← What Bitcoin Did
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- [00:03]
Michael Howell
One's got to be realistic and face up to the fact that the world has changed. And that change in the world is partly a function of China and partly a function of demographics. And the fact is that the west is bust. And the reason that the UK goes through prime ministers every two years is simply the fact there's no money left. They can't fulfill an agenda and they lose the confidence of their party. But that's the reality, and that's probably a fact across Europe as well. And then if you look at data that came out of the Philadelphia Fed last week, you know, you're looking at a lot of demand growth in the US economy. So I think it would be absolutely madness if they tried to do anything like, or even got near, you know, trying to ease policy. I mean, it would just be. It would just be crazy. I don't believe that that's what they're going to do. I think the strength or the firmness in the US dollar is actually already telling us that that's what the. That's the direction they're going and they're going towards more tightness.
- [01:00]
Danny
Let's get into this. Michael Howell, the liquidity king. Thank you for coming on the show.
- [01:05]
Sponsor/Ad Reader
It's good to speak to you.
- [01:07]
Michael Howell
Well, great. Good. Good to be here, Danny.
- [01:09]
Danny
I've heard a lot of good things. I know you've spoken to Nick Bhartier a lot and James Lavish, the sort of macro people I speak to on the show all the time, all recommended having you on the show. So I'm excited about this. I don't know exactly the best place to start. I think maybe we should start off with why you focus so much on liquidity and what it is that means that's the thing you keep your eye on the most within the economy.
- [01:32]
Michael Howell
Yeah, okay. I mean, it's a good question. I mean, the short answer is that money moves markets, and it's really as straightforward as that. Broadly, the way that we see things is that what starts the whole cycle or the investment cycle going is money flows, money coming into financial markets. Economics is downstream of markets, and geopolitics are downstream of economics. So you kind of see the sequence of maybe our thought process, but what we really want to understand is is there money coming into markets or leaving markets that will effectively change transactions? And one of the things you need to think about or conceptualize is that there are, broadly speaking, two big pools of money in the world economy, one that's in financial markets and almost a separate one that's in the Real economy. And so many people confuse these two things. They conflate them, they think they're the same thing, but they're not. They're very distinct. And all money that's anywhere must be somewhere. So it's either in the financial sector or it's in the real economy. Generally speaking, as investors, we prefer it to be in the financial or asset economy than in the real economy. Because if it's in the real economy, it's just driving activity. Whereas if it's in the financial or asset economy, it's driving asset prices higher. And that's really what we're looking at. So that's, I suppose, the sort of the basic thesis.
- [02:59]
Danny
And when you say economics is a downstream of markets, what exactly do you mean there? Because I think there's probably a lot of people out there who would think that whatever's happening in the economy is the thing that's driving markets. Maybe have that flipped the other way around.
- [03:12]
Michael Howell
Yeah, I mean, see, it basically works the other way. Well, I mean, there are feedback effects, there's no question. But the real economy will come back and influence financial markets as a sort of echo effect. But the first stage is that money, if you think about. If you said that money is the important factor that we all need to look at, I mean, I suppose, you know, in a capitalist system that almost goes without saying. But the fact is that that money process effectively starts transactions. And typically you've got to ask the question, how does money get into or get into our pockets, into our bank accounts or whatever? And it tends to move first through the financial system. It comes from the financial system, so it's then sustained the financial system first. Then it will spill out into the real economies. That's the transmission mechanism. So we look for guidance as to what's happening in real economies at the financial sector. And it's so often the case that you've probably heard the sort of the line before that the stock market tends to predict what's happening in the real economy. That's not really a prediction. It's more the fact that the stock market is reflecting the surge of money or the fall of money that's hitting the financial sector. And then there'll be an echo effect later that will affect the real economy. And it looks as if the stock market's been very prescient in terms of its prediction, but in actual fact, it's just following the money, which is the important factor here. So real economies tend to follow financial markets and financial markets tend to be led by liquidity. Or tend to, or money flow. The traditional economic textbooks kind of have things completely asked about face. So they, you know, you wouldn't, I mean, you wouldn't. I mean, if you were studying economics, I would recommend that people wouldn't. You shouldn't pick up an economics textbook because it's basically so wrong. I did economics through several degrees, so I've got a PhD in economics. But I must say most of the stuff that I've learned about economics I learned in practice in the markets, not from picking up textbooks or understanding what academics say because their view of the world is so distorted and actually so wrong that it's actually unhelpful. And we can have a whole episode on that. But broadly speaking, the markets are the truth in many ways. And to understand how the markets work, you just gotta effectively understand money flows. I mean, clearly there's a bit more to it than that, but that's really the essence. And so what you tend to find is some of the best investors are non economists by definition, very far from it. They actually have much better insight into how markets are working because they're actually using experience or in many ways common sense.
- [06:00]
Danny
So how have your views on economics changed then? So obviously you went through a lot of schooling. I'm sure that was mainly sort of traditional and Keynesian economics. Have you sort of come round to a more Austrian view of the world?
