In Conversation With Michael Howell

This is Ahan speaking. I'm the founder of Prometheus and your host for today's conversation. I'm joined by Michael Howell, who is the CEO of CrossBorder Capital. Michael, how are you? I'm good, Ahan. Yeah, we're good to be here. Lots going on in the market, so lots to talk about. Yeah, very much. Exciting day to be on with all this stuff that's happening with the Treasury. So, perfect day for us to chat, huh? Yeah, I think so, yeah. Well, Michael, to kick us off, why don't we start by talking a little bit about liquidity? For those unfamiliar, Michael is the foremost authority on the subject of liquidity, and most liquidity work you'll see anywhere is usually derivative of his. So, Michael, maybe we can talk a little bit about how, in a world where the majority of macro research is very much focused on growth and inflation, you came to focus on liquidity. Yeah, great question. It basically goes back to the time when I was working at Salomon Brothers, which is now part of Citibank. Salomon was one of the casualties, one of the successes and casualties of the financial cycle. Salomon used to be talked about as the king of Wall Street, really through the late 70s, 80s, but it was basically the bond king. And Salomon was. It was a firm that put a huge emphasis on two things. One was trading, and the other was research. So, they pretty much were the bond markets, and they understood the bond markets better than, I think, most people. And one of the things that Salomon Brothers used to pride itself on was, in every location where it was, certainly every big financial location, it had a massive trading floor, which was called The Room. And there were lots of trading positions in that. In that room or on that floor. And you could pretty much sit above the room or above the floor. There was a balcony in most locations. You could look down on it, and you could actually see traders trading actively, and you could see money almost visibly moving around the floor. And whether it was U.S. equity, U.S. treasury, Forex markets, whatever, swap markets, these things were really active. And not only was. One of the phrases that Salomon Brothers always. Was there was no unrelated event in financial markets, because visually there wasn't. Everything was connected. But you kind of see money moving, and it was money that moved markets. And that's pretty much why my view was that you had to track not just domestic money flows in the U.S., but you had to track global money flows, because at that stage, the Japanese were big buyers of the treasury market. And, you know, so it's gone on. Since then, China has been big buyers. Europeans have been massive buyers of the MBS market. Et cetera. Now, you know, foreigners are buying U.S. equities, you know, as if they're going out of fashion. So, you know, global flows are important, and that's really the legacy. And so that's a really cool story. And kind of getting into when you were at Salomon, what really kind of put you on the path to investigating this idea of liquidity? Was it something that they were thinking about at the time, or were they thinking about something adjacent to it, and you happened to follow? How did that kind of emerge? Well, it basically came because, I mean, there were two principal or key research heads at Salomon Brothers. There was Marty Leibowitz, who focused on the fixed income markets and, you know, came up with or reinvented things like duration. Marty was prominent in devising the yield curve, which, you know, facilitated a lot of the bond arbitrage, et cetera. And Henry Kaufman, who was the chief economist, Henry said, his focus was very much on flow of funds. He was a great pioneer of flow of funds analysis. And what that really meant was tracking money flows through the economy and through the financial markets. And, you know, Henry's sort of creed of curve was, that money matters, but credit counts. And it was all about understanding credit flows within the system. And, you know, I bought into that pretty readily. But then I realized there's an international dimension. You know, the U.S. was no longer an island. Global financial markets were evolving rapidly. Cross-border flows were becoming, you know, key in all markets. And it was a question of tracking not just U.S. liquidity and the U.S. Fed, but you had to work out what was happening in Japan, what the BOJ was doing, you know, what ultimately the European Central Bank, actually at the time, the Bundesbank was doing, et cetera. These things were really important. So it seems like cross-border flow of funds analysis is really central to the way you've defined it. So can we start to kind of build an intuition for the audience about what liquidity really is? Yeah, I mean, I think the best way to think about that, I mean, you know, liquidity is one of those things, you know, maybe like love or whatever. It is very difficult to define. And, you know, we attempt to do it. We try and make it a granular or clear concept. And the way that we think about it is probably really in two ways. One is to say it is the, it's the flow of funds through financial markets. So we exclude the real economy from that. And the reason for excluding the real economy is the real economy is a use of funds. It's not really a source of funds. And it's that source of funds through financial markets that are really moving asset prices. Another way conceptually to think about that, which becomes very useful where you want to understand the impact of liquidity, is that if you step back and say, well, what are financial markets or capital markets really about, really about? And, you know, a textbook finance textbook would say, well, okay, what a capital market is, is it's there to raise, you know, new money for new capital projects. And the cost of capital is really the critical thing that everyone worries about. Well, I would say that was true, but it's no longer true because capital markets today are predominantly about refinancing existing debt, something like 80%. Of all primary transactions in world financial markets now are not about raising money for new CapEx spend, you know, partially clearly the AI boom, but AI CapEx boom, but they're much more about rolling over existing debt. We've got an awful lot of debt. Now, if you take that perspective, then you can say, well, liquidity is also, you can also think of it as the balance sheet capacity of the financial system. And debt needs to be rolled over. So if you're going to roll over debt, you need this liquidity capacity, you need the capacity to do the role. And that's another way of thinking it, because in the long term, you have to have a stable ratio between debt and liquidity. And if you, if that ratio deviates significantly, you'll either get in a case where there's too much debt, you've got a refinancing crisis and a sell-off of assets as people try to liquidate everything fast. Or on the other side, if you get too much liquidity versus debt, you then get asset, and that's