Is the Federal Reserve’s shift in focus setting the stage for a major liquidity increase? Renowned global liquidity expert Michael Howell, Founder and CEO of CrossBorder Capital, joins James Connor to discuss the Fed’s economic concerns, its upcoming policy pivot, and the resulting boost in global liquidity, asset prices, and inflation. He also dives into liquidity trends from central banks worldwide, the challenges of rising U.S. debt, strategies for navigating an era of sustained inflation, and much more. Don’t miss this timely discussion, part of Wealthion’s special coverage of the Fed’s Open Market Committee this week.
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Michael Howell 0:00
We are on the cusp of a major liquidity expansion coming out of the Federal Reserve. Powell’s last speech was sufficiently sort of nervous about the economy that it suggested there was some hint of panic. Every financial crisis has largely been a refinancing crisis. Think of 2008 think of the Asian financial crisis in 97 you know, think of what happened in the US repo markets in 2019 all these, all these are instances where refinancing becomes a problem.
James Connor 0:31
Hi and welcome to wealthion. I’m James Connor, before we get on with our show, as a reminder, we have live coverage of the Fed announcement today with Vincent thuliard And Maggie lake at 2pm Eastern, once again live coverage today on wealthion at 2pm Eastern. My guest today is Michael Howell, founder of cross border capital, and Michael and his team focus on analyzing liquidity trends and capital flows for 90 different economies. So Michael will have some great insights on where the capital is flowing and how we can profit from it. Michael, thank you very much for joining us today. How are things in the great city of London?
Michael Howell 1:10
Well, pretty good. James, great pleasure to be here. I’m looking forward to our discussion very much.
James Connor 1:15
I was recently in London, and I was shocked by the number of tourists everywhere I went, the place was jam packed, and it didn’t matter if it was early morning or late evening.
Michael Howell 1:25
Well, I can, I can understand and empathize with you. There’s a lot of tourists around, and you know, I guess that tells us something about the value in Sterling, or maybe the value in some of the attractions that are that are still in London.
James Connor 1:37
Well, I thought it was interesting, because we keep hearing both empirical evidence and anecdotal evidence that the economy, the global economy, is slowing down. People aren’t traveling. But, yeah, when I was in London, that was not the case. It looks like people are busy spending money. Yeah, I
Michael Howell 1:54
think that. I guess if you analyze those tourists, I think a lot of them would be from the States, and I think that’s testament to actually a pretty good US economy generally, certainly relative to the rest of the world, and the fact that US dollar is, as we know, might even pretty strong still.
James Connor 2:09
So let’s start with the very basics. You and your team focus on liquidity flows. And I want to know what exactly is liquidity as you define it, and why is it important, and how can it help us?
Michael Howell 2:20
Okay, well, the first thing to say is that we’re monitoring the flow of liquidity, which is cash plus credit, that is flowing through world financial markets. We’re not really focusing on money that goes into the real economy. It’s very much a financial market metric. And the reason for looking at that is that basically money in financial markets drives financial asset prices, and that’s really what we’re interested in trying to analyze. So those are the, really, the, I think, the defining distinctions and what we’re really, I suppose, the other thing to say is what we’re really looking at is the funding background. Now, people talk about liquidity, particularly traders in markets, and when they talk about market liquidity, they tend to think about bid, ask spreads, in other words, the depth of the market, what sort of transaction volumes you can undertake. But we’re looking at a stage before that. We’re looking at the funding background is that, are there resources around, in other words, cash and credit to actually buy assets and therefore drive asset prices higher, and that’s really a key question. So what we’re doing is we’re watching the money flows worldwide. Interesting,
James Connor 3:27
and you, as I mentioned on the onset, you cover 90 different countries, or cover capital flows for 90 different countries. Why is it necessary to look at what that many countries are doing? Why wouldn’t you just focus on the largest economies like the US and China and Japan? Well, I
Michael Howell 3:45
think that’s that’s a very fair point, James. And clearly the there’s a sort of big five, if you like, that are really very important. And one can sort of think of countries like the US and watching the Federal Reserve is clearly critical for financial markets. But then you’ve got to also add in the activities of the Bank of Japan. They had quite a significant effect on markets through the last month. Then you’ve got the European Central Bank, then you’ve got the Bank of England, the the Swiss National Bank. These are all important players. I mean, the Swiss National Bank, as we know, is a major investor in Wall Street. So what they do and what they say can actually matter quite a lot. And then out there you’ve got the People’s Bank of China, which is, you know, now, a giant central bank. Its balance sheet is bigger on paper than the Federal Reserve. It’s rich not may not be so far, but if the bank of sorry, if the People’s Bank of China makes a move that has a big impact on both the Chinese economy and because of China’s large industrial footprint on the world economy as well. Now I think that one of the sort of you know, points to make about what’s been happening recently in markets is the fact that the People’s Bank of China has actually been pretty tight over the past 12 months. But. That’s caused the Chinese economy, really, to lag and to falter quite seriously, and that’s one of the reasons that I would venture that the world economy is currently pretty slow. What we’re waiting on now is signs of ease from the Federal Reserve, that easing process that the Fed is going to undertake, probably, as you know, as early as this week, we’re going to start to, you know, see the Fed cutting rates and maybe adding more liquidity. That really rests on the fact that inflation is under control. And one of the questions to raise is, to what extent does a slow Chinese economy also contributed to this fall off on inflation?
