“Liquidity Is Peaking — This Will Hurt Markets” | Michael Howell on Bitcoin, Gold & Fed Policy

Understanding Global Liquidity and Its Impact on Financial Markets

The Relationship Between Debt, Liquidity, and Financial Crises

• A high debt liquidity ratio can lead to refinancing tensions and financial crises.

• There is a negative correlation between business activity (PMI numbers) and financial liquidity.

Market Trends: Bull vs. Bear

• Bull markets focus on themes and trends, while bear markets are characterized by cycles; currently, we are in a down cycle.

• Recommendations include buying gold and crypto during market weakness, particularly Bitcoin around the mid-$7,000 range.

Introduction of Guest Expert

• Michael Howell, managing director of CrossBorder Capital with over 40 years in global finance experience, discusses liquidity indicators.

• A disclaimer emphasizes that the episode does not provide financial or investment advice.

Differentiating Liquidity Indicators from Traditional Measures

• Howell explains how his liquidity indicators differ from broader measures like M2 money supply.

• M2 primarily reflects retail deposits in banks but does not accurately represent what drives economies or financial markets.

Understanding Money Flow in Financial Markets

• The flow of money through financial markets is crucial for driving asset prices; traditional measures like M2 do not capture this effectively.

• Howell emphasizes that money must be tracked based on its presence in either the real economy or financial markets.

Conceptualizing Liquidity Beyond Textbook Definitions

• Liquidity should be viewed as a global factor where money moves across different asset classes rather than just being tied to new investments.

• The primary function of capital markets today is to roll over existing debt rather than raise funds for new projects.

Implications for Asset Allocation Strategies

• Balance sheet capacity within the financial sector is critical; if funds are used for debt refinancing, they cannot be allocated to purchasing financial assets.

• Strong performance in the real economy can limit available funds for investment in financial assets due to competing demands.

Understanding Global Liquidity Dynamics

Measuring Global Liquidity

• The focus is on measuring the momentum of liquidity rather than just its level, which is crucial for understanding economic cycles.

• The global liquidity measure aggregates data from 90 countries, with the US and China being dominant components.

• Each country’s liquidity is divided into three components: central bank money flow, private sector contributions (including banks and corporations), and household savings.

• Cross-border flows are also considered in calculating national indexes, which are then aggregated to form a global liquidity index weighted by size.

• Historical context shows that China's financial system has grown significantly since 1990, affecting its weighting in global liquidity measures.

Importance of Liquidity Momentum

• The change in liquidity momentum is more impactful than absolute levels; traditional metrics like M2 may not be as relevant.

• Liquidity acts as a leading indicator; while forecasting can be tempting, monitoring current trends provides better insights into future movements.

• Lead times for different asset classes vary: up to 18 months for real economy impacts, about 3 months for crypto assets, and around 6 to 9 months for fixed income and equity markets.

Current Trends in Global Liquidity

• A chart illustrates fluctuations in liquidity momentum over time; it follows a cycle averaging around 65 months due to debt refinancing patterns globally.

• This cycle was validated by independent research confirming the same average frequency of approximately 65 months based on underlying data analysis.

Factors Influencing Current Peaks in Liquidity

• Potential reasons for current peaks include deteriorating cross-border flows and marginal tightening by central banks—though they aren't fully tightening yet.

• A significant decline in private sector liquidity is noted as funds shift from financial assets to the real economy, impacting overall market dynamics.

• Recent gains in commodity markets indicate that these sectors are absorbing liquidity from financial markets, reflecting broader economic shifts.

Economic Growth and Liquidity Trends

Current Economic Climate

• The economy is experiencing strong growth, influenced by significant fiscal policies, which may further stimulate economic activity.

• There is a notable correlation between liquidity trends (black line) and economic cycles (red line), indicating that recent fluctuations align with theoretical expectations.

• Global liquidity peaked around the end of Q3 last year, with varying lead times for different asset classes: approximately 3 months for crypto and 15 to 18 months for real economies.

Impact on Financial Markets

• Financial markets are beginning to reflect changes in the liquidity climate, suggesting an impending shift in market dynamics.

• Despite positive PMI numbers indicating manufacturing expansion, there exists a negative correlation between business activity and financial liquidity moving into the real economy.

Asset Allocation Cycles

• The speaker emphasizes that many investors misinterpret ISM numbers as indicators of a bull market for risk assets like crypto; however, this may not be accurate according to their thesis.

• A schematic diagram illustrates four phases of the liquidity cycle: calm, speculation, turbulence, and rebound. Each phase corresponds with specific asset class performances.