when you get in a bubble. And so you see a very clear cycle in the debt liquidity ratio over time. And it's that which really signals those two points. So my view is that, you know, looking at debt to GDP, which is what economists argue for, is pointless. I can't really see the merit in that or what it means. But debt to liquidity is real because it's all about refinancing. And I think the thing that you highlighted, which is that it's really about the sources of funds, not the use of funds, is a very important, when it comes to analyzing and understanding what's going on. So what would you say are the kind of the principal drivers or principal components that move liquidity today? Because I imagine that that composition has changed a lot over the decades, right? Yeah, the mechanism has changed. And I'd say there's really three things matter very generally. I mean, one is, you know, probably most obviously central banks, because central banks can, you know, get the system started by pumping liquidity into the system directly or by ultimately improving the collateral base. The second thing is the collateral base itself, because so much credit is now backed by collateral. Something like 80%, according to the World Bank, of all global lending is collateral based. So you need to understand that collateral. And that can be something as basic as a home mortgage. Or it can be something that's more complicated as a financial instrument, where you need a U.S. Treasury bond or U.S. Treasury note to back that as collateral. Now, that is at the heart of the system. And so if you get volatility in the collateral base, you can get liquidity being destroyed. So the second thing is having good quality collateral. Or equally, if you get, you know, if that collateral is impaired, such as occurred in the GFC, and more bad securities, then you're going to get an implosion of liquidity. And then the third thing, which is in a way counterintuitive, is the real economy, the strength of the real economy. And the fact is that all money that is anywhere must be somewhere. So if it's in financial markets, it's not in the real economy. And if it's in the real economy, it's not in financial markets. And that's how we tend to think about it. So what that means is that strong economies don't always have strong financial markets, and similarly, vice versa. So what I'm hearing is that the three movers, really, it's government securities or government liquidity provision. There's a private sector liquidity creation, which is really dependent on the quality of the collateral base. And then the real economy, which can actually be a net negative for liquidity because it sucks money out of financial markets. Correct. 100%. And so when we're thinking about that collateral base and that private sector aspect, it sounds to me like the repo markets are really central and the collateral that fuels those repo markets are really central to that private sector aspect, right? Absolutely correct. 100%. Yeah. Repo is really important to understand. And that's why we put a lot of focus on doing that. And so if you want to understand the risks in the system, one of the risks to look at is the risk of the collateral repo markets blowing up. And you need to alter that by looking at two things. One is to look at the. One is to look at what's called the SOFA, Interest and Overnight Reserve Balance Spread. In other words, taking another way, look at the green repo rates, which are SOFA rates and Fed funds, another way of doing it. That spread is very important. And the other is to look at the volatility of collateral, which you can summarize through what's called the move index, which is a measure of the volatility in the bond markets, which is a key for the VIX index and equities, but the move is much more important. So those two things are really two barometers, of the stability of repo. Right. And so that basically measures the stability of the underlying collateral. Michael, how do you think about the demand for repo? Like, you know, I think we're talking about kind of like the stability of the underlying collateral that goes into repo, but how do you think about what creates the demand for the usage of repo? Well, a lot of that has come out of the GFC. And the regulation of banks or the extreme regulation of banks made a lot of banks find taking on wholesale deposits too onerous. So in other words, you're quite happy to have a small retail deposit sitting in your balance sheet, but to have a wholesale deposit, which was deemed by the authorities to be flighty and uncertain and requiring a big capital charge, was not attractive. So basically there was a decline. And the appetite of banks to hold corporate deposits. And that would, you know, that would embrace, you know, not just treasury departments, but it would be wider. It would include sovereign wealth funds. Sovereign wealth funds, by coincidence, have grown enormously in the last 20 years. And you can argue that is probably one feature is the one driver, maybe the U.S. current account deficit, which is pushing the wall of dollars internationally. But those large sovereign wealth funds need somewhere to invest. So they basically come back and bid in the repo markets for, or they're prepared to buy collateralized repos. Right, right. And what do you make also, I feel, my sense of the repo markets today is that there is a huge uptake also for things like basis trades, right? What do you think that does to the stability of repo markets today? Yeah, your general thoughts on that. Well, I mean, the whole idea about the basis trade, this is one of the things that, you know, going back to Salon Brothers days, I mean, this was basically how Salon Brothers used to make a lot of its money, doing those sort of trades or doing, you know, or doing similar, you know, very short-term spread trades, which were clipping, you know, small world were basically clipping dimes, but they were leveraged, you know, hugely. And really the same sort of idea with the basis trade. So with the basis trade, what you're doing is you're exploiting the fact that the futures market, the futures bond price sells at a discount to the cash market. So basically you go short futures, long cash treasuries, and maybe clip a few basis points. But if you leverage that enough times, you're going to make a lot of money. And that's really how the repo, or that's one of the sources of demand for repo. And the reason that works is that if you post a treasury to repos, let's say to a dealer bank, the dealer bank will give you a haircut. In other words, it will lend you, let's say for argument's sake, 99% against that treasury. Okay, so you will lose 1%. You'll be haircut 1%. Now if you think about that, if you keep going back to the dealer bank and borrowing again and again, you've got 100 times multiple on that. That shows you the leverage within the system. And that leverage will change if the volatility, the underlying collateral changes, or if the amount of liquidity that the dealer banks