James Connor 5:33
So I just want to clarify one thing you said about the Bank of China. You said they’re very tight right now. What do you mean by that exactly?
Michael Howell 5:41
Yeah, well, I’m going to let me just be precise here. We’re talking about the People’s Bank of China. The the Bank of China is Taiwan, so People’s Bank of China is the, is the is Mainland China. And when we say they’re tight, what they’re doing is basically crimping the markets of liquidity. So they’ve been taking quite a lot of liquidity out of their money markets. And really, the focus of the People’s Bank has largely been on currency stability against the US dollar. Now, one of the things that we saw in the last few weeks, you know, really, beginning early August, was the yen started to rocket against the US dollar. The dollar started to come off, and that gave uh, China, a window whereby the yuan, the or the renminbi currency, China’s national currency, began to strengthen against the US dollar, and actually tested some of the highs for this year in terms of value. Now that’s important, because if you get a strong Chinese currency that gives the Chinese an opportunity to ease monetary policy, and boy, do they need an easier monetary policy. Because, you know, as people will appreciate this reading through the media, China currently suffering deflation. We think we may have an inflation problem, but they’ve got a serious deflation problem. What they need is liquidity, monetary policy easing in their economy right now. So
James Connor 6:57
why don’t we spend a few minutes talking about China? Because it is the second largest economy in the world, representing 20% of global GDP. And as you mentioned, there is a massive, slow slowdown there. We really never know what’s really going on in China, but maybe you can give us some sense of how bad things are in China and how it’s impacting the rest of the world. Well,
Michael Howell 7:18
I think what you’ve got to do in terms of analyzing China is to sort of split out the secular, the trend from the cycle. And as I said, if you look at the cycle, the cycle has really been affected adversely by a tight monetary policy. And that tight monetary policy has really rested on the fact that China has had a goal, which is maintaining a firm, or at least stable Yuan against the US dollar. And that really goes back to their maybe longer term ambitions of trying to create a rival for the US currency, certainly within the Asian region, maybe even ultimately globally. And what they perceive is that they can actually extract a lot of soft power, if you like, by having a robust currency. So that’s been one of their geopolitical goals, if you like. And therefore, as the US dollar is strengthened over the course of the last two to three years, what you’ve seen is the Chinese really struggle to maintain the value of the yuan, and therefore they’ve had to tighten monetary policy. Now the reason that’s significant is that all economies were hit, as we know, two to three years ago by the covid emergency, and the West came out of that, accomplished by a very easy fiscal and monetary policy, and in fact, so much so that we know we’ve got this short term legacy of inflation that policymakers are currently fighting. But China didn’t really have that luxury, and what China faced, as it was trying to come out of covid was this tight monetary policy that was put in place by the by the People’s Bank to try and maintain this firm Yuan against the US dollar. So they’ve never really had the opportunity of really a recovery from covid. The economy has been in the doldrums for some time. That’s the cycle. Now, that cycle could be reversed as soon as they start to throw monetary policy or ease monetary policy back in onto the economy. The secular is a very different question. And I think what China is really seeing now is something that is called by economists, the middle income trap. And that really means that you get up to a certain level of income per head, and you just find it very, very difficult to actually grow any more. The easy growth is there, and the more difficult growth where you’ve got to you’ve got to actually incentivize the consumer, you’ve got to get deeper productivity gains. You’ve got to invest in new technologies, etc, etc. It’s actually very hard to come by now. The problem that China has had, or still has, in fact, is that the consumer is not really enfranchised in China. So if you look at Western economies, clearly they’re driven to a very, very large extent by consumer spending. That is not the case in China. Consumer spending is important, but it’s not the same share of GDP that you see in Europe or. States, and that’s something that the Chinese ultimately will have to remedy. That means that their economic growth really depends on two features. One is more and more capital spending, or particularly infrastructure spending. And the problem here is that you can’t just keep building bridges or roads to nowhere. They’re very unproductive. They create a lot of debt. They saddle the economy with interest expense, and ultimately it’s a drag on economic growth. And the other dimension is export growth. Now, if you’ve got tariffs and trade protection isn’t emerging, it’s very difficult for China to actually maintain market share and actually grow its exports. So you can see the problems that China is facing, both secularly, cyclically and secularly, and those two problems are significant, and they’re basically causing China a lot of grief right now that have to be addressed. China is a big economy. This matters not just for China. It matters for the world. But we’re researching for some sort of solution, and I think the ultimate, my ultimate answer, is that the current model of red capitalism, if you like, this doesn’t work.
