Global Liquidity Has Peaked: What Happens to Bitcoin? | Michael Howell

[00:00:02]One's got to be realistic and face up to the fact the world the world has changed and that change in the world is partly a function of China and partly a function of demographics. Uh and the fact is that the west is is bust and you know the reason that the UK goes through prime ministers every 2 years is simply the fact there's no money left. They they can't fulfill an agenda and they they lose lose the confidence of their party.

[00:00:26]But that's the reality and that's probably a fact across Europe as well.

[00:00:29]And then if you look at um uh 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 go near um 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 in. They're going towards more tightness.

[00:01:00]Let's get into this. Um, Michael How, the uh the liquidity king, thank you for coming on the show. It's good to speak to you.

[00:01:06]>> Well, great, good, good to be here, Danny. I I've heard a lot of good things. I know you've spoken to, uh, Nick Bartier a lot and James Lavish, the 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. Um, I don't know exactly the best place to start. I I think maybe we should start off with why you focus so much on liquidity and and what it is that that means that's the thing you keep your eye on the most in within the economy.

[00:01:32]>> Yeah. Okay. I mean it's a it's a good question. I mean the the the short answer is that money moves markets and it's really as straightforward as that.

[00:01:40]Um you know broadly the way that we see things is that uh what starts the whole cycle or the investment cycle going is is money flows money coming into financial markets. uh economics is downstream of markets and geopolitics are downstream of economics. So you kind of see the 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.

[00:02:10]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.

[00:02:26]They they conflate them. They think they're the same thing, but they're not.

[00:02:29]They're they're very distinct. And all money that's anywhere must be somewhere.

[00:02:34]So, it's either in the financial sector or it's in the uh in the real economy.

[00:02:39]uh generally speaking as investors we prefer it to be in the financial or asset economy uh 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 that's I suppose the sort of the basic thesis.

[00:02:59]And when you say economics is a downstream of markets, what exactly do you mean there? Because I 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 round. Yeah. I mean, see it it basically works the other way. I mean there's there are feedback effects. There's no question.

[00:03:18]But u you know 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 uh if you said that you know money is the important factor that we all need to look at. Uh I mean I suppose you know in a capitalist system that almost goes without saying but the fact is that 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 then sustain the financial system first and then it will spill out into the real economies that that's the the transmission mechanism. So we we look for guidance as to what's happening in real economies at the financial sector.

[00:04:08]And it's so often the case that you you've probably heard the sort of the uh the line before that the stock market tends to predict what's happening in the stock in the in the real economy. Uh that's not really a prediction. It's more the fact that the stock market is reflecting uh 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 um the stock market's been very precient in terms of its prediction but in actual fact it's this 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 or or money flow. The traditional economic textbooks kind of have things completely asked about face. So they you know you you wouldn't I mean you wouldn't I mean if you were studying economics I would recommend that people wouldn't you know shouldn't pick up an economics textbook because it's it's basically so wrong. Uh you know I did uh I did economics through several degrees. So, I've got a PhD in economics, but I must say uh most of the stuff that I've learned about economics, I learned in in in practice in the markets, uh 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 it's it's actually unhelpful. Um and you know, we can we can have a we can have a whole episode on that, but broadly speaking, uh the markets are the truth in many ways. And to understand how the markets work, you just got to effectively understand money flows. I mean, included, there's a bit more to it than that, but that that's really the essence. And so, what you tend to find is some of the best investors are non-economists by definition. Uh, very very far from it.

[00:05:51]They actually have much better insight into how markets are working because they're actually using experience or in many ways common sense.

[00:06:00]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 around to a more Austrian view of the world?

[00:06:11]>> Um I don't know about an Austrian view.

[00:06:12]I mean I think there are sort of there are there are flaws in both sets of uh both sets of of theories. But I mean the the point very simply is that if you I mean this is where we we start from is that what you what you've got to try and understand is the money creation process. how money is being created in financial markets or in the in the world economy and that money will migrate.

[00:06:37]Money is fundraable. It will tend to flow uh to where returns are highest or where they there are you most attractive investment opportunities or buying opportunities. So that money will flow.

[00:06:47]But the first thing is to say is that you know money has to be created and that money creation process has a trend to it. There's no question about that.