can get hold of changes. So if you see the move index suddenly spike, then that haircut is likely to change from, let's arguably say, 1% to 2%. But that means your collateral multiplier is halved in value. And if that is the base for liquidity, then you get a big equity shock. And that's why this idea, I think you called it yield volatility control. Am I saying that right? Yeah, absolutely. It's become really central. Yeah, absolutely. I mean, what's going on in the Federal Reserve right now is not about interest rates at all. I mean, that's just a bit of a pantomime. I mean, the main thing that's going on is, well, I would say two or three things, and this embraces the treasury as well, is that Walsh has said very clearly that he wants an, ample or adequate, depending on which day you catch him, system for bank reserves. So in other words, that's another way of saying that they want money market liquidity, repo market liquidity, in other words, to be good. So they want lots of liquidity at the front end of the market. And that will facilitate things like the basis trade. Now, what would destroy the basis trade is volatility in the bond markets, because that will be, that will be something that will scare hedge funds and they won't engage in a basis trade during a volatile period because their losses could clearly spiral. So you want low volatility. Now, that's what Besant is doing through treasury when he's doing these bind banks. He's basically suppressing volatility or attempting to, because he's taking out of the market or buying out what's called off-the-run treasuries, which are the more illiquid treasuries, and he's replacing those with sort of brand, you know, shiny new, on-the-run treasuries, mainly at the short end of the market. And what's more, a lot of the issuance that the treasury is doing on top of that is bills, not notes or bonds. So those tend to be a lot lower volatility as well. And, you know, just for the record, the reason that it's a slightly quirkish comment, but the on-the-run, off-the-run goes back to the days when you used to have huge computer printers, machines that spewed out, you know, reams and reams of paper, that sort of green, you may not remember, but that sort of green computer paper with lists and lists of bonds. And if a bond was traded, it was on the run, on that computer run. And if it wasn't, it was off that run. And that's why the expression came, that's why it comes about. Really showing your experience there, Michael. You know, I think we've kind of naturally drifted towards the current context, and I really want to get in deeper in that direction. But I think it might be good for the listener, you know, if they're unfamiliar with the evolution of our views, to basically just understand what has been your assessment of the post-COVID macro landscape from a liquidity perspective. Yeah, I think it's a very interesting question. I mean, I'd almost go a stage backwards and say really since the GFC. And I think what you've seen since the GFC, is liquidity has been an increasingly important factor in markets simply because of maybe two key developments. I mean, one is what we've just spoken about, which is the repo markets and the fact that the capital markets, if you like, or the repo markets, the money markets, probably more accurate to say, rather than the banks, are sort of controlling, to a large extent, liquidity supply. And that has proved to be a lot more elastic than maybe people thought. So you've got, you know, potentially a lot of liquidity growth coming through these repo markets. It may be more volatile. It may require the Federal Reserve to, you know, extend it so rather more to control it. But that's pretty much what's going on. And the other is the central banks themselves through QE and sometimes, of course, sometimes not very much, QT policies are basically, you know, adding fuel to those flames. So, you know, liquidity has become a much, much bigger factor in markets and liquidity has grown enormously really since the GFC, the pool of liquidity. And what I'm talking about here is obviously not money supply. I'm talking about the pool of liquidity, the pool of funds, the flow of funds through financial markets. Now, those are the key developments. Now, what does that basically mean? Well, it means a number of things. I mean, one is that the first vent for that excess liquidity is, asset markets, I mean, I said right at the beginning, beginning that you know we live in a debt refinancing system and the first thing you need to do is to refinance debt which is what liquidity is used for but any excess goes into asset markets and that's clearly what we've seen with what you might call the everything bubble over the uh the last few years okay uh the other thing that that um that you'd expect is that you get increasing wealth effects which can spill over from those asset markets into the real economy now if that liquidity is largely swimming around in the real economy and it doesn't spill over very much or it spills over into very narrow channels uh through wealth effects and that immediately explains why you've got a k-shaped economy not just in the u.s but in many uh you know many western economies worldwide uh and i think that's just a phenomena of this uh of you know of this new world of of more liquidity now the other thing it does uh which you know you can read as being sinister or more or not is that basically through this mechanism it gives governments huge power and one of the things that we've we're seeing is the rise of sort of the big state now you know although uh a lot of people are sort of talking right now about what it what they deem to be the sort of so-called death of keynesian economics actually i'd say completely the opposite i think this is the rise of keynesian economics because basically keynesian economics was all about economics of the big state and that's exactly what we've got be it in the u.s uh be it in europe euro in the euro area or be it in china uh and basically what you need is a funding mechanism to do that and what besant uh and uh and kevin walsh you know latterly are doing is really exploiting that particular mechanism and i think besant has done it brilliantly i mean what he's doing is he's he's engaging in what i call treasury qe uh and he's engaging in what i call treasury qe where he's where they're doing directed spending into the u.s economy uh and clearly with a background i mean i should say that i wrote a book a few years ago called capital wars which is actually the name of the sub-state that i write and capital wars as the name suggests is basically about trying to get your capital or your currency dominant against any competition so this is clearly a fight between the u.s and china and what you must do is you know not engage in austerity policies because you're not going to be able to get your capital or your currency clearly that never works you don't want to get the deficit down you want to keep the government spending uh rolling and you