Liquidity Is Finally Falling. Here’s What That Means for Markets | Michael Howell

Fed liquidity is falling, and that is a danger sign. Everything here tells me that next year won't be a great year for financial assets. I mean, I hope I'm proved wrong, but that's what the data is telling us. Now, my view is that we're somewhere near the peak of this cycle. The monetary debasement trade is real.

You basically say US financial markets are showing signs of a tightening liquidity crisis. The Fed is really the overseer of global financial markets, and therefore, if the Federal Reserve starts to turn off the money tap, there is a problem.

Today, I'm sitting down with Michael Howell. But this is a little different than our previous conversations. Over the last few years, Michael has absolutely nailed this bull market, not just in stocks, but in gold and Bitcoin, too. He used his liquidity models and data to call the bottom in 2022 and stay long through all the noise. So, what's different now? This is the first time since 2022 that I've heard Michael raise this much concern about how the liquidity cycle and the bull market might be coming to an abrupt end. When Michael issues a warning, I pay attention. That's why I read his research on the Capital Wars Substack and why we have a special offer for Monetary Matters subscribers. Go to the special link in the description to get 20% off an annual subscription. Without further ado, let's get into it. Very pleased to be joined once again by Michael Howell of Global Liquidity Indexes and Capital Wars Substack. Michael, welcome back to Monetary Matters.

Well, hi Jack. Very good to be here.

You're known as the godfather of liquidity, which leads asset markets and prices. So we're talking about things like stocks, bonds, precious metals, as well as Bitcoin. How do you measure global liquidity? And why is it so important?

To answer the second question first, it's important because a rising tide floats many boats. And, you know, over the course of the last three years, unless you've been asleep, you'll realize that liquidity factors have really been the dominant factors driving markets everywhere. What we do is that we basically track where the money is and where the money's flowing. And that's, that's very important for asset markets. Now, how do we actually do that? The answer is that we look at data very intensively. We gather data from just over 90 financial systems worldwide. And we've been doing this for over three decades. So we know where the data is and we know the data intimately. We do a lot of screening of the data to make sure the data has got good integrity. And we provide indexes, global liquidity indexes, which show the pulses of liquidity through different markets. And we can drill down in a very granular fashion to individual markets among the 90 we look at. Now, clearly, some markets are more important than others. So China and the US and the Eurozone and Japan are probably the dominant players. But, you know, there's a whole tale that we look at as well if anyone wants that granularity. The other thing that we've done is that we've invested very heavily over the last five years in technology. We incorporate AI into our systems, but more particularly, we've got a daily nowcasting system where our data feeds will allow us to basically create a daily plot of what liquidity is across the major markets. And that's pretty invaluable because what it's been showing recently is liquidity has been declining.

Liquidity is declining. Tell me about that, Michael, because I remember you absolutely nailed the bottom in risk assets, and particularly the stock market, which bottomed in October of 2022, and you saw an upsurge in liquidity when almost no one saw it. Everyone was talking about the Federal Reserve doing quantitative tightening and the Federal Reserve raising interest rates, both of which, of course, were true. Now, I think everyone is so excited just about this huge bull market we have, which, you know, there's no denying it. It's a bull market. What are the declines in liquidity that have you concerned, Michael?

Well, I'd also say with some humility that, in actual fact, if you look back to 2021, we were actually pretty bearish through the back end of 2021 because what we were seeing then, we're beginning to see the first signs of now. And that was a tightening of liquidity conditions that was really coming from the central banks, particularly led by the US Federal Reserve. Now, what's causing liquidity to go down in terms of our latest readings is principally tighter liquidity coming out of the Fed. And you're seeing those tensions expressed in US repo markets as we speak. So SOFR spreads, and SOFR is the key interest rate in the repo markets. It's replaced the Eurodollar rate as the main gauge. SOFR rates are starting to bound up higher. In other words, the spread is widening against Fed funds. And that is a sign of growing tensions. And what we'd expect to see is liquidity support coming from the Federal Reserve. However, the Federal Reserve seems to be pretty clear that they're not going to do this unless there is a major crisis. Now, that's not a particularly comfortable world to be sitting in right now. If you look at the Federal Reserve, it's not simply the balance sheet that's the critical metric. What you've got to do is to sort out within the balance sheet which are the line items that add to liquidity and which don't. And our measure of Fed liquidity, which is the one, one of the ones we've been touting over the years, and that goes back to sort of Fed watching at Salomon Brothers, but effectively, if you're looking at the balance sheet and the liquidity-creating elements of the balance sheet, Fed liquidity is really the key metric. And Fed liquidity has been going up quite noticeably since late 2022, even despite the fact that the headline, the headline said QT, QT warning. It wasn't QT. In fact, it may have been QT under a very narrow definition that the Federal Reserve was letting debt roll off its balance sheet, but through other means, it was injecting a lot of liquidity into markets. And now what's happening is that it is genuinely taking liquidity out, which is why you're getting the tensions in repo markets. Fed liquidity is falling, and that is a danger sign.

Michael, reading your recent research on Capital Wars Substack, I was struck not so much by your outright bearishness, but by your concerns about the global liquidity cycle going forward.

Well, that's a pretty good assessment, Jack. I mean, the answer is that we're a lot more cautious than we've been. You know, we're really driven by data, and the data that we're picking up is beginning to roll over. I mean, that's really the sense that we get. A lot of that's coming out of the US. You know, we can point fingers directly at the Federal Reserve here. And, you know, there's got to be concern. If the Fed starts to turn off the money tap, then that's, you know, that's a major loss of liquidity for the world economy or world financial markets. So, I wouldn't like to say we're outright bearish right now. I think that the situation we're looking at in terms of liquidity getting near a peak is probably consistent with markets probably at best kind of flatlining, being range-bound with more vol. But, you know, the problem is that the upside from where we see it is not going to be great, and the downside looms ahead of us if the Federal Reserve, you know, continues the path they're on and actually even makes a mistake. And that's got to be a worry. Now, I know there are other offsets. I mean, the fact is that China is easing a lot. But the problem is, is that a lot of China's liquidity, or the bulk of China's liquidity, doesn't go into global financial markets. It goes into the real economy, simply because China is, you know, it's got a huge industrial footprint. And if China starts to inject liquidity, that's much more a boost to the global economy than it is to financial markets. The Fed is really the overseer of global financial markets, and therefore, if the Federal Reserve starts to turn off the money tap, there is a problem.

And Michael, you write about how global liquidity is not the cost of capital, which is basically interest rates, but global liquidity is the capacity of capital. Michael, when the Federal Reserve raised interest rates in 2022, a lot of people thought that the party was over. But there have been various mechanisms by which liquidity has been kept abundant, particularly in the United States. Can you start by just reviewing those dynamics and then you can get on to why you think those dynamics might be at an inflection point?

We can throw up a chart immediately of actually what's going on. And if you take a look, there's a slide there which is basically looking at all forms of liquidity that go into the US markets. This is looking at both the Fed, the Treasury, all sources of liquidity. I mean, we've dubbed that before, not QEQE, and not yield curve control, yield curve control or whatever, but it basically differentiates what the Treasury is doing in terms of its QE operations from what the Federal Reserve has been doing. That chart, which is a sort of trickle layer of orange, red, and black zones, basically shows back in the time of COVID, a huge liquidity expansion that was firing on all fronts. So, basically, what you had there was the Federal Reserve was expanding its balance sheet. That's, you know, that's clearly positive. There was something we've labeled not QEQE, which was basically other forms of stimulus that the Fed can operate and other ways of getting liquidity into the system rather than changing the SOR account, the open market operations that the Fed undertakes. In other words, they could do things like reverse repo, Treasury General Account, other sort of wonky conduits, but that's another form of liquidity injection that is outside of sort of so-called headline QE or laterally headline QT. Then there's another element that comes in. So the red area on the chart is straightforward Fed QE balance sheet. Orange is not QEQE, the subtle elements, if you like. And then the black area that we show in the chart is basically coming out of the Treasury. Now, we've labeled that before, Yellenomics. I mean, we did that at the time, and that was really the policy that Janet Yellen, the previous Treasury Secretary in the US, basically devised or operated, which was changing the tenor or the average maturity of debt issued by the US Treasury. And there was a big swing away from longer duration debt issues towards shorter-term bill finance. And that's something that has been actually picked up again by Scott Besson, even though somewhat paradoxically, he sort of railed against that at the time that Yellen was doing it and said that it shouldn't be done, but I think he's found that there's really no alternative to but to do this. So if you look at the evolution of that chart, you can see it's very cyclical. The straight, plain vanilla QE, the red area, has basically become de minimis, and a lot of the stimulus has been relying on both the Fed's not QEQE, the sort of the hidden elements, and Treasury QE. And if you roll into 2026, what you find is that the Treasury is really dominant in terms of its operations. Now, I'll just say that although it's a sort of wonky area, the reason that we say that this shift towards bill finance is a liquidity stimulus is you can broadly define liquidity as equal to an asset divided by its duration. So, if you've got a bill which is, let's say, a three-month bill compared with a 10-year Treasury, a three-month bill is a lot more liquid because it's much shorter maturity and it can be treated as a near liquid asset. It's highly liquid.

Right, like a 30-year Treasury bond moves a lot in price. A three-month Treasury bill moves almost not at all in price. So, it's a lot more risky from a price perspective.

Yeah. Exactly. And therefore, as a result of that, because it's less risky, it doesn't take up so much balance sheet space in terms of credit providers. The other point being, which again is sort of bit in monetary mechanics, but if you look at bills, bills are really lapped up by banks, or bills and short-dated debt is a sort of instrument that a bank would like. And if a bank buys a government bond, or in fact, a bank buys any bond, but particularly a government bond, that is monetization of the deficit, and that's the issue that we've got going on. So if you look at the following slide, what you can see is that a lot of the growth, the money growth in the US at the moment is basically coming through banks monetizing the deficit. So you've got this huge pickup and growth in agency and Treasury holdings by banks, and that's basically, you know, another way of saying they're printing money, but that's what's ultimately going on. So the monetization. And if you feed that back, that's, you know, my view is why the gold market is so strong right now.

