If you look at the performance of Bitcoin and gold, I mean, take those two assets together as being sort of pure monetary inflation hedges.
Over the long term, Bitcoin and gold tend to correlate positively.
But one of the anomalies and one of the curiosities one finds in the data is that they have a short term negative correlation.
So basically, they tend to trend together but cycle apart.
Why it's happening is kind of curious.
And it may be with practicalities is it may be this arbitrage which is going on.
And so people felt gold had gone too far and they were switching out of gold back into Bitcoin.
Since the 2008 crisis, markets are much, much more collateral based.
And so, you know, the Fed has really got to be on guard against disruptions or volatility in that market.
And they need a decent sized balance sheet to do that.
You know, I'll come quietly and accept the fact that they could throw the switch, come back in quickly and add a lot more liquidity if necessary.
They can inject a lot of money.
But the trouble with doing that is that you're kind of hostage to fortune each time.
and every crisis you have to deal with,
the Fed's reputation is on the line.
So I don't think that's sort of good policy
or good politics to do that.
We can see here, Joe, is the global liquidity cycle.
This is looking at the underlying momentum
of global liquidity.
And what you can see is that the cycle moves
with a frequency of about five to six years.
That five to six year cycle bottomed in October of 2022.
It peaked in Q3 of 2025.
And it's slated to fall into 2027.
So this year is basically a year where liquidity is really slowing down quite markedly.
And that's really why we're concerned.
The impact of higher oil prices is pretty significant.
And you can pretty much gauge it as a rule of thumb by saying that every 10 bucks on a barrel of oil is probably taking about 2% out of liquidity.
So it's a material effect.
Certainly in the short term, the impact effect is pretty significant.
Welcome back to Over the Horizon.
Today, I'm here with Michael Howell, the founder of Cross-Border Capital, the author of Capital Wars and the Capital Wars Substack, and the proverbial godfather of global liquidity.
Michael, thanks so much for joining me.
Well, Joe, great pleasure to be here.
Yeah, absolutely. It's been a while since we last spoke, I think 18 or 24 months, something like that.
The world has changed. Quite a bit has changed. Obviously, gold has more than doubled over the last year and some change.
And more recently, we've had the kickoff of the Iran war and obviously the oil shock that has resulted from that.
As we're recording this, it's March 25th. We're going to be uploading this tomorrow. But since February 28th, the U.S.-Israeli strikes on Iran and basically shut the Strait of Hormuz. Crude oil has been all over the place, hugely volatile. You've been talking about oil on the shows that you've done over the last couple of months. Walk us through what this oil shock is doing to the global liquidity picture in real time and what this war has done as far as your outlook for markets for this year.
Well, I think the first thing to say is it reinforces the kind of negative spin we've
been developing about the outlook for risk assets.
And I think the first thing to say is that the liquidity cycle, which is what we deem
as being sort of paramount or a paramount driver of asset markets, peaked in late 2025.
It inflected lower, and it's been basically falling thereafter, not at a particularly rapid
speed, but the fact is that it's going down and that's not helpful. So what we've had is the Iran
crisis basically hitting markets at that same time. And that's clearly created yet another air
pocket, which markets have got to deal with. Now, I think the problem that one faces, particularly
if one puts the Iran conflict into context and the result of higher oil, is that all money that's
anywhere must be somewhere. And if that money is going into defense spending or it's going into
higher oil prices or maintaining working capital in the energy industries or wherever,
it's not in financial markets. And this is a problem. And so we're going to get further
depletion of liquidity as we go forward unless central banks act. Now, my take is that I don't
think they are going to act or they're certainly going to act positively or favorably. The general
tenor that we're getting from looking at bond markets is that bond investors are basically
discounting tightenings of monetary policy, in other words, higher policy rates. I think that's
probably correct. I think the problem that one gets or one faces is that if you look across the
range of policymakers worldwide, there are not that many that really have dual mandates like the Fed.
A lot of those central banks around the world have single mandates, which is fighting inflation.
So if you've got an inflation hit, although the textbooks may tell you that you don't want to be tightening during a supply shop,
the reality is that they probably will because the COVID emergency told us that was actually, with hindsight, the sensible thing to do.
Very well said.
Obviously, oil is one of the biggest absorbers of working capital on the planet.
We've seen crude between 90 and 100 quite often over the last couple of weeks.
What is the impact of crude oil sustaining itself around or above $100 as far as private sector liquidity is concerned?
This down cycle in the global liquidity cycle that you're speaking of, would that accelerate that?
And would that then not ignite sort of an easing impact from central banks?
Or what way do you see that playing out?
Well, then the answer is yes, it would.
I mean, the impact of higher oil prices is pretty significant.
And you can pretty much gauge it as a rule of thumb by saying that every 10 bucks on a barrel of oil is probably taking about 2% out of liquidity.
So it's a material effect.
Certainly in the short term, the impact effect is pretty significant.
So let's not diminish the role of oil.
And I think the thing as well is that do oil prices kind of stay here or do they go higher?
And I think one of the concerns we've had is that if you look at what's been happening to commodity markets, commodity markets are really seeing maybe a fairly normal cycle or a normal cycle blow off.
And what I mean by that is that you've seen the typical pattern that liquidity has gone up.
But the gold market has already responded to that, certainly in size.
I mean, gold has skyrocketed, we know.
I know it's falling back at the moment, but I would imagine that's probably, you know,
forced selling because a lot of CTAs have had leveraged positions.
And one would imagine that many of the Gulf states who have got, you know, big outlays
to face without revenues from oil in coming months are probably liquidating some of their
gold positions.
