You've had a dynamic where money has become freer than free.
If you talk about a Fed just gone nuts, all the central banks going nuts.
So it's all acting like safe haven.
I believe that in a world where central bankers are tripping over themselves to devalue their
currency, Bitcoin wins. In the world of fiat currencies, Bitcoin is the victor.
I mean, that's part of the bull case for Bitcoin.
If you're not paying attention, you probably should be.
Michael Howe, we last met in February.
It's now the end of July.
Happy to have you back.
Well, Marty, it's always pleased to be here.
Well, we were chatting a bit before we hit record.
I think probably the best place to start is Kevin Warsh and this federal reserve rate decision.
And he's got to make or the board has to make this week.
As you were saying, many people are focused on bond yields right now.
And it's actually, I didn't mention this before we have recorded, but it looks like yields want to drift higher.
They probably have to let that happen.
Will they is another question.
But one thing that I've been observing as these bond yields have been drifting higher is the move index, the volatility index of the government bonds here in the U.S.
And it looks like that's relatively controlled.
And that's one thing I'm wondering is if they're watching the move index more than the actual yield and trying to make sure that they can just suppress volatility on the way up.
Yeah, I think unquestionably that's what's going on.
There seems to be deliberate manipulation of volatility in the market.
I mean, I call that yield volatility control, not yield curve control.
I think there is a policy to do that.
That policy basically embraces two things.
One is issuance at the short end, which has clearly been on a roll over the last two to three years.
And the other factor is basically doing treasury buybacks, which always seem to pick up in response to increases in the move index.
So when you see a jump in bond volatility, the treasury comes in, offers an auction to buy back more off-the-run bonds, and lo and behold, the move index comes down.
So I think there's a direct response there.
So in my view, they're doing it.
Why are they doing that? Because essentially, they can encourage leveraged funds, i.e. hedge funds, through an arbitrage trade to borrow in the repo markets and basically buy the cash bond.
And that depresses yields. And I think that that is a meaningful factor. It's probably at least 50 basis points, if not more, off the yield on the 10-year.
So, I mean, this is a material effect. But I think we've got to put this into perspective.
And the fact is that you're looking at the pace of the US economy, which I figure is at least between growing in nominal terms, at least between 6% and 7%, if not breaking through the top of that, given the AI spend, yields have got to be a lot higher.
I mean, this gap of more than 200 basis points between nominal GDP and the 10-year bond is unsustainable compared to history.
Yields have got to rise, and they are trying to rise.
The administration in various forms is trying to pull them back.
It's struggling to do that.
As you know, U.S. is continuing to edge up.
But the fact is that history shows that it's the long end of the market that determines the short end of the market.
And not as textbooks tell us, the short end that drives the long end.
Ultimately, the Fed is going to have to start hiking rates.
Walsh could surprise us perhaps and do it today.
I mean, the market is only discounting 30% chance of a rate hike.
But it's going to come either this meeting or the next meeting, it might be.
Yeah. And I've heard commentary around it.
The dark horse bettors betting on a rate hike saying that it would be good to do it now because it would confirm this new framework that Warsh has come in with is that they don't want to do forward guidance.
So a relatively a relative surprise with the rate hike, considering where the odds are right now, would do that.
It will be really interesting to see if he takes the opportunity to do that.
But as you mentioned before we hit record, does he have the gumption and the balls to do it?
Yeah.
The fact is, would he carry the rest of the FOMC?
I mean, he's only one vote, but he may be persuasive enough to swing the balance.
I mean, who knows?
But I think it would be a decisive move.
And as you rightly say, it would basically end the forward guidance regime, which I think has been a bad regime.
for sure. And it would basically endorse some of his thinking, which is money supply matters.
Money supply is on a tear at the moment. That often tells us that inflation is a problem down
the road. So these are the questions that the FOMC have got to tackle. And I think a right
hike now would basically draw a line in the sand and show the Fed is serious And I think the firmness of the dollar in my view is saying that the market is starting to believe that rhetoric that the Fed is in the process of tightening When you say the money supply is growing what are you looking at M2
Well, if you look at M2, I mean, it's admittedly, you know, in the last two or three weeks, it's cooled down a bit.
But it was a three-month annualized rate was testing 10% a little while ago.
So, I mean, that's a pretty solid growth rate.
What's leading to that expansion? Is the SLR ratio changes, is the commercial banking industry issuing more credit?
Yeah, I think that's clearly having some effect. But I think at the end of the day, this is really a response or reflection of strong nominal GDP growth.
And why is the economy growing so well? And I think whether it's a K or not, the fact is the average is growing at a high rate.
And this must be the AI cap expense.
It must be the large fiscal deficit.
It must be the pickup in exports, particularly oil energy exports, following tensions in the Gulf.
All these factors make a big difference.
And the economy looks, looking at NGDP numbers, nominal GDP, it looks pretty solid.
It looks solid.
A lot of people are worried about this AI cap expense.
Specifically, there's a lot of bears out there.
We're saying that we're in a bubble.
Yeah, well, I think, I mean, in many ways it is.
I mean, that's how capitalism works.
We've seen it time and time again.
It's those investment opportunities.
You are compelled as a company to invest.
You don't really know what your competitors are doing, but they're copying.
And so you get this massive overcapacity.
We saw that with fiber optic.
And you think back to Global Crossing at the end of the 90s.
Global Crossing was one of the big IPOs that came in the late 90s.
Within five years, Global Crossing was in Chapter 11 because the prices of fiber optic
had dropped by 80%, 90%.