Michael, I love this chart. The commercial banks' holdings is so important. And as you say, if you or I, or people watching this, individuals, they buy treasury securities with real money, that is, they're drawing down from savings in order to fund the government. But when banks buy them, they do so basically with credit. So that is similar to when the Federal Reserve buys it. They are printing money in order to fund the government.

Yeah, it's funded by balance sheet expansion, not from savings. And that's the point. So that's the risk we're running into. Now, the other thing that one's got to say is that there is a policy going on which is, in my view, would be to say that any notion of the Fed injecting liquidity into markets is being sort of diverted or changed into the Treasury doing it. The Treasury trying to get control and to take control away from the Fed. And a lot of that is really coming back from Bessant and Miran's comments to say that, you know, the Federal Reserve has been responsible in many ways for this sort of wealth, this wealth divide, if you like, in the US. So you've got this huge wealth anomaly, the haves and the have-nots, and that's really because the Federal Reserve has been showering everyone with liquidity, all markets have gone up. And what the Treasury is really saying is this has got to be directed into the real economy, and the Treasury is really best suited to do that. So fiscal spending is part of this whole agenda of Make America Great Again, and it's being funded through the bill market or the very short-term debt markets. The Federal Reserve's QE is being diminished correspondingly. The Treasury is taking over. The trouble is that transition is quite an awkward one. And the problem that the Federal Reserve have got themselves into, which is getting, you know, again, slightly wonky here, is the Federal Reserve is basically saying that, or they accept the fact that the Fed's balance sheet has to be pared down, that bank reserves have to drop. The trouble is that their figure for what is adequate or minimum levels of reserves for banks, I think, is way, way too low. So they're judging the fact that banks can get away with holding 2.7 trillion. They currently have about just under three, okay, 3 trillion. My view is that they need probably a minimum of 3.3 trillion. Now, as that level of liquidity starts to go down and bank reserves shrink, you start to get a lot of tensions in repo markets. And that's exactly what's happening. And I think it's well worth exploring that because this is clearly a risk. And what we're seeing right now in the US system is that the repo markets have tightened. And this is not just an overnight phenomenon. There's a trend to this. And that is the ultimate risk in terms of a future financial crisis.

Now, if you look at a slide which is looking at the debt liquidity cycle, it's a schematic diagram. What that basically illustrates is the structure of not just the US, but actually the global financial system. And it's well worth thinking about this because this is not what is written about in textbooks. This is really how the system has evolved, particularly in the last 10 or 15 years since the GFC. What this is basically telling us is that at the heart of the system is this debt liquidity nexus. And the paradox that's at the heart of modern finance is that debt needs liquidity for refinancing, and liquidity needs debt in terms of collateral. So liquidity can be expanded. The reason that this is an important slide is that the whole financial system today is geared up for debt refinancing. It does not fulfill the traditional textbook model, which says that capital markets are here to raise new funding for investment projects. That just doesn't happen. That's an archaic view, probably 30, 40, 50 years out of date. What you've got to look at now is the fact that something like 70 to 80% of all transactions, as we say on the right-hand side of that slide, are all about refinancing debt. In other words, rolling over debt. We've got such an enormous pile of debt in the world economy that it has to be refinanced on average every four to five years. And that requires balance sheet capacity, in other words, liquidity. Now, if you go to the left-hand side of that chart, what it says then is that the heart of that debt refinancing is the need for collateral, and it involves the repo markets very closely. And you'll see that it says there that 77% of all lending globally is actually now collateralized. And that's a fact since the GFC, lending is not done on trust, it's done on collateral. And that figure comes from the World Bank. What this basically says as well is that if you get tensions in the markets, if there is a difference between debt and liquidity, you can get a financial crisis.

And if you look at the following slide, what that shows you is a graph that goes back to 1980 of looking at the ratio between debt and liquidity. Now, my view is that the normal metric that economists look at, which is debt to GDP, doesn't really mean anything. I can't really understand what that tells us, if anything. What you really need to do is to look at debt to liquidity because debt to liquidity tells you how easy it is to roll the debt over. And what this chart illustrates, rather contrary to what you see in a debt to GDP chart, is a stable series, in other words, a stationary statistical series which is mean-reverting. And it says that the system is trying to get to an equilibrium. And that equilibrium is a level of about two times, as the graph shows, between debt, the stock of debt, and the stock of liquidity. And broadly, that's the amount of liquidity you need for normal rollover of debt. Now, if you get an excessive debt to liquidity ratio, other words, there's not enough liquidity in the system, you get a financial crisis. And those financial crises are annotated in the graph. And my contention is that almost every financial crisis we can think of has really been a debt refinancing crisis. On the other side of that divide, of that two times divide, the dotted line there, when there is excessive liquidity relative to debt, you get asset bubbles. And we've just come through a whopping great bubble, which is the everything bubble. And that is now probably ending. And if you look at the graph, what we show there is that the orange line, the debt liquidity ratio, is moving up quite strongly northwards to meet that broken line. Trades just above that. So that's a risk to say that we're moving into a tighter liquidity regime. Now, the reason for that is twofold. One is that we perceive that the flow of liquidity is slowing. That may be a normal cyclical development, but it's a fact it's slowing. And the evidence we've currently gathered is the Federal Reserve is foremost, maybe accidentally this is true, but it's foremost in that tightening process. And secondly, there's an awful lot of debt to refinance. Debt was termed out into the latter part of this decade during the COVID crisis when interest rates were slashed to zero, in some cases negative levels. Now, I used to work at Salomon Brothers, and at Salomon Brothers, the sort of bible that we research bible we looked at was Sydney Homer's history of interest rates, which is a book which covers 4,000 years of interest rate history. Nowhere in those pages will you ever see any reference to zero interest rates. So that's the anomaly that we've just come through. Central banks slashed rates down to zero levels. It incentivized debt take-up and it forced or encouraged a lot of people to term up their debt into the latter part of the decade.

So if you look at the following slide, what that shows is the change in the debt roll every year. So this is the amount of, not the amount of debt that has to be refinanced, it's the change in the amount of debt that has to be refinanced. It's the extra increment. And so what you're looking at here is sizable amounts of debt that's sort of concentrated in the latter half of this decade. And you can see very clearly the bite out of that chart that we could see in the 2021, 2022, 2023 period, in the period following COVID when zero interest rates were the norm.

And so a negative figure on this chart indicates a large amount of refinancing. Positive. What's negative?

Basically saying that's the annual increment. So if you said you've got 30 trillion of debt to refinance every year, these are the changes around that level. So if it's 33 trillion, and then if there's a negative figure, it may be 28 trillion, for example.

And so it was negative in 2021 and 2022 just because there was so much refinancing.

Yeah. Exactly. So, so you've got a big dip in the amount in the, uh, need for balance sheet capacity, and therefore that balance sheet capacity could be used elsewhere in terms of funding financial asset purchase and, you know, roaring asset prices, which is what we saw. Now, if you start to get this issue of tension in the repo markets or tension in the money markets, repo spreads will start to blow out. And if you look at the following slide, this evidences what we've been seeing over the last two or three years. The point that we've been repeatedly making here is that it's all right until it's not. And what you've got is this trend appearing in terms of SOFR spreads. This is looking at the difference between SOFR rates, which are the repo rates, the interest rates in the money markets, in other words, what the markets itself establish versus Fed funds, what policymakers aim for. And you can see that spread is beginning to blow out more and more frequently. Now, I wouldn't pay that much attention to the scale of the spikes. I think that's less important than the frequency of the spikes. And what you've got there is a very clearly developing trend, which is saying that money market liquidity is starting to get tight. Now, we know that Jay Powell actually alluded to this about a week ago when he more or less said de facto QT is ending. Great. That's one step in the right direction. But if you look at the next chart, what you can see is Fed, what we call Fed liquidity growth. Now, Fed liquidity is a concept that we used to play around with at Salomon Brothers, but it was something I wrote about and defined in a book I put together about five or six years ago called Capital Wars. And this was trying to understand the structure of the Fed balance sheet and the various conduits through which the Fed would operate. And what this is really looking at is not the balance sheet per se, because the balance sheet per se does not represent liquidity. What you've got to look at is the liquidity-creating parts of the balance sheet, and that's what Fed liquidity is looking at. Now, if you look at that graph, what it hopefully plainly shows is that there are periods of growth and there are periods of decline in Fed liquidity. The periods of decline, which we've had historically, have not been great periods for the market. And you can see that pretty clearly. Those big dips are when you either saw the tightening after COVID, when markets fell through the back end of '21 and then through most of '22, and then the air pocket in liquidity in '24. What we are starting to see now is another one of those dips. And it looks as if Fed liquidity will be down on average by about 10% over the next nine months. If you end QT, will that help? Yeah, sure, a bit. But it's not going to make that series turn positive. And the scale of this withdrawal of liquidity can be seen in terms of what the Fed has done in rebuilding, or what the Treasury and the Fed together have done, I should say, in rebuilding the Treasury General Account at the Federal Reserve, which is effectively taking liquidity out of the system, and also running down another program which is called the reverse repo facility. And those factors together mean that the amount of liquidity that's available for the markets is being reduced significantly. And in fact, on the next chart, I try and show this in terms of what we've been seeing recently. And that chart is basically saying this is the hidden stimulus that the Fed has been operating outside of the headline balance sheet. What we've loosely called not Fed QEQE, which is the hidden stimulus. And this is showing where it was at the peak, which is around $2.5 trillion of net stimulus, and how much that's declined over the course of the last few weeks. I mean, since basically early June. So, you've lost about well over $400 billion of net stimulus in terms of what they've done so far. And this is clearly very significant. Now, if you want to look at that in a slightly different way, and this really hammers home, hopefully, the point here is that the following slide is looking at bank reserves. Now, bank reserves are, if you like, the counterpart to Fed liquidity. So Fed liquidity is an asset for the private sector. This is a liability. And bank reserves pretty much match, or broadly match, that Fed liquidity impetus. Now, what we show on this chart is the movement of Fed liquidity in orange. There are various annotations there to show what's been going on. And I've put on that chart a dotted line, which is my estimates of adequate reserves in the system. This is not the Federal Reserve's estimates. This is our own estimates. And we've estimated that by looking at the repo markets and identifying when you get tensions in the repo markets and creating a model which basically says when there are more tensions, that is giving us clues as to whether you've got the correct or the incorrect amount of reserves in the system. And from that, we've estimated what the minimum level of reserves the market needs. And you can see how that's tracked over time. Now, where we are now is relative to that dotted line of adequate reserves, we're seeing a noticeable shortfall. And that shortfall is clearly of great concern. And the broken line in Fed on the bank reserve chart is then extrapolating that into 2026. So on current slated programs of what the Fed is telling us it's going to do, you've still got this big shortfall. Now, the following slide is then looking at excess reserves of banks. In other words, that shortfall or the surplus when there's a surplus, but the difference between bank reserves and my estimates of adequate and trade fails among primary dealers. Now, that is clearly something of great concern because what this is telling us is that when liquidity in the money markets, in other words, when bank reserves are below normal, what you get, not surprisingly, is an increase in trade fails among primary dealers. And if you get an increase in trade fails among primary dealers, it's likely that volatility will step up in the bond markets. And, you know, the concern here is what happens to bonds because bonds have been unusually quiet or stable in recent weeks, defying a lot of the scare stories about how bonds were going to sell off. They've actually been remarkably robust. The trouble is that if you start to get now a deterioration in the bond markets and vol picks up, that is going to lead to an unraveling, probably in the hedge fund basis trade, given the fact that hedge funds have been big buyers of cash bonds in recent months or quarters, and they're really, in many ways, the marginal buyer. So if they start to unwind their carry trade, then you're going to start to see potentially a jump in volatility and a spike in yields. And that's clearly a dangerous thing. So, um, um, Messrs. Besson and Powell will like to see that risk prevented or stopped. And the question is, how do they do that? I think one of the ways that they could do that is by explicitly restarting a QE, but I don't think they're going to do that. They're certainly helping by ending QT, but as I said, that's not enough. But they may have to sort of put their thinking caps on to try and do something else. And at the moment, I don't really see what options they've got. There's a short-term possibility that they're running a very high level in the Treasury General Account right now of $850 billion. In fact, as we speak, it's topped $900 billion, but the target's $850. And I think that they're running that very high level of the TGA because they're funding the government through the bill market. They need that extra cushion of flexibility. But it does give them the option that they can run down the TGA temporarily to give the markets necessary liquidity. But this is, you know, we're we're it's difficult to fine-tune. And the risk in all this is that as the following slide says, what that is illustrating is Fed liquidity again and the S&P 500. The orange line is the S&P 500. The red line is Fed liquidity. I've extrapolated Fed liquidity into 2026, as we suggested. And you can see as well, because we've lined up the two charts by lagging the S&P by 25 weeks. So there's about a six-month lead time, in other words, between the two series, that when you start to see Fed liquidity dipping sharply, the market tends to adjust downwards. And that's really the problem. So this is why we're getting a bit nervous right now. It's not the end of the party, but you can hear someone calling time.