- [06:12]
Michael Howell
I don't know about an Austrian view. I mean, I think there are sort of, there are flaws in both sets of theories. But I mean, the point very simply is that if you, I mean, this is where we start from is that what you've got to try and understand is the money creation process, how money is being created in financial markets or in the world economy. And that money will migrate, money is fungible, it will tend to flow to where returns are highest or where there are most attractive investment opportunities or buying opportunities. So that money will flow. But the first thing is to say is that money has to be created. And that money creation process, it has a trend to it, there's no question about that. But there's also a very clear cycle. And it's understanding where we are in that cycle and what's driving that cycle that's really very important. And you know, you can in many ways dance on the head of a pin and say, you know, Keynesian economics is the best way of understanding it, or Austrian economics or whatever it may be. But you know, basically we're thinking much more about cycles which either, which, you know, both those two sets of Views don't really explain very well. I mean, they're explaining disequilibria when economies have crises or whatever, but they're not really understanding the fact that what you see most often in markets are fairly regular cycles. And it's a question of understanding why you get those cycles and why policymakers react in the way they do to certain events. And what we're seeing now is yet another example in markets of a typical cycle, a cycle in liquidity. That cycle has been blown up since mid to late 2022. We've probably peaked in terms of the liquidity impetus. Now it's beginning to roll over. But you've still got momentum in the system where asset prices are still rising. But very sensitive asset prices. Those that are most sensitive to liquidity already been troubled. I mean obviously Bitcoin is one clear example, which is probably the most liquidity sensitive asset on the planet. And then you' gold, which is also very liquidity sensitive. But that's also having a pretty difficult time right now. But these are features of the fact that liquidity is losing momentum.
- [08:35]
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- [11:17]
Danny
want to get into sort of where we are in this liquidity cycle because Luke Grohman, who has been on the show a few times, he calls bitcoin the last functioning smoke alarm of liquidity. And I've listened to a lot of your work and I know you've said that liquidity probably rolled over towards the back end of last year. But before we get into sort of where we are now, can you just explain what drives these cycles, like as liquidity ebbs and flows, where is it going to and where is it coming from?
- [11:40]
Michael Howell
Okay, well, I mean the answer is actually a complicated one, but let me try and make it more straightforward by saying let's say that the main driver are central banks. I mean there's obviously a Lot more going into it than that. But let's say it's central banks. I mean, central banks clearly play a very big role. There are other factors which can influence private sector behavior in terms of liquidity creation. But for the moment, let's say it's the central banks. So the central banks will begin to ease policy. Now, what could drive them to ease policy? It could be an external shock such as the COVID emergency, it could be a financial crisis like the gfc. But their response basically is to come in and throw liquidity at markets. Now one of the reasons for that, and perhaps the fundamental reason is they're not necessarily at the first instance trying to revive economic activity. What they're trying to do is to bail out the system and maybe bail out the banks. Because ultimately financial crises, and let's throw Covid into that same pot, they're really refinancing crises. And it comes back to the fact that debt is a paramount issue and a major problem in the world economy right now. We have way, way too much debt. And when I said that if you go back to economic textbooks, and economic textbooks are wrong or at least misleading, they tend to depict financial markets as being new capital raising mechanisms. In other words, that if you're a corporation and you spy some wonderful investment opportunity, what you're going to do is to go to the capital market, you're going to raise new money, you're going to take that money and you're going to invest in new capex, you know, plant and equipment or buildings or whatever. It may be a new enterprise. Well, that's a great idea, but it doesn't really work. It's not really what's happening now. There's not much of this going on now, I would say I'll come quietly and say, well, okay, I accept the fact that maybe the AI boom is creating this sort of temporary surge in capital investment. But this has been an unusual phenomenon over the course of the last 10 or 15 years. We haven't really had that much capex going on in Western economies. Most of the capex that's been undertaken in the world economy is operating in China and they're clearly not operating with the same model. This is state directed investment. So you've got to say that the textbook model is incorrect. So what are capital markets in the west doing most of the time? They're refinancing existing debts, they're rolling over debts. And given the fact that we've got this huge pile of debt, 350 to 400 trillion dollars of DEB debt with an average maturity of probably about five years or so. What you're doing is you're rolling over 70, $75 trillion of debt every year, which is a phenomenal amount of debt roll. And to do that you need capacity in the financial sector. You need balance sheet capacity for the intermediaries to do that. Now if that breaks down and you haven't got the financial capacity, you're going to get a financial crisis. So I come back to the shock and say, well, okay, what you've got is a financial crisis. You can't refinance the debt. In a capitalist, a modern capitalist system where you have where credit money, we are in a credit money world, you simply cannot default debt because debt is the collateral that's used to basically support the new lending, a lot of lending, in fact something like 70, 80% of all lending now is, is collateral based. In other words, you need some sort of asset to borrow against. And the bizarre thing is that that asset tends to be an old debt, in other words a treasury debt or gilt edge bond, gilt edged security or whatever it may be. So you simply can't default these things. So you basically have to provide liquidity so the refinancing process can continue. And that's basically the central bank's response to all financial crises or all of these problems that we see the tensions in financial markets. They'll come in on that ad liquidity, that's their ultimate remit. Okay, now there's other things they say, of course we're in the business to control inflation or improve employment. But the fundamental factor is basically to make sure that debt refinancing continues. And that's what they do. So if you look at the COVID 19 emergency or you look at the GFC, central banks came in and poured money into the system. That money inflated asset markets. Liquidity is fungible. So once it had facilitated the debt rolls, it was still there. It basically spilled out into other areas, it migrated into other risk assets, corporate bonds, equities, et cetera. And it began to inflate asset markets generally. It's what we loosely called the everything bubble. A good barometer of that, as you, you know, as you noted, as Luke Gromen has said, as we say is the great barometer is Bitcoin or traditional monetary inflation hedges like gold. And they clearly witness a strong bid during those periods where liquidity was abundant. Now liquidity will then spill out into the real economy ultimately because what you've got then is a situation where wealth effects because people feel wealthier, et cetera, et cetera, they can spend more money. Consumer spending goes up, the consumer spending may induce further investment spending, et cetera. And then the real economy gets momentum. Now, as the real economy gets momentum, it will require more liquidity to keep going, and so it will start to suck liquidity out of the financial sector. So what you see is the upswing of a liquidity cycle caused by central banks trying to relique the system and then ultimately that money spilling to the real economy and the financial sector being then or then losing liquidity to a then buoyant real economy. So one of the things that you tend to find is a paradoxical feature that strong economies rarely have strong financial markets, and strong financial markets are often associated with weak economies. And many people in Main street scratch their head and think, well, we can't get our head around this seems to be bizarre. But that's why that works, because you've got these two very separate pots of money and it's a question of understanding the sequences. So that's broadly one of the reasons why you see these cycles. Now there are other, other reasons that can come in. It may be that central banks then get concerned about inflationary pressures, and if inflation picks up because of a strong economy, they will actually initiate a further tightening in financial markets and that will then cause a bigger cycle and then we'll get debt refinancing problems because money in the financial sector is so short, and then they'll have to come back in again. So you sort of see the idea. I mean, we just go 360 degrees round again and so the cycle continues.