And it could easily happen again, deja vu.
Yeah, that's the thing. Well, is it day job? Is it like, is this time different? It's like famous last words.
that's like uh i've been really trying to wrap my head around this because
as somebody like we were just uh discussing too we've been using you were using the tool i was
mentioning uh the newsletter that you released uh today about bitcoin and cryptocurrencies and
where they may be in their cycle but you were mentioning that you you ran an analysis using
these ai tools i've been using ai near tftc pretty pretty vigorously my my usage is going up
considerably as i as i find more things that i can do with it and that's um a lot of people
usually tying it to the dot-com bubbles like is it really and then you look at like the pe
forward pe ratios of the memory stock specifically um out of south korea and they're only training
at like a four if you look at the the revenue and profitability and margins they're going up
considerably and so how what i agree with you this is how markets work and capitalism works i
guess the better question is like what stage of the bubble are we in even though we've had
incredible um runs in the stock market for individual stocks obviously korean stock market's
getting hammered this week but before then like is this just the correction um in a longer term
bull market. Yeah. I mean, I think it's still above its 200-day moving average. It still looks
as if it's potentially in a bull market despite the spike in the index. But I think you've got
to separate out earnings and you've got to separate that from valuations. And we're probably
jointly in a valuation bubble and an earnings bubble. The earnings bubble may go on, as you
correctly say, for some time because the momentum is there, people are spending. AI is a reality.
I'm using it, you're using it, a lot of people are using it.
It's going to be a must-have and a must-use in the future.
Will it have big productivity benefits?
I'm not sure about that.
I mean, probably the answer is yes.
I'm not fully qualified to answer the question.
But the fact is that it's inflationary in the near term because of the scale of the capital spending.
And we know that capital spending booms are always inflationary.
And yet we've got another one here, which is basically pushing up NGDP and ultimately inflation.
So I think those are the factors to watch.
And then if you look at valuation bubbles, I mean, those are always ended by central bank tightening.
So we revert to what Kevin Walsh is likely to do.
But I think his hands are largely tied by the bond markets.
And the bond markets, in my view, drive what happens on the policy end.
And the bond markets are telling us that you're going to be seeing monetary tightening.
has this capex this ai capex boom is have you noticed it affecting the global liquidity index
or trends in it yeah i mean there's there there's no mistake that it has i mean uh you know i can
revert to um uh let me put a slide up and try and um and try and show uh that if we can see
Hopefully, you can see the deck.
What this shows is the global liquidity cycle.
This is a measure of momentum of money flow through the world economy It not M2 or any of these what I would call retail or real economy measures of money This is money going through financial markets And what you can see is an
inflection that occurred around the end of Q3 of last year. Bear in mind, this is a growth rate,
not a level, but the growth rate has clearly slowed down a lot. And that slowing was not
because central banks were tightening, because they hadn't really started to tighten yet,
as we know, just on that point, it's really turning down because all money that's anywhere
must be somewhere. So if it's in the real economy and it's fueling strong economic growth,
it's not there for asset price appreciation in financial markets. And that's really the reality.
And so what you're seeing is a downswing of the cycle, as you would expect at a time when the
real economy is picking up and things like commodity markets, hard commodities have got
momentum. And that's a very normal cycle. And what you'd expect to see through this phase on top
is flattening yield curves, which is exactly what we're beginning to see.
So everything, sort of the dots join up. And you could always argue on top of that,
that you get bubbles around the peak and maybe the semis or whatever bubble,
or even the Mag7 bubble a bit earlier, are symptomatic of that excess liquidity.
Yeah. I mean, in February, you said it looks like we're going to trough in mid-2027. It looks like
we're right on trend. Yeah, it's looking that way. I mean, I think there's another chart I can show
you, which is actually a lot. I'm going to come back to these other ones, which I just wanted
just to touch on, which I think is an important one a little bit further up. So this is two-year
yields and SOFA rates. So what this is basically telling us is that the orange line is what the
Treasury market, the two-year note is signaling in terms of yields. And that pretty much embeds
expectations for Fed policy rates over the next two-year period, by definition. The black line
is looking at overnight SOFA rates, which is effectively the rates in the repo markets.
Now, that difference is an interesting difference to note, because the orange line tends to be a
lead indicator of movements in sofa rates, overnight rates. You can read the overnight
rate as equivalent to Fed funds. So that's pretty much what the Fed is seeking to guide.
And if that's the proxy for Fed funds, the orange line is a proxy for what the market is expecting
the direction to be. Now, I actually ran this data talking about AI systems. I ran this through
an AI system. And I said, if you look historically, how many times has that orange line on the upside
or the downside when it breaks through the black proved a false flag? And the answer was, it
basically is a false flag only 10% to 15% of the time. Now, that's kind of interesting. So in other
words, 80% to 85%, sorry, 85% of the time, let's say, to 90% of the time is correct. And that's an
interesting point when you look at this chart. And this is looking at the history of what happened
in 2021-22. The black line is the same difference between the SOFA and the two-year yield. So in
other words, if you subtract on that earlier chart, the one I just put up, sorry, if you
subtract the black line from the orange line, you get this one, which hopefully you can see now.
Right. So now this says so for less two year yield. So this is just subtracting one from the other. And the orange line is the current period, the 2426 cycle. And the black line is what happened in 2020 to 23. And you can see the path of what happened in 2021, 22, where the black line starts to create a lower.
And that is basically saying that the two-year note is flagging correctly increases in interest rates as the Federal Reserve tightens policy.