You define a few terms. Quantitative easing is when the Federal Reserve expands its balance sheet with the goal of lowering bond yields, even though, as you have written, the tendency is actually for bond yields to increase when the Federal Reserve expands its balance sheet during quantitative easing. Quantitative tightening is the reverse, when the Federal Reserve has been reducing its balance sheet, which it's been doing since 2022. In Federal Reserve liquidity, you don't just include the QE or QT part of the portfolio. You also include the repo facility, the reverse repo facility, which has been really the driver, as well as the Bank Term Funding Program, which was now over but far bigger in 2023. So, Michael, you know, in your most recent Capital Wars Substack, you basically say US financial markets are showing signs of a tightening liquidity crisis. Tie all of this together. You talked about how the financial system is incredibly levered, but on a collateralized basis, and a lot of that collateral, unlike in 2007-2008, is actually pretty good collateral, the Treasury market collateral. So, so when SOFR spreads are blowing out, explain what that means. That basically is hedge funds and leveraged collateralized players financing is getting marginally more expensive than the risk-free rate or the Fed funds rate, as well as, let's just introduce, there's basis, there's the basis trade of Treasury futures versus cash bonds. There's bond volatility, which, as you noted, has been muted. One thing that hasn't been muted, Michael, is credit volatility. And it's interesting to me that in the stock market, as well as the credit markets to a smaller degree, there's been some what some are perceiving to be an overreaction to alarming but not crisis-level credit events of some frauds, some frauds in the auto market, some frauds in the California real estate market, and things are kind of on edge. Would you associate that with this tightening liquidity environment? And where else are you seeing evidence of weakness in financial markets that is directly or indirectly related to the decline in Federal Reserve liquidity and overall the decline in US liquidity?

The very first thing that I was taught at Salomon Brothers was a saying that everyone used to repeat was, in financial markets, there are no unconnected events. And I think one's got to put it in that context. The plain fact is that we've had tightening liquidity conditions. It may not be that liquidity is falling in absolute terms yet, but certainly the growth rate is slowing down. That's for sure. And I think that, you know, it's one of those things that I think whatever Warren Buffett's famous saying is, when the tide goes out, it exposes people that are swimming naked. And this may be part of the issue that's coming up in the credit markets. I don't think that these events are unconnected. I think that we've had a situation where for the last three years, there's been very loose liquidity conditions, and that loose liquidity has clearly been channeled into a lot of probably bad or inappropriate lending. I mean, that always happens. That's the nature of cycles. As the volume of liquidity increases, so the quality tends to go down, the quality of things that are bought goes down. And I think there's, it's not different this time, as far as I can see. So, as we're getting near the top of the cycle, you're going to start to see people getting a little bit skittish about some of the loans they've got or whether these things can be refinanced. And we know that private credit is probably an area which is, you know, very heavily leveraged, or it's a source of leverage within the system that no one's really got a true idea about.

Michael, earlier this summer, we did an interview when you talked about the speculative phase there has begun. And you talked about there's four different phases: turbulence, rebound, calm, and the speculation or the speculative phase. And I'm looking at, we can show up later, a table or a guide, a legend of in those different four phases, what does well. And in the speculation phase, credit does poorly, or it's a poor investment to invest in credit. Commodities do well, so gold and silver. Bond duration does fine, and then equity and beta does fine as well. That kind of maps on pretty closely to where we are because gold and silver are absolutely mooning. The stock market is doing well. Credit is not doing well because, I guess, you know, hallmark of a speculative phase is that it starts when credit spreads are so low, so there's not that much excess return to to sort of harvest. Um, but yeah, just shape your overall outlook on asset markets as well as your view that we are getting further and further into the speculative phase.

Well, if you're looking at those traffic lights, I mean, the traffic lights that we use are a sort of long-term benchmark, and this is informed by performance, historic performance. It doesn't change from month to month or even year to year. It's a pretty, you know, set in stone chart. And what this really says is you've got four phases of the liquidity cycle, which I'll go into in a second, which we call rebound, calm, speculation, turbulence. According to the phase of the cycle, asset classes are shown on the left of the diagram. Industry groups within the stock market are shown on the right-hand side. What it says is that in terms of asset allocation, if you're in the early cyclical phases from the low of the cycle towards the midpoint, that's rebound, and equities and credit tend to do really well during that phase. It's true that you don't want bonds in that area. You don't really want commodities. As you move to calm, you start to shift out of credit and put a bit more money into commodities. Commodities do very well in the speculation stage. Equities are still okay. And then equities really turn down around the turbulence phase, which is when bond duration, in other words, holding long duration government debt, tends to do very well. In terms of industry groups, the upswing of the cycle, the risk-on phase, is always led by technology. Nothing different this time. Financials tend to do well mid-cycle. And then you start to see commodities, mining stocks, and energy starting to pick up around mid-cycle. And that's what we're seeing. I mean, downswing, you want defensive stocks. I mean, there's nothing, there's no rocket science there necessarily, but this is really saying that this cycle has been an absolutely plain vanilla cycle. There's nothing unusual about this cycle. A lot of economists say it's different this time. It clearly ain't different. It's a very, very normal cycle. The economic cycle has not been well-behaved. Economies have flatlined since COVID. There's been no business cycle to speak of, but there's been a very pronounced liquidity cycle. And if we go back to, just for reference, the previous slide, which is looking at the asset allocation cycle, this basically says in a different way or explains in a different way that traffic light diagram. Now, what that says is here you have on the left-hand side the liquidity cycle, the four phases: calm, speculation, turbulence, rebound. Risk on is when you go up. Risk on is when you come down. And the asset allocation implications are basically shown on the right-hand side, where it says around the peak of the cycle, you want commodities, you want cash. In the downswing, equities in the upswing of the cycle. And you want government bond duration around the trough. And it's really as straightforward as that. Now, the $64,000 question is, where are we right now? And if we, if we go to an earlier slide, let's look at slide 12, that shows the global liquidity cycle, at least for the advanced economies. Now, the advanced economies are basically pretty much everything excluding China. China's been taken out because China's been very volatile of late, and it's a big component of this. So this is a clearer view of what's been happening, certainly in the last two years. And what you can see is that the liquidity cycle has picked up significantly. Now, what I should say about this diagram is that this is monthly data. The black line is showing a momentum or rate of growth of liquidity over time. It's not an absolute level. It's showing the rate of growth or momentum. It's shown as an index. And the data we've got goes back to 1965. The sine wave we put on top of that was basically put there in year 2000. It was devised by Furer analysis. The cycle shows an average five to six-year wave. And what that shows is the cycle bottomed in late 2022. In fact, October of '22. It's slated to peak in late 2025. There are grounds for saying that it might be extended if policymakers add more liquidity, but as I speak, one's got to pay homage to the data, and the data is deteriorating, as you can see that latest plot. The fact is that this cycle seems to be pretty regular. The Foundation for the Study of Cycles, which is an independent body in the US, took our data and wanted to do a sort of cross-check of our analysis. And they came up with a more rigorous study using all their various algorithms, but they did reach exactly the same conclusion as us that this was, you know, or independently checked as a 65-month cycle. So I think that's greatly reassuring. And it looks as if it is fluctuating within that time zone. Now, what I wanted to show, just before we get on to where we are now more precisely, is to show two slides. One is to go back two slides to a chart that says global liquidity daily, which is another way of looking at this data on a much higher frequency data basis. Now, this chart is looking at daily data for global liquidity since the beginning of '25. It shows two lines. The orange line is our latest analysis. We've put a lot of resources into actually getting very granular data out of the system. This is like a nowcast system which enables you to look at liquidity on a daily basis. And it uses the most up-to-date data from all the data sources we get, which cover about 90 financial systems worldwide. So I can assure you that this has taken us about five years to develop, and there's an awful lot of computing power which goes into doing this. And what it shows is a nice evolution which corresponds to the other chart, but gives much more granular detail. The dotted line that we put on top of that is actually a measure of market liquidity. So this is just a straightforward index which is showing a combination of spreads and market depth, volumes, etc., bid-ask spreads, market depth, volumes within financial markets. And we would expect that to correspond very broadly to what's happening in liquidity, and it seems to. So that gives us again, a sort of a further cross-check. So it looks as if from this data that you've seen over the last two months of deterioration. Now, why aren't markets responding right now? The answer is liquidity is a leading indicator. It tends to lead by different horizons, but it tends to lead, you know, things like Bitcoin by about three months. It tends to lead equities by maybe six to nine months. Bond markets about the same sort of period. And it tends to lead the real economy with a much longer lead time. Now, to put this in context, if you go on two slides to slide 13, we show the liquidity cycle on average compared the current index, which is the red line, with the average cycle over the 1970 to 2025 period. Now, what that shows is, you know, a broad correspondence. And it says, you know, what we've been arguing, this is a very normal liquidity cycle. In many ways, it may have taken a little bit of time to get going this time, but it's basically pretty much matched the average cycle. And what you're seeing is that sort of evolution at the end of the cycle, which is where you're seeing a bit more volatility. It hasn't yet turned down definitively, but clearly there's a warning there. We've got to be alert to that. So, we're not saying it's over, but we're saying that we're very late. And it's liquidity which has been the major driver. And what we show on the following slide is the fact the business cycle hasn't really been a great help in terms of understanding where we are in the cycle. I don't use business cycle for asset allocation because I don't think it works, and that's been my long experience. But this is really attesting to that. And what we show there are three different measures of the world business cycle. The first of those is the broken line, which is the JP Morgan World Business Cycle Indicator. The JP Morgan PMI. Alongside that in orange is a simple weighted average of all the major business surveys worldwide, weighted by GDP. So the USI is the Tankan in Japan, the CBI in the UK, the INSEAD survey in France. All these are added together to show what the business cycle is doing there as an index. And then the black line is an AI projection, which is basically saying what is this algorithm assume the world economy is doing by feeding in things like commodity prices, credit spreads, exchange rates of trade-sensitive currencies, etc. And you can see that pretty much concurs. All three pretty much concur, but the business cycle has flatlined. Where's the cycle? The cycle is in liquidity, and that's what you need for asset allocation. So, you know, that's where we hang our hat on understanding the liquidity cycle. So this is a pretty typical cycle.