- [18:50]
Danny
So I know that you've been tracking global liquidity for quite a long time now. As we get further and further into this sort of debt spiral that we're in, do you find that the peaks and troughs either become higher and lower or is the cycle shortening as the debt gets more and more unmanageable?
- [19:06]
Michael Howell
Well, it's a very good question. I mean, I wish I could be definitive here, but it's very difficult. I mean, the first point to say is that one of the things that you are seeing is, is an exponential rise in debt. And that is almost an arithmetic point simply because the, the debt to GDP ratios of most economies are growing now. They're over 100% in many, many cases. And that means that once you, once your interest payments start to get of a, of a significant size, the whole thing begins to compound viciously and you get this sort of exponential growth and and so in order to sort of decap the growth of debt, governments will have to go back to fiscal surplus. There's just no chance of that happening at all. No chance demands for welfare spending or whatever it may be. And you know, the whole welfare system in the west needs to be radically reformed because it's certainly, I mean, it's going to bankrupt countries. And so anyway, that's another rabbit hole we can go down. But the point being here is that debt is growing exponentially and therefore you need liquidity to grow exponentially on top of that. Now, given the fact that liquidity tends not to grow exponentially, tends to be more cyclical than exponential, you can see why you get these financial crises. Now it would be a nice, you know, thing to say that you, that, you know, as the world sort of, as the world moves on, you tend to get bigger and bigger financial crises and, and you tend to get them more frequently. That's not always the case. I mean, I think you can see those tensions building and then being dissipated at different times. You don't always. Every crisis, every subsequent crisis is not necessarily bigger, but they're certainly, they tend to have a fairly constant frequency. I mean, if you look at our liquidity cycle, for example, that liquidity cycle tends to move with an average frequency of about five to six years. Now why is that? Why does it move with a five to six year cycle? The reason for that. And by the way, that's a big contrast to what people normally cite as a bitcoin cycle, which is four years, which I don't believe there's a four year cycle in bitcoin. I think there's a five to six year liquidity cycle. And my view is that that liquidity cycle is dominating things like Bitcoin, gold, etc. Now that five to six year cycle is occurring because the average maturity of debt in the world economy is about that tenor. It's about five to six years. And so what you're looking at is ultimately a debt refinancing cycle as I've described. So I think that's why you get them. So there is a fairly constant frequency. I don't think the things, I don't think cycles are becoming more shorter or more frequent. I think there's a fairly constant cycle and you can see at different times, depending on the background, that those tensions are dissipated sometimes and at other times they express themselves in a big crisis. So is the next crisis going to be bigger than 2008? I'm not sure. There's clearly a case for that, but it's very difficult to say at this time. It depends on the speed of response of policymakers.
- [22:29]
Danny
It's interesting. I agree with you that Bitcoin doesn't have a four year cycle. I just can't believe there's something special about every fourth October that means Bitcoin has to crash. But if it did fit into this liquidity cycle, that would give a nice reason that I could actually understand. So last October, obviously bitcoin topped and I think that coincided with what you said was the top of the liquidity cycle. Is that right?
- [22:52]
Michael Howell
Correct.
- [22:53]
Danny
Okay, so where are we in that cycle now? And what do you expect to come next?
- [22:58]
Michael Howell
Okay, well, let me see if I can transfer to some slides. So what this is showing is the global liquidity cycle as we think of it. And what this is showing is the black line is a rate of change of liquidity through financial markets. So this is using data goes all the way back to 1965. It's using data from about 90 economies worldwide. And for each country we are looking at about 30 different data series. So it's a very comprehensive analysis of liquidity worldwide. And the black line, as I said, is measuring a rate of change of liquidity. So it's not a level. And when we say that liquidity has peaked, we're talking about the rate of change, we're not talking about the level of liquidity. Just to be clear about that. Okay. Now what we've put on top of that cycle is on the top of the black line is a sine wave, which for those that are mathematically inclined has been estimated using Fourier analysis. And that was done actually in year 2000, so 25, 26 years ago. And we haven't changed it since then. And we've just run that sine wave on.
- [24:19]
Sponsor/Ad Reader
Wow.
