinese yuan.

And if you look at the trend in the dollar, which is illustrated on slide nine, you'll see there that the trend, and this is our preferred measure of the dollar, which is the real trade weighted exchange rate. If you look at that, it's very clear that the real trade weighted exchange rate of the US dollar has broken higher ever since the global financial crisis. There's a new trend forming.

That trend looks remarkably robust. And if you flip to slide 10, the next slide. you'll see that that dollar upswing is underpinned by strong capital inflows.

Now, those capital inflows may well have lost a tad of momentum, but they're still positive and they're still driving the dollar higher. And I think that part of this move upwards in the dollar, or if you like, weaponization of the dollar against the Chinese yuan, has been reinforced by deliberate devaluation of the Japanese yen. which is putting even more pressure on the Chinese yuan to devalue.

And basically what I think the US wants is a China that has a reset. And that reset is basically a major devaluation of the currency in some form. Now, while we're on that subject, the issue really to think about is what does the Chinese yuan devalue against? And everyone immediately thinks that they've got to devalue against the US dollar. But that's not necessarily the case.

And the reason that it's not necessarily the case is that China doesn't really have a competitiveness problem against the US dollar. What it has is a debt problem. And that debt problem needs the paper money of China to devalue against real assets.

What that really means is that the yuan has to rise against gold or the yuan gold price in other words has to go up. Now, clearly, if you've got a static dollar gold price and the yuan gold price rises, then by definition, the arbitrage must mean that the yuan dollar equally weakens. But I think maybe there is scope here for a deal.

And maybe just maybe. And I've got no insight, but it's pure conjecture that maybe what the Trump and the incoming Trump administration is looking to do is to do some deal with China. And.

I think they've definitely got to do a deal. It's in the interest of both economies to do one. And that deal may be to solve everyone's problems is an easing in China, coincident with an easing in the US, a little bit like, you know, we saw back in the mid 1980s with the Plaza Accord in 1985, when then the problem was Europe and America, not America and China. And then it was a strong dollar, which the dollar had to come down.

And ultimately what that meant was that the US eased aggressively ahead of the 1987 stock market crash two years before that. And ultimately, the Europeans also joined in as the dollar began to go down. So it may be that that's what we're leading up to.

But, you know, note the fact in a sidebar that the yuan gold price is near an all time high. I think it's going to go higher. That's what we should be looking at.

Yeah, I guess the risk is, you know, the dollar as it's sort of been, it seems like a liquidity vacuum. You know, all dollar assets have sort of been attracting a lot of the global. You know, money, money, at least.

And it seems like the risk is that they could, you know, it's a wrecking ball, but it could not just affect China. It could affect all, you know, basically the whole of Europe, Japan, Australia, every other country as well. It seems like that's that's the way it's moving. Yeah, I think that's right. And I think, you know, I mean, the issue that one's got to try and tackle in all this is, you know, what is the what are the dynamics that are sort of driving markets in the world economy underneath the bottom?

Sort of all the. the noise that we get from a day-to-day basis. And what's driving this whole process is basically debt and the impact of debt on the world economy. Now, our conjecture is that all this talk about looking at debt-GDP ratios is wrong. It's misguided.

The talk about financial repression, I don't buy into particularly. I don't think that's the world we're in. I think we're in a world where...

you've basically got you've got to try and align debt to the pool of liquidity. That means that to effectively devalue debt against liquidity, you need monetary inflation, not financial repression. And what monetary inflation ultimately leads to is a continuation of this, what people have called financial nihilism, which actually is a term coined by Dimitri Kofinas in the US.

which I think very neatly summarizes the sort of plight that many people are in, particularly, you know, Generation Z, where, you know, houses are unaffordable. People seem alienated from society. If you haven't got assets, you're in a really difficult position, because what this is really saying is it's not necessarily high street inflation that we're getting. It's actually asset price inflation. If you're not on the asset price in America around, you've really got a big problem.

And that's really the issue. Now, if you come back to why is it that this is why is debt a problem and why? Why are we in this mess? If you look a little bit further in the presentation on slide 19, what I've tried to articulate there is really the underlying problem. And if you think about it, I mean, there's nothing wrong with debt per se.