Michael, I want to ask you more about gold, about China, about Bitcoin, as well as specifically some more in-the-weeds liquidity indices. But first, I want to remind viewers of this special promotion that we're doing for your Capital Wars Substack. Michael, you know, and long-term followers of my programming and interviews before Monetary Matters remember that actually my previous show, Forward Guidance, that still exists and is a great show. I actually got that name, Forward Guidance, from the index of your book called Capital Wars, which is a phenomenal read. And I've really been following your work on liquidity and cross-border flows for a very long time and found it very valuable. You now have a Substack of the same name, Capital Wars. Tell us about the work that you do there and how does it differ from the work that you post on

Twitter or in your other public interviews? What do subscribers get and how do you share your data and your views?

>> Well, thanks for the kind words. Um, the these sort of podcasts I do a few of those as you probably recall. They tend to be I suppose I don't skimming the surface but they're not really the same depth as you get in Capital Wars. And what we're doing is really bringing people's attention to data. The point is that Capital Wars is a much more thorough analysis of what's going on. It's a discursive or narrative of what's going on in markets uh and in terms of the liquidity detail. We try and explain things a lot more in that. There are more thematic approaches. The Capital Wars idea at least in the book was really I suppose twofold. One was to explain to people what global liquidity is and why it matters so much and the other was to to articulate the ongoing struggle between particularly the US and China in terms of establishing a new financial system or in other words establishing dominance within the financial systems and that capital war we maintained is far far more important than trade wars. Trade wars are simply the sort of veneer on top. What's really happening, the real action is in terms of capital wars, capital markets and currency flows and etc. capital flows. So I think the short answer is that what you get in Capital Wars is we typically write about three times a week. We do two think pieces and we do one piece which is dedicated to data or understanding the data that's come out.

>> So it's a lot more in-depth. I can attest to that and it comes out two to three times per week. So, it really is much greater frequency and much greater depth. Michael, we're offering a 20% discount to Monetary Matters listeners. And this discount is only lasting for a short limited time offer. Remember when I say, you know, act now, act for a limited time and then, you know, that lasts for a month. This is not the case. This is, you know, going to be gone away soon. So, there's a chance if you're watching this that actually it may already be over, but click the link in the description to to find more.

Michael, let's now talk about gold and China. Two topics that are more related than they might appear originally. Michael, in December of last year, you talked about how gold could hit 26,000 yuan per per gold ounce and how it actually China may actually be targeting that in order to devalue the yuan and keep up its its trade competitiveness. I believe gold is now at over 27,000 yuan per gold ounce. So, that was a a a great call by by you. Should we start with China or should we start with with precious metals? Take it away.

>> Well, let's start with China because I think China is the driver. I mean, the key question that [clears throat] people have got to figure is who's setting the gold price? Is it being said in the West or is it being you know is it purely a Western uh monetary debasement trade or is it something is it something more maybe deeper and it involves China and maybe involves many other countries and I think it's uh I think it's the the latter and I think China is very much in the driving seat. You got to look closely at what the People's Bank of China is doing and not least because I think they're having a huge impact on the price of gold right now. I don't think it's necessarily just Western central banks that are influencing it. The PBOC is clearly instrumental. China has the world's biggest physical gold market at Shanghai. It may be that London is bigger in terms of its derivative exposure etc. But China basically has the physical controls the physical metal. And the point being here is that I think what China is doing is trying to devise or grow its financial system not as a gold standard but as a gold content system. So gold is very important for increasing confidence in the Chinese system and it may well be that the US is simultaneously going on a different road and the US may be using digital assets to collateralize the US dollar system but China I think is using a partial collateralization of its monetary system through gold. Now gold plays a key role here because we know that China has a huge debt problem and it needs to get out of that debt problem. My particular interpretation of what's been going on is that I think the introduction of stable coins has been a huge warning to China which they've taken very seriously in terms of a threat to the integrity of the yuan or RMB financial system and the reason being is that uh if you're a Chinese exporter garnering huge surpluses where you going to put that surplus are you going to put it into a Western banking system where it could be sequestrated rather like Russian assets in times of conflict or you going to put it back into your own domestic financial system and risk falling out with the PRC. So, you're sort of between the devil and the deep blue sea here and stable coin uh gives some anonymity and I think they are gives some security for many investors across the world outside of the US. The Europeans are clearly scared by this prospect and they've said so China I think equally. So what China is doing is trying to get its financial system back to caliber. And the way that they're doing that is by getting rid of the debt problem. Now, if you look at a slide, which is slide 35, which compares Japan and China, their debt liquidity ratios, I think you can probably see what they're trying to do. Now, don't get too hung up about the levels of debt liquidity ratios. That really reflects the underlying maturity of debt. It doesn't matter that much. What you need to look at is the history and the underlying tendency of these two series. Now the black line is Japan. Japan had a big debt problem. It got out of its debt problem by creating liquidity and monetizing the debt. And it did that very successfully under the label of Abenomics. The BOJ took on huge amounts of JGB's, Japanese government debt, held onto its balance sheet, printed money, and ultimately the yen devalued. And what you're seeing now is the fruits of that in so far as the Japanese economy is sort of digging its way progressively, albeit slowly, out of this debt deflationary period. China is about 15 years behind. The orange line shows the debt liquidity ratio of China. And just think back to the earlier chart we showed of the debt liquidity ratio of all advanced economies. It's pretty much the mirror image of this. And China is clearly an anomaly. It sticks out like a sore thumb. We're having way way too much debt relative to liquidity because they've been tightening liquidity over the last few years to try and keep the yuan stable against the dollar. Now they're changing policy. They're injecting liquidity. They're trying to devalue the yuan. And what you can see on this chart is they're getting the debt liquidity ratio down. The following slide shows PBOC, People's Bank liquidity injections into the Chinese system. What you can see here as the chart evidences is six month changes in liquidity and it confirms the fact that really over the last year they've injected something like 7 to 8 trillion into their money market. So on a six-month change, it's about 5 to six, but you accumulate that over 12 months. And what you've seen is about 7 to 8 trillion. My view, they've got to double that. So you're looking at pretty much the same again. What has that meant? It's basically meant if you go to slide 38, what it shows is the China US bilateral real exchange rate as calculated by the BIS in Basel. And you can see there that the Chinese real exchange rate has devalued quite significantly against the US dollar. So that is clearly of of significant import. But even more important is the following slide which looks at the yuan gold price. Now as you pointed out Jack, our view is that they're targeting this probably deliberately. We thought that they were going to get up to at least 24,000 yuan about a year ago. That was that that was our target to say that they had to do this really just to scratch the surface of debt. They exceeded that and the gold price is continuing to move higher. China is reliquifying its economy. You're looking at bond yields rising, the Shanghai stock market zooming over this year, and the yuan gold price moving ever northwards. And this is basically pure monetization that we've seen in many different economies before. What you will see next is likely some turn in the real estate markets. So, China is progressively digging itself out of debt. And what you can see on the following slide is Chinese liquidity and world commodity prices. And what this is saying is that this stage of the cycle with China injecting liquidity, commodity prices are firm. And that matches exactly what we would say in terms of a normal liquidity cycle. So, China is clearly helping this process. that commodity prices are being lifted by a combination of late cycle in the advanced economies and China's liquidity injections because China has such a large industrial footprint that it's bound to make a big difference to commodities.

Are you saying that China is looking to basically have a weak yuan against the dollar, but do it in an indirect way? Because if they actually weaken the yuan against the dollar, that would make the the Europe and US quite quite angry. But if they just pump the gold price up tremendously, they can kind of get get around it and do that indirectly. Is that what you're saying?