want to start uh you know encouraging or underscoring the strengths of u.s industry uh in that whole process and so you need a funding mechanism to do that now fed qe which was the old policy clearly had limits and it was largely destined for the real economy sorry for the financial markets not the real economy and what treasury qe is doing is basically the treasury is issuing lots of very short dated bills in other words the treasury is issuing lots of very short dated bills in other words the treasury is issuing lots of very short dated bills in other words the treasury is issuing lots of very short dated bills in other words the treasury is issuing lots of very short dated bills in other words the treasury is issuing lots of very short dated bills in other words the treasury is issuing lots of very short dated bills in other words the treasury treasury debt of under a year maturity and they're doing some short dated notes as well so two years ever and what that what that type of security uh is is a security that is very attractive to the banking system because if you're running think about this if you're running a big government deficit uh bank deposit accounts are rising because people are getting paid through the government and the banks need an offsetting asset uh to match that match that line of ability of a similar duration and one to two year treasuries or treasury bills fit that tick that box entirely so the banks are big buyers of this stuff now think about it if you're funding a government deficit not with existing savings but through getting the bank balance sheets expanding that's monetization that's printing money so that's what's going on uh but clearly they're not saying they're printing money but they are and that's that's going to end badly because it always does and so perhaps tell me whether this is an oversimplification but effectively reducing the duration of the aggregate government balance sheet is what you're likening to to printing yeah i mean you can you can basically define liquidity in another way by saying that liquidity is equal to net assets divided by the average duration of those assets so you think about that for the economy as a whole or for the government bond market uh if you you can expand the amount of net assets because you're if your average duration is dropping you that's like a liquidity boost for the private sector and how do you think about the relationship between fed and treasury in the circumstance because you know to to my mind um they're kind of they're kind of opposed in terms of mandates right where the the the treasury in some ways is trying to kind of stabilize uh the levels of yields or the volatilities of yield while i'm not sure if that's the right word but i'm not sure if um the fed has to deal with these increasing inflationary pressures and rising nominal gdp how do you think about that relationship well i mean in my view they're joined at the head but i think always have been i mean uh i mean the the plain fact is look what happens during crises they both act together i mean look what happened in 2008 look what happened in the gfs in the not the covid crisis i mean basically you see them acting together and that's what they should do the job of uh of the federal reserve is to preserve the integrity of the sovereign debt market uh there's no question about that uh you know the inflation mandate and the employment mandate are completely secondary uh you've seen that in country after country um you know when problems occur in sovereign debts look what happened in britain uh with the list trust debacle the bank of england was doing a qt one day and uh within seconds they switched to qe um that was their job they had to protect the bond market and so then what do you make of the the current sell-off in in in u.s fixed income how do you think about that uh it's absolutely nothing to do with debt problems and you can say that categorically because term premiere are the flat or declining in the u.s um if there was a problem about debt if there was a problem about supply and demand um you would see term premiere rising strongly and they're not and that's true that's global i mean probably with the exception recently of japan although in the last week or so japanese term premiere come down quite quite heavily so i i think that you know the media and the press have got this absolutely completely wrong uh it's nothing to do with with debt concerns i mean there may be future debt concerns i'm not going to deny that but that's not what's causing the sell-off now what's causing the sell-off is the fact that the economy is a red hot and if you look at a very simple track of bond yields against nominal gdp you'll see that virtually one for one uh you know until recently and there's been a gap and what's happening now is that basically bonds are repricing for a faster nominal gdp environment and that is a combination of the ai boom uh the six percent fiscal deficit and arguably rising oil prices or right in the oil ecology prices all those factors are weighing on the bond market it's not about debt concerns debt concerns may be there in the future but if debt is a concern then you've got to expect term premiere to rise and they're not yet so michael maybe help the listeners understand this term premiere decomposition of yields and how it helps you understand what's driving the current rising yields okay so i don't want to get stuck in the weeds because bond markets normally make people's eyes glaze over sure and their heads ache so let me try and do that without uh putting a wet towel on people's heads around uh okay so what you've got with a bond yields the bond yields really consist of two two parts one is an average of the policy rate in other words the fed funds rate let's say over the term of the bond so a two-year bond you've got to think about average fed funds over two years a 10-year bond think of average fed funds over 10 years okay and then on top of that there's another element which is called a term premiere which is effectively a risk premiere for holding duration and that's because the path of interest rates are uncertain uh it may be that you you want a conversation against inflation inflation uncertainty or another factor is that supply and demand for particular tenors of bonds um are out of line so it may be that for example uh the treasury is issuing an awful lot of 10-year debt and no five-year debt and so you see um five-year yields depressed and 10-year yields elevated relative to normal so you can get those quirks now the term premiere uh tends to be dominated by supply and demand factors uh in reality and one of the interesting points and this is an aside but it's it comes back to maybe explaining what's going on right now is that since year 2000 80 of the variation so four-fifths of the variation in u.s treasury yields at the longer end have been termed premier phenomenon uh and that's very very unusual uh it's normally uh around 40 so it's twice what it normally is and that's