The capital markets became accustomed to an ever-rise tide of the liquidity over the decade of rolling stimulus programs that followed the 2008 Global Financial Crisis.
But after reaching its apex during the COVID rescue era, that liquidity suddenly dropped in 2022, and market prices fell accordingly.
Here in 2023, many analysts are warning of a further ‘liquidity crunch’, as central banks continue to hike rates and reduce their balance sheets, while banks lending standards pucker up in response to the recent bank failures.
But is there a different side to the liquidity story? One more bullish for asset prices?
Today’s guest thinks so. We’re now joined by liquidity and market analyst Michael Howell, founder & CEO of Crossborder Capital.
Michael Howell 0:00
The liquidity cycle leads asset markets by somewhere between three and nine months depending on the type of asset you’re talking about, and the liquidity cycle and our view definitively bottomed in October of 2022. That is now coming up for more than six months ago. And what have we seen since then? an emergent bull market and a lot of asset classes
Adam Taggart 0:27
Welcome to Wealthion. I’m Wealthion founder Adam Taggart. The Capital Markets became accustomed to an ever rising tide of liquidity over the decade of rolling stimulus programs that followed the 2008 global financial crisis. But after reaching its apex during the COVID rescue era, that liquidity suddenly dropped in 2022, and market prices fell accordingly. Here in 2023, many analysts are warning of a further liquidity crunch, as central banks continue to hike rates and reduce their balance sheets, while banks lending standards pucker up in response to the recent bank failures. But is there a different side of the liquidity story? One more bullish for asset prices? Today’s guest thanks. So we’re now joined by liquidity and market analyst Michael Howell, founder and CEO of cross border capital. Michael, thanks so much for coming on the program today, all the way from London.
Michael Howell 1:25
Great to be here.
Adam Taggart 1:26
Great. It’s a real pleasure to have you here. Michael, I’ve had a couple of recent guests, including Darius Dale spoken very highly of you. I’m very glad that we could get you on the program right now. I’m actually really fascinated to get into the topic of liquidity with you. I know it’s something that you and your team at cross border capital focus on very closely in that some of your conclusions may be a bit divergent from what kind of the common narrative is, and I would love to talk to people who have a different perspective. Before we get there, if I could just start by asking you the general kind of starting question. I like to ask everybody at the beginning of these interviews, just to set the context. What’s your current assessment of the global economy and financial markets?
Michael Howell 2:08
Okay, obviously, the sort of big question, but I think you’ve got to slice those in half. Because the outlook for the economy is very different from the outlook of financial markets, very often the two are unconnected. And it’s an old adage in the market that says that strong economies don’t always have strong financial markets. And similarly, vice versa. When I first started in the business, I mean, eons ago, the first lesson I was taught was buying the market aggressively when unemployment starts to pick up strongly. So that’s not necessarily the sort of narrative that we’re hearing right now, people are concerned about the prospect of rising unemployment, they’re thinking the economy is going to go into recession, they may well be correct on that score. But the fact is that that’s has no connection with really the financial markets. And actual fact, you could say it’s the inverse. And if you get very bad economic news, it could easily be a great buying opportunity. Now, our view is that you’ve got to take these two concepts completely separately, liquidity drives asset markets, it may ultimately drive the real economy, but it’s stepping off point is to look at what the effect is on asset markets. First, the liquidity cycle leads asset markets by somewhere between three and nine months, depending on the type of asset you’re talking about. And the liquidity cycle and our view definitively bottomed in October of 2022. That is now coming up for more than six months ago. And what are we seeing since then? an emergent bull market a lot of asset classes, the most liquidity sensitive asset classes, things like cryptocurrency, precious metals, technology, stocks, have all basically embraced strong upturns, despite the fact that the clarion call from economists are avoid these areas. You’re about to hit recession.
Adam Taggart 4:07
All right, fascinating. And that is a great segue into the topic of liquidity. And you’re right. October 2022, was the bottom of the markets, all those liquidity sensitive assets that you’ve talked about have done well since then. So I, I guess, where are we in the liquidity cycle here? Are we at an early stage? You mentioned the word bull market a little bit earlier? Are we now in a new bull market for for asset prices? Do you expect things to go materially higher from here? Where are we in this liquidity cycle and what’s driving it?
Michael Howell 4:49
Yes. And when we were at an early stage, I mean, there’s no question about liquidity conditions are tight right now. That’s not the point. What markets tend to focus on are inflections. and an inflection upwards is a very positive signal doesn’t mean to say that we won’t get bad news, typically around the trough in the liquidity cycle, we see banking crises, this is exactly what we’re seeing right now. So it’s following the script. pretty much exactly what you’d expect to see within, within six months of a turn in the liquidity cycle is that the yield curve would begin to steepen, we’re seeing the first signs of that beginning to happen right now. So from the perspective of what the bond markets are telling us, what the Banking Markets are telling us, it’s very much on track, in terms of a normal liquidity cycle, what we would expect to see is sometime within the next three, maybe six months for some turn in economic data upwards. Now I’m very encouraged by what I’m seeing right now, looking at the US isn print yesterday, actually gave a lot of confidence in that sort of prediction. And although the headline PMI index actually picked up on the month for manufacturing, the key thing that I would look at, which is a very good leading indicator itself, is to look at the spread between new orders and inventories. And that is a very good lead indicator of the isn itself. And that’s actually been picking up for several months. Our point is that, although many economists are saying, you know, recession is coming around the corner, etc. The fact is that if you look at those sort of indicators, in other words, business confidence indicators, we’ve been in recession for more than six months, economies, many economies are actually expanding significantly below trend. And they have been. The fact is that employment data, which is anomalous, probably because of COVID, is not signaling the sort of recessionary signals that we would typically see. But that’s an anomaly. And that shouldn’t derail the fact that probably economies have slowed markedly already from their peaks. And that’s exactly what we would expect looking at the liquidity cycle. So in our view, the liquidity cycle is picking up, it’s inflecting. It began to pick up around October, and I’ll go into the details why in a few moments, but the cycle normally lasts around about 60 to 65 months. That’s the the normal length of a cycle. And that means that the upswing should continue well into 2025. Now, the key thing is that that will not be a straight line move. There’s no question about that. Markets never move in straight lines are not linear. But we’ve now got the wind behind us. We haven’t got a gale force, wind and our front, which is holding back asset markets.