>> Yeah, I think that's one way to look at it. I mean, for sure. I think the other thing to say is to go back to the real exchange rate or the or exchange rates more generally is that the way that we we think about this is that the the price of money is not the interest rate as textbooks always tell us it's the exchange rate and you know what better than the real exchange rate to look at because it's a purer measure and if you get imbalances in flow of funds which is what we're talking about you'll see adjustment in exchange rates and real exchange rates and that's pretty much what we're seeing so I think that squares that circle In terms of what China is doing, I think as I said before, China is trying to back its currency with some form of gold collateral that does a number of things. I mean, one, it encourages trade, particularly among commodity producers with China. They're probably quite happy to hold or happier to hold yuan. They may well allow certain trades. For example, if the Saudis wanted to swap oil for gold, they could do that. But I think there would be restrictions on who could do that and how much. But I think that would be that's the idea. And in terms of how much gold they're accumulating, I think you've got to put this in context to say, well, look, how much gold has China got? Short answer is we don't know. Uh they've got as little as 2,000 tons. They could have as much as 5,000 tons in terms of official holdings of gold. In terms of private holdings, they're vastly bigger. That's for sure. If you compare the official holdings of 5,000 with the US 8,000 tons in Fort Knox, China is accumulating gold now as of the latest data last year at about,000 tons a year. So on that basis within two or three years it could be eclipsing the US in terms of its official holdings. So I think that puts it into context and I think that's why you've got this race for collateral is very important and therefore I think you've got to see this in the context of what China is doing is to get gold. What the US is doing is trying to get some sort of digital backing or if you like repackaging treasuries as some form of digital asset via stable coin that will create new buyers for treasuries. it will give some support to the dollar but these are if you like economies which are moving in different directions in terms of the way they foresee the financial future.

>> So Michael tell us specifically about China's new more accommodative more liquidity inducing monetary policy stance. you referenced the People's Bank of China liquidity injections, but I know there are also other tools that go into your indexes on reserve ratios, lending standards, but and then also I don't know if this is in it, but state banks as well. So, not the official sector, but the government controlled banks that are nominally private, but really controlled by the government.

>> Yeah, I mean, we look at all those areas. So, you've got the stateowned banks, which are clearly an important element in operating monetary policy. You've got the policy banks, which are a different entity as well. You've got things like changes in reserve requirements. You've got now a new relatively new conduit which is outright reverse repos. You've got normal open market operations. So there's a whole array of different instruments that the PBOC uses. And what you can see is across those programs consistently there's been a significant uplift in liquidity operations or injections since the beginning of this year. And you can see that confirmed by the movements in both the bond market where yields have started to turn upwards and the stock market where Shanghai's shares have rocketed through this year.

>> They absolutely have Michael. I've you personally owned in quite a concentrated exposure for me Chinese equities and I you know your work on China the principle of my analysis was valuation and certain industry trends in the the Chinese financial fintech space but your work gave me confirmation and greater confidence and I think that's something I want to say to potential subscribers of Capital Wars that they could be fundamental investors and stock pickers and still find tremendous value in this work maybe even more value like if if you're a macro only investor there's tons of other macro stuff you're paying attention to but I think that you know this can be a very good guide for people just in terms of confirmation in the same way if someone's a fundamental investor who doesn't focus on technical analysis every now and then they can look at technical analysis as a general guide for entry and exit this can be the same type of thing

>> thank you for saying that I naturally agree I mean my point is that at heart I'm a value investor I like to buy low PE stocks, that's for sure, are stocks that I perceive to have value. But at the end of the day, if you look at asset allocation from a macro standpoint, and you look at investing in different markets, PE multiples at the market level or the aggregate level simply do not work as a tool for asset allocation. And you can see that Ian very plainly by considering European markets where PE multiples have been consistently below the US and Japan for decades. But the European markets have never outperformed consistently. The US has had a very high PE relative to Europe certainly for the last 15 years. But look at look at the outperformance that American stocks have made. And that's simply because there's more liquidity in the US system and it's attracting huge capital inflows. So that's the metrics you've got to look at when you're looking at diversifying internationally or understanding the cycle of asset allocation.

>> And Michael, when we we can show up a chart just of the People's Bank of China liquidity injections and you know there's some months where it is negative but it has been broadly positive when you look at the data but also the commentary from the People's Bank of China. Are you seeing not just that they have been injecting liquidity but that they have a plan of being more and more accommodative over time?

Well, I mean, my my answer is that they have to be more accommodated because the only way you're going to get out of debt is to basically devalue it. And what they're doing is they de they're devaluing it against real assets and those real assets can be proxyed by the gold price. Now, the real problem in China is clearly real estate and they need to get real estate values up and I think that, you know, we can uh we can talk, you know, equally at length about the integrity of the US welfare system, if you like. uh the fact that increasing social security and Medicare expenses are pushing the deficit skyhigh and debt up. But China's welfare system is really based around ownership of dwellings or ownership of real estate. U they don't have uh a typical welfare safety net and they rely on these assets. Now, a lot of those assets, those real estate assets are underwater. And if you're going to preserve the long-term wealth of your society, you've got to get uh those real estate values up. Uh and that's what their plan, I think, is. So, they got to get rid of the debt and they've got to try and devalue the debt and essentially get the real estate market turning. So I would envision that certainly in the next 1 to two years you're going to start to see a positive incline in real estate prices in China because they're printing so much liquidity. The vent for that liquidity is going to be equally Shanghai's shares and equally it's going to be commodity prices globally.

>> So Michael, now let's turn to precious metals and Bitcoin. So let's start with gold and silver. This run up in gold is enormous. Where are you seeing prices going for gold and silver? You can choose the time horizon and tie it to your thoughts on liquidity, the liquidity cycle, as well as this Chinese and maybe Indian buying, which so far has just been enormous.

>> Well, if you look at slide five in the presentation, there's a chart that looks at gold bullion against US real interest rates. Now what that chart basically says is that there was a break in the normal relationships between those data series around early 2022. And the black line is referencing TIPS real interest rates in America, Treasury Inflation Protected Securities inverted on the left hand scale upside down. And the orange line is the gold bullion price on the right scale in US dollar terms. Now what you'd normally see is a relationship that says as real interest rates decline so the gold price goes up because the cost of carry of gold relative the opportunity cost is reducing and therefore the gold price goes up and contrary if real interest rates go up then the opportunity cost of holding gold clearly is much greater and gold comes down. That relationship broke in early 2022. A number of people it's quite widely held I suppose view that that was because of the invasion of Russia's invasion of Ukraine and the subsequent sequestration of Russian assets. I think that's played a role. I don't think that's the main factor. I think the main factor is that what you've got is a period which was ushered in of sort of monetary recklessness and this is where the US started to shift towards more bill finance more yelanomics as we called it. You've seen a similar trend evolving worldwide. It's now almost a given that more and more governments will start issuing debt at the short end of the market. They come up with excuses like, "Oh, well, there's no demand for longdated stuff because populations are aging. There's no more pension fund demand, etc." Well, that may be a fact, but if you're funding at the short end of the market, that is irresponsible irresponsible in a monetary sense. Um, so they're ultimately just printing money. And that's what that chart principally says. Now the dynamics of that are shown on the following slide which looks at the underlying factors that are pushing up liquidity growth in the long term in the US. And this is identifying the structural deficit, the fiscal deficit in the US out to the mid 2050s. This is data that principally comes from the Congressional Budget Office. So, a bipartisan body seemingly neutral in this. We've only made one change to that structural deficit data, which is to push the defense spending element up to 5% of GDP, which is the NATO target. And I think that's a pretty reasonable assumption. The structural deficit consists of Medicare, Social Security, interest payments, and and defense spending. No discretionary spending at all. That will have to come on top. And you can see what that chart does. you get a sort of secular increase in the size of the deficit and that increase in debt which is associated the dotted line on the right scale is showing debt to GDP held by the public uh uh generally. So what this is telling us is you're moving from about 100% of GDP to 250% and that's clearly an eye watering number. Now, we just did a very simple exercise to say if you look at the following slide, what would happen if you kept the real value, in other words, the gold value of US debt constant. And that says that if you did that, look at what the gold price would have to do. [clears throat] Now, this is exponential growth. We may not get to that, but I I'm going to give you a caveat in a moment. And that would suggest that by what the middle 2030s, you could easily see $10,000 an ounce for gold. And by the 2050s, you're talking about $25,000 an ounce for gold. Now, over that time frame, the amount of debt and gold rise par. They rise hand in hand. So the increase in debt means an increase in the gold price to equilibriate that in real terms over the period of the last 25 years since year 2000 US debt has increased by around 10 times. Okay. Uh an eyewatering thought but that's the reality. A tenfold increase in federal debt. Okay. Over that same period the S&P has gone up 4.7 times but the gold price has gone up 13 times. So the gold price has more than matched the increase in debt over the previous 25 years. Let's just assume it matches the increase in debt in the next 25 years. And that's what you get at the orange line on the chart. And I think that's a significant point about what could happen to gold in the future. And that's basically aligning these two things. The other thing to say is what about Bitcoin?

Michael, I apologize. I I we'll get we'll get into Bitcoin in a moment, but just so your starting point is 2000 and you said S&P did four times the debt increase, but gold did >> 4 point S&P went up 4.7 times if my maths are correct. >> So gold has done twice as good as the S&P in >> 2000. Okay. >> More than better than that. Yeah. Yeah. Yeah. >> I knew I knew it had done very well. I wasn't aware there. Of course, I'll point out, you know, that is starting at a local low in gold of of 2000. In the same way, you know, if people start the gold price in 1971, it it looks pretty good. I think from 1981 to 2000, you had, you know, a 19-year bare market in gold while debt to GDP increased while debt increase. So there there can be lags on these things, but yeah, there's no doubt gold has done quite well. And Michael, so that that is a predict a potential projection of holding the debt constant. Gold could go to $10,000 an ounce. Do you think that that is a possibility in any near term over the next five years? I mean, to me, it seems like the price of gold being at $10,000 would be a much different world. And already with the nosebleleed levels in gold, that is making me and frankly, I think a lot of other investors uncomfortable. You know, what is that signaling about investors confidence in this financial system that we have, stocks and bonds and real estate, you know, all traditional stuff. Uh why is why are so investor so many investors flocking to gold? What's going on? I mean $10,000, you know, is is that is that a call you're making over the next few years or is that a projection?