Performance of Asset Classes

• In upward cycles (risk on), equities perform well; commodities peak at the top; cash excels during downturns; long-duration government bonds thrive at cycle bottoms.

• The current investment cycle appears standard: technology leads initially, followed by financial stocks mid-cycle, while resource stocks gain momentum later.

Observations on Crypto Market Sensitivity

• Crypto assets are highly sensitive to liquidity changes. Recent sell-offs in Bitcoin indicate potential early warning signs for global liquidity shifts.

• A chart comparing crypto performance against liquidity indices suggests that declines in major cryptocurrencies could signal broader economic implications.

Cryptocurrency Performance and Liquidity Analysis

Overview of Cryptocurrency Basket

• The orange line in the chart represents the performance of a cryptocurrency basket, including Bitcoin (60%), Ethereum (30%), and Solana (10%).

• The analysis covers a six-week period to minimize data noise, although other time frames could have been chosen.

Global Liquidity Impact

• A black line on the chart shows changes in global liquidity, measured at $185 trillion, with a focus on six-week changes advanced by 13 weeks.

• There is a clear lead time of 13 weeks indicating that liquidity movements precede changes in cryptocurrency values.

Sensitivity to Liquidity

• Bitcoin, Ethereum, and Solana are identified as highly sensitive to liquidity fluctuations compared to traditional assets like gold or stocks.

• A VAR analysis reveals that over 40% of Bitcoin's price variation is linked to prior movements in global liquidity.

Investor Risk Appetite and Gold Correlation

• Investor risk appetite, represented by NASDAQ index trends, accounts for about 20% of Bitcoin's price variations.

• The relationship between Bitcoin and gold shows short-term negative correlation but long-term positive correlation; they trend together but cycle apart.

Debasement Trade Discussion

• Current market conditions raise questions about whether cryptocurrencies serve as effective inflation hedges compared to gold.

• Despite rising gold prices due to perceived debasement trades, discrepancies exist between crypto and traditional asset performances.

Bond Market Insights

• Analyzing bond term premiums indicates varying compensation required for holding longer-duration bonds across different countries.

• If significant debasement were occurring, one would expect higher term premiums for bonds; however, current data does not support this notion.

Conclusion on Market Dynamics

• The lack of increased term premiums suggests alternative factors are influencing market dynamics rather than a straightforward debasement trade narrative.

China's Economic Strategies and Global Liquidity

The Shift Towards De-Dollarization

• Discussion on how central banks are diversifying away from the dollar, indicating a trend of de-dollarization.

• Mention of Chinese individuals using gold as a hedge against risk amidst economic uncertainty.

Bitcoin as an Inflation Hedge

• Argument that Bitcoin should be rising in value if it is indeed a good inflation hedge due to its fixed supply.

• Assertion that Bitcoin reflects global liquidity movements rather than just inflationary pressures.

Comparative Analysis of US and China Liquidity Cycles

• Presentation of liquidity cycles for the US (black line) and China (orange line), showing their historical correlation until mid-2010s.

• Explanation of China's distinct monetary policy changes post-mid 2010s, leading to desynchronized liquidity cycles with the US.

Implications of Chinese Monetary Expansion

• Observation that increased Chinese liquidity typically correlates with strong stock market performance, particularly in technology sectors.

• Noting upward momentum in Chinese government bond yields as evidence of expanding liquidity.

Understanding Debt to Liquidity Ratios

• Introduction to debt-to-liquidity ratios as a more meaningful metric compared to debt-to-GDP ratios for assessing economic health.

• Comparison between Japan's and China's debt-to-liquidity ratios, emphasizing Japan's struggles due to insufficient liquidity for refinancing debts.

Historical Context: Japan’s Economic Challenges

• Overview of Japan's rising debt-to-GDP ratio over decades without significant economic collapse, attributed to misinterpretation of metrics.

• Discussion on how Japanese monetary policies have evolved since the 1990 bubble burst, focusing on efforts to inject liquidity into the economy through various means.

Economic Insights on Debt and Liquidity in China and Japan

The Role of Debt Liquidity Ratio

• The debt liquidity ratio can only be improved by expanding liquidity, which has been a focus for the Japanese economy, leading to its recent renaissance.

• China's economic situation mirrors Japan's past struggles with high debt levels, indicating that they are approximately 15 years behind in addressing these issues.

Currency Manipulation and Gold

• The yuan's value is politically manipulated; thus, analysts should consider broader currency markets including gold for a more accurate assessment.

• Since 2020, the People's Bank of China has injected significant liquidity into financial markets, totaling $1.1 trillion by early 2025.

Impact of Monetary Policy on Gold Prices

• Increased liquidity injections have elevated the yuan's value significantly against gold prices, suggesting a deliberate strategy by Chinese authorities.