So, you know, there will be profit taking.
But at the end of the day, what we've had is a big rise in the gold price.
Let's say it's circa hovering around, what, $4,500, $5,000 an ounce.
And I think you've got to put that in context and think what that means for oil prices.
And over the long term, the oil-gold ratio is basically averaged about 20 times.
That's been a very robust statistic.
I mean, going all the way back to the 1970s or early 1970s, it tends to show mean reversion
when you get a displacement back to that 20 times level within about two to three years.
and broadly at the end of September,
sorry, the end of February,
we were at about 70 times.
So we were way, way, way above the normal ratio.
So if you start to factor in,
let's keep the math straightforward
and say, okay, we're going to keep,
we're going to say gold prices
are stuck at about $5,000 an ounce.
If you divide that by 20 times,
you're talking about an oil price of $250 a barrel.
Now, that's an eye-watering size. We made a presentation to clients about a week ago or so,
10 days ago on that point and said, look, this is the backdrop. This is the context you've got to
try to think about oil and commodity prices in. They're responding to a general monetary inflation
and it's not impossible for oil to go a lot higher. Now, somebody said to me, I was insane
by suggesting that oil could go to that level. But my response is, well, okay, you've got three
moving parts here. One of them is wrong. Either the gold price of $5,000 an ounce is wrong.
I think that's probably nearer correct than not, because the Chinese are buying gold with some
alacrity. The second thing is, is the gold ratio incorrect? 20 times has been our long-term history.
Okay, you can make a case for saying it could be a tad higher, but it's always dangerous to say it's
different this time, isn't it? Or the oil price is wrong. So you choose which one of those three
is out of line, and then we can have a debate. But broadly, you've got risks of higher commodity
inflation. And if higher commodity inflation is the result, I think central banks are going to
have to address that. And what's more, liquidity is going to get further sat.
Very, very well said. Either gold has to revert hugely back down to its long-term growth rate,
which seems relatively unlikely because of how much purchasing is happening from sovereigns
around the world. In the near term, obviously, it may be impacted that the sell-off could be
attributed to, as you mentioned, Gulf states who are no longer running their trade surplus,
at least temporarily having to sell, or the oil price having to correct up massively,
or just the oil to gold ratio fundamentally does not mean revert to 20 anymore. And in this
new world order, this new economic regime globally that we have, perhaps that ratio is higher.
Not to sort of be predictive here, but of those three situations, which do you view to be the
most plausible? I think the most plausible is higher oil prices, for sure. Now, that clearly
will be negated if we get a major economic recession, because the old adage in the commodity
markets is the cure for higher prices is higher prices. So the reality is if you get a significant
sell-off rise in oil, you're going to get markets selling off. You're going to get an economic
recession probably is an outturn. And that by itself will probably correct the commodity price
spike. But the fact is that we've got to live through what is likely to be upward pressure
on commodities in the near term, and actually maybe in the longer term, if you start to believe that
governments are, their government finances are shot through. And, you know, we're overtaxed,
we all know that, we're probably on the wrong side of the Laffer curve. It's very difficult to
sell bonds, you know, bond vigilantes are basically, you know, keeping tabs on governments,
then the only course they've got is really to start printing money. And that's pretty much what
they're doing. I mean, they're not telling us that. But, you know, you look at the shifts that
Treasury Secretary Besson is making towards the front end of the market in terms of doing a lot
of bill issuance. You know, the real question to ask is who buys those bills? And the short answer
is who buys the bills? The very short dated debt tends to be banks. Banks buy government debt,
That is pure and simple textbook monetization.
That's what's going on right now.
The US is doing it.
The Japanese are saying they're going to start following.
The Brits are going to start following.
This is an easy way out for governments to do funding in the short term.
But it's not good prudence in terms of public finances.
Because, you know, to do a lot of short-term funding puts you really at the – you're hostage to markets and short-term interest rates.
And that's not good.
But the fact is it's monetization.
And that probably is what the gold market in the long term is going to start responding to.
Absolutely.
It certainly seems that that may have been the preliminary response over the last year and a half or two years.
Speaking of the treasury market, what's your outlook for the yield curve over this next part of the year?
Since what happened in Iran, obviously twos are up, tens are up.
But the shape of the yield curve, what's your view on how that's going to unfold over the next couple of months as we head into Q3 here or Q2?
Well, I've got a very clear view on that.
We've been saying that we expect the yield curve in the US, but true globally too, will basically flatten by the middle of the year or begin to flatten by the beginning of the year.
So we definitely see an inflection.
So what you're seeing in the Treasury market right now is actually no great surprise.
We've been on that side to say that the yield curve will flatten.
And that's broadly because if you see – I mean this is really outside of the Iran conflict.
This is looking at the broad trends, that if you get liquidity conditions tightening, the demand for treasury or safe asset treasury is going to pick up significantly.
And if you go back to, you know, not even, you know, two, well, probably two and a half months ago, you go back to the start of the year, you know, that was the absolutely non-consensus trade.
Basically, everyone was arguing for a steeper yield curve.
You don't want to own bonds.
That was the sort of credo curve that was around in everyone's lips.
and actually that's turned out not so well.
I mean, okay, long-term yields have moved up a tad,
but at the end of the day, the great, great surprise in markets
is how stable and actually how flat
and maybe even how much lower term premium
have actually moved in recent weeks.
And that has really gone completely against
what the consensus has been arguing.
Yeah, absolutely.
I mean, just one month ago,
slightly prior to the initial strikes,
you had the belly of the curve was inverted
And now we've tended to normalize a bit.