[00:06:58]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 many ways dance on the head of a pin and say you know Kenzian 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 um you know explain very well I mean they're explaining disequilibria um you know when economies have crises or whatever, but they're not really uh 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 um and why policy makers react in the way they do to certain events. And you know what we're seeing now is yet another example in markets of a typical cycle uh a cycle in liquidity. that cycle has been blown up uh since mid to late 2022. Uh we've probably peaked in terms of the liquidity inputters now.

[00:08:04]It's beginning to roll over, but you've still got momentum in the system where asset prices uh are still rising, but the very sensitive asset prices, those that are most sensitive to liquidity are already being troubled. I mean, obviously Bitcoin is one clear example, um which is probably the most liquidity sensitive asset on the planet. Uh and then you've got gold which is um uh also very liquidity sensitive but that's also having a pretty difficult time right now. But these are these are features of the fact that liquidity is losing momentum. If you already self-custody Bitcoin you know the deal with hardware wallets complex setups, clumsy interfaces and a seed phrase that can be lost, stolen or forgotten. Bit key fixes that. Bit key is self-custody built for real life. It gives you an intuitive, easy to use wallet with no cphrase to sweat over. And it has a strong recovery system and built-in inheritance for long-term peace of mind. And Bit Keys just had a massive upgrade. The new device now has a screen. So before you approve something, you can check it on the Bit Key itself. The transaction, the address, or any account changes. It's a big difference. You're not just trusting what's on your phone. You're seeing it for yourself on the device. It's simple, secure self-custody without the stress.

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[00:11:15]I I definitely do want to get into sort of where we are in this liquidity cycle cuz Luke Groman, 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 and I know you've said that liquidity probably rolled over towards the back end of last year. Um but before we get into sort of where we are now, can you just explain what drives these cycles? Like as as liquidity es and flows, where is it going to and where is it coming from?

[00:11:40]Okay. Well, the I mean the the the answer is actually a complicated one, but let let me try and make it more straightforward by saying let let's say that the main the main driver are central banks. I mean there's obviously a lot more going into it than that but let's 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.

[00:12:08]So the central banks will will begin to ease policy. Now what could drive them to ease policy? It could be an external shock such as the co uh 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 crisis and let's throw CO into that same pot.

[00:12:50]that they're really refinancing crisis and it comes back to the fact that debt is a paramount issue uh and a major problem in the world economy right now.

[00:13:01]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, you know, 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, uh, a new enterprise. Well, that's a, you know, great idea, but it doesn't really work.

[00:13:39]It's not really what's happening now.

[00:13:42]Um, there there's not much of this going on. Now I 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 uh an unusual phenomenon over the course of the last 10 or 15 years. We haven't really had that much capex going on uh in western economies. Most of the capex that's been undertaken in the world economy has 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?

[00:14:18]They're refinancing existing debts.

[00:14:20]They're rolling over debts. And given the fact that we've got this huge pile of debt, 350 to400 trillion of debt with an average maturity of probably about 5 years or so. What you're doing is you're rolling over 7075 trillion of debt every year, which is a phenomenal amount of u of debt roll. And to do that, you need financial cap you need capacity in the financial sector.

[00:14:48]You need balance sheet capacity for the intermediaries to do that. Now, if that breaks down, 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 uh where where credit money we're in a credit money world, you simply cannot default debt because debt is the collateral that's used to basically support the new lending. Um a lot of lending, in fact, something like 70 80% of all lending now is collateralbased. In other words, you need some sort of asset um to borrow against. And the bizarre thing is that that asset tends to be an old debt. Uh in other words, a treasury debt or guilt edge bond, guilt edge 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 crisis or all all of these um uh problems that we we see the tensions in financial markets.

[00:15:58]They'll come in on that ad liquidity.

[00:16:00]That's their ultimate remmit. Okay. Now, there's other things they say, "Oh, 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 uh continues." And that's what they do. So, if you look at the COVID emergency or you look at the GFC, central banks came in and poured money into the system.

[00:16:22]That money inflated asset markets.

[00:16:25]Liquidity is fungeable. 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, etc. And it began to inflate um asset markets generally. It's what you know we loosely call the everything bubble. Um, a good barometer of that as you, you know, as you noted, as Luke Gman has said, as we say, is the the great barometer is Bitcoin or mon 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, uh, etc., etc., they can spend more money, consumer spending goes up, the consumer spending may induce further investment spending, uh, etc. 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 requequify the system and then ultimately that money spill into the real economy and the financial sector being then uh or then losing liquidity to a then buoyant real economy. So one of the things that you tend to find is uh a paradoxical feature that strong economies rarely have strong financial markets and strong financial markets are often associated with weak economies and many people you know 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.