Adam Taggart 7:38
Okay, so if I could restate what you said, the worst is behind us. It sounds like so we’ve been likely in a recession. Maybe that’s been masked to a certain extent, because employment hasn’t unemployment hasn’t gone up as much as it typically does in a recession. And you’re saying this case that might be due to, you know, the uniqueness from COVID. And what happened with jobs there and all the steps that companies took to labor, hoard, and all this type of stuff. But now the worst is behind us, the headwinds of a slowing economy are now switching into tailwinds. And there’s tailwinds. If they continue, like a normal liquidity cycle does, we have a couple of years of tailwinds ahead of us here. So you’re, you definitely seem to be sending a more sanguine tune than than I’ve been hearing from a lot of the experts on this channel, which is great. We love to have people coming in with with different viewpoints and different ways of looking at things. You’re sort of nodding as I’m saying this, but here’s what I’ve said sort of generally. Correct.
Michael Howell 8:46
Correct. Absolutely. Spot on. Yeah. I mean, I’m, you know, our view is I’ve got 100% conviction that the liquidity cycle is has bottomed. Okay, that that’s what I would say with certainty, doesn’t mean that the asset market cycle has, has hit a low not necessarily, but we do know that liquidity leads asset markets. So you know, never say never in this business, we know it’s always dangerous. We don’t know that they, you know, there could be a deeper banking crisis around the corner. But I think that seems unlikely. You know, one of the things we’ve been arguing through this year, is that a banking crisis in the west or in the US specifically, would be a gift to China. And the authorities must be endeavoring, that that doesn’t mean have to make sure that doesn’t occur. So I think that there are attempts to stabilize the system. And I think that if you go back to the reason why the global liquidity cycle trough in October, the catalyst was the British guilt crisis in September, and that was a big wake up call. Now, the point is that, you know, many of your listeners will recall, probably recall that event. Britain is now a much smaller blip on the radar screen these days. But the fact is that the brief gilt markets sold off aggressively This is a sovereign debt Mark. it in the UK it sort of aggressively when a new prime minister and her Chancellor came in with a very ambitious fiscal program that the markets didn’t feel was correctly priced. And gilt yields, British bond yields spiked higher. Now, the point is that that cause two things. One was that it caused the Bank of England with alacrity to shift from a Qt quantity, tightening policy to a QE policy almost overnight. Okay, so forget the inflation remit, forget, you know, the business cycle. Number one priority is protect your sovereign debt market. And that’s what they were doing. Number two effect was, I think there was a wake up call, generally, we can see central banks beginning to take their foot off the brake pedal around October. But the the sort of salutary lesson here is that had that guilt crisis occurred in the US Treasury market, they would unquestionably have been a global financial crisis, not dissimilar to 2008. So, you know, the fact is that the British gilt market is not a big, big mover in the world. It’s a signal, the US Treasury market is absolutely paramount to what happens in global finance, and the Treasury market asked to be controlled and preserve. And Janet Yellen in October, if you recall, said that she was worried about the integrity of the US Treasury market, right concerned about it liquidity was drying up. Since that point, what you’ve seen are a number of attempts, we think, to try and stabilize that market. We were saying, you know, from late September, that it’s very, it’s a key point, that Federal Reserve liquidity injections rather than continuing to go lower, actually began to flatline. So that was the first sign. Now people dismiss that and said, You know, it’s random noise, the Fed is still operating a cutie. I think the fact is that the Fed has changed the goalposts here. It’s basically trying to have its cake and eat it. If I’m not mixing my metaphors. Basically, what it’s trying to do is to say, look, we will allow treasuries to roll off the balance sheet, that’s our cue T definition. It wasn’t always the cuties, everyone, by the way, but we’re going to add liquidity at the same time into the system. Consequently, bank reserves have began to move higher, and in the wake of SBB, they’ve jumped significantly higher. And this shows that liquidity is coming back into the system. Now, we don’t only have to look at the central banks, the central banks are clearly an important part of this equation. But we need to look at the big central banks. And that means the Federal Reserve, it also means the People’s Bank of China, which is a large, large player doesn’t have such a big effect on financial markets. But believe me, it has a big effect on the world economy, and that needs to be taken into account. The other thing we need to address as well is what’s happening to cut to collateral in the system. Because ever since the GFC in 2008, global financial markets are really rested on a bedrock of collateral. And that collateral is important. One of the things that the British gilt crisis did was it caused a wobble in that collateral base. And since that time, there have been attempts to control or improve that collateral base veers look at the move index, the index of bond volatility in markets. Now, we’ve been saying to our clients, look, you’ve been used to looking at the vix index, the vix index is important, but it’s overshadowed by the move index, look at Bond volatility, because that’s going to tell you a lot about liquidity in the future. Move volatility is still elevated, but it’s come rocketing down from the 200 print that we’re at in late Well, in fact, only a few months ago.