I mean, debt is the lifeblood of capitalism. If you don't have. debt, you can't expand economies.

So it really is a critical factor. And, you know, most growth is really underpinned by debt and credit. So it's not necessarily a bad thing.

What is a bad thing is unproductive debt. And that's the issue that we've got. Now, what slide 19 illustrates is our estimates of the underlying return on capital in the US economy. And what I've tried to show on that chart is there have really been It really looks like a staircase of or descending staircase of returns.

And if you look at the back into the 1950s and 60s, you had rates of 12, 13, 14 percent or so for return on capital. And then you see the oil crisis in the early 1970s where all those returns on capital sort of hit an air pocket and they drop by about 40 percent. So you see.

those rates going right down to about 8% or maybe even lower. And that's clearly a problem. Now, in that environment, what you need to happen is you need a debt restructuring because a lot of debt has been taken on at the old or expected returns on capital. And so once you've got this air pocket and returns and this new world of higher energy prices, you need to devalue a lot of debt or restructure it. And that's why you need a monetary inflation.

And that's exactly what we got through the 1970s until we didn't when Paul Volcker came in to the Fed at the end of the 70s. But basically, debt was devalued. There's a second step down that I've highlighted, which was around 2001, which is China's entry into WTO, the World Trade Organization. And that is an equally large hit to returns on capital.

And what it basically means is that U.S. returns on capital dropped by another 40% down to these lowest levels that we're seeing now. That requires another debt restructuring, another debt monetization, if you like, devaluation of paper money, rather like what we saw in the 70s. And that is what this monetary inflation is all about.

To get out of bad debt, to get out of unproductive debt, you need to print money. And that's exactly what's happening. So the U.S. is in this process of actually monetizing debt or the world economy, one would say, is in that process.

Now. What has added a twist to that is shown on the next slide. And what that next slide highlights is the more recent plight of China.

And China, through this, if you like, weaponization of the dollar, through increasing trade sanctions, technology bans, whatever, the return on capital in China drawn it. equivalently, but over a shorter time period, is actually collapsing. So whereas it took America something like 75 years to go from a rate of return on capital of about 14% to about 4%, the Chinese have managed it in barely 10 years.

So what you're seeing here is a very significant collapse in Chinese returns on capital. I mean, you can see from the chart that America's return on capital is beginning to pick up a little bit. I mean, it's actually probably higher now than what you're seeing in China. Germany is in a bad situation, but let's not go there. And that's probably symptomatic of the rest of Europe.

But it's that return on capital in China, which is collapsed. Therefore, China needs a debt restructuring. It needs a big monetization. And that's what we're talking about.

And if you work out the maths of that, which is shown on the following slide, slide 21, what that is comparing is debt to liquidity ratios, not... debt to GDP ratios. Now, what that chart basically, or those charts suggest, is that there is an underlying equilibrium between debt and liquidity.

And that underlying equilibrium has to be honoured. And you can see, you know, those different ratios of different countries. But if you start to look at China, China probably needs something like a 30% expansion in its liquidity base to devalue existing debt. And that's a... benchmark as to what the yuan should devalue again that that's how much it should devalue against gold now the black lines on those charts are debt gdp ratios and debt gdp ratios are just completely meaningless as far as i can see i mean academics have told us or they warned us you know whatever it was 15 years ago that 90 was the critical threshold and the world would end after 90 well here we are at sort of you know sky high levels in japan china Singapore and other Asian countries, you've got much higher than 90% rates in most of the West generally, and the world still goes to work every day.

So debt GDP is not really the bogey or the hurdle that we need to think about, it's debt to liquidity. And if you look at slide 22, that illustrates the average for the world economy. These actually are the advanced economies worldwide, but notwithstanding. So what this basically tells us is this is the debt to liquidity ratio going back to 1980. And we projected what will happen in the next two or three years. Now, the reason for citing this chart is that if you look at how it's drawn, there's a dotted line going through the middle, which is an equilibrium that effectively the economies are adjusting back to.