[00:18:14]So that's broadly one of the reasons why you see these cycles. Now there are other reasons that can come in. may be that central banks then get uh you know get concerned about inflationary pressures and if inflation picks up because of a strong economy they will actually initiate a further tightening uh in financial markets and that will then cause a bigger cycle uh 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 uh and so the cycle u continues So I I know that you've been tracking global liquidity for quite a long time now. Um 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 or is the cycle shortening as the debt gets more and more unmanageable?

[00:19:06]Well, it's a very good question. I mean I wish I could be definitive here but it it's very difficult. I mean the first point to say is that one of the things that you are seeing is uh 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 a significant size, the whole thing begins to compound viciously and you get this sort of exponential growth.

[00:19:44]Uh and so in order to sort of decap the growth of debt, governments will have to go back to fiscal surplus. Uh there's just no chance of that happening at all.

[00:19:55]Demands for welfare spending or whatever it may be. And you know the whole welfare system in the west needs to be radically reformed um because it it 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 um you know thing to say that you that you know as the world uh sort of as the world moves on you tend to get bigger and bigger financial crises um and you tend to get them more frequently. That's not always the case.

[00:20:46]I mean I think you can see those tensions building and then being dissipated um you know at different times. You don't always every crisis every subsequent crisis is not necessarily bigger um but they they're certainly they 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 um an average frequency of about 5 to 6 years.

[00:21:14]Now why is that? Why does it move by the five to six year cycle? The reason for that and by the way that's a big contrast to what people normally site as a bitcoin cycle which is four years which I I you know I don't believe there's a four-year cycle in bitcoin. I think there's a 5 to six year liquidity cycle and my view is that that liquidity cycle is dominating things like bitcoin gold etc. Now that 5 to six year cycle is occurring because the average maturity of debt in the world economy is about that tenner. It's about 5 to 6 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 you know shorter or more frequent.

[00:22:01]I think there's a fairly constant cycle.

[00:22:04]Um and you can see at different times depending on the background that those tensions are dissipated sometimes um and at other times they express themselves in a big crisis. Um so is the next crisis going to be bigger than 2008? I'm not sure. Um 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 policy makers.

[00:22:28]>> It's it's interesting like I agree with you that Bitcoin doesn't have a four-year cycle. I I 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. Um 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?

[00:22:51]Correct. Okay. So where where are we in that cycle now? And and what do you expect to come next? Okay. Well, let me 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 um goes all the way back to 1965. It's using data from about 90 economies worldwide and for each country we we're looking at about 30 different data series. So it's a very comprehensive analysis of um uh 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.

[00:23:48]We're not talking about the level of liquidity. Just to be clear about that.

[00:23:52]Okay. Now what we've put on top of that cycle is uh on the top of the black line is a sine wave which for those that are mathematically inclined has been estimated using furer 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.

[00:24:18]>> Wowate >> yeah what what you see is what you get.

[00:24:22]So it either works or it doesn't, but it seems to be pretty good. And that analysis was our attempt um some years ago to to do this. Um 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 uh 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. Uh, 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. uh 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, you know, an an important factor in this 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, uh, 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 um 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 that basically is a uh you know 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 um basket we call bees u which is essentially bitcoin 60% ethereum 30% and salana 10%. As a sort of broadbrush uh index of crypto and again that six week changes the black data series has been advanced by 3 months i.e 13 weeks so it's predictive and that's the the tracking that you get. Now again what you see is what you get. Um we've been using this you know consistently for many years now. Uh trying to predict what happens in in crypto. Um the correlation um over that period uh has been about 0.55 or actually higher than 0.55. Um so in other words an R squared of about over over.3 which is pretty good for any financial series. And um um it's latest data is basically showing as you can see this sort of sluggishness if you like in um uh in crypto prices which is completely consistent with the fact that liquidity is slowed down and with gold would that look very similar to this?

[00:27:57]Um yes it would. It would. I mean there are there are different dynamics that are going on here. Um, 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 in the sense that um the US dollar area and the Federal Reserve is by definition going to be a lot more important in terms of driving uh cryptocurrencies than say China because in China you can't buy it's illegal to buy crypto.