So you can read anything below that dotted line as being a monetary tightening and anything above that dotted line as being a monetary easing.
Now, if you look at the path that we're on, we're pretty much tracking what happened in late 21, early 22, where you start to see an acceleration now in monetary tightening.
And I think that is more or less what the Federal Reserve is suggesting from what we know, the non-forward guidance, forward guidance.
And if that's the case, just recall what happened.
The S&P was down 25% through that period in 21-22.
And things like crypto were down 75%.
Now, crypto is already down heavily.
It could fall further.
But I think we're getting nearer the lows on those assets.
But generally speaking, this is not going to be good for other risk assets like stocks
that certainly haven't discounted this move yet.
Yeah, it's interesting.
You seeing the spreads here between SOFR and the two blowout And then if you look at just the corporate debt CDS it looks like rate spreads are exploding there as well particularly in some parts of the AI sector on the infrastructure side
So it looks like what we're seeing at the Federal Reserve is happening in the private market as well.
So what that's basically showing is nominal GDP growth in the US.
Let's just run through this.
I think this is sort of critically important to understand.
So what you've got is a very long-term history here of US 10-year interest rates.
So this is a 10-year Treasury note, basically shown here as the orange line.
It says risk adjusted.
So what I've done here is I've taken out term premium because this gives you a clearer idea
of what the underlying interest rate expectations are.
And the black line is looking at nominal GDP growth, so NGDP.
I've used here a four-year moving average.
So in other words, what that's showing is the trend in the economy.
Now, the point about the chart is that you can see that long-term history from 1955 onwards.
And that was pretty much the period just after the Treasury Fed Accord, when the Federal
Reserve had a lot more independence in terms of monetary policy.
And you start to see the US long bonds starting to catch up, the yields starting to catch up with the underlying growth in the economy, normal growth in the economy.
And then you see the overshoot back around in 1980 when Volcker, 79, 80, when Volcker came in.
And then you see a long period of decline in both yields and nominal GDP.
But yields basically are running above normal GDP.
and you get to the current situation where there probably was an inflection in that curve again
around the GFC, where you start to see the black line, which is driving the whole system,
which is nominal GDP, starting to move up strongly. And what I've done here is I've
added the latest data to the nominal GDP and extrapolated it using consensus projections.
So what we're looking at is probably an average rate of growth somewhere around 6% to 7%,
or let's say, to be generous, between 6% and 8%.
And you can see where the long bond is currently trading.
And the dotted line indicates the direction of travel.
It looks as if you're going to have to see higher yields.
And if you don't see higher yields, you're going to see much slower end GDP growth.
But it seems to me, given the fact that the fiscal taps are open, that there's a big amount of AI spend still to go.
And the economy looks pretty robust, in my view.
NGDP or underlying economic growth is not going to fade at all.
So we're looking at upward pressure on the bond market.
And if that's the case, the Fed is going to have to struggle hard to basically keep yields down.
and that will require a lot of yield suppression at the long end if they manage it.
And it will require keeping the front end very liquid
and pushing a lot of borrowing into the front end.
But that's going to put a lot of pressure on front end rates like repo rates.
And that's going to be incompatible with a Fed fund's target of where it is now.
So it looks as if, by my reckoning,
the strong economy is going to be driving the Fed towards higher rates.
and we can already see that trend
towards monetization in the M2 data.
Or as I said, the M2,
whatever it was a month or six weeks ago,
was on a roll, was on a tear
at nearly 10% three-month annualized growth.
That's telling you a lot about
the state of the economy, inflation pressures.
And if Walsh pays attention to money,
which he says he does,
he thinks money has a role in monetary policy,
then the FOMC have got to take this and board.
Yeah. Well, that begs the question, what is the fiscal side? What does the Treasury think of all this? Because they have to manage the interest expense on the debt. Obviously, we're approaching $40 trillion and have a ton of debt to roll over.
And so it's like this weird situation where the economy is hot.
We've got to invest.
I mean, it seems that the administration here in the U.S. and over across the Pacific and China view this AI race as existential.
So it seems like they're going to throw everything they have at winning the race towards AGI, if that ever manifests.
At least that's the narrative right now.
And so it seems like you have a situation where you have to put your pedal to the metal to keep this build out going in this infrastructure and reindustrialization effort going.
But you also have the looming debt situation, which you can see spiraling out of control and the interest expense going up pretty rapidly and hitting levels that were unfathomable a decade ago.
Yeah, I think absolutely, I agree 100%, Marty.
I think that we're in a regime change,
and I think that regime change is probably
colored by the whole notion of either you call it trade wars or more accurately capital wars.
And the whole point here is that under a capital war regime where there was competition between
capitals, you are likely to see much, much higher end GDP growth. In other words, the underlying
economy in normal terms is expanding at a rate probably at least 200 basis points,
two percentage points higher than where it's been in the past. And governments are deliberately
pushing this because they want AI, they want competitiveness. They're going to restrict
whatever exports they can to rival capitals, which is clearly in train. They're going to try and
preserve what access they can to energy, which is clearly a vital resource. I think we're seeing
that play out. And what that means is there's got to be a lot more capex spend, generally,
whether it be on aggressive moves like AI or defensive moves like securing resources,
is holding higher inventory, warehousing more, whatever it may be, onshoring.
And that is going to mean faster end GDP growth,
and it's going to mean higher bond yields.
And that's the problem you've got in the system right now.
And the reality is that if you've got strong economies, red-hot economies,
or probably I exaggerate by red-hot, you've got strong economies.