And so it seems like your thesis is playing out here in real time.
So taking a step toward asset markets here, you said obviously the liquidity cycle is
moving into a downturn.
It has been since late last year.
Bitcoin seems to be one of the first assets, along with software stocks and a number of
other really high beta equities, to sniff that out and begin selling off in early October.
The question I have is a little bit different from what you may have been asked before.
Maybe you've had your eye on this over the last month, but relative to a suite of major
macro assets, gold, the S&P 500, silver, Bitcoin has been outperforming since the start of
the war.
This is very strange to me because typically, right, in these events where correlation is
true to one, Bitcoin is one of the assets that gets hit the hardest.
If you see the S 500 down 4 which it is over the last month Bitcoin tends to be down 8 or 9 However Bitcoin is up about 7 7 while silver is down about 20 gold is down about 17
Spooze and the NASDAQ are down marginally.
What do you think is the explanation for this?
Is this purely a function of the sell-off in Bitcoin being front-loaded to the end of last year, or is this something different?
I think it could be.
I mean, I think there are a number of things going on.
But I mean one of the things that – one of the factors that I would cite is that – or to recall is that if you look at the performance of Bitcoin and gold, I mean take those two assets together as being sort of pure monetary inflation hedges.
Over the long term, Bitcoin and gold tend to correlate positively.
But one of the anomalies and one of the curiosities one finds in the data is that they have a short-term negative correlation.
So basically, they tend to trend together but cycle apart.
And that's curious, and that may tell us a little bit about the dynamics between the two markets, maybe people doing substitution trades or arbitrage trades between the two.
I'm not sure.
But that seems to be really what's going on.
In a way, it fits in with the pattern of the data.
Why it's happening is kind of curious, and it may be with practicalities, is it may be this arbitrage which is going on.
So people felt gold had gone too far and they were switching out of gold back into Bitcoin.
That's a possibility.
The other thing is that you've got to remember what the Federal Reserve has been doing in the very short term
is the Federal Reserve basically introduced reserve management purchases late in 2025.
Now, those reserve management purchases have basically caused treasury holdings at the Fed to spike upwards quite significantly.
So in other words, what you've seen is something like a restoration of about $200 billion back into US money markets.
So in other words, US bank reserves are now testing around the $3 trillion mark, having been down at about, from my memory, about 2.8 or maybe a tad lower in late 2025, early 26.
So you've had this sort of rebound in liquidity, which has really been the result of the Fed moving liquidity back in.
Now, that may be a short-term impulse.
I'm not sure.
Liquidity conditions, if you look at it on a very short-term weekly basis, have ticked slightly higher.
But that doesn't deny the fact that the trend generally looks to us to be downwards.
But, you know, these things happen.
My view would be that, you know, like probably the same sentiment towards gold.
I mean, these are proven long-term monetary inflation hedges.
Bitcoin, admittedly, has only proved it over 15 years, gold 5,000 years.
But the fact is that both have got a pretty good, let's say, recent track record of hedging monetary inflation.
If we're going to get more monetary inflation, which I would be 100% certain we are because that's the only route out, you've got to own both these assets.
And generally speaking, you don't necessarily want to trade these assets.
You want to own them.
And that's really the sort of bottom line.
We know that gold and Bitcoin trend together.
We know there's history of them cycling apart.
The way to operate in this environment is basically to say, well, okay, I'm trying to
build my positions up, and I'll do it when they fall significantly below their trend lines.
That's not going to happen overnight, but it probably will happen because that's the
way the markets work.
They go up and down.
But I would be looking to buy both assets when they're about one standard deviation or
hopefully more below their trends.
What does that mean in sort of dollars and cents?
It probably means about 20% below.
But that would be a fairly decent rule of thumb.
So that's what I would be doing.
And I wouldn't try and sort of, you know, never try and catch a falling knife in financial markets.
But, you know, equally, when sentiment gets really beaten up, it's probably not a bad time to be moving back in.
But I think you'll wait for a little bit of stability first and then start to act.
Absolutely.
Yeah, and it seems gold has at least begun to demonstrate that stability or at the very least begun to demonstrate that it is bouncing off long-term trends.
A couple of days ago, we bounced, I believe, off the 200-day or 200-week moving average.
I think it was the 200-day moving average for gold, 27% dry down, which is not typically what you see in gold.
So certainly a good entry point there.
You talked briefly about the Fed's R&P facility, their reserve management purchases.
It's funny, a friend had joked to me,
it seems like they're running out of acronyms
for their liquidity facilities at this point,
but I don't think there's any shortage of them.
The cadence is about $40 billion a month in bill purchases.
Is this liquidity positive?
Is it liquidity neutral, liquidity negative?
What's your view on this RMP facility
and any impact it may have on risk markets, if any?
Well, I mean, the answer is that it's positive
because it's more liquidity.
It's a QE exercise.
They deny that, but clearly it is.
I mean, there's no question about that.
is it positive yes for sure is it big well probably not i mean in in in overall terms it's
not going to be that big i mean it may add back you know i mean potentially 250 possibly 300 billion
this year i mean that's not insignificant clearly but you know in the big scheme of things it's not
going to necessarily move the needle over the long term um you know the fact is that it's been
front end loaded. So, you know, it's in anticipation of the April tax paying season when the TGA will
spike. So that's probably the peak of their activity. But, you know, I mean, it's not bearish,
but in that way, the question is really just to find how bullish it is. And I don't think it's
that bullish, but I mean, it's clearly a positive, not a negative. Are they going to do more? Well,
I think the thing is, I mean, what's been demonstrated here, and I think this is a,
pretty good point as to the future, is that repo markets sold off at the end of last year.