[00:28:33]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 um they tend to have more of their influence on gold. So if I shift to a probably get there if you bear with me uh there's a chart a little bit later I've got which which will show this u this is the relationship uh 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 uh central bank purchases other liquidity other countries liquidity etc. But you can see that China I mean just eyeballing that chart China has quite a big effect on the gold price. uh and this is illustrating again six week changes to remove the noise that the PBOC uh you know tends to have an impact about two 2 and 1/2 months um uh 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 uh is that you know what you've seen over recent weeks is gold is gold weakness.

[00:29:43]Now, this is the long-term relationship between um PBOC liquidity and the gold bullion price. Okay? Now, this is I know a step to the side of 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 uh is driving uh 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 uh is really what has explained the rise in gold u 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 um 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 China Chinese investors or Chinese residents only vent really for this excess liquidity is precious precious metals and they can put it into the stock market or real estate but you know this is where most Chinese would tend to think about um 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, you know, that they're ch 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 that's not allowed. Now, if we go back um to an earlier slide, this one, you'll see that there's an interesting conspiracy notion going on here. This is the uh data on that previous chart blown up for what's happened uh over the last few weeks. And this is the level of Chinese liquidity. Okay. And you can see that um almost coincident with the beginning of tensions in Iran um China basically hit the brakes and this is the amount of liquidity in their system.

[00:32:33]This is the absolute level. So you know the year-on-year growth will actually see a dramatic drop which it has done.

[00:32:40]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? uh 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 theou between America and Iran may have just been ripped up but it looks as if they restarted uh their liquidity injections around the time of theou signing now okay um 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 the role of gold and and China in this. You wouldn't reuse a Bitcoin address, so why does your phone broadcast the same identifier for life? Every SIM has a static ID and carriers, ad networks, and bad actors all use it to track you. The big carriers have been caught selling that data over and over again. Cape is America's privacy first mobile carrier.

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[00:36:23]Yeah, that's interesting. And it's one of the reasons that China has such a an impact on gold that they're moving away from holding things like US treasuries and moving to hold more and more gold.

[00:36:35]Yeah, that's a that's a slightly different point because that's that's officially that's uh that's what the the Chinese state is doing. But the big buyers of Chinese of gold are retail investors largely. The central bank's also buying gold. There's no question about that.

[00:36:50]But we're looking here at, you know, the role of the of the Shanghai gold exchange and basically retail demand um across China, which is a which is a much much much bigger source of of of buying.

[00:37:01]But notwithstanding I mean you're you're correct to say that this is also happening in the background and that clearly u you know is is also impacting the gold price. Okay. Interesting. So when the liquidity rolled over sort of end of last year, Bitcoin obviously fell off a cliff. I is this one of the things where Bitcoin will react very violently very quickly to liquidity rolling over.

[00:37:23]Um what what will happen next? like is is it going to be more downside for Bitcoin in your opinion or do you think does it sort of stabilize here and wait for liquidity to come back?

[00:37:32]>> Well, I think that I mean put it this way. I think the first thing to if you're bullish on Bitcoin I mean we I mean make no mistake we're 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 uh to basically benefit from these long-term trends. And even if um you know 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 theou has been likely torn up, and it may well be that China decides that it can't afford to press the 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 and put the brake on. I I don't know. We'll have to see how that pans out. That could be the case. Uh but the other thing that's bubbling away in the background is what's happening in uh I know we're sort of straying into the macro macro space, so if you want me to stop, I will. No, macro is great.

[00:38:44]>> But if you uh if you look at the um the problem in the uh in the US markets, this is really what's what's going on uh in the background. Now you what you what you could actually argue is that maybe um the two most important prices in the world economy trying to this is trying to understand what's actually happening to the real economy the oil price and the US Treasury yield are both being 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 not going to be in financial markets. Now, what this chart here is demonstrating is the correlation between the black line, which is nominal GDP growth. So in other words, the the value of uh of US national income uh in current dollars year-on-year change. Okay, that's the trend. Uh that's the black line. And that's basically nominal economic growth in the US uh 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 uh in the US system. In other words, it's telling us what uh the market is expecting for uh interest rates, policy interest rates, Fed funds over the next 10 years. Now, what that shows is a remarkable correlation between those two series. Actually, it's kind of what you'd expect really. Um and you can see where we are now. And it looks as if US Treasury yields are well below um where they should be. And the dotted line, the orange line, dotted orange line is saying where we expect they may end up.