because of fluctuations in liquidity uh changes in policies like qe qt uh etc changes in issuance behavior uh issuing bills not bombs, uh, or long bonds, all these sort of factors cause term premium to change. Now, what is going on at the moment is that actually term premium are flatlining. So what it's saying is that there's no particular distortions affecting bonds from that score. But what's driving bonds up is the market is expecting or is saying equilibrium policy rates should be a lot higher. Does that make sense? Because of the stronger economic growth. Right, right. And you can triangulate that too, right? If you look across a sovereign CDS, you look at swap markets, you look at an array of things, you can see that it's not really a sovereign crisis of some kind, but just markets saying that, hey, nominal economic activity is quite hard. Inflation is running quite hard. Yields probably need to be a little higher. Exactly. Yeah, exactly right. And so I think a big driver of at least the inflationary concern, you know, is kind of what's happening in the Iran oil dynamic. What do you make of that? Well, I think that, I mean, one of the things I would say maybe to step back is that, you know, if you look at the, if you look at liquidity, liquidity moves in cycles and those cycles tend to be five to six year in length. And the reason it's five to six years is that, as I said at the beginning, it's really a refinancing cycle and the average duration of, well, debt is about five to six years long. So in other words, every five to six years, you've got to refinance a bulk of debt. And that really explains why you've got a liquidity cycle. And that is different to maybe the traditional business cycle. If you go back to what people would write about in the 19th or early 20th century, a nine to 10 year business cycle was all about the period, the lifetime of capital goods. So it was assumed that capital goods would be replaced every 10 years. So you get a 10 year business cycle. What I'm saying, paramount factor now is debt, is debt refinancing. And that's really what's driving the liquidity cycle, which is in turn driving the economy. Now, the liquidity cycle basically bottomed in late 2022 globally. It's been expanding very aggressively from that floor right through to a peak in late 2025. Liquidity has been losing momentum. It has not been falling in absolute terms, but it's been losing momentum for several months now. That is a leading indicator of what should be happening in financial markets more immediately and in the real economy about 12 to 15 months later. And therefore, the big rise in liquidity that we've been seeing over the last two or three years is now feeding through into the world real economy. So it's not surprising that growth is beating expectations and you get continual economic surprises. And it's not surprising and no question that what you should be seeing as well in very strong commodity markets. And that's what you're seeing. Okay. Getting these factors coming into the picture. Now, one of the things that one needs to say is that it's very typical at the end of financial cycles, the commodity price inflation and higher oil prices tend to be a cycle ending feature many, many times as we know. So we've got to be cautious about what's happening in the crude market. Now, the problem is with doing that is I reckon that the crude price is, well, I think that fixed is probably the wrong way of saying it, but it's certainly artificial even though it's rising because you just got to look at diesel. Diesel is a much, much better barometer of the impact on the real economy of higher commodity prices. And if you start to triangulate back using diesel prices, crude oil would currently be about 160 to $65 a barrel, so appreciably above the 99 or 100 where it is today. And that is telling us that things are getting difficult. Now, my sense is that whereas policymakers would normally be wanting to tighten about now, they're not. And the reason they're not goes back to what I was saying earlier, is we're in a world of capital wars where austerity policies on the fiscal side are impossible and where tightening monetary policy, it's probably not a great idea either if you want to fund those deficits smoothly. So that's why I think there's a lot of foot dragging going on. That makes sense. And I guess, would you say that, I think your contextualization of the liquidity cycle is important because do you think that the AI capex boom and generally the strong economic activity is basically just a sign of liquidity leaving financial markets and making its way into the economy? And I guess my followup to that is, does that mean that as liquidity leaves financial markets and makes its way to the economy, there is less potential for more of an asset price boom as we go forward? Yeah. I mean, I think that's clear because just take a look at what's happening to yield curves. Yield curves are flattening. And that's exactly what you'd expect in this regime. Yield curves, I mean, it was one of the things we used to use at Salomon Brothers to try and understand the fixed income markets, is that the yield curve tends to follow the liquidity cycle by around about nine months. So if you get a peak in liquidity, you will find about nine months afterwards, almost like clockwork, that the yield curves will begin to flatten. And that is an indication of money leaving the financial sector and actually going into the real economy. So that's point number one. Now, if you then look at the three asset classes, let's take three asset classes, fixed income, equities, and commodities, or real assets, okay? Now, if you think about these two pools of money, financial liquidity and real economy liquidity, what drives the bond markets is almost exclusively financial liquidity. So in other words, if liquidity expands, the yield curve will steepen. If liquidity contracts, the yield curve will flatten. And that will initially be a bearish flattening, but it will turn ultimately into a bullish flattening of the curve. Now, that's the fixed income markets. The commodity markets move oppositely to the bond markets. Now, going back to a Salomon Brothers story, when I joined Salomon Brothers in the mid-1980s, Salomon Brothers had just come through the night of the long knives, where they'd basically knife to death the Phillips Brothers partners who they'd joined up with in, I think it was, I forget now, 1981 maybe, when Philbrow Salomon was formed from Phillips Brothers, which was a big commodity trader, and Salomon Brothers, which was a big bond trader. And that was the stock that was listed on the exchange. And the reason that that merger took place was that those two cycles of fixed income and commodities basically moved completely anti-cyclically. So in other words, it was the perfect hedge. It was the ultimate financial firm. As it happened, what the Phillips Brothers didn't understand was that the bond markets were about to go down. So Salomon Brothers got the upper hand. And