In other words, what I'm saying here is that repo rates spiked well above Fed funds or interest
and overnight reserve balances of banks. That spiked significantly when there was a relatively
minor drawdown in money markets. So it shows how poised or tense markets are, repo markets at least.
And we saw these spikes and there had only been a drain of about 200 billion. Now,
If you start to think of what the Fed is kind of talking about, maybe, you know, incoming Governor Walsh and Treasury Secretary Bessender inferring, they're talking about, you know, taking trillions out of the Fed balance sheet to get it down to some what they call nostalgically some sort of normal level.
I just don't think that's possible.
I would really, really struggle to feel comfortable with that because, you know, the fact of the matter is, is that since the GFC, the Federal Reserve has not only got to look after the banks, it's got to look after the bond markets and the shadow banking sector combined.
And if you look at the scale of the change, since the GFC, if my memory serves me correctly, we've had a twofold increase in overall bank lending, okay?
And we've had a five and a half fold increase in the size of treasury debt outstanding, marketable treasury debt outstanding.
So that fivefold or more than fivefold increase in Treasury debt is saying that the Federal Reserve is going to have to be on guard against disruptions in the Treasury market, not least because dealer capacity in the private sector has probably halved or maybe more than halved during that period.
So the normal stability mechanism is really not there and the market is way, way, way bigger. What's more, since the 2008 crisis, markets are much, much more collateral based.
And so the US Treasury bond is really at the center of the global financial system now in a way that it wasn't before.
And so the Fed has really got to be on guard against disruptions of volatility in that market.
And they need a decent-sized banal sheet to do that.
Now, clearly, I'll come quietly and accept the fact that they could, at a throw of a switch, come back in quickly and add a lot more liquidity if necessary.
So from a much lower level, they can inject a lot of money.
But the trouble with doing that is that you're kind of hostage to fortune each time.
And every crisis you have to deal with, the Fed's reputation is on the line.
So I don't think that's sort of good policy or good politics to do that.
So I would be guarded and slightly wary about a big shrinkage in the balance sheet.
Certainly.
So if that's the case – I mean we have Warsh coming in in just a couple of months here.
First time we've had a new Fed chair in quite some time.
Do you think he's going to be much different from Powell?
Well, if the mathematical reality is that we have to keep expanding the balance sheet, we can't necessarily normalize it to pre-GFC levels like a lot of folks are trying to say we can, then what, if anything, about Warsh is going to be different from the way that Powell is operating right now?
Well, I would like to say, at least I think, he's going to be radically different for sure.
I mean, I think that's the intention.
You know, my view is that, you know, the route forward for the US and US policy is to really enhance the virtues of stablecoin.
I think stablecoin could be big.
I mean, we're, you know, we're only in the foothills yet at that market, but it could grow sizably.
It would enable the re-dollarization of the world, something, a theme that Brent Johnson has spoken about many times.
And I think he's absolutely spot on with this, that this could be a very significant development.
A pointer to the threat is what's happened in China in the last few weeks.
The Chinese have come out with a new restraining order called Notice 42, which basically doubles down on their previous blocks on Bitcoin, digital money of all form of cryptocurrencies.
So they're making absolutely sure they're raising a significant firewall or great wall or whatever you like to call it against this threat.
So they really see it.
But once you start to go outside of China and look maybe at Africa or you look at Latin America, you look at countries like Turkey, you even go to mainland Europe, you look at Britain, you look at Australia.
Are these countries really prepared for stablecoin, the threat of stablecoin?
Now, it may well be that if you're in the developed or advanced economies, you might not see or residents might not see a great need.
But there clearly will be some people that think the anonymity of stable coin is actually worth having.
If they think they can get outside the tax net, then they're going to start to accumulate these things.
But if you're in these other economies, Africa, Latin America, Turkey, et cetera, where you've got an inflation problem and you've got a flaky domestic currency, I think it's a no-brainer, quite honestly.
And so you're going to get a very rapid dollarization of these markets.
Now, I don't think the policymakers have kind of thought through what this means yet, but it could be a real windfall for the US Treasury if they can pull this one off.
It's significant. It's a game changer.
Absolutely. Yeah, you've – I think in one of the podcasts you did, I think it was the MacroDirt podcast, you said that stable coins are potentially one of the trump cards that the United States holds.
Obviously, now that we're in a hot war with the Middle East, countries are sort of scrambling for US dollar liquidity.
Oil is being rerouted.
Do you think that this crisis is actually accelerating stablecoin adoption globally?
I think it's making people certainly think or rethink the idea of moving away from the dollar, in my view.
I know one reads in the sort of the financial media, particularly the Financial Times, which seem to have a thing about the US dollar,
that every chance they get, they want to stick the knife in and say, this is the end of the dollar.
I just think the trend is going the other way, to be perfectly truthful.
I think it's actually more the opposite.
Now, we can debate about the merits of the paper dollar,
and I'd be the first to say that US public finances don't look strong.
But at the end of the day, that's not necessarily the only thing that the dollar's strength really rests on.
There's a huge network.
And I think increasingly, if you start to look at the digital world,
It's really the sort of the payment system which is really deriving the adoption of currencies.
And if those payment mechanisms are going to start using stable coin or even just dollars per se, you're going to drive increasing demand and increasing usage of the US dollar.
And as far as I can see, that's, if you like, a kind of inverted Gresham's law.
So it's not a question of – or is it bad money drives out good?
