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- [00:07]
Michael Howell
You've had a dynamic where money's become freer than free. If you talk about a Fed just gone nuts, all, all the central banks going nuts.
- [00:16]
Marty Bent
So it's all acting like safe haven.
- [00:19]
Michael Howell
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. Probably should be. Probably should be.
- [00:37]
Marty Bent
Michael Howell. We last met in February, is now the end of July. Happy to have you back.
- [00:43]
Michael Howell
Well, Marty's always pleased to be here.
- [00:45]
Marty Bent
Well, we were chatting a bit before we hit record. I think probably the best place to start is Kevin Warsh in this Federal Reserve rate decision he's got to make or the. 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 hit record, 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 US 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.
- [01:36]
Michael Howell
Yeah, I think unquestionably that's what's going on. There seems to be deliberate manipulation of volatility in the market. 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 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 ten 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 aren't trying to rise. The administration in various forms is trying to pull them back. It's struggling to do that. As you know, it's 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. Wash could surprise us perhaps and do it today. I mean the market's only discounting 30% chance of a rate hike. But it's got to come either this meeting on the next meeting in my view.
- [03:49]
Marty Bent
Yeah, I've heard commentary around it. The dark horse betters betting on a rate hike, saying that it would be good to do it now because it would confirm this new framework that Wash 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 would be really interesting to see if he takes the opportunity to do that. But as you mentioned before we hit record, it's. Does he have the, the, the gumption and the, the balls to do it?
- [04:26]
Michael Howell
Yeah. Oh, it's, you know, the fact is, would he carry the rest of the fomc? I mean he's only one vote but you know, 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 rate 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.
- [05:17]
Marty Bent
When you say the money supply is growing, what are you looking at? M2?
- [05:21]
Michael Howell
Well, if you look at M2, admittedly in the last two or three weeks it's cooled down a bit, but it was three month annualized rate was testing 10% a little while ago. So I mean that's a pretty solid growth rate.
- [05:35]
Marty Bent
What's leading to that expansion is the SLR ratio changes, is the commercial banking industry issuing more credit or.
- [05:42]
Michael Howell
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 it's whether it's a K or not. I mean the fact is the average is growing at a high rate and this must be the AI Capex spend, 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 at NGDP numbers, nominal gdp, it looks pretty solid.
- [06:18]
Marty Bent
Looks solid. A lot of people are worried about this AI Capex boom specifically. There's a lot of bears out there. We're saying that we're in a bubble.
- [06:25]
Michael Howell
Yeah, well I think in many ways it is. I mean that's how capitalism works. But and we've seen it time and time again is there's 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. I mean 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 you know, could easily happen again. Deja vu.
- [07:01]
Marty Bent
Yeah, that's the, that's the thing. It's. Well, is it deja vu? Is it like, is this time different? Like famous last words. That's like. I've been really trying to wrap my head around this because as somebody like we were just discussing too. We've been using you. You were using the tool. I was mentioning the newsletter that you released today about Bitcoin and cryptocurrencies. And where they may be in their cycle. But you were mentioning that you ran an analysis using these AI tools. I've been using AI. You're a TFTC pretty vigorously. My usage is going up considerably as I find more things that I can do with it. And that's a lot of people usually tying it to the dot com bubble. It's like, is it really? And then you look at the pen forward PE ratios of the memory stock, specifically out of South Korea, and they're only trading at like a 4. If you look at the, the revenue and profitability and margins, they're going up considerably. It's like, 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 sort of runs in the stock market for individual stocks. Obviously the Korean stock market's getting hammered this week. But before then, is this just a correction in a longer term bull market?
- [08:29]
Michael Howell
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 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 in GDP 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 at the policy end. And the bond markets are telling us that you're going to be seeing monetary tightening.
- [09:49]
Marty Bent
Has this CapEx, this AI CapEx boom, have you noticed it affecting the global liquidity index? Or trends in it.