as they used to school when you joined Salomon Brothers, in most Wall Street firms, you get knifed in the back. But at Salomon Brothers, they'd come at you from the front with an ax. And that's what happened to Phillips Brothers. They were one more. And it became Salomon Inc. And basically, that's the story. So the commodity markets are all about what happens in the real economy pool. What about equities? Well, they straddle the two. So PE multiples are more related to fixed income and therefore the financial pool. And E, the earnings, are all about what happens in the real economy. So if you get a situation whereby the fixed income markets are selling off, in other words, yields are rising, and finance is leaving the financial sector and going to the real economy, PE multiples will contract. That will be offset to some extent by the E rising as the economy accelerates. And that's why my view this year, which has proved not that good, well, it's certainly for equities. I thought equity markets would be range-bound this year. I thought commodity markets would be very strong. And I thought bond markets would be very weak. So I've got two out of three right. But the third one is the equities I thought would be range-bound actually have been stronger. But that's all because the E, and largely because of the AI boom, I guess, has been so strong. But if you look forward, that logic still applies. So that's how I basically see that process. Yeah. And I mean, there are two things that come to mind when you're describing this. The first is that this gives you kind of like a nice investment cycle template, right? So as you progress from, as liquidity progresses from the financial system into the economy, so you start with the financial system where it impacts fixed income. When it starts to make its way into the real economy, you are looking more at equities. And then as you transition into the real economy, which is really the late to end cycle, you're looking at commodities. Is that a fair? Yeah, correct. And if you've got, you know, two pools of money, where you've got money shifting from one to the other, if you or anybody are mathematicians, that defines a difference equation, which is what cycles and therefore explain cycles. And I guess, how are you, you know, because I think what you're describing with regards to the to the equities, I think that there is some sort of cycle break kind of dynamic, right? Like when you look across most macro watchers, unless they are very, very tech and AI, heavy um the the ai capex and ai innovation seem to be something that's inconsistent with you know typical cycles and so how are you thinking through that aspect and kind of navigating markets well i think that i think it's a great question i i'm not sure i'm qualified to give the best answer but what i would say is that if you look at what this means i mean i think from a geopolitical standpoint uh it's absolutely crucial that uh the tech innovation and the ai boom is is uh is uh is kept going and i think the authorities are basically not prepared to kill it and the way that i would i would uh you know describe that as i don't think kevin walsh is about to drive a knife into the heart of the u.s economy so i don't think there's going to be any significant tightening um you know upcoming i mean there may be a small i mean the paradox and a funny sort of thing is that there's going to be a significant tightening um you know upcoming of a way is that if he decides to raise rates you know 25 basis points at the next fmc watch the bond market and i would bet the bond market rallies in other words you're probably going to go down because term premium will begin to fall and um that is probably exactly what should happen and what they want but that may be an aside so i think from that perspective they're not going to do a lot of tightening and that may be a corollary of the existence of ai and the other thing is that you've got this situation whereby um ai needs to be able to do a lot of tightening and that needs to be funded it is challenging the government in the debt market something clearly the government's much bigger but it's uh there's a lot of funding which needs to be done and you've got to throw into that the fact that in the next few years there's something called a debt maturity wall which is coming back into the system now that sounds a bit wonkish and let me just explain that when um in the covid crisis uh what happened in the covid crisis policymakers decided they'd do two things they'd do one is they'd cut the interest rates and they'd cut the interest rates to zero in case it's negative now again wearing a salon brothers hat the book that we always used to read to understand the fixed income markets was a book called the history of interest rates by sydney homer which looked at four millennia of uh of a history of interest rates okay something you read if you can't sleep at night obviously but anyway we were forced to read that and in that book there is no mention at all anywhere of zero interest rates okay four thousand years of history we've had we've had positive and uh you know strongly positive interest rates not zero or negative right uh therefore what policymakers did in the covid period was unprecedented and completely reckless because what they did is encouraged even more debt take up but more particularly they encouraged a terming out of existing debt whereby borrowers who were saying paying five or six percent of their income were paying five or six percent of their income for their borrowings thought okay we're going to refinance now half percent or one percent and we'll pay that debt back in 2027 2028 2029 and that debt is coming back into the system again so there's an echo effect from covid and that means that the weight of debt refinancing that needs to be done in the next few years is quite ominous i mean it's it's a problem now if you believe stability in the financial system going back to the beginning of this uh is that um the debt liquidity ratio has got to be stable for financial stability that tells you that as debt starts to grow exponentially you need more and more and more liquidity and that's really the story so in this world that i've sort of called this sort of keynesian renaissance uh where big government is in control and uh there's not going to be a lot of tightening and debt is growing exponentially and liquidity has to keep expanding um this is monetary inflation uh writ large and you've got to invest accordingly and you've got to invest in it and you've got to invest in it and it's not as some people call it financial repression financial repression uh hits your income right it's it's about interest rate suppression it's your income monetary inflation hits your wealth it's much more important and therefore you need things like gold or cryptocurrencies uh which have demonstrated uh you know pretty good inflation of monetary inflation hedging characteristics so talk to me about that a little bit because i mean there's