>> Well, it's a projection. It's a realistic projection because it's saying that, you know, if if you're telling me there is a way of stopping debt accumulating in this fashion, then I'll come quietly and say maybe the gold market doesn't do what I projected to hear. But if you believe that debt is uncontrolled and uh you know I would suggest that a lot of the policies of the current administration in the US are not doing anything to reduce the increase in debt and there may be novel ways of funding it but the amount of debt keeps going up and ultimately that must create monetary inflation and that's what we're saying. Now if you go back to the chart that was on slide six which is looking at the structural deficit. The real question to ask and maybe to appreciate is that that structural deficit is climbing and that structural deficit is climbing really for two reasons. One is that welfare spending in a generic sense is going up because of aging demographics and the promises that politicians have made. No one is thinking of reaging on those promises at least of all President Trump. And the second thing is that you've got the compounding effect of interest because the debt GDP ratio is over 100%. And you start to get this compounding effect from higher interest, a higher interest bill. You can see why politicians want interest rates lower because that will help slow the accumulation of debt. But the fact is that the structural deficit, that orange line, is radically higher than any period that we've seen over time, apart from the spikes during COVID or during the GFC. Those were one-off anomalies, but the trend is unremitting. And that's the point that we're making. This is why we're in a new world and people have got to realize that. And I think that that's why you come back to this point about monetary debasement. The monetary debasement trade is real and alive. People are concerned because they can they can appreciate the fact that what you've got is governments who are promising too much and they're going to have to fund it through monetary means. And what you're seeing right now as we speak and I've alluded to already, the deficit is being monetized because bill issuances is hefty. And those bills and short dated government debt are being bought by credit pro by credit providers. That is monetization. There's no getting away from it.

>> Michael, I also just looked up. up. So even though the price of gold in dollars had a brutal bare market from 1981 to 2000, I looked it up because I'm talking about Chinese yuan, from 1981 to 2000 and to 2007 and 2011 in Chinese yuan, gold has pretty much gone nothing but up. So I do understand the psychology of Chinese investors, you know, viewing gold as a store of value because other than from 2012 to 2015, it's pretty much gone up [laughter] you know, very very very often. You know, even though I happen to be probably more bullish on Chinese equities than I am on gold priced in Chinese yuan, I do understand that perspective. Michael, earlier you hinted at a note of caution regarding risk assets and equities because we're in the middle cycle or perhaps the late cycle of the speculation phase. What does that say for gold and Bitcoin? Are they risk assets? And do you think that the tide is also going to go out there or do you think that these could do well despite the potential inflection point in the liquidity cycle that you see ahead?

>> Well, I'd say two things, Jack. One is to say that if you look at the example I gave about what happened in the last 25 years, you didn't really need to time gold through thick and thin and you made a lot of money, a lot more than buying into Wall Street, that's for sure. So, you don't really need to do that. But what you've got to do with any asset allocation is to separate the trend from the cycle in asset allocation and a lot of the stuff that I was talking about earlier. We were talking about the cycle, but there's also a trend and that trend is a monetary inflationary trend. What you need to do is to think about your portfolio in terms of the core of the portfolio, the structural components which reflect those trends and have whatever one's preference is. This is a personal choice. How much do you have in the core portfolio? Could be 50, 60, 70%, could be as little 30%. But that's really a personal choice. That depends on age and risk profiles. Then you have a tactical overlay that you put on top of that. And that tactical overlay should be thinking about the cycle. And as I said, that could be 50%, uh, 20%, whatever people's choice is. That tactical sleeve, I would argue, has to be top sliced right now. My view is that we're somewhere near the peak of this cycle. You can never get it exactly, but there are a lot of cycle ending or late cycle signs around that make me nervous, particularly after a big run up in markets and a big run up in liquidity. So, I'd be top slicing. I wouldn't be getting ultra bearish yet. That time will come. But for the moment, I'd be prudent and top slicing. In terms of the core portfolio, I would have that devoted to traditional monetary inflation hedges of which you could say one is precious metals. Two, things like high quality equities, companies that have got pricing power, u you know, large cap stocks we're talking about here. Uh, and thirdly, prime residential real estate. Those are the factors that normally are great monetary inflation hedges. you might want to throw in Bitcoin because Bitcoin has demonstrably achieved monetary inflation hedging over the last few years. It seems to be of that caliber. So, I would put that in as well. Don't put all your eggs in one basket, but you know, certainly consider all these different elements.

>> About Bitcoin specifically, what is your outlook right now? We we got, you know, well over $100,000. There has been a a modest decline even as the gold has been going crazy. So, a lot of gold bulls are kind of dunking on on on the Bitcoin people right now. What's your how are you thinking about Bitcoin right now?

>> Well, I think the what I would do is look at maybe look at two slides. One is to say slide 19 which is looking at the relationship between global liquidity and all world wealth. This is looking at the growth rate of global liquidity and it's illustrating what happens to a portfolio invested in all global assets. So this is all bond markets, all equity markets, all liquid asset markets, all residential real estate, precious metals and crypto. And that basically shows the relationship and we've illustrated on that chart with a broken line what we think is happening. We're near an inflection as you can see, but that relationship is pretty tight. And what I would also say is that if you go back in time prior to year 2000, there's a similar relationship, but the tightness of these two lines increases as we move from left to right, as we move through time. So for the last 10 years, there's been a particularly tight relationship between liquidity and asset markets. Okay, so this is the this is what's the key driver. If you look specifically at Bitcoin, which is the next slide, we've shown this on a very high frequency basis. So what we've looked at is six week changes in liquidity shown in black and the orange line is six week changes in Bitcoin prices. The reason for taking that that filter is that that strips out any noise in the data series and we've advanced liquidity by 13 weeks I 3 months. Now, uh, Bitcoin is one of the most sensitive assets on the planet to changes in global liquidity. I've looked at this rigorously in terms of fiscal analysis, doing vector order regression analysis, etc. for those that favor that. And what it demonstrates is very robust relationships and what it shows is this lead time. So, it shows there's a clear connection between global liquidity and Bitcoin. That's what I would use for the trend analysis. So I think you want to if you believe that liquidity is going up as part of this whole debt monetization process then you need to own Bitcoin as part of your portfolio. It's very sensitive. And what you can see here is that there's a relationship which is also a short-term cyclical relationship that happens to operate over a 3-month period. Um what we can see now is that Bitcoin is sort of churning. There's been a big there's there's recently been sort of swings in liquidity. Bitcoin didn't really participate in that most recent upswing, but I'd tell you that Ethereum did. And if I put Ethereum on that chart, you'd see the orange line matching pretty much that black spike. So, there may have been some switching between asset classes by crypto investors during that period. But typically, what you would see is Bitcoin being the sort of the main protagonist in this investment sphere. And we've got an article on the Capital War Substack about the impact of global liquidity on Bitcoin and in greater depth. You talk about the relationship between Bitcoin and gold. So we'll include a link to that in the description.

>> Exactly. Yeah. I mean, that basically says there are um there are uh three things that really move the Bitcoin price. One is global liquidity which is very crudely about half of the influence. Then you've got risk appetite which is about 25% and then you've got gold which is another 25%. So there's a very convoluted relationship between gold and bitcoin that we go into in the article but generally speaking those are the factors and um you know another way of looking at this is sort of using the same data is to say ask the question that many people do ask is bit Bitcoin a technology stock or a commodity and what we say is that broadly the characteristics would suggest that it's about onethird tech stock about 2/3 commodity

>> Michael let's talk about the dollar and particularly the core of your book Capital Wars and the the Substack capital flows. You've got a fantastic chart. It shows a an exodus from the US dollar out net outflows from the US dollar from 2000 to 2011 and then a huge spike in 2013 2015 that moderated but basically flows into the dollar have been positive to the tune of hundreds of billions in some instances trillions of dollars since around 2011 2012 and they haven't really moderated but do you think that this is going to change Michael because in March and April when President Trump was talking a big game on tariffs. The narrative was, and I repeated this narrative, I'll be honest, was that this was going to catalyze a lot of outflows from US assets from Japanese, Chinese, European equity and bond investors in US assets. And I think you saw that for a few days, maybe a week in April, but I don't believe you've seen it since. So, what does the data say about the crossborder flows from the rest of the world, non- US, into and out of the US? Your overall outlook on it going forward?

Well, I think the answer is that they been positive through this year and that's what the data show. There was never any compelling evidence of a big exodus and this was a fake narrative that was perpetrated by the media, particularly the Financial Times in London that was always ready to pour scorn on the dollar or US assets any chance they seem to get. They were arguing that there was this massive money coming leaving America which was clearly nonsensical. And what you were seeing is maybe an increase in hedging activity and you saw some top slicing of portfolios but that's only natural given the fact that the US assets have been such a big outperformer. So there was natural rebalancing going on and that was part of that equation. Now if you look at the data that you illustrated uh in terms of the net capital flows that capital flow data is not data from the US treasury in other words tick data which I always thought is probably an underestimate. This is data which is coming from the other side. It's what other countries are saying they're putting into the US dollar and that's been wholeheartedly positive. And you broadly speaking seen three waves of that money over the recent decade. One has been the Eurozone banking crisis around from 2010 to 2012. Secondly, there's been the fact that you've had this encouragement of Basel 3 and the use of US treasuries as safe assets including this is covers banks and solvency too for insurance companies. So, US treasuries are really a main form of collateral and I've said how important collateral is in terms of the lending markets. And then you've also had the huge exodus of money out of China when um um President Xi announced the corruption crackdown in the middle of the last decade and that saw huge amounts of money leaving China and going into US dollar assets. So that really explains a lot of the swings but it's still true and it's certainly true more recently during the COVID crisis that money came into US dollar safe havens. I don't think that's changed. I mean, I think if there's another financial crisis, the US dollar will benefit. I don't think that the mechanics have altered at all. And I think the the problem that the administration has is that is getting the dollar down if that's what they want. Because of these capital inflows, they're going to have to persuade JPAL to start slashing interest rates more aggressively. And if you go back to the Plaza Accord back in the mid1 1980s which was the last time there was an attempted adjustment of the dollar vulkar who was then chairman of the Fed hawish vulkar was very much on board on slashing interest rates jal right now is not. So the administration has to lean pretty heavily on pal to actually get maybe get the dollar down and that's one of the things that I would envision going forward. I mean, our our data at the moment is saying that you may get modest weakness in the dollar or some flatlining, but it's not really going to be radically weak and maybe not as weak as they would like under the MAGA agenda.