It's actually the opposite.
is that good money drives out bad,
and people will start to realize that the good money is what you can pay with.
So if these digital payment networks are actually using dollars
and that's an embedded currency within the system,
then people are going to use these things more and more,
rather use the US dollar than the Brazilian real
or the Mexican peso or the Nigerian currency, I mean, for sure.
These are going to be ultimately international payment mechanisms
or big international payment mechanisms which underpin the dollar.
Absolutely. It almost seems like we're sort of recreating the euro dollar market from first principles and re-dollarizing the world at a time where many pundits have argued that we're actually moving in the opposite direction.
Yeah, I think that's right. I mean, we're basically moving there. I think that what I'm going to do is shift and turn and put a light on because you're talking to me as dusk is breaking in Europe.
So we're going from bright sunshine to nighttime.
So anyway, yeah, I think what we're getting here is that the euro-dollar market was essentially a wholesale market, which was very leveraged.
Now, I think if you look at the stable coin market, you won't get the leverage, and it'll be retail, not wholesale-focused.
But nonetheless, that parallel with those caveats, I think, applies.
Very well said.
Outside of the control of policymakers Absolutely I want to chat quickly about the debt maturity wall You spoken numerous times about how financial crises most financial crises are refinancing crises
It obviously doesn't help right now that U.S. Treasury yields are spiking across the curve.
So with the debt maturity wall climbing, liquidity is obviously declining, oil spiking,
which is not helping at all. And on top of that, we're now in a hot war and Congress is debating
spending hundreds of millions of dollars. How close are we to sort of the debt to liquidity
ratio crossing what you would consider to be the danger threshold?
Okay. So what we can see here, Joe, is the global liquidity cycle. And this is really the
centerpiece of what we do. And this is looking at the underlying momentum of global liquidity.
And what you can see is that the cycle moves with a frequency of about five to six years.
The red dotted line is a sine wave that we've estimated using Fourier analysis on top of
the actual data, which is in black.
And that five to six year cycle bottomed in October of 2022.
It peaked in Q3 of 2025, and it's slated to fall into 2027.
So this year is basically a year where liquidity is really slowing down quite markedly.
And that's really why we're concerned.
Now, what you pointed to was what are the risks of this because clearly less liquidity is not as good as more liquidity for financial markets.
So let me just move on to what this really means.
And I'm going to come back to this chart.
Now, what this chart basically shows is a schematic which argues that at the heart of stability in the modern financial system is a relationship between debt and liquidity, which we think of as the debt liquidity nexus.
that basically says that liquidity needs debt insofar as that something like almost 80% of all lending is collateral backed.
And also debt needs liquidity and something like 80% or 70% to 80% of all transactions in the financial markets are refinancing transactions.
In other words, debt needs liquidity for refinancing.
So you've got these twin legs, and what the diagram is trying to show is that there is an equilibrium there between debt and liquidity, and you have two wings.
Either of those two wings can derail, so you either get the right-hand leg, which is the refinancing leg basically unraveling, and that will be signaled by credit spreads blowing out or term premia on government debt, in other words, safe assets coming to demand and term premia falling.
Or you see the left-hand leg, the repo collateral leg, in other words, turning debt into liquidity, that leg breaking down, which basically is signaled by sofa spreads blowing out, or the move index of bond volatility, which governs the collateral multiplier and collateral haircuts, starting to spike upwards.
Now, if you start to look at that particular process, the debt liquidity ratio is basically illustrated here. And what we show is the long-term track of that going back to 1980. And what we've used here is our data on global liquidity and IMF data on world debt.
and that gives the ratio that you see here for the advanced economies.
And if you look at that, there's a long-run equilibrium at about 200% or two times.
So in other words, debt to liquidity of two is normal and anything significantly above that,
up at the 220, 230 levels, tends to see crises resulting.
In other words, what that's saying is there's too much debt in the system relative to liquidity
to be refinanced, you get refinancing tensions, and central banks are forced to come back when
there's a crisis. You've seen, as you can see, illustrate on that chart, refinancing crisis that
we've identified. If you go to the opposite extreme, at the bottom, what you find there is
you get basically asset bubbles, because if there is so much liquidity in excess of the amount of
debt that needs to be refinanced. What you get is the vent being asset price increases, asset bubbles.
And we've illustrated those on the chart. Now, what we've just been through is the so-called
everything bubble. And the everything bubble is actually, as you can see here, quite a big one.
There's been a huge amount of liquidity relative to debt. And that's really been caused by two
factors. One is the response of policymakers to almost every crisis is to bump in more liquidity.
and we've seen that as recently as late last year with the reserve management purchases by the Fed.
We saw it in 2019 with the repo crisis. We saw it in 2020 with the COVID emergency.
We saw it in 2008-9 with the Lehman crisis or global financial crisis. So all these responses
basically mean more liquidity is pumped back into the system and it's going to happen again.
But the problem is that central banks are reactive. So number one is that liquidity conditions were
abundant. As we've said, they're beginning to weaken now. The other factor is that debt or the
amount of debt that was coming due to be refinanced has basically slowed recently because as a result
of the COVID emergency, recall that central banks also slashed interest rates to near zero in cases
is negative, in fact. And what that did is not only encourage the take up of more debt,
paradoxically, it also meant that debt was being termed out into later years. So in other words,
you take your borrowing, which is due in two or three years time that you're paying 5% interest
on, and you think, well, hey, why am I doing this? I'm going to refinance near zero. I'm going to
term it out back into 2027, 2028, 29. And that's what was being done. So if you look at the debt
maturity wall, this is showing the increments. This is not the actual level. This is the
incremental changes in terms of debt that is coming into the system, growing each year. This
is the incremental increase each year in the amount of debt that needs to be refinanced.