James Connor 11:07
So the consumer in the US economy represents approximately 70% of GDP. What would it be in China, not near a 50% right? And it’s interesting. You brought that up because a couple of high end retailer retailers, lvhm and also Gucci, have both said their sales within China are down significantly. I think they it was around 50% so the consumer there is definitely feeling some pain. And I believe veil VHM also said their champagne sales were down 50% because people there have nothing to celebrate.
Michael Howell 11:40
Yeah, absolutely right. Yeah. They can’t even drown their sorrows. And in
James Connor 11:44
terms of the GDP growth, it was growing, I believe, at 10% for many years. Where would it be now? In China, well, I
Michael Howell 11:51
think the underlying growth rate is still relatively healthy from a comparative point of view looking at other countries. You’re probably talking about underlying growth of maybe three to 4% but you know, that’s largely because China is still able to catch up with the West. In other words, there’s a productivity leader out there, which is the US, and China is increasingly, you know, trying to match that productivity level. The fact is that it’s becoming harder and harder to do that, but they can still maintain a growth clip of around three to 4% but the problem is that may not be enough to satisfy Chinese consumers, and the one thing that the CCP, the Chinese Communist Party, basically wants to do is to keep everyone happy. They want to provide jobs and wealth, and if they don’t do that, their role on modus operandi is really questioned. So
James Connor 12:40
let’s talk about the US economy now. And the Fed recently spoke in Jackson Hole, and I want to get your thoughts on what he had to say. He being Powell, but his his big comment was that a change in policy is coming, and we’re going to find out on Wednesday what that change is. But maybe you can give us a sense of what, give us a sense of what he said. And in, I think in the past, I saw you make comments about the stress test, you can, if you could also expand on that,
Michael Howell 13:08
yeah, I think these are two things. So let me, let me tackle one, one and then the other. In terms of what Powell is saying, He signaled, or flagged, the fact that US monetary policy is going to change direction. This is a super tanker that is changing course. And when super tankers change course, it really matters. And so we’ve got to think about in that light, will they do 50 basis points? Will they do 25 basis points? Doesn’t really matter, in my view. The fact is, the trend is changing, and what we’re looking at is a course of easier monetary policy over the course of the next, probably at least one to two years. Now, that process we view through a different lens, not an interest rate lens, but a liquidity lens. And what you’re starting to see is evidence of liquidity beginning to pick up quite seriously in the US economy. Now we don’t look at, or we don’t favor, I should say conventional monetary aggregates such as m1 and m2 and the reason is that those focus almost exclusively on the high street banks. And the financial sector, as we all know now, is a lot, lot bigger than high street banks. Nonetheless, you’re still starting to see an acceleration in these conventional monetary aggregates. So it’s clear that something is also changing, and that is the result, partially the result of fiscal policy, and the very loose fiscal policy that the US has currently got, and arguably will maintain over the medium term, because it looks as if the deficit is going to remain at around the sort of very, let’s say, high single figure levels of maybe, you know, 678, percent of GDP. These are big, big numbers by historical standards, and they’re basically being accommodated through the banking system, a sort of monetization, if you like. Now, let me go back to some of these other or getting for we. Of monetary policy and say something about the detail of what’s going on. Now, the reason that we look at liquidity is that liquidity is really the main factor for asset markets, and we take a global perspective. So we look at global liquidity, although, you know, I’ll come quietly here and say that the US Federal Reserve matters an awful lot in that global liquidity equation, particularly in the last decade. So we’ve got to focus on what the Fed is not just saying, but what the Fed is also doing. And there are two aspects that I think when one needs to look at here. One is the point that you cited, which is the stress tests on US banks now US banks have to fulfill at least every month a stress test for their regulator, where they can basically attest to the fact that they’ve got sufficient liquid assets. Now, one of the questions that you may pose is, what is a liquid asset, and what are the criteria that are used? And what the Federal Reserve has just done is basically broaden the range of liquid assets. So they’re now facilitating things like the ability to borrow through the Fed’s discount window. They’re looking at the ability to use the standing repo facility, and they’re also extending that to say any borrowing from Federal Home Loan Banks will also constitute a liquid asset. So these are new dimensions. And what that basically means is that the reserves that US banks have built up at the Federal Reserve are probably now, well superfluous to some degree. Banks currently hold something like $3.3 trillion of reserves at the banks. And one of the questions that analysts and even the Federal Reserve have made themselves is, do we really know whether this is an adequate, an ample, or a or a, basically a tight level of reserves to hold? And no one really knows the answer of that. But the fact is, because they’re loosening the definitions of liquid assets, it would seem feasible to say, or reasonable to say that now you’ve got excess reserves in the system under under old or conventional definitions. And if you’ve got excess reserves in the system, that is basically an increasing source of liquidity to do, think, do other things, to buy assets, to make loans, etc. And what you’ll like you to see is us, banks starting to pare down their reserves at the Fed. I mean, no one knows how much. Our estimates might be, as high as maybe half a trillion dollars or something like