Adam Taggart 13:48
Okay, and that tells you that the markets just becoming less worried about a recession and the
Michael Howell 13:55
collateral, the collateral multiplier, so to speak, will actually begin to expand again. Now, I think if you start to explore this whole issue about what drives liquidity, and I know a lot of people are becoming spooked by the idea that the trip that the debt ceiling and changes in the treasurer general account on the Federal Reserve’s balance sheet, which pretty wonkish concepts are going to interfere with the flow of liquidity. The answer is they may never say never as I as I alluded to, but it will be very much in the Federal Reserve’s and treasurer’s interest, if they didn’t allow these sort of wobbles to affect the markets, they should be trying to steer and even course through these, you know, these through these rapids. Now, the point is that stepping aside from the central banks, there are other reasons why liquidity can pick up and you got to remember that what we’re focused on here is not the traditional measures of money supply, which are basically measures of retail deposits in the banking system, okay. Which tend to It means a lot more for the real economy and consumer patterns. What we’re looking at is money in financial markets. And money in financial markets does not come from the banks, it comes from other financial institutions, it comes from shadow banks, it comes from the repo markets, etc. that pool of money can expand. In other ways, it can expand, as I say, of collateral picks up of the central banks putting liquidity, it can expand, if oil prices drop oil, the oil industry is a big, big user of liquidity for inventory and transactions or whatever, if oil prices come down, and they come down dramatically from the peaks that releases liquidity from the real economy back into financial markets. If inventory build is slashed, that releases liquidity back working capital demands drop money comes back into financial markets. If you know if inflation prices start to ease if the dollar weakens, all these factors are things which will encourage financial liquidity to pick up. And that’s principally what we’re saying here. It’s not just the central banks, but we recognize the central banks are important. But two of them, in our view, are building it beginning to turn, the Federal Reserve is turning, albeit gradually People’s Bank of China as just engaged over the last six months, one of the biggest easing it’s ever undertaken. That’s significant.
Adam Taggart 16:27
Okay, wow. And yeah, I mean, a number of the factors you just mentioned, there are happening in real time, you know, dollars coming down. You mentioned oil prices are easing. What are two other things you mentioned were happening in real time, too. So let me let me just dig a little bit further into this, because, again, it sort of competes with some of the headlines that folks are reading here. So yes, the Fed is probably, you know, much closer to the end of its its hiking cycle, then, you know, certainly it was through all the last year, right. And most of the discussion is, yeah, maybe there’s one quarter basis point hike or whatnot. But it seems pretty clear unless something else happens that that is going to be at least pausing relatively soon. I guess first question is, is a pause. Is that contributory to the liquidity cycle? Or is it only when the Fed is easing that the central bank is contributing to the liquidity cycle?
Michael Howell 17:32
Well, I think the I think the first thing to say is that let’s not get too hung up on rates, okay, the focus of everybody was on rates on interest rates, particularly Fed Funds policy rates, but that’s not really what moves markets. What moves markets is liquidity, liquidity and interest rates can be two very different things. And I would suggest what central banks are increasingly doing now is that they’re using their rate policy to try and influence inflation expectations. And they’re using their balance sheet to try and maintain financial stability. The issue we’ve got, which is being highlighted by a number of bank difficulties in the US and internationally, is the fact that we’ve got funding problems out there. And the thing, the question to ask, I mean, the point to ponder in this is that you’ve had interest rates rising significantly, but the distress is not among the borrowers. It’s among the lenders. Right? And that’s pretty odd. Yeah. So what that’s telling us is a funding problem. It’s not necessarily a high interest rate problem, not saying that won’t be there. But with inflation, quite high, and interest costs, you know, probably in real terms, not that significant. You’re not getting the distress among borrowers that you might expect, or you might have normally seen under a recession. And if you look at things like credit spreads are actually pretty well behaved. Now, I would suggest that is because inflation is taking a lot of the sting out of those credit costs. But where you’re starting, you’ll see the problems in terms of the funding area. And every financial crisis that we’ve seen over the last two or three decades, has fundamentally been a funding crisis. And it’s because the funding structure of modern Western economies is very, very fragile. Now, it’s been fashionable for many analysts to point the finger at China, and sort of smirk and say, Well, look, China’s got a very ropey financial system, and it’s about to collapse. The paradox is it’s the other way round. China has actually got a very robust financial system, because it’s very simple, okay. It’s a very basic system is probably inadequate for their economy. I grant you, but the fact is, it’s not going to go broke in the same way as the Western system could because it’s very leveraged. Now. What’s the reason for that problem? Let’s come back and think about the problem, which is a four letter word beginning with D debt. And we’re sitting on this huge, huge pile of debt. Okay, which is Something like $350 trillion of debt, okay? Three and a half times world GDP, the average maturity or duration of that debt is about five years. Which means that in simple math 70 built some 70 trillion rather, has to be refinanced every year, every year 70 trillion right. Now, if you look at financial markets, they’ve got to somehow finance that. And what you need to finance that degree of, of debt rollover, is balance sheet capacity. And balance sheet capacity means liquidity. And that’s what we’re really, really focused on. Now, in comparison, the economic textbooks tell us that financial markets are new financing mechanisms, new financing mechanisms for capex, while Hey, there’s not much capex going on out there in the West, all