The fact is that going back to the adage, all money that's anywhere must be somewhere.
If it's in the real economy driving growth, it certainly is not in the financial economy driving assets. So we've got to be very conscious that it may be an airport getting risk asset prices.
Yeah.
The.
What are your thoughts on the quasi?
I mean, it's a wartime footing here in the United States.
The Trump administration is taking equity stakes and a lot of these companies.
And that signals to me that like this is very much existential, like the government's getting
to build on that last comment you make the air pocket in risk assets and equities, particularly
It's just, again, regime change, inflection point, fourth turning, put whatever label you want on it.
It's just trying to wrap my head around how much liquidity they can bring to the market.
Because you can see a situation where they need to facilitate the CapEx boom and the expansion of NGDP.
but at the same time you have the government sort of like backing dell intel um rare earth metal
companies and i'm sure the uh list of companies that they've they've got direct equity stakes in
is is going to grow at some point in the future and so it looks like they're trying to backstop
the companies that are critical to this build out as well and i'm just trying to figure out if
the government doesn't care really what what the stock's trading at but they want to signal to the
market like, hey, we're going to be backing up these companies, doing whatever it takes.
Yeah. And China is doing the same and Japan is doing the same. I think, you know, more,
I mean, these are really the leaders. I mean, Europe has got to wake up to this.
It hasn't really, you know, Europe hasn't embraced this model yet, but they're going to have to at
some stage. But this is it. You're building national champions and you're building security.
And I think the US being, you know, first and foremost in that race, or actually maybe arguably
Maybe China was first and the U.S. is copying, but the U.S. has got a lead at the moment in many areas.
But, you know, clearly it's a competition.
So with that competition in mind, comparatively with the three players that you mentioned, Japan, China and the U.S.,
how would you rate the success of the strategy of each individual country?
Well, I think it's a difficult question to evaluate how this is going to fall into line.
But, you know, the U.S. has clearly got at the moment an advantage in AI and in energy, you know, generally technology and energy.
China is catching up on the technology area fast.
It's going to be hard push to secure energy, but then it does have, you know, another advantage with rare earth minerals.
So that's a factor.
And we know that China's got this huge, I'd say, dormant labor force that it's still engaged.
and basically mass-produced manufacturing at low cost.
And that's clearly a threat.
What does Europe have?
The answer is Europe has pretty much nothing.
It has history, and that's it.
Japan basically has the ability, I think, after some restructuring,
to be a bulwark against China in the region.
But at the end of the day, we've got to accept the fact Japan probably is too small
to make that much difference.
But it's clearly there and it's having an effect on the Japanese economy, is being restructured.
But you can see the impact that having already on the Japanese bond market where yields have jumped at the 10 level by over 200 basis points in the last couple of years I mean from half a percent to 50 basis points to two and a half I mean that a big move in the bond market And that clearly going to have an effect because you know
when I was at Salar Brothers, the adage was always, you know,
in financial markets, there's no unrelated event.
If you've got rising yields in Japan, that's going to be a magnet for capital
to pull that up elsewhere, pull that out of other places.
and the public pension fund
was already being directed
to invest more in Japanese bonds.
That could have a material effect globally.
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unchained.com. Well, it's been interesting to observe too, particularly as Japanese yields
have screamed higher. Obviously, the whole basis trade scare that popped up last year and in
previous years, it hasn't seemed to manifested this time around. So I wonder if the cent and
the Treasury have been working behind the scenes, knowing that eventually the Japanese yields were
going to have to rise significantly. We're rejiggering things to make sure that the basis
trade didn't blow out and didn't have a massive effect on US hedge funds or players in the
Western world.
Yeah, I think that could be the case.
I mean, I'd say that I think the whole idea of the yen carry trade was always exaggerated.
I mean, it was big a couple of decades ago.
I mean, I think it's, in my view, it's a lot smaller than this now.
It's not really the force it was.
That's not to say that the Japanese are not big investors internationally, they clearly
are.
But they have a big impact on European markets.
They are, I think, the biggest foreign investors in France.
And if you look at the oat market, which is the French government bond market,
the oats are trading at increasing premiums to German bunds.
And that may tell us something about the risks of Japanese investors pulling out.
So there are no unrelated events in financial markets,
and there are even fewer in the bond markets.
These markets are joined at the hip.
And therefore, if yields start to expand, they're going to have a knock-on effect.
And that's what I think we're seeing.
So you can't take the US or Japan or whatever as isolated examples.
Bond yields generally are rising everywhere, with the one notable exception being China,
where China is basically where yields are still depressed.
But that really reflects the fact that the Chinese economy is on its back.
And it's struggling to survive.
I say it's struggling to survive, I was overreacting it, but it's struggling to grow at a decent pace.
And it's wholly dependent on export growth.
So you think Trump's tariffs and export controls are having an effect there?
Or is it a number of things?
Yeah, I think that's right.
I mean, it's, you know, they clearly are having an effect.
And, yeah, and what's happening is that China is being forced to go elsewhere,
into Europe or into Central Asia or whatever it's so called,
or Latin America, Africa as well.
But these are increasing tension points, and Europe is facing the full thrust of Chinese competition.
And that's not going to be a happy place in the next two or three years.
You're already seeing a lot of instances of big German companies, Volkswagen being the latest,
to announce large labor layoffs, and this just can't go on.