And the overall amount is close to $50 trillion. But this is the increases you're getting. So about
10% increases each year in the actual amount that needs refinancing. That is on top of what we're
also seeing, which is new debt take up. So this is what's crowding into the markets. And it's fairly
clear there that the big bite out of that chart in 21, 22, 23 was because of very, very low interest
rates. Now, the crazy policy that policymakers enacted is coming back to haunt them. And that's
That's what is called the debt maturity wall, which markets will have to face.
If you go back to listening to who was probably the doyen of central bankers, somebody called
Walter Badgett, who wrote some of the definitive very early works on central banking in the
UK back in the 19th century.
He has a famous quote, which is basically, lend freely at high interest rates against
good collateral.
And what our central banks have been doing in the last few years is lending furiously at low interest rates or negative interest rates against no collateral.
And that seems to be a completely crazy policy to adopt and we're ripping the consequences.
Absolutely. Yeah, it certainly seems so.
I want to go back to the previous chart briefly because I've got a question about the debt to liquidity ratio there.
What it shows here, you can see for the viewers at home, the everything bubble that's sitting on this chart, not only the deepest trough that we've ever seen going back to when the chart begins, but obviously central banks created that by flooding the system with just an insane amount of money printing, a crazy amount of QE.
Scott Bacent and Kevin Warsh both have explicitly said that they want to avoid repeating that.
Right here, you show that we're going to reach Eurozone banking crisis levels around 2029, 2030.
So if we have this scenario where they succeed in keeping the Fed's footprint smaller, they don't do massive balance sheet expansion, does that mean the ratio could ostensibly climb faster in the next crisis may come sooner than later?
Entirely possible, yeah.
I would agree with that. No question. I think that this is why it's very dangerous to sort of
muck around with the architecture of the financial system. The fact is that since the global financial
crisis, despite all the regulation and whatever else we've had, the system has basically become
more fragile, not more robust. And although there's been a lot of regulation of banks,
and banks are not really the problem today. That's not the issue. The issue really comes
much more to the credit markets and maybe even the government debt markets themselves.
And that's really the issue we've got to face. I mean, government debt markets, as I indicated,
are five times bigger than they were in 2008. I mean, this is eye-watering and eye-wateringly
bigger problem. Absolutely. A question that's a bit of a departure from what we've been talking
about. In previous podcasts that you've done, you've laid out a vision of two competing monetary
systems forming globally, one being a U.S. system that's backed by stable coins and treasuries and
that complex that's sort of taking shape, and the other being a Chinese system that's backed by gold
or physical commodities. Now that we have an actual shooting war in the Middle East, a hot war that
we haven't had in quite some time, disrupting real physical commodity infrastructure with the Strait
of Hormuz being closed, which underpins the Chinese system, does that accelerate this bifurcation or
does that complicate things a little bit?
You know, to be perfectly truthful, I don't really know.
I find the whole landscape of geopolitics kind of very difficult to read right now.
And, you know, although this war may seem on the face of it to be going not so well for
Trump, I'm not sure whether this was actually planned anyway.
You know, I mean, the real casualties that come out of this and not the US.
The US is self-sufficient in energy.
The real problem comes to Europe and also Asia.
I mean, that's where the costs are going to be in terms of getting oil or gas again.
And what it really means is you need a reset of maybe energy politics worldwide.
And it may well be this could be a precursor for somehow getting Russia back into the world system, partially the Ukraine crisis.
But I mean, at the end of the day, maybe this is what happens longer term.
I don't know.
But as far as I can see, actually, the US is in a much better position than maybe a lot of the media kind of suggest.
Now, that's obviously predicated on the fact that we don't have a particularly hot war.
But, you know, nonetheless, I think the US is pretty much OK here.
I think as regards China, what does it do for China?
I would tend to think that what this is broadly doing is bringing the US and China maybe closer together paradoxically
because I think it shows that there is a need or there's an impossibility of decoupling in a sort of a decent or workable way.
So I think this is almost emphasizing the interconnectivity of the world.
Now, that may seem a certainly non-consensual view, but that's how I would see it.
Now, if you kind of put the currency question on top of that, it probably does, having said that, accelerate this movement towards a bifurcated system.
Because China will have to make its own economy and financial system more robust.
and the issue at the end of the day is that
this goes back a long time
and it goes back to the book I wrote
called Capital Wars back about five years ago
I mean the sort of
maybe the sort of takeaway from that
in many cases was that
China was leaning far too heavily on the dollar system
China was, I don't want to say a dollarized system
but it wasn't far off bad
it was very dependent on the US
and it was trying to get away from that
And, you know, they've made small steps so far, but they may have to accelerate that rather more. And I think the only way that they can really do that to create a viable financial system is to use as collateral an asset that internationally we all understand.
Now, the US has got the advantage of using the US Treasury bond as a backing for the dollar.
And that really is what is sort of backing, ultimately, the collateral that backs the dollar system.
What has China got?
Well, OK, it's got a bond market.
It hasn't got an international bond market.
The Chinese bond market is big, but it's really domestic.
The only asset that they could use to benchmark the yuan would be gold.
And I think what they're doing at the moment is a very, very tricky exercise.
where, in my view, they're trying to devalue the yuan internally
because of this huge debt problem they've got.
And let's not forget the fact that whatever we may say about Western debt
or US federal debt or whatever it may be,
China's got a bigger problem.
They've got much, much more debt, and it's in the wrong places.