of it probably is mostly in the east or China. And you could argue that’s a different factor anyway, most of the action in financial markets in the West is debt refinancing. So you’ve got 70 trillion of a rollover, compared with how much the capital markets raise each year, about 10 trillion. So for every $1 of new financing, which is all about interest rates, you get $7 of refinancing, which is about balance sheet and liquidity. So that’s why liquidity is much more important. And the central banks don’t really get it, although they’re learning fast. And it’s not about interest rate policy, it’s about liquidity. Liquidity has to go into markets. And that’s what we’re looking at, I think the cycles turn, now I can share with you a chart, and I’ll share with you a chart, which is our long term cycle. And hopefully, you can see this if I put it on to share, slide. There you go. Oops, sorry. Got one here, there is that slider? Yes, we can. Let me just explain what that slide is doing. And that slide is basically showing the global liquidity cycle, which is an index, which runs between zero and 100. It’s normalized data. So it has a mean of 50 and a standard deviation of 20 units. But we’ve put a dotted line red line on that, which is a sine wave, which repeats every 65 months. Now, that’s been fitted by eyeball largely, but it was done many years ago. And it seems to be unfolding in the sort of way that you’d expect. And correlation is pretty amazing, do you find is that the current trough is pretty much exactly in line with what you’d normally see the cycle? Yeah. Now, that would tell me that, you know, looking at history, you don’t get a straight line up. Never right. There’s always setbacks. But I would say that by the end of 2025, you’re going to be a lot higher than you are now I’m probably near the peak of that cycle. And that’s what we think is going on. Now, one of the things that is very important to think about is why that liquidity could be coming back. And one of the things that we keep saying is, look, right now you’ve got the central banks, bailing out the banks, okay, what you’re going to get in the next five to 10 years is the central bank’s bailing out the governments. And let me just show you this data, which is data that we drew from the CBO, the Congressional Budget Office, which is shown in orange on this chart. Now, let me just tell you what this data is saying because it’s interesting, but it needs to be explained for clarity. The orange bars are the expectations or the numbers that are penciled in that projection by the CBO of how much Treasury debt the Federal Reserve holds on his balance sheet. The period from 22 to 25, is basically acknowledging the so called Qt policy of the Fed, which I would be staggered if we get anywhere in there. Okay, but let’s put that to one side pop that thought start looking at the elevation. The other side of the dogleg as that yellow bar starts to expand on the right. That is the projections that the CBO makes of what the Federal Reserve will have to buy of US Treasury debt. Why is that happening? It’s happening because mandatory spending in the US starts to skyrocket in the next few years because of aging demographics, that is a reality. And that’s pretty much set in stone. At the same time. We’ve got tax revenues, which are challenged because the tax base has been squeezed dry. And that is before you start to get AI doing its work, which is likely to disenfranchise a lot of workers and reduce the tax take. So you’ve got a problem there, right? It’s so happens that America is probably the cleanest shirt in the laundry. So if you think this is bad start looking at Europe or Japan, because they’ve got seriously big problems. And therefore, what this is saying is the central banks are going to have to come in and start buying this deck, because there’s nobody else, a third of American debt is owned by foreigners. And if China is turning off, its willingness to buy US debt, then there’s a further issue to address. But what I’ve also put on that chart, are the gray bars. And those gray bars include higher defense spending, because I think the CBO numbers for 3% of GDP are way, way too optimistically, low 5% of GDP is probably more realistic, looking at the geopolitical mess we’ve got. And in that case, you start to see some really big jumps in the size of the Fed contribution to Treasury purchases. And the numbers that you see above those bars are in indicative percentage changes for how much the federal reserve balance sheet, in other words, the monetary base of the US system could increase the annual an annual pace. Now, what that basically says, in all this is there is a there is a problem out there. And basically what you’ve got to start to do is to think that Q or recognize that Q E is coming back big time. And if QE is coming back, you want defense against monetary inflation. What are the best hedges against monetary inflation, gold, crypto currencies, this is not an investment recommendation, but a distant acknowledgement that they probably are fairly decent monetary hedges, they may have no utility in themselves. You know, I don’t know, I’m not an expert on that. But they’re probably monetary hedges in the same way that gold is, and what we’d expect to see, as some of these things starting to pick up a bit, as this quantitive easing starts to return to return. And I think he’s gonna return.
Adam Taggart 26:56
All right, wow. And I do want to get to in a little bit, Michael, sort of, you know, how you recommend people might position for the type of future that you see ahead here, both on the bullish side, but also on just the purchasing power protection side as this, you know, global central bank’s Gone Wild era kicks off. So I was, you know, from your chart, there were certainly looks like quite an inflection point, you use that term earlier here. Do you to sort of expect us to build steam as we go forward from here through the rest of the year? Or do you expect there to be some sort of trigger that that gives the central banks a green light to start doing more of this? So for example, a lot of discussion over the past year has been the Feds going to get a hike until something breaks? Right. You know, Powell sure, is talking a tough game. But he’s only going to be able to follow his course, until his current policies break something so systemically important that he finally has the air cover to revert in go back to an easing program. So is this something that’s just going to be again, sort of like a slowly rising tide? Or is it something that’s going to be more like a, you know, an explosion, like something that’s self contained? And then all of a sudden, boom, the starting gun goes off?