[00:40:48]So what you've got is a lot of upward pressure on bond yields. Now, think of this a little bit like um well, let's say this is suppressed and think of this a little bit like holding a beach ball, an inflated beach ball underwater. And the people that are holding it down are the US Treasury and the US 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. Uh 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 they did it on trust.

[00:41:49]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 repo stands for sale and repurchase. What you're actually doing is you're effectively uh borrowing against collateral that collateral tends to be something which has got uh you know uh well recognized value like a US treasury bond is liquid you know secure etc. Uh so you'll post uh a treasury security to your credit provider and he will lend against that. Maybe they'll lend 98% of the value against that collateral or 95% or 90% or whatever it may be. Uh 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 uh if you like the pot boiling and uh the Treasury market yield 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.

[00:43:07]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, the Japanese government bond market. The dotted line is my estimate of what the fair value is on the Japanese long bond, the 10-year bond. And you can see those figures. I mean roughly for a long time about 1%.

[00:43:31]But actually through that period, Japanese yields, the actual yields, the solid line went negative. And that was curve control program.

[00:43:40]>> 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 uh 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 two 2 and a.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.

[00:44:21]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 um 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, you 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 longerdated area of the market, it's going to be bulging elsewhere in the term structure and it's bulging at the front end. And what this is basically illustrating is those pressures. Now the orange line is the 2-year Treasury yield in the US and that's a very very good marker to what the private sector markets believe uh policy rates will have to do in the US.

[00:45:26]So it's a very good sort of indicator based on supply and demand as to where interest rates will really be set uh over the next two years. And can can I just ask you a quick question on this this chart because a friend of mine Jeff Ross uses this chart a lot and 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 look at this?

[00:45:49]>> 100%. That's exactly what we've been saying. It's always the case that it's it's the long end of the market that determines the short end of the market.

[00:45:58]the Federal Reserve is is not I mean it can influence things in the very very very short term but is there's not much it can do and that's really the point 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 he will do >> well I I just don't think he can he can't he he can't ease because I mean what you're doing is you're you're stoking a fire already because you know the the um the US economy is already growing very fast and if you look at um I mean the these are sort of you know economic statistics I can throw out but if you look at um US money supply measures I mean we 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 less actually incorrect not the latest but of about a few weeks ago four or five weeks ago, the rate of growth of the rate of monetary growth was up at close to 10%. Okay. Um a 3-month annualized rate. I mean, it's cooled a little bit since, but that was a clearly a big spike. And then if you look at um uh data that came out of the Philadelphia Fed last week um and you use that data which was showing a big jump in activity and still very high inflation pressures u that's pretty much consistent with nominal GDP of about 9 possibly 10%. So 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 um 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 um that's what the 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 uh you the US 2-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 21-22 caused the S&P to fall 25% and it caused Bitcoin to fall 75%. Now, I'm not going to say, you know, you're not necessarily going to get a repeat of history, but just be careful.

[00:48:32]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 of 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 the narrative and doing what he actually wants to do?

[00:48:59]Well, I think he's giving him he's giving himself some degrees of freedom.

[00:49:02]That's that's for sure. I mean, you know, I don't know the the exact figure, but it's something like is it 63 or 64 months now uh since the Fed last hit its 2% inflation target. I mean it it's so so long ago that it's almost ridiculous that they're still uh trying to target 2%. Uh I mean the underlying inflation rate in the economy is is much higher than that. Um and they they simply can't recognize that uh because it will then become embedded in expectations. So they got to keep keep the sort of falsehood that 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." Uh because that will mean I may not have to tighten as aggressively as maybe I should do. But, you know, then again, you know, the cynic in me says that, you know, all these little tools that uh or or tricks that the policy makers are using are really just telling us that they really want to raise rates quickly. Uh they want to keep this thing going as long as possible. But the problem is, you know, using the beach ball analogy, maybe events overtake them and they have to uh start to tighten aggressively at some stage. I mean, you know, not not doing not being early in the tightening um causes you to do a lot more overkill later on later on. And so when like to use your analogy, when they let go of the beach ball, um what happens is that is that sort of financial crisis in the US like what how does that play out?