So a little bit like a sort of a wobbly man. You knock him one way and he comes back to the middle. That's how this debt GDP ratio kind of works. Now, as you can see, when you're significantly above that dotted line, the median level, you tend to find that there are financial crises quite often.

And we've labeled those on the chart. And that's why looking at debt to liquidity is so important. So you get financial crises or more specifically refinancing crises when that ratio is high. significantly below the dotted line, you get asset booms or asset bubbles because there's a lot of surplus liquidity in the system relative to debt refinancing needs.

And this comes back to my sort of central point that I've made probably many times before, Anthony, and that is to say, look, modern capital markets are no longer mechanisms for raising new investment or new capital spending. They're mechanisms or systems for refinancing. this huge pile of debt. And in a world where you're raising new capital, interest rates are important. But in a world where you're refinancing debt, it's balance sheet, balance sheet capacity, which is critical.

And that's global liquidity. And that's what we need to understand. Now, if you look at that chart closely, you'll see that in the projection window on the far right, that ratio of debt to liquidity starts to go move strongly upwards through 2025, 26, 27. And the reason that's happening is that what's coming back into the frame is something called the debt maturity wall, which is the. debt that was taken out or termed out in the COVID years at very low interest rates, that's got to be refinanced. And that refinancing begins about the middle of 2025. So central banks are going to have to pay a lot of attention to that if we want to avoid another financial crisis.

And they've got a lot on their plate. What happens to China? What happens to this debt maturity wall? And how... the US government is funded?

Is it funded at the short end or the long end? These are big, big questions to pose. At the end of the day, we think you're getting monetary inflation over the long term. And that's how portfolios have got to be structured.

Therefore, you know, the 60-40 portfolios we've long said is dead. And you need to do something different. And that means taking in more explicit monetary inflation hedges into portfolios. Yeah, it's a really interesting way to look at it, and I guess the trend that we've experienced over the past 15 years or so. If I look at that chart, it does seem that sort of after 2010, you know, really the time of QE infinity, when they just sort of would inject as much as liquidity as possible into the markets, it's been a very obvious downwards trend that even during COVID sort of continued down.

So do you think that now with, you know, the cat's out of the hat, you can't really put infinite QE back in? Do you think there's a... Will it ever get to that point or will the central banks just keep pumping money back in? I know there's talk about deregulation in the banking system as well. Do you see that as a potential?

Yeah, because I think that, you know, we've set ourselves up to kick the can down the road. And we being collectively Western governments, that is, that's what's going to happen. So, you know, they're going to find some way of sneaking QE back into the system. Whether they label that QE or something.

You know, the acronym Department of the Fed is going to be working overtime to come up with something like a QS, quantitative support. But they're going to have to do it. They're going to have to find some way. Otherwise, it'd be a financial crisis. And I think we're getting close to I don't want to say close to a crisis, but we're getting close to, you know, tensions in markets becoming more apparent.

Just look at the repo markets in the US. These are important markets. They're the money markets.

They're really the anchor rates in the whole financial system. And if you look at spikes in repo rates in America through last year, 85 percent of the spikes, and there are an increasing number, have occurred since July of last year. So you're looking at a real concentration of tensions beginning to come through into the money markets in the second half of 2024. So this is a warning sign that the Fed's got to pay attention to.

On top of that, as I said, we've got, you know, obviously serious tensions in China. which is what the bond markets there are telling us yeah so what actions do you think scott besson can take when he cut when he comes in because i know he's talked a lot about wanting you know more longer dated bonds but it seems like uh that would potentially exacerbate the current issue yeah well it will i mean if he steps further away from issuing bills um you're going to get the uh not yield curve control yield curve controller we labeled it going to reverse So you're actually going to have a big liquidity squeeze. And I guess, you know, his boss, Donald Trump, is not going to like that very much because the market will come off sharply.

So that may or may not be an option, but it's certainly an attractive option to think about. So he's got to be a little bit more innovative. And I rather think he's boxed in and he's going to have to, you know, bite the bullet and accept the fact that Treasury bills are, at least in the short term, an important part of the funding equation. I mean, why upset the apple cart now?