Michael Howell 28:24
Well, I think the fact is that you what, what we’re seeing is, is the sort of the classic signs, and you know, what I would recommend your your listeners do is look what’s the financial markets closely and watch those more closely, maybe the economic data, because the financial markets are a leading indicator of it. Yeah. They predict the economy, not vice versa. And that’s always something to remember. So, you know, one of the things I think the I think the sort of legendary investor Stan Druckenmiller was used to say, was the, you know, the best economic forecaster is the inside of the of the stock market. So if you look at the performance of cyclicals versus defensive stocks, that always leads the real economy. It doesn’t like it right. And it shows you when you’re getting an upturn. So if you see cyclical stocks beginning to pick up, that’s a really good sign. So I’d be looking at things I’d be looking at the yield curve, the yield curve, steepens, that’s again, a positive sign. I’ll be looking at these monetary hedges, precious metals, Bitcoin, these are signs, technology, stocks should leave because they’re long duration investments, all these things should go but it won’t be a straight line, that’s for sure. I would suspect that the economic news will deteriorate near term. All our indicators are telling us that there’ll be an inflection around mid year, probably not before so the news will get worse before that the Federal Reserve may well be exercise to ease liquidity again. And I think what they’ll want to do is to maintain adequate liquidity within the system, which probably means some expansion from here, I think is dangerous. Take liquidity down to much lower in the US, and certainly aren’t the SBB. And first national, you’ve got the old, very, very strong first republic, you’ve got the, you’ve got the probability that many banks are suffering liquidity problems right now. So we’ve got to get the levels up. So I think all these things are happening. China needs a stronger economy, that’s for sure. The main vehicle, the only vehicle that they can use to get that is to expand people’s bank liquidity. In other words, that’s the engine of growth in China typically, and it’s going to likely to be again, and I think that the other factor, you’ve got a, as I said, is liquidity being released from a slower economy and improving collateral values. So I think the liquidity cycle is turning for sure. But above all, I would say, you know, what makes me bullish about markets is to think what this crisis has really been about, okay. It’s been about inflation. It’s been about getting inflation down. Now, if you if you score a victory on inflation, I think that markets will be significantly rerated. We’re not there yet. But we’re getting very close. And if you look around the world, you look at you know, look at the data out of China, you know, that’s a leader in terms of inflation prints, inflation is very low there. Japan is struggling to create inflation, Brazil, which used to be a hyperinflation country, if I recall correctly, their inflation rate came in at 4%. Last week. Well, there are there abouts, I mean, these are signs that inflation is coming down quite seriously. US it’s sticky, Britain’s Got a problem. But as I say, that’s a small blip on the radar of the world these days. But you’ve got inflation, which is coming down. If Jay Powell manages to pull off a low single figure inflation print, in the next six months, I’m talking here, three, maybe even 2%, I think markets are going to start to go on fire because they’re realized that the Federal Reserve has done enough to control inflation. Now, that doesn’t mean to say that inflation won’t come back. And I’m the first to say we may have a longer term inflation issue. But for now, financial markets may be prepared to give them the benefit of the doubt. And it’s the inflation angle I’d be thinking of, not the recession, angle markets are quite prepared to look through the recession, because they can see it being temporary. And it’s really an expedient for getting inflation down.
Adam Taggart 32:23
Okay, great. I’m glad you went there, because that’s where I was gonna go next. So the question I was going to ask you, which you mostly answered was, Do you think that the major central banks fed ECB, etc, will be successful in getting inflation low enough to then sort of justify reversing policy? Because obviously, if they don’t, if they reverse policy before they do, then the inflation issue, you know, is still a headline one, and it’s likely to get a lot worse because of the reversal in policy. So do you expect that inflation is going to sort of have to be tamed before they can unleash these floodgates?