It's burdening the private sector, and they need to get out of that.
And the only way they can seriously get out of that is to devalue debt because in modern financial systems defaults are ruled out because effectively defaulting debt you defaulting your collateral
that backs the system. And the paradox here is that you need old debts to create new credit.
And that's the fact of the system. So there's no way they could default. They've really got to
devalued debt. And that's what I think they're doing. And that's what I think all the increases,
and I can demonstrate with a chart, this is what China is basically doing. This is the net
liquidity injections by the People's Bank in China. This is actually, to be accurate, this is
the year-on-year change of liquidity injections. So this is the increment that they're adding to
the markets each year. So you can see this is climbing quite significantly. And what we're
talking about is a figure here, which is close to a trillion dollars a year. So, you know, these are
big amounts of liquidity put in. And, you know, just to think here that the US Federal Reserve's
balance sheet or the effective balance sheet, you know, let's say bank reserves are three trillion.
So, you know, China is adding a third of that every year to its financial system. So these are
big amounts. And, you know, one of the things that we've said before is that, you know, what
they're trying to do is to devalue money internally in China, while at the same time trying to
maintain the external value of the yuan as best they can. Now, that is a very, very tricky exercise.
And I hope they pull it off, but it's kind of a difficult one. And what that really means is
that if you look at this chart, what it's showing, and this is out of date now because,
I mean, the gold price is moving so fast. In fact, the orange line is down testing 30,000
in the last two or three days. So you've had a big sell-off in gold, fair enough. But let's just
look at the trend here. What you're looking at is a huge increase in the yuan gold price over that
period. And that has been basically the result of the Chinese printing lots of money. So let's not
get carried away with the idea that the West is debasing its monetary system, which it may well
be doing in the long term. China is doing it at a much faster rate. And that probably explains why
the gold market has gone up so much. And what this chant here identifies is Chinese PBOC liquidity
injections, which is the black line, and the orange line is the price of gold. Now, is it really the
West that's been driving the gold market or is it China? Well, if you talk to gold traders and
gold investors, they will tell you that the marginal price is the Shanghai Exchange, no longer COMEX
or the London market. The central gravity has very clearly moved towards Asia. And that's what
I think is going on. So what you're seeing is the paradox simultaneously of the Chinese retail
investor buying gold to protect against domestic monetary inflation. And at the same time,
the Chinese government buying gold to maintain the external value of the yuan.
So they can, at some stage, offer notional gold, maybe gold oil exchanges or whatever it may be,
whatever they want to do, gold, copper or whatever.
They could do that with selected countries in much the same way
as the old gold exchange standard operated in the 1950s and 60s.
So it was only central banks that could basically get access to full nox.
And that was highly selective.
And it's going to be exactly the same in China's case.
So maybe the Saudis could do the odd deal, oil and gold,
but this is not going to be offered to everybody.
Very selective.
And that maybe gives a benchmark for what the yuan, what will back the yuan.
So I think that you're getting this process.
And China has very, very clearly put a marker down to say that it is not doing, that is not, you know, going the same route as the US, which is digital cryptocurrency for the yuan.
It may be doing it internally, but they're certainly not doing it externally.
And, of course, they've got capital controls, which makes it doubly difficult.
Gotcha. Fantastic. As we round out, and thank you for the explanation, as we round out the show here in the next 10 minutes, one thing I wanted to ask you is about sort of the evolving relationship between the Fed and the U.S. Treasury.
I think you were on with Jack Farley in talking about this and sort of laying out the case for why the Fed is sort of becoming less important relative to the Treasury as they sort of become one of the sort of take the reins, if you will, as far as the main monetary policy engine through bill issuance and stable coins.
You know, if that is the case as we move forward, what does that mean for how investors should think about Fed meetings and rate decisions as we move sort of into this new regime, this new Fed Treasury accord, if you will?
Well, I think the whole, as you rightly suggest, I mean, what we're getting is a shift in
favor of the Treasury.
The Federal Reserve, I mean, the whole intention or the tenor of what the incoming Fed chair
Kevin Walsh is talking about is to reduce the size of the footprint of the Fed to basically
try and cut its wings or clip its wings because the Fed is sort of straying into too many
areas.
I mean, we probably all acknowledge that. And it really needs a smaller footprint in that sense, maybe philosophically.
As I've said, it's kind of difficult when you're talking about managing the financial system to have a smaller balance sheet.
But in terms of the direction of policy, I think that that is probably a pretty good summary of the trend.
Now, what does that mean in practice?
I mean, one of the ways that we described that before was to say you're getting a shift from Fed QE towards Treasury QE.
And what we meant by that is the Fed's ability to inject or maybe the Fed's willingness, I should say, to inject a lot of liquidity into the system is being compromised.
And the Treasurer's ability to inject liquidity has been enhanced by bill issuance.
Because as I alluded to before, if they issue a lot of bills, they tend to be bought at the margin by banks.
And if the banks buy any form of government debt, that is monetization, that's printing money.
But the difference here is that when the Fed injects liquidity, it is spraying it everywhere, particularly through financial markets, and asset prices tend to go up.
When the treasury creates liquidity and spends it, it spends it in the real economy on real things and it tends to – for the most part, real things.
And it tends to buy things like defense procurement, strategic stakes in US tech companies, critical minerals or whatever, these sort of things which are much more creative of economic growth rather than asset price inflation.
So I think that's one of the ways to think about it in terms of liquidity.
In terms of interest rates, I think we just need a fundamental rethink about what's going on.
And that may be difficult to rewrite textbooks or unlearn economics in the short term.