I think the other thing that one's got to think about is what happens to the dollar and currency. And, you know, it's been my certainly my view for many months now that the strong dollar is really a deliberate policy, because if you're going to do a trade deal or even a Forex deal of reorganizing the international monetary system, it's much better to do that against the background of a strong dollar than a weak dollar. because you're holding all the, well, excuse the pun, trump cards.

But you are in that environment. The strong dollar really matters. And so I think that's certainly in the interest of America.

And I can absolutely understand why it's being done. So, you know, you've got that. Now, the problem is, is, as we know, and you highlighted it at the beginning, the dollar is a wrecking ball and it's starting to wreak havoc across the world.

You know, the problems with sterling and the problems with the UK gilt market are not unconnected to the strong dollar. I mean, that clearly a lot to do with the incumbent chancellor. Rachel Reeves, you know, seemed, one would have to say, charitably out of her depth. But, you know, the fact is that a lot of these problems, China, UK, Europe, French bonds, I mean, all these things are kind of connected. Yeah, definitely.

Maybe a very niche question to the UK sort of QE. I know they do it differently where they actually sell bonds into the markets versus the Fed who sort of allow their... bonds and bills and et cetera to roll off.

Does that have a larger effect on liquidity or are they both similar? David Stein The UK has been more aggressive in that regard without question. But to be perfectly truthful, the UK doesn't really matter anymore in the big equation.

The big central banks are the Fed and the People's Bank of China. And then you really have to scratch around. The ECB matters to some extent. David Stein boj matters to an extent bank of england matters a little bit but i mean that they don't really affect things that much it's much more about the fed and the pboc they're the big ones okay yep makes sense uh we won't tell the europeans because i'm sure they we all won't be too happy but uh the power yeah there's no initiative going on yeah no definitely uh so what does this mean for markets i know as you said at the start you know you've been quite bullish 2023 2024 yeah what does this mean it doesn't seem too too good especially if we link the liquidity to performance well i mean i mean my view in the short term would be by the two-year two-year bond uh because i think this i think with the world economy potentially slowing down uh i mean if you take a look at slide eight in the presentation um what that shows is um a now cast that we put together of the world economy i mean it's a daily plot but effectively is trying to take the temperature of the world economy on a daily basis. I mean, it seems that that after having sort of chugged along at a fairly constant tempo, suddenly took a dive sometime around mid-December to a lower level.

I mean, you took at least one percentage point out of world growth. But, you know, although one percentage point may not sound a lot at the margin, it really matters. You know, the world feels very different if it's growing at 3% compared with 2%.

So. um you know the these things are uh are significant and then if you look at the chart just before that on slide seven it looks at the risk exposure of all world investors now um you know that don't read too much into that chart necessarily but it basically tries to identify cycles in risk exposure and what it's looking at is or what it's highlighting is there seems to be some sort of rollover now whereby despite you know a lot of these assets making all-time highs, the actual positioning of investors is actually beginning to come down. So they're buying more safe assets. Now, all that's really saying is that probably the highs that you're seeing in asset classes, where they're occurring, is being done on very low volume, which is not a great point. It's an important point to think about from a risk standpoint, but investors in terms of the...

their money flows are seemingly reducing their risk exposure, which I think is an important point to make. And, you know, all these things, you know, add up to a not happy picture. But I would be particularly concerned right now on a short term basis by number one, the dollar keep going up. And number two, the U.S. Treasury market, particularly the term premium, continuing to rise.