- [24:19]
Michael Howell
It's pretty accurate. Yeah, what you see is what you get. So it either works or it doesn't, but it seems to be pretty good. And that analysis was our attempt some years ago to do this. An institution called the foundation for the Study of Cycles in the US Actually asked for our data last year and they said they'd like to do a more thorough and rigorous analysis because they study cycles in depth and they've got much better algorithms than we have. And they came away, looked at the data and came back and said, yep, we find it's 65 months too. It seems to be pretty standard and doesn't seem to have changed since you first estimated it. So that's kind of reassuring. And that's the movement of the cycle. What you see, as you noted, is that that cycle peaked in, at the end of Q3 last year. It had previously bottomed in September of 2022. And that upswing in liquidity has clearly launched what we've also called the everything bubble. So that's been an important factor in this story. And it looks as if, which is the less good news is that that cycle is going to bottom sometime probably in 2027 and probably the second half of 2027, if I'm honest. So, you know, we may have some way to go yet. And that's really the problem that we, that we face now. What about the relationship to, to things like bitcoin or crypto? Let me just try and see if I can show that now. So what that shows is the black line is the movements in global liquidity on a much higher frequency basis. So what that's doing is looking at six week changes. Now you may well ask, well, why six weeks? And the reason is that basically is a small filter that gets rid of noise in the data because looking at week on week changes would be hugely noisy, there'd be no signal there. And a six week change is basically getting rid of a lot of the noise. There's still noise in that, but most of it's disappeared. The orange line is looking at a basket of crypto. So we have this basket we call BS, which is essentially Bitcoin 60%, Ethereum 30% and Solana 10% as a sort of broad brush index of crypto. And again that six week changes, the black data series has been advanced by three months, that is 13 weeks. So it's predictive. And that's the tracking that you get. Now again, what you see is what you get. We've been using this, you know, consistently for many years now, trying to predict what happens in crypto. The correlation over that period has been about 0.55 or actually higher than 0.55. So in other words, an R squared of about over, over, over 0.3, which is pretty good for any financial series. And its latest data is basically showing, as you can see, this sort of sluggishness, if you like, in, in crypto prices, which is completely consistent with the fact that liquidity has slowed down.
- [27:53]
Danny
And with gold, would that look very similar to this?
- [27:58]
Michael Howell
Yes, it would, it would. I mean there are, there are different dynamics that are going on here and one of the things that is, is, I mean, I don't want to get caught in the weeds too much, but one of the things that we tend to find is that if you look at, I mean, this is maybe not a, you know, this is not rocket science in the sense that the US dollar area and the Federal Reserve is by definition going to be a lot more important in terms of driving cryptocurrencies than say China. Because in China you can't buy, it's illegal to buy crypto. So the pboc, the People's bank which is driving Chinese liquidity, is not going to have any effect on this or certainly not directly. So they tend to have more of their influence on gold. So if I shift to probably get there, if you just bear with me, there's a chart a little bit later I've got which will show this. This is the relationship between PBOC is the People's bank of China and this is gold. Now there are a lot of other things going on on gold affecting gold, central bank purchases, other liquidity, other countries liquidity, et cetera. But you can see that China, I mean, just eyeballing that chart, China has quite a, on the gold price. And this is illustrating again, six week changes to remove the noise that the pboc, you know, tends to have an impact about two, two and a half months ahead of what happens in gold. Now there's a story going, I mean, there's a story associated with this chart, which is why we put it up, is that, you know, what you've seen over recent weeks is gold is gold weakness. Now this is the long term relationship between PBoC liquidity and the gold bullion price. Okay? Now this is, I know, a step to the side from Bitcoin and crypto. But it's actually very important in this context to try and understand what's going on. Because both of these asset classes, precious metals and crypto, are monetary inflation hedges and they haven't always been aligned over the last few months. Now what this chart is illustrating is that people's bank liquidity, the black line, is driving the gold bullion market. And that's something which is kind of counterintuitive or maybe counterintuitive to a lot of people who have been arguing that the great debasement trade is really what has explained the rising gold certainly over the last year or so. Now, our point is that the great debasement hasn't really happened yet. I mean, okay, it's out there, it's going to happen. The challenge for Western countries is that debt is going to explode exponentially and they will have to monetize and that will undermine Western financial systems. And it will mean monetary inflation, you know, in large size. But it's only China who's really doing it at the moment. And it's very hard to see what China's doing because they've got capital controls on and money is not allowed to leave or it's not leaving very easily. And Chinese investors or Chinese residents only vent really for this. Excess liquidity is precious metals and they can put it into the stock market or real estate. But this is where most Chinese would tend to think about monetary inflation. Hedges would be buying gold, and that's what they're doing. So China has to get rid of its big debt problem. And the only thing it can do is to devalue the yuan domestically against gold. And the reason that they're controlling the gold market. But they've banned people buying crypto because they've realized that that's a very easy way, a very easy conduit for money to leave China. So that's not allowed. Now, if we go back to an earlier slide, this one, you'll see that there's an interesting conspiracy notion going on here. This is the data on that previous chart blown up for what's happened over the last few weeks. And this is the level of Chinese liquidity. Okay. And you can see that almost coincident with the beginning of tensions in Iran, China basically hit the brakes. And this is the amount of liquidity in their system. This is the absolute level. So the year on year growth will actually see a dramatic drop, which it has done. In fact, I can illustrate that you can see the year on year drop in terms of Chinese liquidity growth after this big, big surge through 23, 24, 25. They hit the brakes. Why have they hit the brakes? They hit the brakes basically because of the Iranian tensions and they wanted to slow the Chinese economy down to reduce oil imports during this difficult period. And that's what they've done. And it looks as if, although the MOU between America and Iran may have just been ripped up, but it looks as if they restarted their liquidity injections around the time of the MOU signing. Now. Okay, you know, two swallows don't make a summer, but I mean, this is not bad evidence to say something's been going on. And that may explain gold and it may explain why you could be seeing over coming weeks some stabilization in the gold market if they start to push more liquidity back at the system. So that's a long winded way of explaining the role of gold and China in this.