that, so they could get, you know, bank reserves could fall seriously under 3 trillion, but they’ll still be adequate, because on the sidelines, the banks are holding Treasury securities, which can now be used as collateral if they ever go to the discount window, or if they ever try to borrow against that through the standing repo facility. So these are, you know, these are big changes, potentially. The other thing you’ve got going on, which is something which has been, if you like, bubbling on for several months now, is that Janet of the Treasury, Janet Yellen, is doing an extremely good and competent job, if you like, duration, managing the Treasury calendar. And this may not seem a big issue, but I would argue it is, and what they’re basically doing is they’re restricting the supply of long dated coupons to the market. Now, as we know, pension funds and life insurance companies like to buy long duration US bonds, notes and bonds. That’s really their their main meal, if you like. That’s what they have the appetite for. And if the Federal Reserve or the Treasury restrict the supply of these longer dated coupons, then they’re going to start to push more and more investors down towards shorter dated bonds, and shorter dated bonds create more liquidity in the system. Now, one way to see that is to say that if the Treasury is issuing a lot of bills, and we know that Bill finance has crept up very significantly, or it’s issuing two year paper. Who are the big buyers of that paper, traditionally And traditionally, it’s credit providers like banks. Now, if banks are buying government debt, it worries the late Milton Friedman, because that is monetization. And what you’re starting to see now is very clear evidence of monetization in the US economy. This should worry people who are concerned about inflation in the medium term. It is a clear and unambiguous monetary inflation. And what does that mean? It means, it should mean a rising gold price. And what if you got gold sitting at an all time high. So this is the background that we’re seeing, in other words, that we’re on the cusp of a major liquidity expansion coming out of the Federal Reserve.
James Connor 19:52
So let me try to unpack what you said there. So first of all, the message that the Fed has been sending out for many. Months now is that they are hyper focused on inflation. They want to get inflation down from the high of 9% down to their target rate of 2% but you’re saying with this last speech that Powell made in Jackson Hole that he is now saying he’s still focused on inflation, but it sounds like they’re very concerned about what’s happening within the economy, and the growth and the slowdown that we’re seeing in the economy. Do I have that right? You have
Michael Howell 20:25
that absolutely spot on. But also add another dimension, which is the fact that also financial stability is a key, key criteria, and that and that financial stability extends to the Treasury market on the ability of the government to fund itself. So we’ve got to look at these dimensions too.
James Connor 20:41
And so what were you saying the you think the Fed is concerned about what’s happening, even though they’re not saying in the
Michael Howell 20:48
economy? Yeah, yeah. I think they are for sure. Are they more
James Connor 20:54
concerned about the inflation rate or about the economy slowing down? No,
Michael Howell 20:58
I think they’re more concerned by the economy slowing down, I think they that they’re not sure they’ve got a handle on it might be
James Connor 21:04
right, even though, yeah, okay, that’s good, because even though they don’t communicate that well, I
Michael Howell 21:08
think Powell’s last speech was sufficiently sort of nervous about the economy that it suggested there was some hint of panic. So do
James Connor 21:15
you think the Fed is sees a potential problem on their horizon, and that’s why they make these changes.
Michael Howell 21:24
I think they they see a I think they recognize there’s a problem in terms of funding in the medium term for the US public sector, absolutely, because there is a big problem. And you just got to look at what the Congressional Budget Office is projecting for the future debt GDP ratio in America. I mean, there’s, there’s an underlying secular, fast rising, secular trend in mandatory spending that somehow has to be funded. And the CBO are very explicit about this as being a major problem in the medium term. So there’s a lot of debt financing to do. And I think the Federal Reserve and the Treasury together, because of their activities, their joint activities in what I was saying, if you like, actively, duration, managing the calendar, they’re very concerned about this. So I think this is a background point, but it’s an important point regarding the economy. I think Jay Powell flagged growing concerns among the FOMC about the integrity of the economy. I don’t think the economy is in recession. I don’t think it’s near that near recession, but I think the Federal Reserve maybe is hinting here that it’s uncertain about the medium term, whether it has control over the economy, and what they clearly want is to put some support in, in my view, so this is perhaps a cushion or a safety net underneath the economy, and therefore cutting interest rates now, and read that as adding more liquidity, which is the key factor, is really what they’re up to. I mean, at the end of the day, the Federal Reserve, despite what it’s despite the market’s focus on, you know, monthly CPI numbers, Federal Reserve is really looking at what the fixed income markets are saying in terms of longer term break even inflation that that’s really the key. This is the whole, the whole sort of, if you like, framework of Federal Reserve put in place for inflation fighting. And what that’s telling them is inflation is beaten. So
James Connor 23:11
you touched on debt, and the federal debt now stands at $35 trillion mind blowing number, and it’s growing by a trillion dollars every 100 days. Interest expense on that is a trillion dollars annually. So are you saying that the Fed is very concerned about potential interest rates when they go to refinance this debt, it’s going to be costing a whole lot more
Michael Howell 23:34