>> And what about the private sector flows? You know, at the way way bottom of your report, you've got these, you break down the liquidity from central banks, private sector and crossber. We talked about crossber and central banks. Now the private sector flows have been quite large this year in particular. Is that mostly bank lending? Is it is it mostly capital expenditures? What does that capture and what does that indicate about the the liquidity cycle?

>> Well, in terms of the components of overall liquidity, we split that out in terms of three elements. We look at what the central banks are doing. We look at what the private sector is doing. and we can split the private sector into domestic elements or domestic liquidity creation and crossber flows. Now if you look at the US at the moment one of the interesting points about US liquidity is that the private sector liquidity component is actually starting to strengthen and that would suggest that the real economy is probably beginning to come back to life again.

>> Yeah. But I think it's basically saying that maybe 2026 is going to be a better year for the economy than maybe currently people are projecting and that may be because you get starting to get a lot of money being spent on capex plus the fact you've got government spending which is still motoring along at a pretty heavy clip. So I think those factors are important and of course the consumer doesn't really show any signs of dying. So at the end of the day that growth or that economic spurt is coming through in terms of corporate cash flows and you're starting to see evidence of that in the data. Now the point I'm making to make sure I'm not confusing people is that if you've got two components, one which is the private sector and the other which is the Federal Reserve, the Fed may be slowing its liquidity at the margin maybe quite noticeably that could be offset to some extent by the private sector. But the issue that I really come back to is that the marginal effect on financial markets is bigger from the Fed than it is from the private sector. The private sector is going to have a bigger effect on the real economy. The Fed is going to have more an effect on financial markets. And that's why, you know, we're, as I say, we're becoming a bit more cautious,

>> a bit more cautious on financial markets, but on the real economy, you actually think that there could be a continued expansion. And that is the dichotomy that you see between the real economy and the financial markets. Correct. I mean, strong economies don't always have strong financial markets. That's the reality. And as they say to sort of co another phrase, you know, all money that's anywhere must be somewhere. So, if it's not in financial markets, in the real economy. And if it's not in the real economy, it must be in financial markets. And the only way that that equation changes is if the Federal Reserve just dumps huge amounts of liquidity into both spheres. And it is ain't doing that at the moment. So, Michael, we began by talking about some potential stress in the repo, the repurchase market and how the the Federal Reserves balance sheet or bank reserves were by your estimate 250 billion or 300 billion below a stable level. So, J Pal, Federal Reserve Chair has announced that the end of quantitative tightening is approaching. I am paraphrasing. So, the direct drag on bank reserves from that is over. However, the reverse repo facility is basically at zero. So, as that goes down, that boost reserves you in an indirect way. So, that is over. So, reserves are not going up in that regard. There is the now repo facility that is now October 15th, $4.7 billion. Okay, that's not nothing. But where is this liquidity going to come from?

>> Well, as I say, that that's the issue. Um I mean, the only the only uh source of significant liquidity or the only potential sources one is if there is uh dramatically more borrowing out of the standing repo facility which is the Fed's emergency tranch and that's sort of the equivalent of the old discount window if you like but that's more more attuned to modern financial markets where you need assistance for repo transactions. So the standing repo facility is one of those vents. But you know the problem is rather like the discount window in the past. I mean this this didn't prevent financial crisis. Discount didn't it was used clearly during the crisis but it in the run-up to the crisis people were reluctant to use it. And I think the same thing is potentially true with the with the standing repo facility. So it's it may be a help but it's not a solution. Then you've got another element that could come in which is the Treasury General account. Now, as I said, the Treasury General account is historically very high at 850 billion. That's the targeted level. We're now at just a tad above that as we speak, near 900. But the fact is that that is a high level by historic standards. Now, I think that they've gone down the road of putting down a large figure for a target because they're relying a lot on bill finance and bill finance needs a little bit more flexibility because you got to keep coming to the market with auctions or obviously more frequently and therefore you need a little bit more of a cushion in your treasury account and therefore I think they've built up deliberately built up the TGA with that in mind that does give them scope in times of crisis or near crisis. is when there are tensions in markets to allow the TGA to run down by a few hundred billion and that would you know give the market some sort of window a brief window of safety but it's not a long-term solution and you know if you're going to get liquidity into the system over the medium term you got to find another route as I sort of alluded to um you know you're you're you're getting that you're you're getting the the um uh liquidity impulse coming out of the treasury but that is being directed into the real economy through defense procurement, strategic alliances, whatever it may be, typical government spending, those elements. And you know, you go back, I think there was a speech by Lorie Logan, who was the lady who used to run the SOM account at the Federal Reserve quite recently in her capacity as a governor, and she said, u paraphrasing uh maybe doing her great injustice, that uh if you're going to make an omelette, the omelette being desire to have lower bank reserves, you've got to break eggs. and breaking eggs is tensions in the repo markets. I think they realized this was going to happen. The question is is is how much you know how much mess do you create with broken eggs? And that's the problem. Uh and I think that it's a it's a risky situation and consequently explains our view. Michael, earlier in the conversation, we had a chart of Fed liquidity versus

The S&P 500. And that is a far superior chart from you and global liquidity indices and crossber capital war substack than just the S&P 500 balance sheet verse S&P 500 versus the Federal Reserve balance sheet. That correlation has, you know, there's been some alligator jaws there. But, you know, interestingly, like the Federal Reserve's balance sheet, your measure of Fed liquidity is effectively close to zero pre the date of when the Federal Reserve first did quantitative easing. And I actually believe it was October or November 2008 because basically the nature of the monetary system changed and they targeted interest rates by paying interest rates on reserves and then doing quantitative easing instead of the old way which was they manage interest rates by affecting the level of reserves which used to be ridiculously small.

So how did you used to measure Fed liquidity back in the day before quantitative easing when you know just by looking at the chart optically Fed liquidity as measured by the Fed's balance sheet was tiny? There's obviously a structural break there but the private sector was a lot more important in terms of liquidity creation at that stage. I mean, the Fed still had a role clearly in changing the dynamics of the private sector but you know you could broadly speaking say that what the Federal Reserve did in that jump that you see during the global financial crisis is it basically replaced the interbank market. The interbank market disappeared through that time and effectively the Federal Reserve expanded its balance sheet to accommodate that loss. So you know their operating techniques clearly changed at that time but you can't say the Fed had no influence before because it clearly did but the marginal driver of liquidity in many cases or certainly through the period of the early 2000s was the private sector and it was particularly shadow banks. Shadow banks were really important in terms of driving liquidity but we know that didn't end very well.

So Michael, are you expecting a rupture in the repurchase market like we saw in September of 2019? Never say never. You could see that. I mean, that was a vicious spike, but it basically came out of nowhere in many cases. And I think what you've got to say is that it could happen again. There's a risk. There's a risk when you start to see the pattern of tensions that we're getting. In actual fact, if you go back and look at the chart that I think I put up for the repo market, which was back on slide 27, you see this increase in tensions. Let me just reference that. But if you get the same chart with a longer time horizon going right back to 2019, you see a similar increase in volatility just ahead of the big spike in 2019. So it's never say never, but the Fed's got different tools now, more tools, and supposedly it's alert to these things. But the reality which is what I keep coming back to is if you look at things rather like that slide we looked at earlier 31 which is excess reserves of banks and trade fails among primary dealers that's a significant worry I would say if you're starting to get a big increase in trade fails then you're going to get more volatility and the whole system the repo system can unravel and that's really what we don't want and that would be you know a serious test of the repo markets. And these markets have never really been stress tested in the way that, you know, simply because they've only been, I mean, they really been a dominant part if you like of liquidity really since the GFC.

Michael, in a previous interview you said something to the effect of Jack, if you're telling me there's not going to be more quantitative easing, then there's going to be a liquidity squeeze or a financial crisis. So on the one hand, I hear that from you and then I look at the Federal Reserve Board of Governors and other officials, presidents and they are say, I sense no appetite from them whatsoever to do quantitative easing of any scale like you saw QE1, 2, 3, 4. You know, maybe modest purchases to keep in line with GDP, but that is not comparable at all. So on the one hand, I have Federal Reserve officials saying that there's going to be no more QE unless there's a financial crisis. And then on the other hand, I have you telling me that if there's no more QE, there's going to be another financial crisis. So if I add those two things together, that means that there is going to be a financial crisis and then more QE. So to get to the next liquidity upcycle, do you think that there needs to be a liquidity squeeze, a financial crisis?

Well, I think we're heading in that direction. There's no question. I mean, my point, which I mean, hopefully is not inconsistent, is simply to say, look, at the end of the day, you've got so much debt in the world economy and in the US markets that needs to be refinanced, and you need liquidity for that refinancing. If you don't get the liquidity, you're not going to get the refinancing and therefore you get debt defaults and tensions in repo markets. That's what we've always faced and that will come back for sure. There's no question about that. But what I'm also saying is that, you know, if you look at the dynamics short-term, and I agree 100% with what you've said, the Federal Reserve have got no appetite for doing QE. Scott Bessant and Steven Miran have also got no appetite because they've said that this is more or less ruled out until it isn't, of course. And what they're doing is they're trying to replace Fed QE with Treasury QE. The problem is, is that Treasury QE favors Main Street and Fed QE favors Wall Street. And that's the dilemma we've got. We may get a better economy, but we may get worse financial markets ahead of that. Now, I know that there is clearly a connectivity between the two. And if Wall Street does sell off significantly, the consumer may be impaired in terms of spending through negative wealth effects. But you know, that may be a cost that Bess and Etal are prepared to take if they're going to create this war economy as I would call it and get directed fiscal spending funded through the bill markets.