- [33:44]
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- [36:25]
Danny
And it's one of the reasons that China has such an impact on gold that they're moving away from holding things like US Treasuries and moving to hold more and more gold.
- [36:35]
Michael Howell
Yeah, that's, that's a slightly different point because that's, that's officially, that's, that's what the, the Chinese state is doing. But the big buyers of China of gold are retail investors, largely the central bank's also buying gold, there's no question about that. But we're looking here at, you know, the role of the, of the Shanghai Gold Exchange and basically retail demand across China, which is a much, much, much bigger source of buying. But notwithstanding, I mean, you're correct to say that this is also happening in the background and that clearly is also impacting the gold price.
- [37:11]
Danny
Okay, interesting. So when the liquidity rolled over sort of end of last year, bitcoin obviously fell off a cliff. Is this one of the things where bitcoin will react very violently, very quickly to liquidity rolling over? What will happen next? Is it going to be more downside
- [37:27]
Sponsor/Ad Reader
for bitcoin in your opinion or do
- [37:29]
Danny
you think does it sort of stabilize here and wait for liquidity to come back?
- [37:32]
Michael Howell
Well, I think that, I mean, put it this way, I think the first thing, if you're bullish on bitcoin, I mean, make no mistake, we're bullish on bitcoin in the long term. But the point that I keep making is that cycles have no respect for trends and you've got to understand where you are on the cycle to basically benefit from these long term trends. And even if bitcoin goes up strongly over the next few years, it may still be lower by the year end. Than it is now. And that's really the risk that we want to try and understand. What I would be doing first off is looking at what happens to the gold market and whether this China effect in the near term is going to persist. Okay, now we know that the MOU has been likely torn up and it may well be that China decides that it can't afford to press the gas pedal and get the economy restarted because there's no oil around. So they're going to have to go double down again and put the brake on. I don't know, we'll have to see how that pans out. That could be the case. But the other thing that's bubbling away in the background is what's happening in. I know we're sort of straying into the macro space, so if you want me to stop, I will.
- [38:43]
Danny
No, no, macro is great.
- [38:44]
Michael Howell
But if you look at the problem in the US markets, this is really what's going on in the background. Now what you could actually argue is that maybe the two most important prices in the world economy, this is trying to understand what's actually happening to the real economy. The oil price and the US treasury yield have both been suppressed well below their normal equilibrium. And if that is the case, that's giving a big boost to world economic growth. And if you have strong economic growth, as I've tried to articulate, that isn't necessarily good for financial markets because all money that's anywhere must be somewhere. So if it's in the real economy, it's not only in financial markets. Now what this chart here is demonstrating is the correlation between the black line, which is, which is nominal GDP growth. So in other words, the value of US national income in current dollars, year on year change. Okay, that's the trend, that's the black line. So that's basically nominal economic growth in the US Real growth plus inflation, in other words. And the orange line is the US 10 year bond yield. And I've called it risk adjusted. And that takes out some of the near term distortions. But it's trying to look at the underlying level of interest rates in the US system. In other words, it's telling us what the market is expecting for interest rates, policy interest rates, fed funds over the next 10 years. Now what that shows is a remarkable correlation between those two series. That actually is kind of what you'd expect really. And you can see where we are now. And it looks as if US treasury yields are well below where they should be. And the dotted line, the orange line, dotted orange line is saying where we expect they may end up. So what you've got is a lot of upward pressure on bond yields. Now think of this a little bit like, well, let's say this is suppressed. And think of us a little bit like holding a beach ball, an inflated beach ball, underwater. And the people that are holding it down are the U.S. treasury and the U.S. federal Reserve because they want to keep their interest bill low and they want bond yields to be suppressed because that's kind of helpful to the economy. So they're doing all they can to keep these yields down. And a number of things they're doing are they're very active in what's called the repo markets. Repo markets are basically at the center of funding in not just the US but in the world economy. And it goes back to a statement I made right at the beginning about how the world is dependent on collateralized finance. And what that really means is that prior to the global financial crisis in 2008, banks would lend freely to each other without any security. They did it on trust, okay? There was a lot of trust in the system. Following the global financial crisis, not surprisingly, lenders wanted a bit more security. So what you've had is this sizable jump in the use of collateral. And the repo markets effectively intermediate that collateral. So in the repo markets, that's what a repo stands for, sale and repurchase. What you're actually doing is you're effectively borrowing against collateral. That collateral tends to be something which has got well recognized value. Like a US treasury bond is liquid secure, et cetera. So you'll post a Treasury security to your credit provider and he will lend against that. Maybe they'll lend 98% of the value against that collateral, 95% or 90% or whatever it may be, and then you can get a loan. And that's what the repo markets do. And the treasury and the Fed have been intervening heavily in those repo markets to basically keep, if you like, the pot boiling and the treasury market yields suppressed. Now, to use that beach ball analogy, you're basically holding the beach ball underwater. Now, there's a couple of problems in that, okay? One is this one, which is what happened to Japan when it tried to hold its beach ball underwater. And this is