correct? I mean, that that’s got to be a worry. Because, you know, you can now see, I mean, just by the math of this, is that if interest rates go up, debt service costs go up, which means more debt. And what you’re doing is you’re piling debt on top of debt. And this is not a this is not a great situation to be in. So if you look at the debt GDP ratio of the US as projected by the Congressional Budget Office, it looks like an exponential curve upwards. I mean this, these are not healthy situations. We’ve got too much debt. You know, this is the problem. But the reality is, is that one of the things that people have got to recognize is the debt goes hand in hand with liquidity. And we’re in a situation now where financial markets have moved very clearly away from being new capital raising mechanisms into being, basically debt refinancing mechanisms, and that’s a very important, subtle but very important difference. Now, what that basically means is that liquidity is needed to roll over debt. And you know, the reality which people forget is that, you know, if I issue a five year bond today, that may be great for five years, but in five years time, I’ve got to refinance that bond. And to refinance You need balance sheet capacity, which is really liquidity in the markets. So you definitely have to have with rising debt levels, rising liquidity levels. Now the reality is that that liquidity spills out for the last. Last decade or two decades, most of that over spill of liquidity has gone into other financial assets. In the last two years, it was so significant that it spilled over into the high street, and so you got consumer price inflation as well. But what we’re looking at is debt, which is growing at something like two to three percentage points faster than US GDP, which basically means that you’re looking at something like, what, 8% per annum growth in debt, which means you’re getting 8% growth in liquidity, and that is the sort of benchmark or hurdle you’ve got to think about in terms of your asset market returns, because liquidity drives those asset market returns, and so you need assets that will keep pace with monetary inflation. Gold has shown us for centuries, that’s what it does. It may lead lag a bit, but generally the trend is there. High quality equities seem to do that. That’s what experience shows. Fixed income markets do not do that. Prime residential real estate does that, and for the last five years, Bitcoin has done that. Yeah,
James Connor 26:04
I wish I had some money in Bitcoin. The government debt is approximately 125% of GDP, and the only way the government’s going to be able to reduce these debt levels is either by stop spending or increasing taxes. And both would be political suicide, especially going into an election. And how do you think the government’s going to solve this issue? What are they going to do to get this, these debt levels down? I
Michael Howell 26:30
think there’s only one solution which is a tried and tested solution for every politician, and that’s the kick the can down the road. And that’s what we’re going to get. They’ve got, they’ve got no ability to arrest the problem unless they renege on Social Security and Medicare commitments. Is that likely? Why doesn’t listen to the rhetoric coming out of the two candidates. Now, there’s no way they’re going to do that. Is there any way they’re going to raise taxes? I think is going to be very difficult, particularly in the global world, to do that. So you know, you’re either talking about wealth taxes, which would be anathema to Americans, but maybe that’s coming, or you fund it through the markets. And that’s what I think, is the easy solution, and that’s what the politicians are going to do. They’re going to kick the can down the road. And you know what you get out of this is a global liquidity cycle, which is basically in the early stages of moving higher. There’s a chart I think I’ve got in the pack there, which basically shows what global liquidity, at least for the advanced economy, is doing. We noted that in October of 2022 that cycle bottomed, and a rising liquidity cycle is always great for financial asset prices. And lo and behold, since that low point in October of 22 you’ve seen a sustained bull market. Now, as we know from experience, bull markets always climb a wall of worry. This one is no different. Liquidity is still going in, and that cycle is likely to peak out sometime in late 2025 from a cyclical standpoint, but from everything that I’ve just said, the secular trend in monetary inflation is there embroidered or overlaid on top of that cycle, and that, that exponential trend in monetary inflation is something we’ve never really seen before, but that’s because, you know, fiscal spending is kind of getting Out of control. But the fact is, the cycle and the trend are pointing upwards. And also you’ll see in the presentation a heat map which basically illustrates what not just the Federal Reserve is doing, but what all central banks worldwide are currently up to. And that heat map illustrates very clearly that you’re moving from a red area, which was very tight monetary conditions around about middle of 2022, into a more benign state now, where the hues of the chart, the colors start to turn from red through orange to yellow, and now increasingly green, and green is go or whatever, or an easier monetary stance. And that’s, basically what we’re getting. And, you know, I would say this, James, look, you’ve got a situation where a lot of investors are concerned. I mean, understandably, the world is uncertain. But look, you’ve got three factors that are going on right now. You’ve got, number one, you’ve got a slow, but not recessionary US economy, okay, that’s always, historically, been a pretty good backdrop for markets. You don’t want a hot economy, you don’t want a recessionary economy. You want a kind of Goldilocks economy. That’s the right way of putting it. Secondly, you’ve got a Federal Reserve that is eager to ease. And it’s not just the Federal Reserve, but the European Central Bank, the Bank of England, all central banks, maybe with the exception of the Bank of Japan, but I think the Bank of Japan are being unrealistic about their ability to tighten all central banks. Let’s say want to ease. And the third thing is, you’ve got a deflationary Chinese economy, which is keeping a cap on world inflation. What’s not to like?