Speaker 1 33:04
I will, I hasten to say that they’re going to unleash the floodgates? I think the I think the fact is that we’re seeing an inflection inflection in the currency cycle, I don’t think you’re gonna see a rush of liquidity, that that’s for sure. They’re not going to panic and plow money in. But I think the cycle is turning. So I think that, you know, I’m, let’s say optimistic, but I don’t think there’s going to be a surge of money. The cycle is turning right. It’s like a supertanker. I mean, it’s changing direction. I think the I think the fact is that inflation is going to come down, are the central banks, the architects of that may be to an extent, I think you’ve got other factors going on. I mean, all prices are clearly come down again, you know, a lot of the pressure that you’ve got on food prices beginning to ebb, etc. So the supply shocks are coming out of the system. But, as I said, alluded to earlier on, we’ve got a situation whereby monetary inflation, is going to have to increase substantially from here over the next decade, to pay for what we want from governments and fill those gaps that you were talking about. Exactly. This is the reality. Now, what is high street inflation, high street inflation is a cocktail between monetary inflation and cost inflation, okay. And for the most part, history has basically shown us that we get cost deflations and monetary inflation’s and they kind of, you know, they, they, they they tussle with each other, at the end of the monetary inflation tends to win in the long term, but you can get periods where cost, deflation tends to override that. And that’s what we saw for much of the last 1015 years. Thanks. Right. Thanks very much to China, but China’s you know, entry into the world economy, push price levels down, particularly if goods prices, that probably no longer is going to be around. So what you’ve got is a situation looking forward where we’re going to have monetary inflation of different degrees, but let’s assume it’s a steady rate. And what we’re going to see on top of that, is a series of probably cost shocks, the shocks can be negative, I think it’d be positive, but the underlying level of inflation, I think is going to be higher, but it’s going to be more volatile too. So that would be the landscape, I would tend to think of providing that inflation does not get out of hand. And I mean, by that look back in the 1970s, financial assets will do very well, financial assets do well in the low in generally in a low inflationary environment. In a higher inflationary environment, you want more tangible assets? I think there’s a case for making that moving that that that dividing line slightly on the side of more tangible, but I still think that financial assets can do well in this environment, because they need to be aerated as investors realize that the big inflation prints behind us. Okay,
Adam Taggart 35:50
well, that’s really interesting and really instructive. Let’s see here. So I said, I do want to get to kind of both both your market outlook and your sense of how people, you know, can position for this. And to be real clear. remember correctly, you said that the liquidity cycle leads markets by three to nine months, depending upon the asset class. Once we’re at the nine month mark from the October lows, that kind of puts us in summer, so my guess is is you would expect to see markets beginning to really begin to kind of pick up Come Come middle of the year, don’t let me put words in your mouth. But before we get there, let’s just finish at the macro side for a second. So you’ve done a very good job of saying, hey, look, economy and markets oftentimes not the same thing. You’ve left yourself open to saying, you know, the economy could could still continue to struggle here for a good while. markets might pick up a good deal before the economy does here. Looking at the macro data right now, what kind of year do you see ahead for the global economy? Yeah, there’s a lot of concerns about recession. concerns that that final employment, that strong employment situation may actually roll over eventually here, at some point in time, we have housing markets, in correction. And they had been, you know, in many cases, in many places around the world inflated to very high levels. As you know, you know, for a lot of people, their house is a bigger asset than their financial portfolio. What do you what do you see when you look at the macro? When you look at your macro outlook for the rest of the year, what are you expecting?
Michael Howell 37:35
Well, let me be clear, I’m not a macro forecaster. And I find generally, macro a very blunt tool for understanding financial markets. I think that’s, that’s, that’s for sure. The whole macro economic paradigm, in many ways, I think, is incorrect. I spent many years I’m saying that from a perspective, I spent many years in academia, and I’ve got a, you know, an economics PhD. So I’ve been there and done it. But it doesn’t, it doesn’t tell me a lot about how financial markets work. I think you need to be clear on on that point, the economic outlook is not great, that’s for sure. But my view is that probably much of the bad news is behind us, or at least, from a corporate point of view, we’ve been in slowdown for a lot longer than many people realize, and therefore the bottom is a lot closer than people think. So I think that, you know, in terms of my perspective, we will be seeing an inflection in the world economy sometime around the middle of the year, in many ways to be realistic about this, given the fact that China is the elephant in the room, as regards the world economy. China’s emergence from the COVID, lockdown has given a huge boost to the world economy anyway. And it may well be that we that we recognize that the low point was actually not the middle of this year, but it was could well have been December of last year, for example. Okay. But that’s, that’s arithmetic rather than how people feel. Now. Will there be increasing unemployment? Yes, for sure. But I still think we’re in an environment where there’s a lot of labor shortages generally. And that is because a large part of the workforce, as we know, both in Europe and in the US decided in the wake of COVID that either take early retirement or that better things do or more interesting things to do. So I think there’s there’s been a major shock in that regard. And it is true. I mean, being an employer, you know, I would be the first to say this, it’s very difficult to find the sort of workers you really want. It’s a it’s a hard job now, compared with maybe five years ago. And that’s because there are, you know, there are fewer people with the right skills who want to come in to the business. So I’m sure I know some sample bias in
Adam Taggart 39:48
this regard. Yeah, and I’m sorry to take this on a little tangent, but I’m just curious, like, how sustainable Do you think that is? Right. In other words, at some point when But this way, at some point if we fell into a deep enough recession, and I’m not saying that you’re necessarily calling for this, but at some point, those people run out of savings, their financial portfolios come down far enough or whatever, where they have to get back off the couch or whatever they’re doing and get back into the workforce. Not that may not happen, though. But my point is, is is this is this something secular that we’re just you think we’re going to be dealing with going forward from here that workers are going to have a stronger hand than they’ve always had? Or is this more cyclical where? Yeah, you know, because of all the stimulus and the forbearances, and all sorts of things, people have the ability to opt out, but but once things kind of calibrate, they’re going to have to come back into the workforce?
Michael Howell 40:45
Well, it’s a it’s a great question. I think my you know, my answer is that I’m a great believer in the lessons from Japan, Japan, ification is coming. And Japan demographically is about 20 years ahead of the West. And what we’re seeing in the West is really a copycat of what happened in Japan, a lot of the things that we’re currently vying with be a deflation, you know, aging demographics, whatever QE q t, zero interest rates, all these sorts of things are features that occurred in Japan over the part of the recent history. And Japan is now sort of following week now leading if you like, in terms of policy initiatives, yield curve control, or some of the Japanese have been toying with our guarantee that you’re gonna get yield curve control in the US and in Europe within the next five years. Hey, we may even got it right now, in many ways. So you know, this is the reality, central banks have got to focus on the major, major focus of the central banks is on the integrity of the sovereign debt markets. This is what is key to the ultimate integrity of financial systems in the West. And that’s what they got to preserve. And that that’s fundamentally key. The Japanese should be teaching that us that lesson now.