[00:50:30]>> Well, it could be. I mean that that's I mean ne never say never. So this is looking at this is the my measure of where you get disequilibria or financial crisis to use a u to use um a less poetic term um financial crisis um in the system and this is looking at uh 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 you know financial crisis or financial markets uh more generally are about refinancing. I mean it's all about refinancing debt and that's 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 uh 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 200 220 230 on that chart.

[00:51:56]Now 200 which seem which you know is the long-term average. I don't know why but that's why it is that's where it is seems to be a level of some stability and anything above that you get a financial crisis which 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 is be it 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 vent in the financial sector uh of too much liquidity is ultimately an asset bubble.

[00:52:36]Now what we've just come through is what I've loosely called here the everything bubble uh where you see huge liquidity uh relative to debt. Uh that's not because debt is small. Uh it's largely for two reasons. One is that liquidity has grown enormous because the response of policy makers to every crisis be it COVID or the GFC is just to throw liquidity at the system. You know, spoiler alert there if you you know everyone should be owning um you know these monetary inflation hedges long term. Okay, like crypto or gold uh you know part the cycle but you know this is the this is their response and if you want an insurance policy against it uh you just got to own these monetary inflation hedges because they will go up uh dramatically in that environment. Uh so that's one thing and the other thing is that because policy makers 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 zero or negative, you thought, well, great. I've I've got a, you know, I've got debt which is maturing in 3 years. Why don't I just refinance it now for another 7 years at zero 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 202122 there was a big drop because investors turned 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 refinancing is growing all the time and this is existing debt. It's not new debt. So you 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 uh what the AI capex boom will require all these things are adding to this which is purely uh which is purely um you know the the debt in um uh that's expiring the existing debt if you like. So that that's really the issue that we're that we're facing upcoming and you know it comes back to this general statement which is talking about um the debt liquidity cycle and this is the you know the centerpiece of our analysis which says look financial markets are debt refinancing mechanisms.

[00:55:06]Uh it's all about this interaction of debt and liquidity. Liquidity uh needs debt because most lending is collateralized. debt needs liquidity because debt has to be rolled over. So you get this sort of uh you know 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.

[00:55:34]I mean I'm getting into the weeds of this for most people but that that's when they tend to uh signal flash warning signs. And then on the right hand side um because something like 80 70 to 80% of all transactions in financial markets are rolling over existing debts uh you're going to get problems either in bond-term premia um which collapse or you get credit spreads which blow out and there's a sort of big move towards safety in that in that space. People you know 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 you know the gray area that we project uh 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 uh which is you know 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 you know hesitant about diving in now. Um don't try and catch a falling knife. um just wait for things to stabilize and try and get a reason view because Bitcoin and gold will pick up dramatically um you know in the medium term, but I wouldn't necessarily be uh an aggressive buyer right here. It's interesting. It's um anyone who knows about Bitcoin knows that this isn't something you buy for 6 to 12 months.

[00:57:07]Like this is a long-term buy. Um but when when this um liquidity cycle does reach its bottom, is there is there always a catalyst that that turns the liquidity switch back on?

[00:57:19]>> Well, I mean the the biggest is a financial crisis. Yeah. But I mean we we're not getting a financial crisis or or are we going to get a financial crisis every six years or however long this this liquidity cycle actually lasts?

[00:57:32]>> Well, I mean that that's really been the pattern, but I think we you know we can debate are they are they big or are they small liquidity crises? M >> I mean if the central banks are alert there relatively small ones um you know we saw there was a repo crisis in um uh in 2019 uh there was the co crisis um you know 2020 2020 2020 2021 um you know etc. uh there's been a bigger you actually may maybe that's a that's a the co one's a bad example maybe the big the the bigger crisis was the one the postcoid tightening uh which was 20 2122 probably so you can see you you've got this sort of pattern unfolding um and it's not exactly every 5 to 6 years because things you know nothing is perfect but you get that sort of that frequency and that uh and that's what we've got to we've got to look at I mean that you know we 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 you know what you've got is a future which is going to be dominated by QE processes and don't think of QE1 uh or QE think of QE1 QE2 QE3 QE4 you know you're going to get a series of these of these uh quantitive easing processes because that's what central banks are in the game to do now they the debt has become such a problem that they need to refinance uh debt and they need to requequify periodically the financial system because it can't cope. Um, and that's the issue. And all this talk about, you know, 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.