But the fact of the matter is that what do interest rates mean?
If the Federal Reserve is saying, well, OK, we're going to raise interest rates, what are they trying to do?
Because in a world where you've got the private sector in strong surplus and you've got the government sector in more frequent deficit,
It means something different than the old model where households were at surplus and the corporate sector was a borrower in deficit.
And in that world, when the corporate sector wanted to invest and it needs to borrow money, interest rates were the arbiter of that process.
So higher interest rates slowed capital spending and slowed the economy and encouraged more savings and vice versa.
But that's not the world we're in, OK?
There's no sort of big capex going on really in the West,
apart from this AI boom, but that's coming out of cash flows.
Most of the investment is being done in Asia and in particularly China,
where interest rates are not really that important anyway.
So that's not the world we live in.
We live in a world where governments are in deficit,
private sector is in surplus,
interest rates affect the government interest bill,
and that is a transfer payment from the government sector,
to the public sector, to the private sector.
So actually, if you think about it,
if the government is basically issuing lots of bills
and the Federal Reserve is raising interest rates,
the transfer payments to the private sector start to go up, not down.
That's a monetary or income stimulus, isn't it?
Not a contraction.
So the whole world has kind of turned topsy-turvy.
And this is what I think needs to be rethought.
But it's very difficult with the Federal Reserve to reeducate,
300 million people that easily.
Very, very well said.
Last thing I'll sort of say for you,
to make this practical for our listeners,
obviously lots of information we discussed today.
Oil completely raging, the Iran war,
sort of will they, won't they, and this thing.
Trump is saying one thing, the state is saying another.
Wars coming in in just two months, liquidity on the decline.
Walk us through how you're thinking of asset allocation
given the backdrop of where we are in the global liquidity cycle right now.
Let me go on to the cycle and where we are, and I'll just finish off on that.
So we think of the cycle in this way.
This is really a schematic version of the cycle that we saw.
And this is saying that around the peaks, you want commodities.
That's where we've been.
In the upswings, you want equities.
In the downswings, you want cash.
At the low points, you want government fixed income.
You want bond duration.
and you basically shift around in that fashion.
And we look at it in terms of traffic lights.
So traffic lights, what you see is what you get.
So green is go, red is stop, and amber is proceed with caution.
And what that's basically saying is you've got four phases of the liquidity cycle.
Rebound and calm are the upswing phases.
Speculation and turbulence are the downswing phases.
The US market is well embedded in speculation as far as we can see.
And if you look at the left-hand side of the chart, those traffic lights are assets.
The right-hand traffic lights are industry groups.
And what that's pretty much saying is if you're in speculation, you want to be paring down your equities.
Obviously, in turbulence, you don't want equities.
That's a very low allocation of red.
Credits, you don't want in speculation.
Ironically, you can pick up credits in turbulence because spreads have already widened significantly.
So you've got a pretty good yield cushion at that stage, but you certainly haven't now.
Commodities still look good in speculation.
Bond duration, probably you want toe in the water.
That's beginning to come right as the yield curve flattens.
And by the time you get to turbulence, you want basically more bonds.
If you look at – and by the way, this is a tactical or cyclical view.
It's not – in the long term, I'm not a bond investor.
But in the short term, I certainly am.
and not in the long term because of monetary inflation risks.
But if you then look at industry groups,
what that's really saying is you want cyclicals in the upswings of the cycle,
rebound, calm.
You want defensives in the speculation turbulence phase.
The cyclicals basically run from technology immediately.
You don't want technology now.
You've got to be out of technology, as that red dot says.
Financials, you should be paring down quite quickly
because the yield curve is flattening and credit risks are rising.
energy commodities still are pretty good. And you want to be starting to move towards defensives,
which are consumer staples, utilities, etc. And that's pretty much how we're doing that.
And I haven't put gold or Bitcoin in this particular configuration, because I think
those are long-term assets, in my view. They should be core holdings and portfolios.
But you don't necessarily want to trade those, you want to own them. But my view, as I said,
probably Joe at the beginning, is that buying them on weakness is a fairly decent strategy.
It's always difficult to catch a falling night. But I would generally say,
you want to be buying these things when they're about 20% or at least a standard deviation below
their trends. Fantastic. Michael, thank you very much for laying all of that out. I think,
for our viewers in particular, with Bitcoin being down 45% gold now coming off its highs,
equities beginning to roll over, there's a great deal of confusion. So it's always so valuable to
have you on because you can very cleanly articulate what's happening in markets and sort of where we
are from a cyclical perspective, which is what everybody needs to do. They need to zoom out
and stop being day traders, become people who are allocating for years and decades.
Michael, I really appreciate it as always. Before we wrap up here,
where can people go to find more of your work and follow along?
Well, probably the easiest route is to look at the capital walls sub-stake. We write three to
four times a week on what's happening in markets and provide data.
There is an institutional service which you can get either via cross-bordercapital.com
or glindexes.com.
GL Index is a pure data provider.
Or you can, if you want to read a book about what was, well, what is going on in the financial
market.
So it was written about four or five years ago.
So then Capital Wars, the same name as the sub-stack, is the book published by Mellon in 2020.
Fantastic.
Michael, I appreciate it as always.
And for the viewers and listeners of the program, that will be linked.
All of those will be linked in the show description and the show notes.
Michael, we really appreciate it.
Great.
Thank you, Joe.
Enjoy the normalcy.
And then there's a point which does nothing.
Bitcoin or something like that.
Bitcoin is 17 years old.
I could kill less with Bitcoin trades for.