James Connor 29:58
So I just want to I. I just wanted to ask you about something you mentioned earlier about and I asked you how governments are going to deal with this debt, and you said they’re going to keep kicking the can down the road. Well, if I’m talking to you four years from now, and they keep kicking that can down the road, and then debt as a percentage of GDP is maybe 200% God knows where it’s going to be, but an annual interest payments are maybe three, four, $5 trillion a year. Like, how does that all end? I can’t imagine it’s going to be good.
Michael Howell 30:29
Well, I think the I think is, it’s an interesting point to ponder. And what I would say is that, you know the numbers, the direction of what you say, is absolutely correct. You know the the US debt GDP at some stage will test 200% that may not be in the next four or five years. I mean, the debt GDP is is rising, but it’s not rising quite at that pace. But you are looking at incremental increases in the debt GDP ratio. You’re looking at sizable increases in debt payments within the budget. That’s absolutely for sure. And they can keep this going for some time now, a lot of economists basically say, Look, this is unsustainable. Well, the sad reality is that actually, it’s quite sustainable, because governments can always fund themselves, right? The question is, what price and through what other nefarious activities they fund themselves, like monetization? After all, monetization is a tax on everybody else, isn’t it? So, because it creates inflation. So, you know, that’s one way to look at it. And what I would argue is that if you look at Japan right now, Japan has got much, much higher debt GDP ratios, but that society seems to keep working right? They keep going to work each day, waking up and whatever else, and living a pretty decent life. Britain in the 1950s and early 1960s had a much higher debt GDP ratio in the weight, or public debt to GDP ratio in the wake of World War Two and the huge cost of fighting the Axis powers that caused debt in the UK to skyrocket. Now what were the consequences of those two actions? What I would say is that huge amount of debt, and particularly public debt, crowds out the private sector. So the UK economy, the British economy, has never really recovered from that experience. In the 1950s and 60s, it’s always been a slowish growth economy, a sluggish economy, and stunning has been a weak currency. What are you seeing in Japan? You’re looking at pretty similar phenomenon, aren’t you? You’re looking at basically a sluggish economy. It’s not got the dynamism it had in the 1970s and 80s. And you’re starting to get, you know, periods of significant weakness in the Japanese yen. So this, these are the costs that come through. It’s not that they’re, you know that something you’re going to wake up on the whole system, you know, falls like a deck of cards that clearly that could happen if people lose confidence, but it’s much more, you know, a slow erosion of economic welfare. So,
James Connor 32:52
as you alluded to, governments do one thing very well, and that is, they print money. Okay, so under this scenario that you’re painting, I want to find out what this means to inflation. And as you know, I am residing in the city of Toronto, and our national airline in Canada, it’s called Air Canada, the pilots were going to go on strike, and they just reached a tentative agreement with the pilots Union. This past week, the pilots are going to get a 45% bump in pay. Can you believe that? And I think we saw the same sort of thing out of both United and delta in the past year. And of course, these airlines are just going to pass the cost on to consumers. But this is one of the things that you know, people are feeling pain because these inflated prices. Airbnb came up with their quarterly earnings here a few weeks ago, they were also they had a big mess, and they said people just are not traveling because it’s costing so much money. But what does this? What do you think this is going to do to inflation? Well,
Michael Howell 33:52
it’s going to keep you bubbling on at a high level. I mean, that’s for sure. In Britain, you’ve just had announced that doctors are getting a 22% pay increase, so maybe not quite the same as airline pilots, but, you know, still a pretty significant and hefty increase which someone’s got to pay for. So, you know, maybe catch up. But the fact is that it leads to more and more inflation, and that’s really the backdrop we’re looking at now. I think the way to see this is not that we’re necessarily going to move into an environment of hyperinflation, but we are going to see higher inflation levels than people have been used to, and whether that means that we’re shifting from a base level of 2% inflation to near a 4% I’m not sure, but it’s that sort of magnitude, and that’s what you’ve got to start thinking about. Now it’s not just the high street that we’ve got to be concerned about here. We’ve got to think about asset markets and the way to think about inflation, or the way at least we think about inflation, is to say, look, you’ve got high street inflation and you’ve got monetary inflation. The two things are not the same thing. Monetary inflation is an input to high street inflation, but high street inflation also has costs involved, and those costs can also. Drive high street prices up. It could be higher old prices, it could be taxes, it could be labor increases, because unions want higher wage claims. I give higher wage claims. All these sorts of things can factor into the high street but you’ve got, if you like, two moving parts in high street prices, cost inflation and monetary inflation. Now, for the last 20 years, the cost inflation element has been very negative. In other words, you’ve had cost deflation, and the reason for that is you’ve had cheap Chinese goods. You’ve had falling oil prices at least since 2008 2008 crisis, and you’ve had huge productivity gains because of technology. Now that’s meant that you can have a monetary inflation and you can have this cost deflation, which means adding those two together, you get a very modest level of high street inflation. And that’s we’ve been in that luxurious world for at least a decade or more now. But the question to raise is, looking forward, what are we going to get, well, we know, or we’re pretty sure, we’re going to get monetary inflation, and we’re going to get monetary inflation of a higher level, higher clip, maybe than we’ve had in the last 20 years. Because of the public deficits, they’ve got to be funded and they’re going to be funded by printing money. Are we going to get the same degree of cost deflation? Moot point, but I would venture Probably not, because it’s unlikely that China is going to cut its prices that significantly, despite the fact they’ve got to sell this huge amount of goods they’re producing or over producing, but it’s unlikely they might go up much. But one questions whether you’re going to get the same impact on the high street of lower Chinese costs. Technology will be important. But you know, again, are you going to get the same sort of deflationary gains in costs that you’ve had in the last 20 years? I question that. So the reality is that that monetary inflation may well spill over to a greater extent into the high street than before, but the real impact of monetary inflation where it’s unadulterated, comes through in financial markets, because that’s where monetary inflation starts to have its its main impact, and that’s why asset allocation of investors needs to radically change to a different mindset, and that mindset has to reflect an era of monetary inflation and an era of monetary inflation, the traditional 6040, equity bond split does not work. What you need is a much wider diversification into assets that are good monetary inflation hedges, and I listed those earlier gold that’s had centuries of proof behind it. There’s a great monetary inflation hedge, Bitcoin, maybe.