obviously the empirical uh the empirical uh the empirical uh the empirical uh the empirical work that you've done in terms of the relationship between bitcoin and gold and liquidity but how does that how does that that process actually flow how does rising liquidity flow through to these assets well i mean in the sense that i mean you can it's because in an asset allocation framework what you need to do is to protect your assets uh against uh against devaluation of paper money if you think about and let's take gold as an example uh you know people talk about the gold price rising okay but in reality the gold price is fixed gold is like the pole star that the navigators use and you know to guide themselves when they're sailing um and paper money is devaluing against that gold pole star so that's not actually fact the gold price that's rising the gold price is staying where it is but in real terms what's happening is that the gold price is that paper money is devaluing and the same with um with um bitcoin or crypto or even more so with bitcoin because there's 21 million or in theory 21 million fixed supply of bitcoin so if you've got a fixed supply um compared to a changing supply of money um then or paper money then you know effectively the price of bitcoin is going to go up uh in other words that to put it in my terms uh paper money is devaluing against bitcoin and then you've got a fixed supply of bitcoin and devaluing against gold and that's what's happening and that's that's the process of uh basically debt monetization but the only way i mean history shows you look through the textbooks the only way that you can that you can basically resolve a big debt problem is to is to monetize and you know the fact is that in our ledger based or credit based financial system um new credit rests on a base of old debt or the integrity of old debt uh because that's what the repo markets are all about so you use existing debt for your leverage if that debt defaults i mean look what happened with 2008 with the mortgage-backed security market uh if that debt defaults then you're going to get craps in collateral uh you get a big negative liquidity shock and the economy is thrown into a massive recession you can't have that so effectively central banks will come in with alacrity and shore the system up now if you take that perspective therefore is where you've got problems you are going to get increases in liquidity by definition because the debt liquidity ratio must remain stable and if you extend that parallel which country in the world has got the biggest debt problem um spoiler alert it's china and so what china is trying to do right now is to devalue the paper you want now that's not so easy uh as it sounds um so they've got to be very clever about that so what they do is they stop uh people buying the paper and they buy in cryptocurrencies um um the only thing you can really buy uh in china as an inflation hedge is gold so people are uh you can't export gold um and uh capital controls uh compliant state banks and you know a big nest egg of um uh of forex reserves really protect the external value of the yuan against that devaluation but you can see it visually visibly rather uh in terms of the price and china that's driving gold not western debasement not the great debasement trade that everyone talks about hasn't started yet that's coming for sure in the future but it's not only yet it's china debasement we're looking at right now so let's uh let's kind of zoom out to the you know the the title of your book and the title of your wonderful sub stack which is which is capital wars right and to me what you're describing both in the u.s and china circumstance sounds like a pretty immense downward and fx pressure right but but with the downward fx pressure you also have the challenges of the stability of domestic markets and so how how do you think about you know how these the the sovereign authorities in both countries think about managing what you're calling debt monetization and also the stability of their effects at the same time well i think that you know what this is doing is recognizing the fact that we've moved from what people lose and what people are losing called a unipolar world um you know after the fall of the boleyn wall to what i say a multipolar world but certainly a several polar world and you've got um you've got um or bipolar or whatever whatever the right term is tripolar but um you've got some clear centers and you know you've got china and its satellites you've got the us and its satellites and basically you know what you're getting i think is a situation whereby um and you know i mean this is this is being realistic not any observations you know pro or positive or negative but the u.s uh you know has to get its allies trading more closely with the u.s uh it has to get those allies using u.s financial markets and using uh the u.s dollar more uh and it has to try and separate those allies from um let's say the enemy or the competition which is china and it's uh and uh you know it's satellite states and those satellite states may or may not include russia but they probably do include central asia uh they may or may not include other asian I mean, that's really a moot point at the moment. But clearly, this is a war to do that. And, you know, that relationship between the core and the periphery is a subservient relationship, which I think is what we're starting to see more and more evidence of when we look at what Trump is up to. I mean, he's trying to create this empire built around, you know, the U.S. dollar and U.S. financial markets. But I think that, you know, he, I mean, as I say, without taking sides on this, I think he's a realist. I think he's probably got a vision of, he may be, you know, let's say, awkward in the way that it's delivered. But this is the reality, okay? This is what's going on. And effectively, capital wars is recognizing that particular battle between the dollar and the yuan system. Now, what the Chinese, I think, are doing, in my view, and I may be completely wrong about this, but my interpretation is that the Chinese are basically saying, look, we, you know, we already, this is Chinese talking, we already lean far too heavily on the dollar system and we've got to get off the dollar system. But that's not, that's not so easy, okay? If you've got a trillion dollar deficit, sorry, trillion dollar surplus, where are you going to invest that? And there's not many places, okay? You can't put it in Swiss francs. It's typical. Gold markets. Too illiquid. You can buy commodities, fine. But U.S. financial markets are clearly a big area. But they've got to try and wean themselves off the U.S. dollar. So I think what they're doing is creating a rival monetary system. And I think that rival monetary system is backed by gold. And that explains why the Chinese authorities are simultaneously buying gold. And that's just looking at a straight line going from, you know, bottom left to top right. They're accumulating gold. They're