- [09:58]
Michael Howell
Yeah, I mean there's no mistake that it has. I mean I can revert to, let me put a slide up and try and show 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's not M2 or any of these what I would call retail based 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 haven't really started to tighten yet as we know that really 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, you know, the semis or whatever bubble or even the Mag 7 bubble a bit earlier. Symptomatic of that excess liquidity.
- [11:44]
Marty Bent
Yeah, and 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.
- [11:50]
Michael Howell
Yeah, it's looking that way. I mean, I think there's a, you know, another chart I can show you, which is actually a lot. I'm going to come back to these other ones, but 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 through 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% or 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 that same, 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, if you, Sorry, if you subtract the black line from the orange line, you get this one which hopefully you can see now.
- [14:00]
Marty Bent
Right.
- [14:00]
Michael Howell
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 2020-23. And you can see the path of what happened in 202122 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 what 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 and p was down 25% through that period in 2122 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.
- [15:29]
Marty Bent
It's interesting, we're seeing the spreads here between SOFR and the two year blowout. And then if you look at just the corporate debt cds, it looks like rate spreads are exploding there as well, particularly at 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.
- [15:57]
Michael Howell
So what that's basically showing is nominal GDP growth in the us. Let's just run through this because I think this is 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 and 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 yield 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 nominal 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 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 high yields. And if you don't see higher yields, you're going to see much slower NGDP 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 the Fed funds 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 where as I said, 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 will take this on board.
- [19:34]
Marty Bent
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. So it's like this weird situation where the economy's hot, we've got to invest. It seems that the administration here in the US and across the Pacific and China view this divorce race is 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 re industrialization effort going. But you also have the looming debt situation, which is that you could see spiraling out of control and the interest expense going up pretty rapidly and hitting levels that run fathomable a decade ago.
- [20:42]
Michael Howell
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 nominal terms is expanding at a rate probably at least 200 basis points. In other words, 2 percentage points higher than where it's been in the past. And governments are deliberately pushing this because they want AI, they want competitors risk. 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, holding higher inventory, warehousing more or whatever it may be on shoring. And that is going to mean faster NGDP 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 got to be very conscious that it may be an air pocket in risk asset prices.
- [22:24]
Marty Bent
Yeah, the, what are your thoughts on the, the quasi, I mean it's like wartime footing here in the United States. The, the, 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 could bring to the market. You could 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, Rare Earth metal companies. And I'm sure the list of companies that 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, these companies by doing whatever it takes.
- [23:53]
Podcast Host / Sponsor Announcer
Yeah.
- [23:53]
Michael Howell
And China's 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. 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, you're building national champions and you're building security. And I think the US being first and foremost in that race, or actually maybe arguably China was first and the US is copying. But the US has got a lead at the moment in many areas. But clearly it's a competition
- [24:27]
Marty Bent
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?
- [24:41]
Michael Howell
Well, I think that it's a difficult question to evaluate how this is going to fall into line. But the US has clearly got at the moment an advantage in AI and in energy or 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 another advantage with rare earth minerals. So that's a factor. And we know that China's got this huge, I say, dormant labor force that it still engage and basically mass produce 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. And the Japanese economy is being restructured. But you can see the impact that's having already on the Japanese bond market where yields have jumped at the 10 year level by over 200 basis points in the last couple of years, from half a percent to 50 basis points to over two and a half. I mean that's a big move in the bond market and that's clearly going to have an effect because when I was at Salary Brothers, the adage was always 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 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.
- [26:35]
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- [28:17]
Marty Bent
It's been interesting to observe too, as 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 Descent 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, didn't have a massive effect on U.S. hedge funds or players in the Western world.
- [28:55]
Michael Howell
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, German bonds. 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 things are kind of joined at. These markets are joined at the hip and therefore if yields start to expand, they're going to have a knock on effects. 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 struggling to survive over it, but it's struggling to grow at a decent pace and it's wholly dependent on export growth.
- [30:14]
Marty Bent
And so you think Trump's tariffs and export controls are having an effect there? Or is it a number of things?