James Connor 37:45
And I want to ask you about both of those assets, but before I do that, I want to ask you about the US markets, more specifically the s, p. And during the first week of August, we saw a pullback in not only the US markets, but the global markets. It was all based on weak economic data out of the US and also this, again, carry trade. But since then, we’ve had a nice recovery in the S P. The S P’s gone from 5200 up to its current level. Now 5600 you mentioned earlier that you still like the market. Do you have a target for this year in the S P? Where do you see it going?
Michael Howell 38:18
Well, let me put it this way. I think you can see, let me be more general, I think that over the course of the next 12 months, you can see asset markets in general, rising by around 10% I mean, that would be, I think, a reasonable figure, given the impetus behind global liquidity. Now, if you look at the reaction of the markets in the last few weeks, and looking at the sell off and now recovery, rebound in markets, if that’s all about risk positioning. And there’s a chart that I put in the presentation, which is the risk exposure of global investors, and that really spells out, I think, quite clearly. But what we’ve had in recent weeks is a very sharp de risking of investor portfolios. The interruption in markets is not because of any interruption in liquidity, any break in the liquidity cycle. Liquidity has continued to go up. And as I alluded to, I think there’s been pretty positive news in August about future liquidity trends. But the fact is that what you saw, or what you’ve seen in the last four to five weeks is a very sharp de risking, and now investors are starting to come back into markets reassured by the economy. Now the following chart in the presentation pack that I sent is looking at the US credit markets. And one of the things to start asking is, are the credit markets correct about how they’re seeing the economy? And if you look at the chart, what I show on that chart is the US ism, or purchasing managers index, which is the one that everyone quotes. It pretty much shows right now that the US economy is flirting with recession, and that maybe is what spooked the Fed. But if you look at the chart, there’s all. A line on there, which is basically taken from the credit markets. And what we use are credit spreads to project where the economy should be based on history. And what it shows us is that the credit markets are telling us that the economy is not recessionary, but it is slow, but it’s very gradually recovering. And I think that’s very much the message that comes out from looking more generally at data, looking at liquidity data, and looking deeper into the fixed income markets, the credit markets have got it right. Maybe these ism surveys have got it wrong.
James Connor 40:35
So you’re still bullish on the S, P and the Nasdaq, and what about valuations? Are you concerned? Are you concerned at all about some of these excessive valuations we’re seeing in names like Nvidia, which is trading at 40 times revenues, has a market cap of $3 trillion 2 trillion of which came in this year alone.
Michael Howell 40:55
Yeah, I think one’s one’s got a One’s got to be clear here that if there is a you, if we’re wrong and there’s a US, recession, risk exposure, risk appetite, will be paired down more, and markets will sell off. I mean, that that’s the reality. We know that happens. I don’t think there’s a recession. I think it’s a slow economy. I think that’s a benign environment regarding valuations. Uh, it would be better if valuation levels were lower, I will admit, are they dangerously high? I think that one has to that’s a conditional statement which really depends on what the liquidity background is. If you’ve got a situation where valuations are high and money is coming into the markets, valuations are going to become even more extended. Does that mean they’re more dangerous? Yes, it does. But the danger point comes when liquidity starts to move out again. And that could be a number of things. It could be that the Federal Reserve suddenly decides that they’ve got it wrong. Inflation is a major Bogey, and they’ve got to pull liquidity out again. Or it may be that the real economy suddenly spurts ahead and liquidity is transferred from the financial markets into the real economy to fuel an upcycle in business activity. Those things are clearly negative. Or it may be that foreign investors are spooked by the US fiscal situation, the post election environment. They pull money up. These are all factors that could cause the market to correct Absolutely. So on that basis, high valuations are not as good as low valuations. But I’m, you know, not in that camp. I still think that the market can make progress, you know, because liquidity is going in. Having said that, you know, our point repeatedly is that you’ve seen a lot of the gains in this bull market, which, after all, started in October of 22 okay, you know, we’ve, we’ve been very bullish for much of the last two years, all of the last two years, I should say I had, you know, markets applying a wall of worry. But you know, if you’d invested at that point, you just made a lot of money from from then to now, you’re gonna still make gains in the next six to 12 months, but you know, they’re gonna be harder to come by.