They're not bullish indicators. so i know in a recent interview you were saying you know sort of be close to the door you're a bit uh yeah you're unsure are you sort of out the door yet or you're still still close to the door i've got to pay a lot of attention to liquidity liquidity if liquidity conditions start to come down then absolutely yes but you know the the point about liquidity cycles is they tend to be you know five years five six year cycles and you know i don't want to be jumping in and out every month so i think i've got to be yeah I'd like to be sure that there's a turn, but all I'm saying is that there's a definitive loss of momentum. and i'm getting worried and a lot of the companion indicators uh like term premier uh like the dollar etc are you know not uh are not signaling uh uh you know a particularly bullish outlook right now things can change for sure you get corrections short-term corrections in markets maybe we're seeing one but i i don't like what i see right now and i'd certainly be you know looking for uh you know some uh shift into into safe assets. I mean, not a dramatic one, maybe, but at least hedging some positions. And as I say, the two-year note is not such a bad thing to be thinking about in terms of an investment.

Yeah, that is two-year bonds. I mean, maybe they're an interesting thing to start to contemplate. I mean, not least because if you look at the US term structure, you know, all hopes of major interest rate cuts have pretty much evaporated now.

Whereas I think that if things start to get dicey, they're going to come back pretty quickly. Yeah, great point. And do you see the markets, I guess all markets reacting similar to 2022, where it's sort of basically everything goes down in the future?

Or is that going to be really dependent on what we see when this cycle shifts? Obviously, as you're saying, it's maybe not now, but potentially in the coming years. Well, I think the thing is, is that, you know, the nature of markets has changed in my view. there's an awful lot more passive or indexed investment, which means there's a lot more correlation of asset classes going on.

A lot of this is driven by liquidity, which is the common denominator. So if liquidity goes down, everything goes down. And so I think there is a case for saying that if you get, you know, what follows the everything boom is the everything bust. I think there's a lot in that.

And if you sort of drill down into the equity markets, I mean, this cycle is the first one that I've seen in decades. whereby the US market for many advisors is being treated explicitly as the world market. So, you know, whereas traditionally, let's say European or UK advisors would have maybe the largest equity share in their own domestic markets, they're now putting 60 percent into the US. And that's, you know, that's a big sea change.

So I think that, you know, that. makes a difference. So it means that if US liquidity goes down, and US liquidity is a major driver of the global picture, then everything kind of goes down together. Yeah, great point.

So Michael, thanks so much for sort of going all over the place in liquidity markets, etc. So last question is, what is one message you want people to take away from the conversation? Well, I would, I'd be cautious coming into this year, I don't think it's the end of the party necessarily.

But you know, our indicators anyway. been signaling a peak in liquidity uh in late 2025 for a long time now i mean you know we've been suggesting that um you know since 2022 in fact that there'd be a full run up to uh 2025. so this is not this is not really coming out of the blue i think the you know the issue is that you've got a number of uncertainties that are uh that are sort of distracting us slightly in the beginning of the year one being china one being this debt maturity wall And the third one really being, you know, how the incoming administration handles treasury issuance. I think these are big factors to watch. But I'd be focusing on those three, you know, short-term hurdles.

But, you know, I mean, maybe as you said, to sort of coin a phrase I used before, you know, enjoy the party while you can, but dance near the door. There's, you know, there is bad news coming down the track. And we just got to be cognizant of when that, you know, when that upsets people.

Yeah, great message. And Michael, thanks again. I think you've been on sort of four or five times now.

And I'm sure everyone's always really enjoyed your conversation, our conversations. But yeah, if anyone wanted to find out more about your work and what you do, where would the best place for that be? Well, I think the easiest way is the sub stack, which is called Capital Wars. So that's a piece that we write. We write through three of those at least a week.

And they basically give data, what's happening to liquidity and give our... give some of our views. That's, you know, really for retail high net worth individuals.

And then we have an institutional service, which is much more detailed, includes a lot of data and further analysis. And that is available from our website, which is crossbordercapital.com. Great.

I'll pull out the description below, but thanks again for your time. Good, Anthony. Thank you. Hey everyone, thank you for listening.

I really appreciate the support. If you got value out of this, I'd really appreciate it if you could like, subscribe or comment, you know, good or bad feedback. I'm always open to that, but it really helps to the channel.

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If not, thanks for watching and see you on the next show. You also might like this video right here. All right. Thanks again.

Transcript for:Insights from Michael Howe on Global Liquidity

Transcript for:
Insights from Michael Howe on Global Liquidity