I mean, if you think of the buying capacity of those other countries that China's going to have to go to,
it nowhere near the U consumer buying capacity Yeah correct Yeah I mean yeah it makes sense that it would be on its back and so what are your thoughts on europe has europe woken up to um the fact that it has been woefully behind
and severely under-invested in critical industries and um is very much over-regulated uh preventing
european entrepreneurs from competing well i think tick all those boxes and it's over-tanked as well
and it's got an overly generous welfare state system.
And at the end of the year, this is incompatible.
I mean, you simply can't do it.
It ticks all those bad boxes.
I think that's for sure.
But I mean, we're at a stage where the whole welfare system of the West
has got to be radically rethought.
And we've inherited a system whereby it's the aged who get income support
where it actually should be the young who get income support
because you go back 50 years when the Social Security net was first put in place.
If someone retired at age 60, 65, they're probably, what,
maybe a handful of years to live with no income at all.
And so the whole notion of pensions made tremendous sense.
Now they've got large pension pods.
They're very generously catered for.
They're among the wealthiest in society.
Paying them additional pensions seems to be not the right thing to do,
Whereas younger people, new interests in the labor market, graduates, et cetera, are finding very difficult to make ends meet.
They can't get jobs. They're being forced out by AI.
They're the ones that should be getting income support.
So we've got to rethink that.
But the whole issue is that nobody in the political sphere is keen to do that.
The simple reason that there's an awful lot of gray votes out there.
Yeah.
yeah as a millennial i mean i feel fortunate to be in the position that i am and i think
millennials are better off than gen z and it's uh something i've been observing for for years
and it's been bubbling up here in the united states obviously in europe as well but you have
this this disenchanted generation of young people who i mean millennials were already
the first generation who will, I mean, as of right now, end up worse off than their parents.
And it seems like Gen Z is going to be even worse in that regards. And just trying to think of the,
I mean, taking all the numbers out of it and just thinking of the social side,
the psychological side, it's one thing I worry about is this rising populism of the younger
generations. And I think we're seeing a big bifurcation of the flavor of populism, where you
either have hardcore nationalism, send them all back. We have hardcore democratic socialism,
which is confiscate all the wealth and redistribute it.
Yeah. And in Europe, we're caught between both stalls, because there are big constituencies for
both of those ideas. And I'm not too sure which way it's going to lean. But this polarization of
politics is what we've seen many times before. You go back to the 1930s, and if you think about
the fascist regimes, were they right-wing or were they left-wing? I mean, there's some of each,
but you go to extreme politics in that environment. And that's the sort of,
this is the economy that we're currently building, certainly in Europe, I think.
The US may be in a different shape, but I mean, I think the whole K economy speaks to this problem
as well. Yeah. And then it doesn't help that you have the leaders of the AI, the leading AI
companies saying, yes, not only is this going to take all your jobs, but this technology is
extremely dangerous. And we need to make sure that we get regulatory moats. So only we can
build it and distribute it and have these vertically integrated surveillance tools to
to bring in your AI overlord.
So the narrative from the leading frontier labs
is very perplexing.
And I don't think it's good for their brands
and obviously not good for affinity
if you're trying to build affinity
with younger generations specifically.
Yeah, but I think what this then comes back to
is a sort of $64,000 question about what next.
And you basically find that
If governments are unable to cut back on the state, which, you know, Turkey is no vote for Christmas, of course, so they don't want to do that.
They're reluctant to reform Social Security or welfare payments because there are too many votes behind it.
The bond markets are pretty much saying that they're fed up with issuance.
They're not going to support any great increase in bond issuance going forward.
or there are limits or there's a price for everything,
but there are limits clearly.
And taxation are way too high, tax rates are way too high.
Then the path of least resistance is basically printing money.
Now, this is what we're seeing more and more evidence of.
It's coming in a very subtle form.
It's coming in a form which is wonkish in the sense that
you got to be caught in the weeds to kind of understand what going on But broadly speaking what you seeing is more and more evidence I mean this is led by this was originally the policy of Janet Yellen
was to do so much funding at the short end of the market. And so what the US Treasury has been
doing has been basically funding the deficit, the growing deficit, of course, with more and more
bills. So you've got 80% of US gross issuance now, which is under two years, which is an eye
watering a large figure, but it means that every week, the US government has to auction something
like half a trillion dollars plus of debt, bills and coupons. And that is a big ask for the
financial markets. Now, that's only going to get bigger. But the point is the question,
the key question to ask is who buys that? And the answer is it's largely the banks,
because banks love short-dated government paper because it matches the liability duration of their
balance sheets almost perfectly. So if you're running a big fiscal deficit, which everybody is,
okay, bank accounts are being swollen because the government's issuing checks. So the banks have got
to find some asset to offset that. And what better than a short-dated government paper?
And that's what they're buying. So bank balance sheets are expanding alongside fiscal policy
expansion. And if the bank balance sheets are expanding, that is called monetization of debt.
and that is exactly what's going on.
That's pretty money.
It's just a rather more prosaic version
of the pretty press's worry,
but it's the same thing.
And that's why you've got strong monetary growth figuring
and that's going to be a feature of the landscape
in the next few years.
Now, the question is,
and this is the point that you mentioned
in a sub-state we wrote today,
is to say, well, okay, if you're an investor,
how do you protect yourself against this future monetary inflation?
And monetary inflation, just read that as devaluation of paper money, destruction of
paper money, which is going on.
And as I say, this is not just hitting the US because everyone's on the same game.
The US tends to be leading, as I say, it's 80% of gross issuance.
In Germany, in France, it's 45% to 50%.
In Britain and Japan, it's about 25%.