- [30:22]
Michael Howell
Yeah, I think that's right. I mean it's, you know, they clearly, 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. So good. 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.
- [31:03]
Marty Bent
If you think of the buying capacity of those other countries that China is going to have to go to, it's nowhere near the US consumer buying capacity.
- [31:11]
Michael Howell
Yeah, correct.
- [31:11]
Marty Bent
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 the fact that it has been woefully behind and severely underinvested in critical industries and is very much over regulated, preventing European entrepreneurs from competing?
- [31:35]
Michael Howell
Well, I think tick all those boxes and it's overtaxed as well. And it's got an overly generous welfare state system. And at the end of the day this is incompatible. I mean, you simply can't do it. It takes 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 you know, we're, you know, 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, age 60, 65, they had 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 entrance of the labor market, graduates, et cetera, find it 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 for the simple reason that there's an awful lot of gray votes out there.
- [32:53]
Marty Bent
Yeah,
- [32:58]
Michael Howell
Yeah.
- [32:59]
Marty Bent
As a millennial, I feel fortunate to be in the position that I am. And I think millennials are better off than Gen Z. And it's something I've been observing for years and it's been bubbling up here in the United States, obviously in Europe as well. But you have this disenchanted generation of young people who, I mean, millennials who are 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, all the wealth and then redistribute it. And yeah, you can just Europe.
- [34:04]
Michael Howell
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, you go to extreme politics in that environment and that's the sort of, you know, 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 key economy speaks to this problem as well.
- [34:41]
Marty Bent
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 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, for their brands and obviously not good for affinity from. If you're trying to build affinity with younger generations specifically.
- [35:25]
Podcast Host / Sponsor Announcer
Yeah.
- [35:25]
Michael Howell
But I think what this then comes back to is the sort of sixty four thousand dollar question about what next? And you basically find that if governments are unable to cut back on the state, which Turkey has never voted 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 at a rate 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 is coming in a very subtle form, it's coming a form which is wonkish in the sense that you've got to be caught in the weeds to understand what's going on. But broadly speaking, what you're seeing is more and more evidence. 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 wateringly large figure. And 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 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, 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 printing 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 substack 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 and France is 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 happen 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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Marty Bent
I've got like an angel's halo going around me.
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Marty Bent
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My family and I have been crowd health members for five years now. Literally this month, five years ago, we joined Crowd health.
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Marty Bent
We've had two babies, we've had multiple
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Podcast Host / Sponsor Announcer
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Marty Bent
pay a monthly fee, you help out with other people's bills, and it's significantly
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- [41:39]
Marty Bent
platform in the community.
- [41:41]
Podcast Host / Sponsor Announcer
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Marty Bent
sovereign health in sovereign healthcare. Yeah, and I have today's substack up right now. I just want to make sure that I get the framing of this right. But using these, the Fed liquidity plus nine weeks 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?
- [42:22]
Michael Howell
Let me just try and see if I can do that with a. That should be there.
- [42:26]
Marty Bent
Yes.
- [42:27]
Michael Howell
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 I 3 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 history has shown. That's been remarkably stable. So 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. Maybe at most 5% of a portfolio in crypto that 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 much inflation boom, which I think is inevitable given the fact that governments basically have 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 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.
- [45:13]
Marty Bent
Can you walk me through this? You 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.
- [45:23]
Michael Howell
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, 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 gradient causality testing, which is showing whether you get consistent leads in the data from a shock to liquidity, whether it comes through, 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 of 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, extremely powerful. You can make money out of that consistently.
- [47:02]
Marty Bent
That's gonna. Well, do you have any inclination of what the. The other drivers are outside of just natural adoption or.
- [47:09]
Michael Howell
Yeah, we did an analysis some time ago of actually looking at what, 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, which. 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 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.
- [48:48]
Marty Bent
We saw confirmation of one of those factors in February, March of this year, when Gold was screaming 5,300 and Bitcoin was crashing.