looking at the US JGB market, Japanese government bond market. The dotted line is my estimate of what the fair value is on the Japanese long bond, the ten year bond. And you can see those figures, I mean, roughly for a long time, about 1%, but actually through that Period. Japanese yields, the actual yields, the solid line went negative because of that yield curve control program. Yeah, it was all this yield curve control and whatever else. Now as soon as they stopped that yield curve control, the fair value of the market went up that dotted line, but also the actual market overshot. And you can see what's happened is that you've got something like, I mean, at least a 200 basis point jump in yield since the ending of that yield curve control program. Now, given the fact that the starting point was basically around 50 basis points, we're now up at over 2, 2.5% for JGB yields at 10 year. I mean, this is a phenomenal change, okay? The world's never seen anything quite like this and this is what can happen. So if you're holding that beach ball on the water and suddenly let go, it shoots higher. Now the problem you've got in, in the US is basically this one, and this is showing the pressures at the front end of the US term structure. This is getting a little bit in the weeds and I'm going to try not to do this too much. But basically what this is telling us is that if you squeeze hard on one end of a balloon, right, it's going to bulge somewhere else, so you can't stop that. So if they're squeezing hard at the sort of 10 year longer dated area of the market, it's going to be bulging elsewhere in the turn structure and it's bulging at the front end. And what this is basically illustrating is those pressures. Now the orange line is the two year treasury yield in the US and that's a very, very good marker to what the private sector markets believe policy rates will have to do in the US So it's a very good sort of indicator based on supply and demand as to where interest rates will really be set over the next two years. And can I just ask you a
- [45:38]
Danny
quick question on this chart? Because a friend of mine, Jeff Ross, uses this chart a lot and the thing that he often says is this proves that the market actually decides the rates, not the Fed. Is that what you see when you
- [45:49]
Michael Howell
look at this 100%? That's exactly what we've been saying. It's always the case that it's the long end of the market that determines the short end of the market. The Federal Reserve is not. I mean, it can influence things in the very, very short term, but there's not much it can do. And that's really the point.
- [46:09]
Danny
But that shows what a tricky spot that Kevin Walsh is in now because he's obviously been brought in to lower interest rates, but the market's saying no, like what do you think he will do?
- [46:18]
Michael Howell
Well, I just don't think he can, he can't, he can't ease. Because I mean, what you're doing is you're stoking a farm already because you know, the US Economy is already growing very fast. And if you look at, I mean, these are sort of economic statistics I can throw out. But if you look at US Money supply measures, I mean, we don't look at money supply to understand financial markets really. We look at money supply to understand the real economy. And the latest M2 money supply data, or that's actually incorrect, not the latest, but of about a few weeks ago, maybe four or five weeks ago, the rate of growth, or the rate of monetary growth was up at close to 10%. Okay, a three month annualized rate. I mean it's cooled a little bit since, but that was clearly a big spike. And then if you look at data that came out of the Philadelphia Fed last week and you use that data which was showing a big jump in activity and still very high inflation pressures, that's pretty much consistent with nominal GDP of about 9, possibly 10%. So you're looking at a lot of demand growth in the US economy. So I think it would be absolutely madness if they tried to do anything like, or even got near trying to ease policy. I mean, it would just be crazy. I don't believe that that's what they're going to do. I think the strength or the firmness in the US dollar is actually already telling us that that's the direction they're going in. They're going towards more tightness. This chart is telling us that. And if you look at the net difference, which is shown here as the spread between SOFA rates and the US two year treasury, that negative spread is telling you rather like it did in 2021, 22, that we've got a tightening regime upcoming. Now that tightening regime in 2122 caused the S&P to fall 25% and it caused Bitcoin to fall 75%. Now, I'm not going to say you're not necessarily going to get a repeat of history, but, but just be careful.
- [48:33]
Danny
It's really interesting. Do you think part of this is why Kevin Walsh has come out? He said he wants to create an inflation task force to kind of get back to first principles about what inflation is. And he wants to. And he said that he cares about the left side of the Decimal place, not the right. So essentially saying he'll go up to 3% inflation. Is this him trying to figure ways of manipulating kind of the narrative and doing what he actually wants to do?
- [48:59]
Michael Howell
Well, I think he's giving himself some degrees of freedom, that's for sure. I mean, I don't know the exact figure, but it's something like, is it 63 or 64 months now since the Fed last hit its 2% inflation target? I mean, it's so long ago that it's almost ridiculous that they're still trying to target 2%. I mean, the underlying inflation rate in the economy is much higher than that, and they simply can't recognize that because it will then become embedded in expectations. So they've got to keep the sort of falsehood. They're still trying to target 2% inflation. But I think what he's doing is being realistic and saying, well, okay, let's give ourselves a little bit of flexibility, because that will mean I may not have to tighten as aggressively as maybe I should do. But then again, the cynic in me says that all these little tools or tricks that the policymakers are using are really just telling us that they really want to raise rates quickly, they want to keep this thing going as long as possible. But the problem is, using the beach ball analogy, maybe events overtake them and they have to start to tighten aggressively at some stage. I mean, not being early in the tightening causes you to do a lot more overkill later on. Later on.