• Chinese residents utilize gold as an alternative investment due to restrictions on cryptocurrencies and export limitations on gold.

Real Interest Rates and Gold Correlation

• Historical data shows a correlation between real interest rates and gold prices; when real interest rates rise (black line falls), gold prices tend to decrease.

• A disconnect exists between current market conditions and historical trends regarding gold pricing amidst changing monetary policies.

Future Projections for China's Economy

• Continued liquidity injections are expected as China grapples with substantial debt levels affecting its real economy.

• Despite efforts from the People's Bank of China (PBOC), there are concerns that monetary policy may not effectively reach or stimulate the real economy due to overwhelming debt burdens.

Challenges Ahead for China's Economic Model

• Analysts suggest that without significant changes, China's economic model may struggle long-term due to persistent debt issues impacting growth potential.

Economic Challenges and Monetary Policy in China and the US

China's Economic Dependency and Growth Challenges

• The speaker acknowledges China's successful economic development but highlights its dependency on global markets, which is becoming unsustainable.

• Current issues include significant debt burdens slowing growth and tariffs impacting trade, necessitating new growth strategies.

• Potential solutions may involve doubling down on initiatives like the Belt and Road or increasing consumer spending, with a preference for the former.

• The risks of printing more money to stimulate the economy could lead to inflation problems reminiscent of past crises, such as those leading to Tiananmen Square protests.

• Observations indicate that gold prices are reacting to these economic pressures, while Bitcoin remains inaccessible for Chinese investors.

Changes in US Monetary Policy Dynamics

• Transitioning focus back to the US, recent changes in monetary leadership include Kevin Walsh's appointment as Fed chair, affecting liquidity dynamics between the Fed and Treasury.

• The speaker emphasizes that interest rates can be misleading; understanding Treasury actions is crucial for assessing liquidity impacts.

• Acknowledgment of Scott Bessent's expertise adds credibility to discussions about current liquidity conditions in the US market.

Understanding Liquidity Issues in Repo Markets

• The discussion shifts towards monetary inflation's implications for investment strategies, advocating for gold and Bitcoin as long-term hedges against inflation.

• Short-term dynamics differ from strategic investments; current weaknesses exist particularly within Bitcoin markets compared to gold.

• An analysis of repo market challenges reveals financing troubles due to collateral shortages leading to spikes in repo rates relative to Federal Reserve targets.

• These imbalances signal potential breakdowns in repo markets, prompting concerns from the Federal Reserve regarding liquidity availability.

• In response, the Fed has initiated reserve management purchases resembling quantitative easing (QE), indicating ongoing adjustments within modern financial systems.

Understanding the Liquidity-Debt Nexus in Modern Finance

The Paradox of Debt and Liquidity

• The financial markets operate on a liquidity-debt nexus, where debt requires liquidity for refinancing, while liquidity needs debt as collateral.

• A significant 77% of global lending is now collateral-backed, primarily using old debts like US government bonds and increasingly Chinese government bonds.

Mechanisms of the Liquidity-Debt Nexus

• The process involves converting collateral into liquidity to refinance debt; approximately 70-80% of transactions in financial markets are refinancing transactions.

• Key indicators for monitoring this system include term premiums in government debt markets and credit spreads in corporate markets.

Debt-Liquidity Ratio Insights

• The ratio between debt and liquidity serves as a crucial indicator; it tends to mean revert rather than trend upward like debt-to-GDP ratios.

• High debt-liquidity ratios lead to refinancing tensions, causing difficulties in rolling over debt and potentially triggering financial crises.

Historical Context and Current Trends

• Historically, most financial crises have stemmed from refinancing issues linked to low debt-liquidity ratios, which also contribute to asset bubbles.

• Recent trends show an increase in the debt-liquidity ratio due to slowing liquidity and rising levels of new debts being introduced into the system.

Implications for Central Banks

• Central banks have historically injected liquidity during crises but face challenges with current policies that aim to shrink balance sheets without destabilizing markets.

• The concept of zero interest rates is unprecedented; this environment has forced investors into more debt at a time when caution is warranted.

Future Considerations: Debt Maturity Wall

• The "debt maturity wall" indicates significant financing demands arising from deferred debts pushed out several years into the future.

• As real economic growth absorbs more liquidity, central banks must navigate these pressures carefully to maintain market stability amidst rising financing needs.

US Capital Markets and Liquidity Challenges

Overview of Current Demands on US Capital Markets

• The demands on US capital markets have significantly increased this year, primarily due to new borrowings from the federal deficit and corporate sector deficits driven by substantial AI investments.