[00:59:10]>> Well, that that's always the question I have like with the debt problem is obviously ever growing. What how do they ever get out of this? Do you think their plan is to inflate their way out of it?

[00:59:19]I I can't see them ever defaulting. So, like what other options do they have?

[00:59:23]Well, they have no options. They they can only inflate because in a in a modern credit system, um, 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 that's old debt, right?

[00:59:43]So, the debt that they're um uh that they're using as collateral uh 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 uh the the issue I think we've got to get our heads around or people have got to accept is that the big the the um um the sort of debt um the sort of debasement of debt, the great debasement as people talk it hasn't happened yet.

[01:00:24]Okay, we haven't had that period. We 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 that may be a pointer to the future. I mean it may be very difficult for Western governments to impose um capital controls but doesn't mean to say they won't try. Um and you can see that in many cases I mean already they're starting to you know try and um try and stop try and trying to direct capital into local schemes. Uh 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 uh to where it should flow, which is monetary inflation hedges when they're when they're basically printing money. But, you know, as I say, the the thing to think about is that China is the is the really the the country that's tried to get to grips with its historic debt problem. Okay. The debt problem the West faces is a future debt problem much more than a current one. Do you think they've got any chance of growing themselves out of this debt and obviously AI being the the sort of only obvious catalyst? No, I don't think they have any chance at all.

[01:01:41]Um because you know you you're in a situation where you know growth for the most part. I mean I'm not going to discount AI and say that innovation and technology is is is not any good but you know the fact is that you know a lot of growth depend is is very demographically sensitive and the growth rate of economies is is really at the end of the day dependent upon young workforces.

[01:02:08]>> Yeah. And we don't have that.

[01:02:12]>> There's a Yeah. demographic problem.

[01:02:13]It's It's super interesting. I I've really enjoyed this, Michael. If for anyone listening to this who wants like an actionable thing to do. What is the move here? Like obviously the debasement trade isn't a trade that lasts a year.

[01:02:24]This is a long-term trade. Is it still buy gold, buy Bitcoin?

[01:02:29]Yeah, I think it is. Um I think it is to do those things.

[01:02:34]That would be sensible. I think you've got to, you know, also think about the jurisdiction, the geographical jurisdiction of your investments.

[01:02:44]And, you know, I'm not giving recommendations because I I don't know the answer, but you know, I think that if you start to get uh if you start to get cases where it's going to be very difficult for certain governments to fund themselves, uh um you know, let's go close to home with Britain. I mean, if you 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.

[01:03:12]>> 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, uh, to try and force them to put money into the UK. Uh, and that clearly is something which is going to constrain investors ability to to invest. So I would be very yeah I would diversify.

[01:03:31]That's the the best thing. I think gold and bitcoin are clearly international assets uh that that can be held. Uh but I think one one's got to be realistic and face up to the fact the world the world has changed and that change in the world is partly a function of China and partly a function of demographics. Uh and the fact is that the west is is bust and you know the reason that the UK goes through prime ministers every 2 years is simply the fact there's no money left.

[01:03:59]They they can't fulfill an agenda and they they lose lose the confidence of their party. But that's the reality and that's probably a fact across Europe as well. I think you can probably short any country that's bringing Gary's economics on as an adviser. That that's probably a safe bet.

[01:04:14]>> Yeah, I think that's right.

[01:04:16]>> Um Michael, this has been fascinating.

[01:04:18]Thank you so much for coming on the show. Um, where can people go and and find more of your work? I know you have a Substack. Where do you want people to go and follow you? Uh, best way is the Substack. I think that's called Capital Wars and we write a lot of stuff. You know, we do narrative provide data. Uh, we do two or three pieces a week. Uh, we talk about crypto, gold, uh, asset allocation, Fed policy, China, all these things which we think are relevant.

[01:04:45]>> I'll make sure I I put all the links in the in the show notes, but thank you.

[01:04:48]Thank you so much for this. We'll have to do it again when uh maybe when the liquidity cycle is turning again.

[01:04:52]>> We can be we can be more bullish on Bitcoin then.

[01:04:55]>> Yeah.

[01:04:56]>> Great D. Thank you.

[01:04:58]>> Thank you so much.