Adam Taggart 41:57
Going to ask a similar question that about that. That debt pile that sovereign debt pile that they are just increasingly having to make sure it doesn’t blow up. How sustainable is that? Yeah, man, no, Japan is showing us it can go on for a lot longer than you think. But I mean, does it does it have an expiration date at some point where just the debt gets so big that at any interest rate, it just becomes unserviceable?
Michael Howell 42:22
Well, I think the answer is the there’s an interesting difference in the use of words serviceable, how do you service that you’re talking about interest payments, interest payments will start to eat up a large part of the budget. In Japan, I believe I’m correct in saying that interest payments, even at these low levels of right, take up one take up a quarter of the budget in terms of spending commitments. I mean, this is sizable when interest rates are so low, but the debt burden of Japan is so high. And that really puts a constraint on how much central banks can use interest rates as a lever on the economy, they call in rates rise to too high because they’re basically burden themselves way too on interest bill. So it’s unsustainable that they’re locking themselves in, in this regard. So I think that, you know, Japan has a lesson, but what is Japan? How is Japan getting out of that? What Japan is trying to do is to create inflation, okay, domestically, and they’re basically printing money at the same time to buy the debt. Now, you know, it doesn’t take an Einstein or a rocket scientist to see that basically, part of this formula is that they’re going to devalue the debt by inflating in a way. I mean, that must be the the the endgame in all this, there’ll be financial repression on route and the financial repression will be forcing institutions or banks to hold more sovereign debt would guarantee that as well. I mean, that’s gotta be coming. But at the end of the day, you know, you can say, well, what’s really the commitment of the central banks to to fight inflation? Well, okay, I accept they are fighting inflation. But every little or every extra percentage point of inflation that we get unexpectedly on the high side, devalues that debt pile even more, and just look at the impact of compound interest on it. You know, this is significant. If something’s growing at 7% per annum for a decade, it halves it will hold inflation goes up at 7% for 10 years, that debt pile is filed in real terms borrows a week might quickly
Adam Taggart 44:28
I guess it does, but you know, effect all that you’re basically continuing to devalue your currency and this this just end in the currency crisis or currency destruction.
Michael Howell 44:42
But the interesting thing is that who What do you devalue against? If you if everybody is doing this, Adam, you’ve got a situation whereby, you know, the Japanese are doing it, the Europeans are doing it, the Brits are doing it. The US is doing it. So you know, at the end of the day, you come back to the question, who’s the cleanest shirt in the laundry here? A The US is the cleanest shirt in the laundry. And I think that, you know, the the issue comes down to, fundamentally, is that if you’ve got this debt to finance and your domestic savings pool is too small or you want to use somebody else’s reserve currency status is absolutely critical here. And that’s why the dollar is in such a good position. And that’s why I sort of disparate people are saying this is the end of the dollar. No way is it. And I’m old enough to have heard these these sort of calls for decades, people keep saying the dollar is finished, the dollar is toast. And the arguments before we’re all about the declining size of the US economy. In fact, the great paradox is that actually the dollar has got more it got stronger through that period, not weaker. Through the period of as the US economy has declined as a proportion of the world, the dollar has become a much, much more important currency. And I keep saying, you know, repeating this fact that we’ve never left Bretton Woods one, we’re still in the Bretton Woods one environment. Okay. If you think what Bretton Woods really was, okay. You get these fancy we’ll talk about Bretton Woods two, Bretton Woods three and etc. We’re still in the same regime. Bretton Woods one was the dollar as the centerpiece of the world economy. It was the international means of settlement. Hey, it still is. You basically have the World Bank and the IMF policing, payments imbalances. They’re still doing that. You have the US military backstopping the world trade system, it still does that. But the only thing that you’ve changed is you’ve now since 1944, when Bretton Woods began, you’ve now got freedom of capital movement, which you didn’t have at the beginning. That was a later development, but it was always an aspiration, and you’ve got floating currencies, but floating currencies will force on the system because of capital flow freedom, the movement of capital flows meant you couldn’t have fixed exchange rates anymore. So it’s a natural corollary of development of the system, we’ve still got the fundamental parameters. And at the end of the day, people start saying, Well, okay, China’s going to start muscling in and taking over. That’s just it’s so unrealistic. Because at the end of the day, you can say, Well, okay, let’s denominate more of our trade in yuan. Okay. That’s pretty much like saying, Well, okay, I’m gonna start measuring Park Avenue, you know, meters, not yards, does it make it any longer? No, it doesn’t, okay, makes no difference. What you really need to run a monetary system is to act as banker to the world. Can the Chinese act as banker to the world? No, because they are not going to start creating credit or giving credit out to deficit countries, that won’t happen. And the Chinese financial markets are not deep enough to accommodate savers. So a banker can do both operations, it can take in deposits, and it can give out loans, China is a million miles away from doing that. Realistically, the US is the only country that can do that. Which is why the dollar is probably in a long term bull market, or bear this year, it may dip 10%.