• There are growing concerns about collateral liquidity imbalances and spikes in the repo market, necessitating Federal Reserve intervention to inject liquidity.

Federal Reserve's Role in Market Liquidity

• A focus on the growth rate of Fed liquidity reveals air pockets indicating periods of Fed tightening, which lead to market downturns. Recent RMP programs provided a temporary lift but indicate a potential slowdown in liquidity as we approach 2026.

• If Kevin Walsh aims to reduce interest rates while shrinking the balance sheet, significant issues may arise, with bank reserves expected to hover just above minimum levels without dramatic growth in overall liquidity.

Correlation Between Fed Liquidity and Market Performance

• Analysis shows a correlation between Fed liquidity injections (red line) and S&P 500 performance (orange line), suggesting that when Fed liquidity slows down, market corrections typically follow.

• Currently, the market is described as sideways ranging; any aggressive balance sheet reduction could lead investors to sell risk assets due to anticipated negative impacts.

Treasury's Influence on Market Dynamics

• The interplay between Treasury actions and Federal Reserve policies is crucial; recent announcements regarding refinancing $125 billion highlight potential drains on general market liquidity.

• If Walsh genuinely intends to shrink the balance sheet, it could result in adverse effects for risk assets. However, there seems to be an effort to support markets without drastic measures.

Transition from Fed QE to Treasury QE

• The discussion indicates a shift from traditional Federal Reserve quantitative easing (QE) towards Treasury QE aimed at more focused injections into the economy rather than financial markets.

• Treasury QE involves issuing short-term debt like Treasury bills that banks purchase, effectively funding government operations through expanded balance sheets while directing liquidity into the real economy.

Implications for Future Economic Growth

• The analysis suggests that most future stimulus will come from Treasury actions rather than traditional Fed measures. This shift could potentially strengthen economic performance if managed correctly.

Economic Insights and Asset Allocation Strategies

US PMI Index and Economic Outlook

• The black line on the insert represents the year-on-year change in the US PMI index, indicating a correlation with stimulus measures, suggesting an economic pickup in the US within a six-month lag.

• This anticipated growth comes at the expense of Federal Reserve quantitative easing (QE).

Current Asset Allocation Considerations

• As commodities are performing well due to being at the peak of the liquidity cycle, investors should consider transitioning their asset allocation strategies.

• A traffic light system is used to summarize asset allocation phases:

• Rebound (green),

• Calm (orange),

• Speculation (red),

• Turbulence (not yet reached).

Market Conditions by Region

• The current market status indicates:

• The US is in speculation,

• European markets are in late calm,

• China is experiencing a rebound,

• Japan is also in late calm.

• Advanced economies are primarily in late calm/speculation while emerging markets like China are rebounding. Investors should focus on equities and credits but avoid commodities during this phase.

Strategic Shifts as Markets Evolve

• In anticipation of turbulence, which may arrive mid-year, investors should begin reallocating towards bonds and reducing commodity exposure. This includes:

• Trimming equity positions,

• Focusing on resources and commodities for now,

• Gradually entering bond markets with shorter durations around five years.

Industry Group Performance Insights

• Cyclical sectors perform well during upswing phases while defensives do better during downturns.

• Technology leads through rebound and calm phases; financials gain traction mid-cycle.

• Energy commodities lag until later stages of speculation; consumer staples show signs of strength as defensive areas emerge. Investors should consider shifting towards these sectors strategically.

Long-term Investment Perspectives

• Despite current down cycles affecting assets like gold and crypto, there remains a long-term bullish outlook for these investments.

• Suggested buying points include Bitcoin around $7,000 and gold potentially near $4,800 when they dip below one standard deviation from their trends. Understanding market cycles versus themes is crucial for navigating investment strategies effectively.

Conclusion & Further Engagement

• The discussion highlights critical insights into global liquidity dynamics and investment strategies amidst changing economic conditions.

• For ongoing updates and research insights from Michael, follow his Twitter handle @crossbercap or subscribe to his Substack "Capital Wars." Additional links will be provided for further engagement with his work.

Insights on Global Liquidity and Communication Strategies

Overview of Communication Practices

• The speaker discusses their communication strategy, emphasizing the importance of posting updates and narratives at least two to three times a week.

• They highlight the use of data in these communications, suggesting a focus on transparency and information sharing with their audience.

• A website is mentioned as a platform for disseminating this information, indicating an organized approach to content delivery.

Reference Material: "Capital Wars"

• The speaker references their book titled Capital Wars, published by McMillan about four to five years ago.

• The book focuses on the rise of global liquidity, suggesting that it remains relevant in current discussions about economic trends.