accumulating gold, you know, month after month after month. But that is a little bit like a Bretton Woods type system that they're trying to reproduce. And the Chinese yuan will be ultimately backed by gold. Now, this, I hesitate to say, is not a gold standard by any means. And you will probably be unlikely to ever trade gold. But then that was the Bretton Woods system. You know, the U.S. had all the gold. It was quite difficult to get a hold of that gold at certain times when people would stake it out. And that's going to be exactly the same with China. But I think that's the perception of what they're trying to do. And the U.S. may well be using, doing a similar mechanism, but probably based around, ideally, stable coin. Whether that works, who knows? So in your mind, the tether is either gold or some sort of stable coin? Yeah, I think that's right. Yes, yes. Are you saying tether in the sense of the coin or just… Tethering the FX. Oh, yes. Tethered. Okay. Yep. Yep. Right. So I think that, you know, broadly, that would be the case. Now, therefore, I think that, you know, China is sitting more on a gold backing. U.S. is, maybe you could argue, is sitting on a U.S. treasury stroke technology backing. And so, do you think of the Japanese circumstance today as kind of a microcosm of the dynamic that you were describing where they have to entice their foreign allies to remain invested in their assets? You mean the intervention of the end market? Yeah. Yeah, I think that was, I think that that's connected. I think the, you know, the point is, is that what they, I think what they're trying to do is you've got three, if you like, you've got three big buyers of U.S. treasuries still left. You've got the hedge funds, which is the basis trade. You've got Japanese investors, and you've got long-term U.S. funds. Now, long-term U.S. funds are being controlled by the fact they're being starved of issuance, so that they don't be given the duration they need. Hedge funds are being encouraged by the fact you've got low bond volatility and a lot of liquidity at the front end of the market. And Japanese investors are being encouraged not to sell, at least, by help on the end. Mm-hmm. And so, I think also something that's really important is that, like… The Japanese are going through a pretty serious, I think you, in a recent sub-stack, put up that the Japanese are going through a very similar dynamic to the U.S. in the sense that they're having a very serious nominal GDP acceleration, which is a pressure on their domestic assets as well, right? Mm-hmm. Absolutely. It's the key one, yeah. Right. And do you think that poses any type of systemic measures, sorry, systemic risks to broader markets? Not necessarily. Not necessarily. I mean, I think that you could clearly trace out a path where they do. Mm-hmm. But I think at the moment, I mean, what we're doing here is we're really repricing risk assets to a world of much faster economic growth. And therefore, if you've got much faster nominal economic growth, you've got to have bond yields which can measure it with that. And therefore, the level of bond yields are higher. And if the level of bond yields are higher, the P level of the average P of the market, the equity market, they're going to be lower. And correspondingly, as well, if you've got faster economic growth, commodity markets, real assets should be higher. So we're looking at that repricing in terms of levels. Now, that could be a disorderly move, or it could be an orderly move. And what the Treasury and what Besant and Walsh are doing, as far as I can see, is trying to make that, as far as possible, an orderly move. All right. Well, Michael, as we approach the top of the hour, I'm just curious about what you're thinking about looking forward for markets and what are kind of the guideposts you're going to be watching to navigate global macro markets in general? Okay. I think the first thing to say is if we're monitoring crisis risk, I think you've got to look at the repo markets and you've got to look at bond volatility. Those would be essential factors to watch. I think in terms of understanding the direction of markets, I mean, my view is that you've got to look at, look at liquidity because that's what I do and that's what I've grown up with and those are the tools I devise. So I couldn't, I can't deny that. And if you don't, if you don't do that, then you've got to look at other factors, which are probably more derivative, which are things like the yield curve or credit spreads, which will give you some idea about, you know, risks, risks in the market as well. So, you know, broadly, the landscape I envision is that you've got continual strong economic, growth in the foreseeable future. The risk is higher commodity prices derail that. I think we, you know, we're not there yet, but I think commodity markets are going to go a lot further because of the nature of the world we're in. I think policymakers are reluctant to pull the plug on markets. I think in a normal cycle, given the inflation pressures that are emerging, they should be tightening now. And they're not for the reasons that I stated. So I think this speculation phase, as I call it, in markets could go on for longer. But then at some stage, you've got to pay the piper. So you've got to remember that there are cycles and there are trends. And I've spoken a lot about the trends and the trends, I think, in the long term are very good for certain assets like gold, Bitcoin, probably equities generally as well, not so good for bonds. But the cycle is going to come on top of that. And you've got to be cognizant of those risks. So those are the factors I'd really be looking at. But I think holding gold and some Bitcoin in the portfolio, it makes a lot of sense. And as we said in our, you know, on our, right in our Capital War subsects some months ago, you don't have to hold much Bitcoin to actually get quite a lot of protection against monetary inflation because it's so leveraged to monetary inflation. Yeah, I'm a big advocate for global diversification across assets. So definitely behind that. Michael, you've been so generous with your time. We're coming up on the hour. Thank you so much for coming on and having this chat before we sign off. Where can listeners go to find out more about you, your work, and your firm? Well, the easiest channel is Capital Wars, which is on Substack, which people I'm sure are going to be familiar with. And the other way is that we have an institutional website, which is called glindexes.com, which is really a source of data. So a lot of quant firms use this already because we basically have large databases of liquidity data. We're about 90 countries worldwide, going all the way back to the 1970s. And a lot of that data is now daily. So that's the other source. Listeners, make sure to check those out and get in touch with Michael if you're on the institutional side. Michael, thanks again. Thanks, Alan. Enjoyed it very much. Thanks, everybody. Likewise. Bye. Bye. Bye. Bye.