But that 25% number is going to be a lot higher in two or three years' time in both
economies.
So we're moving in the same direction towards more and more bill issuance, front-end issuance.
Printing money, monetary inflation is a big problem.
That's how your wealth is destroyed ultimately.
So you need protection.
And the best protection happened to be cryptocurrencies, because they tend to have the greatest sensitivity of any asset, even more than precious metals, to money printing.
And that's what they've demonstrated in the last 15 years.
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yeah and i have uh today's sub stack up right now i just want to make sure that i get the uh
the framing of this right but um using these like the the fed liquidity plus nine weeks
um in the basket of cryptocurrencies bitcoin ethereum and solana six week changes that chart
in the scatter plot that you have there too.
I think walking through the relationship of Bitcoin price
and the liquidity cycles and Fed policy
would be a good refresher for the audience.
How are these two things?
Let me just try and do that.
That should be there.
Yes.
So what that is, is this is looking at weekly changes.
It looks a very busy chart,
but this looks at weekly changes,
six-week changes, in fact, in global liquidity, which is the GLI dollar side,
and BES, which is Bitcoin, Ethereum, Solana, in a 60%, 30%, 10% weighting.
So that gives some broad measure, imperfect but broad measure, approximately right measure
of the crypto universe.
And what that's showing is the six-week changes compared.
And what I've done is to advance the global liquidity line, the black line, forward by 13 weeks, only three months to show that it's a predictive indicator.
And what that shows is that the tracking is remarkably good.
It's good until it isn't, of course, but it's been not a bad steer so far.
And what that indicates is that the two assets have moved very closely together.
Now, if you look at the sensitivity of that basket, the BES basket to liquidity, in comparison, the sensitivity of gold would be about two times, gold and silver, let's say, on average, about two times.
In other words, every 10% increase in liquidity means something like a 20% increase in precious metal prices.
In the case of these assets, crypto, it's about eight times.
So what you find is that for every 10% move in liquidity, you get 80% move in cryptocurrencies.
And that's what the history has shown.
That's been remarkably stable.
So it isn't just a sort of sudden experience.
It's been remarkably stable over time, as we show in that report.
And the key thing is, if that is sustained, assuming it is, you need very little crypto
in a portfolio to give you pretty comprehensive coverage or protection against monetary inflation.
Only maybe at most 5% of a portfolio in crypto, I think it gives you a pretty good insurance policy.
And 5% is probably something that people are prepared to risk anyway.
But there could be quite a lot of upside if you get a monetary inflation boom,
which I think is inevitable given the fact that governments have basically run out of money.
or they can only print it and they can print money.
If you're comparing dollars with yen or dollars with Swiss francs
or dollars with pound sterling, you don't want to see that move particularly.
But if you start looking at the dollars against things like gold
or commodities or hard assets, you'll see it immediately.
But the best hedge is going to be, from experience,
is going to be cryptocurrencies.
That's what the data says.
Can you walk me through this?
wrote today, the R-squared exceeds 32%, implying that almost one-third of the variation in the
crypto basket can be linked directly to changes of global liquidity. And so...
Yeah, so that's what this data is showing. And what it says is, I mean, in statistics,
you can clearly never, you can never prove causation. You prove correlation, or you can
establish correlation. We've tried to do proof causation through another mechanism called, which
is a wonkish idea, but it's called Granger causality testing, which is showing whether
you get consistent leads in the data from a shock to liquidity, whether it comes through,
it passes through into crypto, and the answer is it does.
But the R squared is more a test of correlation or association.
And the way to read an R squared figure, and that's just the R correlation coefficient
squared, is to say that gives you an idea of the extent of the variation in the data
that is explained by the other variable.
So if you've got an R squared of 50%,
50% of the variation would be joint variation
between those two factors.
So you've got commonality, if you like.
And what this is saying is a 30% or so R squared
is saying there's a common factor
which you can associate,
which is driving those two factors,
those two variables.
And so it looks as if global liquidity
is a key driver, consistently key driver
crypto Now although people may pick me up and say well of course 30 is not 100 and I fully take that anything that in financial markets anything beyond about 5 to 10 is considered to be extremely extremely powerful You can make money out of that consistently
That's good. Do you have any inclination of what the other drivers are?
That's just natural adoption?
Yeah, we did an analysis some time ago of actually looking at what goes on.
And broadly speaking, the other factors, the other important factors, if you broke down the degree of variation in these things, the other factors were risk appetite.
And we proxied that by looking at something like NASDAQ to say that if there's a euphoria towards tech or whatever it may be, you can find that will influence crypto.
and the other factor, or the other two factors, in fact, were both associated with gold and
precious metals. And what they basically said was that if you get, and this is a sort of
mathematical result, but he said there's like an error feedback system with gold.
And what it basically means that is in the long term, gold and Bitcoin and other crypto
are correlated very strongly. So in other words, they're both trend together.
But in the short term, they're negatively correlated. So it means that they trend together,
but they cycle apart. So those are the other factors that come into it. So you've got, if you
like, four factors in that cocktail, you've got global liquidity, which is the dominant part,
that accounts for about 45% or thereabouts of that total variation, or that pie chart,
if you like, of the variation. Then you've got gold in the short term, the anticyclical effect.
Then you've got gold in the long term.
And then you've got risk appetite effects.
So those are the four factors that we found were dominant in the case of crypto.
And we saw confirmation of one of those factors in February, March of this year when gold was screaming.
Yeah.
About $5,300 and Bitcoin was crashing.