- [48:56]
Michael Howell
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, you know, the way that I would read that or the way that I would say all that is that maybe I can, 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, it's not, it's not bad actually. It's measured on the right hand scale, but it's measured in renminbi. 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 and 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 any great extent. And what money was out there was being increasingly siphoned away into a strong 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, that their RMB currency, the yuan, internally, because of their huge debt problems. So what they need to do is to get the price level on the wage level up to basically devalue debt, okay? 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 it's 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's why you've got that picture. Now I'm 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 is, 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. 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 the on cue with the signing of the mou. Whether the MOU still exists or how fragile it is 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 cooled, deliberately cooled their economy. Now the Chinese have form 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 market sell off, you've seen economic data come in weaker. And it looks as if they're now they're starting to goose the economy once again by printing more money. And that may have been a short term interregnum 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, is evidence that the gold price should be beginning to form a bottom. Now, proof of the pudding will be the eating. But let's see.
- [54:37]
Marty Bent
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 4000. Looks like 4000 is good support for it right now since going back to late June. So July, it's been relatively flat. Is interesting. Yeah.
- [54:54]
Michael Howell
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. And they make announcement after announcement each day, say 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.
- [55:32]
Marty Bent
And you alluded to. I like to dabble in conspiracy theories from time to time, Michael.
- [55:37]
Michael Howell
We all do.
- [55:38]
Marty Bent
I think if you view everything going on in the world right now, whether it's AI, Iran as a proxy between the US 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's reacting to what the US Is doing. And if Trump knows that using this war as a way to push China around to an extent
- [56:24]
Michael Howell
could be.
- [56:24]
Marty Bent
Yeah, yeah, bring it back to bitcoin, you think? I think you wrote in today's newsletter 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 the better part of an hour now should express a higher bitcoin price after that.
- [56:49]
Michael Howell
Yeah, I mean, my view is, look there's no alternative but 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, 1 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, extend and pretend and whatever and say it's around 2 to 3 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 2 to 300 basis points higher, maybe 7 to 8% per annum. But after all, that's the likely growth rate path of US Federal debt. Now US 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, whatever it may be, 12 times over that period over 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've always got to pay attention to cycles in markets for sure, but you 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 that I've already suggested, has clearly got to be part of your investment outlook. And you don't need to have 100% in gold, you need to have 100% 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 buy the weakness. 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.
- [59:16]
Marty Bent
Yeah, 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, it is funny how people will just discard it and throw it away once, once the price falls a little bit. We're down 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. Last question. Do you think there's a when we hit 40 trillion in national debt here in the United States, do you think that level has a psychological trigger that sends people or do you think it's just another number that we had and nobody really cares?
- [60:19]
Michael Howell
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's the reality. The fact is that there's no way to curtail debt unless there's 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 reason that I've said capital wars are there and you need an active state, China has an active state and others are copying the 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 a direct trade, it's got to encourage investment, et cetera, et cetera. And at the same time it's got 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. And you choose. My view is that the path of least resistance to our politicians is printing more money. And they can do that either directly or they can do it subtly. And they don't subtly by issuing lots of short dated bills, lots of treasury 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 US is going out alone, but the US is dragging everybody else with it. So Japan is doing the same, Germany's doing the same, France is doing the same, Britain is doing the same. That just a step behind. But that's. This is the new reality.
- [62:16]
Marty Bent
Yeah. And I think the basement, again, the stat 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 like to the three levers that you pull there, if you pull the taxation lever, you're just going to have an exodus of talent.
- [62:39]
Michael Howell
That's exactly what the UK has found.
- [62:41]
Marty Bent
Yeah, exactly. Yeah. So the basement 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 substack 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, the cycle. So thank you for writing it and thank you for coming on.
- [63:11]
Michael Howell
Well, it's nice to know. Thanks Marty. Enjoyed it and honestly thank you.
- [63:14]
Marty Bent
Peace and love freaks.
- [63:15]
Podcast Host / Sponsor Announcer
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