- [50:20]
Danny
And so when, like to use your analogy, when they let go of the beach ball, what happens is that, is that sort of financial crisis in the US like, what.
- [50:29]
Sponsor/Ad Reader
How does that play out?
- [50:31]
Michael Howell
Well, it could be. I mean, that, that's, I mean, never say never. So this is looking at, this is the, my measure of where you get disequilibria, or financial crises, to use a less poetic term, financial crises in the system. And this is looking at what I define as the debt liquidity ratio. Now, if you come back to the sort of opening statement I made, which is to say financial crises or financial markets more generally are about refinancing. I mean, it's all about refinancing debt. And that's the main role of a financial market. So if you see a financial crisis, it's because you can't refinance, you can't roll over the debt, and effectively there is default threatened because that debt cannot be paid back. Now, what happens in those situations is you get a cascade into a crisis, and that tends to occur when the debt liquidity ratio is so stretched that there's insufficient liquidity, in other words, balance sheet capacity among financial lenders to roll over the debt to provide the balance sheet space to do that. And that tends to occur at levels, as you can see here, at around about 220, 230 on that chart. Now 200, which is the long term average. I don't know why, but that's where it is. Seems to be a level of some stability. And anything above that, you get a financial crisis, which I've annotated. So all these past financial crises have tended to occur when you get very high debt liquidity ratios. And that all comes back to this whole point about refinancing debt. And if you look at the lower part of the diagram, when there's lots of liquidity relative to debt, what you find there is you get asset bubbles because the venture in the financial sector of too much liquidity is ultimately an asset bubble. Now what we just come through is what I've loosely called here the everything bubble, where you see huge liquidity relative to debt. That's not because debt is small. It's largely for two reasons. One is that liquidity has grown enormous because the response of policymakers to every crisis, be it Covid or the gfc, is just to throw liquidity at the system. Spoiler alert there. Everyone should be owning these monetary inflation hedges long term, like crypto or gold, partially the cycle, but this is their response. And if you want an insurance policy against it, you just got to own these monetary inflation hedges because they will go up dramatically in that environment. So that's one thing. And the other thing is that because policymakers recklessly decided they were going to slash interest rates to zero or even negative in cases it caused people to term out their debt. So in other words, if you had borrowings, if you were sitting in the COVID crisis in 2020 and saw interest rates of 0 and negative, you thought, well, great, I've got debt which is maturing in three years. Why don't I just refinance it now for another seven years at 0 or 1%? And I'm quids in. And that's what happened. So if you look at this chart, this is showing what I call the debt maturity wall, which is basically saying, and this is not the absolute level, this is the change in the amount of debt that needs to be rolled each year. So in 2021, 22, there was a big drop because investors termed out their debt and a bit in 23, 24, and now you start to see from 25 onwards that the amount of debt that needs to be refinancing is growing all the time. And this is existing debt, it's not new debt. So you've got to add on to that. You know, the amount of funding that the US government will require because of defense spending, you know, what European governments will require, what the AI Capex boom will require. All these things are adding to this, which is purely, which is purely, you know, the, the debt in that's expiring the existing debt if you like. So that, that's really the issue that we're facing upcoming. And it comes back to this general statement which is talking about the debt liquidity cycle. And this is the centerpiece of our analysis which says, look, financial markets are debt refinancing mechanisms. It's all about this interaction of debt and liquidity. Liquidity needs debt because most lending is collateralized. Debt needs liquidity because debt has to be rolled over. So you get this sort of nervous equilibrium between debt and liquidity. And if that derails on the left hand side, you can't turn your debt into liquidity. You get problems in the repo collateral markets, which is why things like the SOFA spread or the move index, I mean I'm getting into the weeds of this for most people, but that's when they tend to signal flash warning signs. And then on the right hand side, because something like 80, 70 to 80% of all transactions in financial markets are rolling over existing debts, you're going to get problems either in bond term premia which collapse, or you get credit spreads which blow out. And there's a sort of big move towards safety in that space. People are nervous because debts can't be refinanced. So that's how the system works. And that debt liquidity nexus at the heart of it is basically shown here in this debt liquidity ratio. And you'll see the gray area that we project, that orange line goes up. Why does it go up goes up because A the cycle in liquidity is turning down for the reasons that we've gone into and B, because you've got this debt maturity wall upcoming which is causing debt to come back that needs to be refinanced. So that's the problems we've got. And that's why I would be hesitant about diving in now. Don't try and catch a falling knife, just wait for things to stabilize and try and get a reasoned view. Because Bitcoin and gold will pick up dramatically in the medium term. But I Wouldn't necessarily be an aggressive buyer right here.
- [57:02]
Danny
It's interesting. Anyone who knows about Bitcoin knows that this isn't something you buy for six to 12 months. This is a long term buy. But when this liquidity cycle does reach its bottom, is there always a catalyst that turns the liquidity switch back on?
- [57:19]
Michael Howell
Well, I mean the biggest is a financial crisis.
- [57:23]
Danny
Yeah, but I mean we're not getting a financial crisis or are we going to get a financial crisis every six years or however long this liquidity cycle actually lasts?