So bad for Wall Street, good for Main Street. That sounds pretty good for society and the vast majority of citizens, but for investors that potentially could be trouble. So, Michael, as we approach the late stage of the speculation phase, how are you thinking about timing this turn in markets, this inflection point in the liquidity cycle? I know earlier this summer you told me that sometime in 2026, maybe 2027, but how are you thinking about the timing? And also, what tools will you be using to track liquidity? And on the capital war substacks for clients and research clients, what will you be paying attention to to flag to you and to clients? Oh, something is really turning here. We've got to pay attention.

Well, I would say, you know, number one is in sort of doing this over three decades. I mean, the biggest mistakes I've made are when I try and forecast liquidity too far ahead. And that's something I'm sort of reluctant to do. And you don't really need to do that because liquidity is a leading indicator. So what you need to do is to track it and be absolutely correct or precise about what liquidity readings are saying. And that's what we're really emphasizing now. We're seeing the signs that liquidity is deteriorating. You know, we're not projecting that necessarily. I mean, I know I've got projections in here, but it actually it's projections based on policy statements. So if you get a decided downturn in liquidity from now, we are going to progress along that liquidity cycle curve. We've been moving from speculation towards turbulence and then we've got to start shifting asset allocation more aggressively away from risk assets and towards safer assets like longer duration government bonds. And you know, I would say that, you know, at the end of the day, the cynic in me comes back to the point that it could be in the administration's interest to actually push people out of risk assets and into safe assets because it makes Scott Besson's job of actually selling treasuries an awful lot easier. Now, that may be too cynical by half, but nonetheless, it's a reality one's got to have at the back of one's mind.

It is true that demand for duration is high during financial crisis and recessions. Also though capital gains taxes proceeds are going to be lower when you have a bare market. So maybe it doesn't balance out. That's on the other side.

Yeah. I think the thing is politicians see one side, not the other necessarily.

Yes. Um, yes. And so, so what would what would it have to take, Michael, for you to get outright bearish? The things you're seeing in your various measures of liquidity are flagging notes of caution, but for you to be outright bearish and sharing to clients, wow, you know, risk off, beware. What would you have to see?

Well, I think there's a fallout of word data. You got to see the data deteriorate. And the US is leading as so often. And you know, if what you see in the US is a tightening of liquidity, I mean, I'm absolutely 100% sure that Europe is going to follow because it always does. China may be an outlier. That's for sure because it's under different circumstances. But there's only so much the Chinese can do. There's still a lot of connectivity between the Chinese financial system and the US system. China is more or less running a sort of dollarized system. It's trying to get off that hook, but it's still weighed down by the dollar in many cases. So, if you got dollar squeeze or US liquidity squeeze, it would clearly adversely affect China. They can decouple to some extent, but not fully, and they will be pulled down as well. So, you've got to watch the Federal Reserve pretty closely in all this. And what I'm hearing right now is not really music to my ears because what I'm hearing is that the Fed is reluctant to go towards more QE willingly to go easily towards a regime of quantitative easing. Although we know that's got to be the endgame.

And Michael, everyone focuses on interest rates from the Federal Reserve. You focus on liquidity and downplay interest rates. But if the Federal Reserve were to moderate interest rates significantly, either what's priced into markets of going down to 3% or even below 2.5, 2% is that going to make you bullish maybe indirectly or indirectly because low interest rates are often correlated with an intent to increase liquidity?

Well, I think the latter. I mean, the thing is that we're not, you know, um, the only central bank, and even that central bank found it difficult, was the central bank of the Soviet Union could pronounce on interest rates and that was it. The fact is that the Federal Reserve has got to pay respect to markets and what that means is that if they want to get interest rates down and keep them down, they've got to add liquidity because otherwise you get stresses rather like looking at what the sofa market's saying right now. So they'd have to put more liquidity in. But I think that's a different question than the one that says, "Do interest rates matter?" Interest rates alone don't matter. You've got to have the liquidity backing behind them. I think there is a moot point about the impact of interest rates on the real economy, particularly at a time when the federal government is such a large payer of interest payments as transfers from the state to the private sector. Clearly, it's monetizing that, but those interest payments are a source of income. So if you start to reduce that interest bill, you are lapping people's income and that clearly is something which won't help the economy. So the whole argument that lower interest rates stimulate the economy, I think, has got to be radically rethought. It may have been appropriate in a time where capital markets were important in terms of providing funds for capital investment, but that no longer is the case. A lot of capital investment either comes from governments or it comes from, you know, reinvesting cash flow as you know, looking at the big AI spend at the moment, it's just cash flows that are being redeployed.

Do you have any outlook on the large amount of AI capital expenditure, Michael?

It's clearly very positive for the US economy and there's no question about that. Um, and I mean generally speaking, I think that AI is a significant deflationary force in the world economy, but that doesn't mean to say that we won't get monetary inflation at the same time. I think you've got to differentiate very clearly between what's happening to costs or Main Street inflation from asset price and monetary inflation. Now, these are very different concepts. You can clearly have very low CPI inflation at a time when asset markets are booming. But that shows there's a difference between monetary inflation and cost or mainstream inflation.

Michael, the European stock market has been a very, very strong performing market. How is Europe? What's going on with your read of liquidity in Europe from the European Central Bank as well as other forces?

Europe, after having said it wouldn't be pumping a lot of liquidity, is pumping liquidity. The ECB has been instrumental in doing that. They're largely following the path of the Federal Reserve. A lot of central banks are really mapping out a very similar course right here. Uh, there's been tremendous correlation between what central banks have been doing collectively. So if you look at slide 15, that shows what world central bank liquidity is doing. And what this is is illustrating in orange, you've got the volume of liquidity in terms of a dollar amount that's injected. And the dotted line is the percentage of central banks worldwide that are easing or tightening. This is showing the percentage easing. Now you can see that that count has come down from the high 80% and we're almost at a 100 central banks that we monitor. So you can take it almost as numbers. And the orange line is similarly dipping down. So that's in terms of what central banks are doing collectively. But to look at the harmony, take a look at the mosaic or the heat map on slide 11. And that heat map is basically showing where you've got central banks that are moving together or moving apart. You can see for the most part, there's a tremendous herding together of these central banks and they tend to herd around the Federal Reserve. So Europe is doing pretty similar things to what the US is doing, not surprisingly because, you know, dollar euro is important. And if the euro tends to go up a lot, that, you know, spooks European policymakers because they want the euro to be competitive and therefore they're going to be easing monetary conditions, which they've been doing. And you're getting more and more promises coming out of the ECB, particularly given the lackluster state of the European economies, that they may have to do a lot more, that's for sure. But they won't do more, you know, if you, or they can't do more if the Federal Reserve starts to change.

So it's, yeah, it's no secret that central banks often act together. Michael, for so this, you know, on YouTube people can see the chart. On Spotify people can see the chart. I believe on Apple podcast that people cannot see the chart. But for listeners on Apple podcast, 2023 was a sea of yellow, orange, and red. And now 2025 is a sea of light green and green. So things have gone from red color, which in the West is a risk, to to green, which is a color indicating everything is fine. So, you know, one might say, oh, in 2023 the liquidity cycle was bad and in 2025 it's good now. But actually, it is about the rate of change, right? So in 2023 things were bad but getting better. In 2025 they've already gotten pretty good and you have concerns if they'll continue to get good.

Yeah, exactly. I mean, you just got to look back to slide 15, the World Central Bank liquidity chart, and that's really been the driver of markets and the global liquidity cycle over the last 5 to 10 years, I would venture. And that is itself beginning to inflate. And we've got, we've got to ask the question, why is it inflating? Uh, it's the leading country is clearly the US and the Federal Reserve. The big dip down in the volume of liquidity, the orange line that came last month in the September data was principally caused by the Federal Reserve and the rebuild and the TGA and the fact that Fed liquidity dipped down. As I've been alluding to, and not surprisingly, what are you getting? You're getting tensions in US repo markets.

And would he be chasing the duration market, the sovereign bond market? You know, yields have been falling. And if as you get more caution on risk assets, you know, during turbulence phase duration does well. For as long as I've known you, Michael, I don't think you've ever been truly bullish on long-term government bonds because, you know, I think I started following your work in 2020, yields were already so low then.

Yeah.

Are your views changing?

Well, I mean, look, I'm going to be the first to say that if you start to get a significant draw down in liquidity, government bonds will do well. There's no question about that. We haven't had that draw down yet. I think you still got time. Does it mean you should be putting a toe in the water? Possibly. But I would be looking much more at sort of mid-duration right now rather than dedicated long duration. But I think you can start. People should be thinking about making that transition. Everything here tells me that next year won't be a great year for financial assets. I mean, I hope I'm proved wrong, but that's what the data is telling us now.

Next year won't be a great year for financial assets.

Michael, could you summarize your views for the audience?

Well, I mean, the first thing to say is that liquidity drives markets and you've got to take the perspective of global liquidity because we're living in a global world. Capital is fungible. It moves between economies and I think that's key. The two main central banks to watch are the Federal Reserve and the People's Bank of China. The People's Bank of China has a bigger effect on the world real economy and the Federal Reserve much more on financial markets. I think that's a second thing. And what you're starting to see now is a divergence between those central banks, albeit maybe a temporary one, but you're seeing a divergence whereby the PBOC is continuing to flood the system with liquidity and helping to drive the gold market up. And what you're seeing in the US is the Federal Reserve is beginning to inflict. That may be an accident. That may well have to be reversed. We'll see. But that's the warning. And what we would say is that you've got to top slice risk, high risk exposure. I mean, we've been saying that for a month or so now, but you've got to top slice and you've got to start thinking about long-term positioning in monetary inflation hedges and building up as the cycle turns down a more defensive posture.

Michael, thank you so much not just for coming on but for over the years sharing your framework with me and my audience. You really go in so much further detail on your Capital Wars Substack. And for our viewers, Monetary Matters listeners can get a 20% discount for a limited time to an annual subscription. This, I believe, Michael, is the only time you've done a discount with an external affiliate. I'm honored you chose me. And this is going to be only lasting until very early November. So, people should act as soon as they see this and click the link in the description to learn more. Michael, thank you again.

Great pleasure, Joe.

Thank you.

Hope you enjoyed today's episode. Don't forget to click the link in the description to learn more about Michael's Capital Wars Substack where you can get a 20% discount on an annual subscription. This lasts 2 weeks, so it will only be available until early November. Until next time. Thank you. Just close the door.