Yeah.
And that's right.
So what happens is that there seems to be an arbitrage between the two.
Now, the way that I would read that or the way that I would say all that is that maybe I can demonstrate.
What that chart should be looking at is two lines, an orange line, which is the gold price in US dollar terms.
I mean, that's now a little bit out of date, but it's not bad, actually.
It's measured on the right-hand scale, but it's measured in RMB.
and the black line is looking at PBOC liquidity. So that's the People's Bank of China's liquidity
injections. Now, basically what that is trying to demonstrate is that the two are very closely
linked. And what it says is that as you get an increase in Chinese liquidity, Chinese liquidity
is the key driver by far of the gold price. So a lot of the debate that one was hearing in the
markets earlier on this year was to say that the gold price was being driven up by the great
debasement trade. And everyone was jumping on this bandwagon to say it's because governments
in the West are printing money that the gold price is soaring. And that's just simply not true.
Because in actual fact, governments weren't really printing money to an equal extent.
And what money that was out there was being increasingly siphoned away into a stronger
re-economy, which was exactly what Bitcoin was telling us. Now, what was driving the gold market
was China. And China was basically pumping in lots of liquidity, as you can see here by the black
line. And that was driving the gold price up. Now, why are the Chinese doing that? The Chinese
are doing that for two reasons. Number one is that they need to devalue the yuan currency,
their R&B currency, the yuan, internally because of their huge debt problems. So what they need
to do is to get the price level on the way to level up to basically devalue debt. And that debt
is a millstone around the Chinese economy's neck. And that's one of the reasons that the Chinese
economy is so sluggish right now. The other thing that they're doing is they're trying to rival the
US dollar externally. So you've got to think of China as having two almost independent exchange
rates, an internal exchange rate and an external exchange rate. And that external exchange rate is
protected by capital controls, protected by the big forex reserves that China has,
and protected by compliant state banks who do a lot of the intervention.
And what that means is that they can have their cake and eat it, in other words.
Now, the reality is that they can therefore print money domestically,
which is reflected in a rising gold price.
Recall that Chinese are not allowed to buy crypto.
That's illegal and has been made illegal.
And the Chinese have doubled down on that this year.
And that means that money finds it very difficult to seep out of China.
So the vent is clearly the gold price.
So China is driving the gold price, but the US and other countries through global liquidity
are driving crypto And because liquidity globally is going down that why you got that picture Now I going to show you one more chart if I can which is basically looking at what has
happened. Hopefully, you can see this chart, which is looking at what the People's Bank of China
has been doing on a granular daily basis. Now, if you like conspiracy theories, Marty,
This one's right up there.
And what it says is that if you look at the size, the daily size of the Chinese people's
bank's balance sheet, which is measured here as this solid line, the dotted line is simply
a moving average, a 50-day moving average to show the trend.
That shows you what is happening to their balance sheet every day, basically since late
last year.
So it peaked essentially two days after the tensions in Iran began, right?
It then dropped to a low point, which was more or less on cue with the signing of the MOU,
whether the MOU still exists or how fragile it is a moot point.
But that's when they started to change direction.
So it looks as if for that virtual three-month period, they deliberately cooled their economy.
Now, the Chinese have formed here because they did exactly the same thing in 2008 ahead
of the Beijing Olympics.
Well, they wanted to cool the economy to slow pollution, which was likely to spoil the showcase
event.
So they slowed the economy deliberately.
And they're doing it again now, or they have been doing it again, presumably to preserve
oil and to reduce their oil import bill by cooling the economy down. And that seems to be what they've
done. And if you look through that period, what have you seen? You've seen very weak Chinese
financial markets. You've seen bond yields crater. You've seen the stock markets sell off.
You've seen economic data come in weaker. And it looks as if they're now starting to
goose the economy once again by printing more money. And that may have been a short-term
into regnum that was agreed with the Trump administration that China would do this? I
simply don't know. But it looks as if that's what they've been doing. And therefore, if this is
correct, what you should start to see now is evidence that the gold price, it should be
beginning to form a bottom. Now, proof of the pudding will be the eating, but let's see.
Yeah. Talking about seeing, you just pull it up now because I was looking at it while you're
doing that. It looks like, I mean, we're here hovering around 4,000. It looks like 4,000 is
good support for it right now since going back to late June. So July, it's been relatively flat.
It's interesting. Yeah. So that pretty much accords with that signing of the MOU. And
what I would say is that let's not be too hasty, but at the end of the day, you want these monetary
inflation hedges and gold may be the leader because China is injecting liquidity right now.
and trying to support that.
If you look at the announcements that the BBOC is making,
it seems to be deliberately trying to get more liquidity into their money markets.
They make announcement after announcement each day,
so they're adding more funds.
So I think there's a clear remit there to do something.
So I'd be watching the gold price because I think that's a pretty good barometer of that.
And you alluded to it.
I like to dabble in conspiracy theories from time to time, Michael.
We all do.
I think if you view everything going on in the world right now, whether it's AI, Iran, as a proxy between the U.S. and China, that is an interesting lens I like to put on just to think about what may actually be happening.
And if you consider the flip-flopping on the MOU specifically, maybe it's Trump trying to just throw a wrench in the Chinese, trying to turn their economy up and play that game.
And that's the question, who's reacting to who?
Is China reacting to the U.S.?
Is the U.S. reacting to China?
I think based off of that chart, it would be clear to me that China is reacting to what the U.S. is doing.