James Connor 43:00
So you mentioned a couple of times that in this current environment, investors should be long gold, and I just gold’s up 25% on the year, give or take. Are you suggesting investors should be long physical gold, or should they get long gold miners?
Michael Howell 43:16
I think the the arguments for a hedge for monetary inflation, would say you’ve got to look at physical gold, because that’s where the record is, or the long term hedging record is. I think that with gold miners, I mean, it’s fairly clear. I think, to any observer, people that look at the markets, the gold miners are cheap relative to bullion. That may tell us something. But, you know, I mean, it’s probably worth it. May be worth looking at miners, but miners are not, are not gold bullion, and one of the problems that’s held back miners comes back to your inflation point, James, is that their costs are inflated to, you know, particularly energy costs and whatever. And their margins are basically being paired lower, even though the gold price goes up. So I think these are other challenges. But I wouldn’t discourage people with money miners. I think they’ll do pretty well. They’re actually at the right point of the cycle now I think to make some decent gains.
James Connor 44:14
Michael, you have said in the past that all financial disasters are brought on by an inability to refinance debt. Do you see that happening in the coming months? And I guess also what I’m asking here, do you see a potential black swan on the horizon, and that is an inability to refinance debt?
Michael Howell 44:35
Well, I think the sort of glib answer is yes, but I don’t know when, because the fact is that what you’ve seen historically, and you go back through history, when you go back, particularly in the last two decades, what you find is that every financial crisis has largely been a refinancing crisis. Think of 2008 think of the Asian financial crisis in 97 you know. Think of what happened in the US repo markets in 20. 19. All these, all these are instances where refinancing becomes a problem. I mean, you know, arguably, even Silicon Valley Bank was a refinancing crisis. And what it what it comes down to is, if we’ve got so much debt, we’re sitting on so much debt, that debt is a burden, that’s a cost, that debt has to be refinanced. And if that mountain of debt just keeps growing, the refinancing challenges obviously grow with it, and what you need is more and more liquidity to keep pace. Now, liquidity, as we’ve argued, is cyclical, and therefore if you get at a time when you need a lot of refinancing capacity, liquidity turning down, then you’ve got a problem. And in that environment, you either get debt defaults. People tend to fire sale assets so they can refinance in other areas, etc, and that’s where the tensions emerge. So it may be a good comment, but yes, we will get that, because at the end of the day, liquidity is cyclical, and it’s very you know, we can’t depend on monetary authorities to manage things perfectly. So I think it’s going to come. Is it going to come in the next 12 months? I think that’s very unlikely. Because I think the if you look at the other debt wall, the debt wall is probably about 18 months to two years away. That’s when a lot of debt has to be refinanced in the world economy, or the US economy in particular. And I think we’ve got a window now where there’s not that much. So it should be manageable. And the one I’ve argued liquidity is picking up, therefore there should be few problems. I think the question really comes is, when you get an inflection in that global liquidity cycle, which, if you go back to the first chart I showed, our reckoning is that comes sometime towards the end of 2025 and that might be because inflation begins to pick up again. It may be because the world real economy starts to get more traction and financial markets suffer. Could even be because the Federal Reserve thinks it’s made a mistake and wants to push rates up again.
James Connor 46:59
Oh, wow, that sounds like a topic for another discussion. Well, listen, I want to thank you very much for spending time with us today. Michael, and as we wrap up, if somebody would like to learn more about you and your various services or follow you online. Where can they go? I
Michael Howell 47:15
think there are a number of areas. James, thank you for mentioning this. Sub stack is one route. We have a sub stack, which is called capital wars that gives both data and narrative about what’s happening in the markets. We also have a website, an institutional service, which is on www, cross border capital.com and if you want the odd comment that we make. We’ve got a twitter twitter handle, which is at cross border cap.
James Connor 47:46
I’m a follower, by the way. Well, thank
Michael Howell 47:49
you very much. Appreciate that,
James Connor 47:51
Michael, once again. Thank you.
Michael Howell 47:53
Thank you, James. Well, I
James Connor 47:55
hope you enjoyed that discussion with Michael Howell on capital flows, as Michael mentioned, he’s very bullish on the gold price. And if you would like to learn more about gold and how it can benefit your portfolio going forward, check out our sister company, hard assets alliance.com, hard assets Alliance is a trusted platform that’s being used by over 100,000 institutional and retail investors to buy and sell physical gold. Once again, that’s hard assets, alliance.com there’s a link below in the show notes as a reminder. We have a live coverage of the Fed announcement today with Vincent De larard And Maggie lake at 2pm Eastern. Once again, live coverage of the Fed announcement today at 2pm Eastern, check it out. You.