- [57:32]
Michael Howell
Well, I mean that's really been the pattern. But I think we can debate are they big or are they small liquidity crises? If the central banks are alert, they're relatively small ones. We saw there was a repo crisis in 2019, there was the COVID crisis. 2020, 2020, 2021, you know, ETC. There's been a bigger. Maybe Covid one's a bad example. Maybe the bigger Crisis was the one, the post Covid tightening which was 2021, 22 probably. So you can see you've got this sort of pattern unfolding and it's not exactly every five to six years because things, you know, nothing is perfect but you get that sort of, that frequency and that. And that's what we've got to look at. I mean we made a statement, I mean this is going back a long time, back at the time of the GFC is to say that what you've got is a future which is going to be dominated by QE processes. And don't think of QE1 or QE think of QE1, QE2, QE3, QE4. You're going to get a series of these quantitative easing processes because that's what central banks are in the game to do. Now debt has become such a problem that they need to refinance debt and they need to relique periodically the financial system because it can't cope. And that's the issue. And all this talk about brave talk about the Federal Reserve balance sheet is going to be shrunk dramatically. I mean, dream on. There's no way they can do that.
- [59:10]
Sponsor/Ad Reader
Well, that's always the question.
- [59:11]
Danny
I have. The debt problem is obviously ever growing. How do they ever get out of this? Do you think their plan is to inflate their way out of it? I can't see them ever defaulting. So what other options do they have?
- [59:24]
Michael Howell
Well, they have no options. They can only inflate because in a modern credit system, as I said, the paradox that you've Got, if you look at this chart, I mean, basically liquidity depends on debt, okay? So liquidity, call that new credit, depends on debt, but that's old debt, right? So the debt that they're using as collateral is existing treasury debt for, for the most part, okay? So you can't, you can't let defaults happen because you're basically undermining your whole credit system. So if that's the, if that's ruled out, all you can do is basically print money to devalue. That's what the Chinese are doing. But the, you know, the, the thing that the, the issue, I think we've got to get ahead or people have got to accept is that the big, the, the, the sort of debt, the sort of debasement of debt, the great debasement, as people talk, it hasn't happened yet, okay? We haven't had that period. We're getting it in China, right. And the Chinese have sort of managed to do it through capital controls and whatever else. I mean, that may be a pointer to the future. I mean, it may be very difficult for Western governments to impose capital controls, but doesn't mean to say they won't try. And you can see that in many cases, I mean, already they're starting to, you know, try and try and stop trying, trying to direct capital into local schemes. Whether it's, you know, Trump's attempts, you know, make America great again, whether it's the attempts that the, the British socialists are doing. I mean, all these things are, are ways to try and corral money and stop it flowing to where it should flow, which is monetary inflation hedges, when they're, when they're basically printing money. But as I say, the thing to think about is that China is really the country that's tried to get to grips with its historic debt problem. The debt problem the west faces is a future debt problem much more than a current one.
- [61:32]
Danny
Do you think they've got any chance of growing themselves out of this debt? And obviously AI being the only obvious catalyst?
- [61:38]
Michael Howell
No, I don't think there's any chance at all. Because you're in a situation where growth for the most part, I mean, I'm not going to discount AI and say that innovation technology is not any good. But the fact is that a lot of growth dependent is very demographically sensitive and the growth rate of economies is really, but at the end of the day dependent upon young workforces and we don't have that.
- [62:12]
Danny
Yeah. Demographic problem. It's super interesting. I've really enjoyed this, Michael, for anyone listening to this. Who wants an actionable thing to do. What is the move here? Obviously the debasement trade isn't a trade that lasts a year. This is a long term trade. Is it still buy gold, buy Bitcoin?
- [62:29]
Michael Howell
Yeah, I think it is. I think it is to do those things that would be sensible. I think you've got to also think about the jurisdiction, the geographical jurisdiction of your investments. And I'm not giving recommendations because I don't know the answer. But I think that if you start to get cases where it's going to be very difficult for certain governments to fund themselves, you know, let's go close to home with Britain. I mean, if you've got a socialist agenda which allegedly you have being written down in the UK now, I mean bond vigilantes worldwide are not going to be wanting to fund, fund this at existing interest rates. So yeah, how are they going to try and get this stuff funded? Well, there's going to have to be directives to pension funds or wherever it may be to try and force them to put money into the uk and that clearly is something which is going to constrain investors ability to invest. So I would be very, I would diversify. That's the best thing. I think gold and Bitcoin are clearly international assets that can be held. But I think one's got to be realistic and face up to the fact that the world has changed and that change in the world is partly a function of China and partly a function of demographics. And the fact is that the west is bust and the reason that the UK goes through prime ministers every two years is simply the fact there's no money left. They can't fulfill an agenda and they lose the confidence of their party. But that's the reality and that's probably a fact across Europe as well.
- [64:08]
Danny
I think you can probably short any country that's bringing Gary's economics on as an advisor. That's probably a safe bet.
- [64:15]
Michael Howell
I think that's right.
- [64:17]
Danny
Michael, this has been fascinating. Thank you so much for coming on the show. Where can people go and find more of your work? I know you have a substack. Where do you want people to go and follow you?
- [64:26]
Michael Howell
Best way is the sub stack. I think that's called capital wars. And we write a lot of stuff, we do narrative, provide data, we do two or three pieces a week. We talk about crypto, gold, asset allocation, Fed policy, China, all these things which we think are relevant.
- [64:45]
Danny
I'll make sure I put all the links in the, in the show notes but thank you so much for this. We'll have to do it again. When? Maybe when the liquidity cycle is turning again. We can be more bullish on Bitcoin then.
- [64:56]
Michael Howell
Great, Danny.
- [64:57]
Danny
Perfect. Thanks.
- [64:58]
Michael Howell
Thank you.
- [64:58]
Danny
Thank you so much.