And if Trump knows that, is he using this war as a way to push China around to an extent?
could they yeah yeah um bringing back to bitcoin you think i think you wrote in today's newsletter
uh may have a couple to a few more months to find a bottom but then all these monetary factors that
we've been discussing for for the better part of an hour now um should um should be expressed
should express a higher bitcoin price after that yeah i mean my view is look there's there's no
alternative of monetary inflation. And at the end of the day, I mean, one can be cynical and say,
look, if you're a politician, would you accept a regime, a future regime where you've got,
let's say, one to 200 percentage points faster main street inflation? You probably would.
You could disguise that in various ways or you could dumb it down in terms of your rhetoric and try and pretend you know extend and pretend and whatever and say it around two to three or whatever they come out with
But in reality, it's a tad more.
And I think that's the reality we've all experienced over the last five years, that inflation simply ain't the 2% that the Fed has been targeting.
It's higher than that.
It's probably appreciably higher.
But what that means is that if Main Street inflation is running at, let's say, 4 to 5,
monetary inflation or asset price inflation is running at a figure which is another 200 to 300 basis points higher,
maybe 7% to 8% per annum.
But after all, that's the likely growth rate path of U.S. federal debt.
Now, U.S. federal debt has been a great proxy for the gold price over the last 25 years.
So if you look to what the debt load has done, I mean, the debt load is up, you know, whatever it may be, 12 times over that period of the last 25 years.
The gold price is up a similar amount, if not a tad more.
And Bitcoin is up considerably more.
Now, what I'm trying to say here is that the trend, you know, you've always got to pay attention to cycles in markets for sure.
But you've also got to think about the long term trend, particularly if you're a younger generation, you've got to think about this.
And you need ways of protecting your wealth.
Now, monetary inflation hedges in a world where we're likely to get monetary inflation, a lot more of it for the reasons I've already suggested, has clearly got to be part of your investment outlook.
And you don't need to have 100 percent in gold.
You need to have 100 percent in Bitcoin, but you need to have both those assets.
And you probably need to have a decent amount in crypto because that is the best monetary inflation hedge, according to recent history.
It's four times better than gold or silver.
So that's what I would be thinking about. And by the weakness, you don't, no one's ever going to get the bottom. Clearly it's dangerous as they always say to catch a falling knife. But once you start to see some stabilization, it's worth going back in.
Yeah, and it's funny how emotional people get. I've been in Bitcoin for 13 years now. I've been through many of these cycles. It is funny how people will just discard it and throw it away once the price falls a little bit. We're down like 40%, 45% from the top of last October, November. And it's not even been that long. I mean, a year in markets is not that long.
And it's funny that people will give up on something after a bit of a correction.
We're actually looking at this bear cycle on Bitcoin.
It's shallower.
And if we are forming a bottom here, going to begin climbing higher this fall, in winter
would be probably one of the shortest bear markets in history, too.
That does manifest.
Yeah.
Last question.
Do you think there's a when we hit 40 trillion in national debt here in the United States, you think that level has a psychological trigger that sends people or do you think it's just another number that we hit?
I think it's another number.
And what it means is we're going to get to 50 trillion in a shorter space of time.
I mean, that that's the reality.
The fact is that there's no way to curtail debt unless there is a radical overhaul of government.
And that's simply not going to happen.
Because we're in an era where we need big states for the reasons that I've said capital wars are there.
I need an active state.
China has an active state, and others are copying that same model in many ways.
Call that sort of a state-led capitalist system.
I don't know whatever you label it, but it's a reality.
It means the state's got to be bigger and more active.
It's got to take bigger stakes in industries.
It's got to have its fingers in many more pies.
It's got to direct trade.
It's got to encourage investment, et cetera, et cetera.
And at the same time, it's going to pay the welfare bills and the interest bills and the defense bills.
And that's going to take either more taxation, more debt issuance or more money printing than you choose.
My view is that the path of least resistance to our politicians is pretty more money.
And they can do that either directly or they can do it subtly.
And they don't settle it subtly by issuing lots of short dated bills, lots of treasure bills.
And that's exactly what they're doing.
So bear in mind that 80% of US gross issuance now is under two years duration, maturity.
And it was, I think, three to four years ago that Stanley Druckenmiller in one of his speeches said,
this is crazy.
These are the numbers that you would apply normally to a Latin American economy.
And here they are in the US.
Well, that was four years ago, four or five years ago.
We're now even more so.
and in actual fact the paradox is that some of the latin american economies have actually cleaned
their act up so the u.s is going out alone but the u.s is dragging everyone else with it so japan is
doing the same germany is doing the same france is doing the same britain's doing the same um
that's just a step behind but that's this is the new reality yeah and i think the basement again
the the stat that i mentioned before we hit record out of the uk which is they've lost
something like 600,000 millionaires since 2021,
falling from above a million to below 500,000.
in a five-year period is insane.
So to the three levers that you pull there,
if you pull the taxation lever,
you're just going to have an exodus of talent.
That's exactly what the UK has found.
Yeah, exactly.
Yeah, so debasement is the way.
Better have hard assets.
Michael, it is always a pleasure.
Thank you for doing what you do.
I mean, I say it every time you come on,
but I will not relent in saying it.
I love your newsletter, your sub stack.
Capital Wars is a must read.
I read it every time it drops and it is a very calming,
a calming force in my life just to zoom out and look at the,
the overall trend and the cycle.
So thank you for writing it and thank you for coming on.
Well,
it's nice to know.
Thanks Marty.
Enjoyed it.
And honestly,
thank you.
Peace and love freaks.
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