Adam Taggart 47:53
Okay, and the great exposition that it actually it’s consistent with some other guests that we’ve had on this program as well. So seems very clear that you’re in the camp of people saying, take a lot of these sort of hysterical headlines that we’re seeing right now about the end of dollar hegemony with a big grain of salt.
Michael Howell 48:17
Yeah. Who’s planting the stories? Is it the Russians? Or is it the Chinese? I mean, social media is a powerful mechanism. But it can be influenced significantly, it’s very much in their interest to undermine the dollar.
Adam Taggart 48:29
Okay, all right. Well, look sorry for this tangent. But it was very interesting. Thanks for going on it with me. So you know, what I hear you saying, kind of getting down to brass tacks for today’s investors, is we are at an inflection point. And as a matter of fact, that inflection point might have been the very end of last year. For all the reasons you’ve mentioned, you expect the headwinds that we’ve been experiencing, the markets have been experiencing to turn into tailwinds that could last for a couple of years from right now. So this is almost sort of the by while be greedy when others are fearful moment in the cycle, where, you know, everybody is still very focused on recession risk. You know, the headlines are very still negative here, sentiment is still quite negative. But you’re seeing all these green shoots, these early indicators that you look at, and you ticked off a whole bunch here, you’re beginning to see now. And so that this is the point where you can sort of buy low in anticipation that the rising tide is going to bring everything you know, upwards over the coming year plus.
Michael Howell 49:36
can you see a slide what this is basically showing is the movement of global liquidity in orange, and the black line is all wealth worldwide. So it’s the it’s the returns on a global wealth portfolio in percentage terms. And what this is trying to show is the power of global liquidity in terms of driving asset market returns in that wealth portfolio. What it consists of is basically residential housing, all precious metals, all fixed income markets, all equity markets on all liquid asset products. So it’s it’s total world wealth in a very broad sense. And what it shows is that inflections in global liquidity, the global liquidity cycle, shown in orange, basically is a key driver of that World Wealth portfolio. Now, what you’ll see is that the correlation has actually tightened over the last decade, compared to what we saw in the period from 2000. And just as a sort of heads up, I hadn’t cheated by ignoring the pre 2000 years, that’s available, and it shows pretty much the same degree of correlation. So what you’re seeing here is disrupt presentation visual representation of the power of global liquidity in system.
Adam Taggart 50:53
Okay, so I can sum up your world outlook here, your market outlook here, as it’s all about liquidity. And that chart definitely shows exactly that that liquidity pulls wealth around with it. What’s the question? If we could just, you probably answered this earlier, but I just want to make sure folks have as good an understanding of this as possible. How do you calculate global liquidity? What are the big inputs in that?
Michael Howell 51:18
Okay, well, let me let me move on to a slide where I can show you. So this is basically this slide comes from a book I wrote a few years ago called capital wars. And this identifies the structure of global liquidity. Now, what this is basically showing is the top of that inverted pyramid is the pool of global liquidity. It’s $170 trillion pool of, of fast moving funds around the world. And at the base of that inverted pyramid is what we call the shadow monetary base. The Shadow monetary base is effectively what global liquidity is built on. This is what private lenders use this seedcorn if you like to create liquidity globally, it consists of central bank money, cross border flows, which include things like the Euro dollar, the Euro dollar markets, FX swaps, plus the pool of collateral in the system, and that is levered up, the leverage ratio is about 1.7 times so that shadow monetary base is about $100 trillion. So the way that we think of liquidity is in this in this framework. And in factual fact, if you look at the next slide, what that shows you is weekly data on what we call the world shadow, monetary base, which is that, that the apex, if you like, of that inverted pyramid, and what you can see there, hopefully, quite, not quite neatly, is the big jump in the shadow monetary base around from around October of 2020, to that big one upwards, which is now causing the 12 month rate of change shown in orange, does it begin to move more positively. So that’s basically how we you know how we interpret this.
Adam Taggart 53:06
Okay, very useful. Okay. So in that last chart, it shows that the shadow part is getting back, it’s almost at positive right, and the trajectory is headed towards positive here, which totally corroborates your point that, you know, we’ve we’ve been at a turning point, and that tailwind headwind is switching into a tailwind here. So all right. So if if this is the time and again, don’t put words in your mouth, but if this is the time to be greedy when other others are fearful, and to start reentering the market, when you know, folks are still worried about where things are going. And hopefully that means you’re getting better values today than you’ll get tomorrow. How how do you think this is best played. Our interview with Michael will continue over in part two, which will be released on this channel tomorrow as soon as we’re finished editing it. To be notified when it comes out. Subscribe to this channel if you haven’t already by clicking on the subscribe button below, as well as that little bell icon right next to it. And be sure to hit the like button to while you’re down there. And if you’d like to download a copy of the full chart presentation Michael was showing slides from in this interview, you can do so for free by going to wealthion.com/cross border. And finally, if the challenges Michael has detailed in this interview, have you feeling a little vulnerable about the prospects for your wealth? Then consider scheduling a free no strings attached portfolio review by a financial advisor who can help manage your wealth keeping in mind the trends, risks and opportunities that Michaels mentioned here. Just go to wealthion.com and we’ll help set one up for you. Okay, I’ll see you next over in part two of our interview with Michael Howell.
Transcribed by https://otter.ai