Speaker 1- Liquidity moves in a cycle, and we've already seen the peak of the cycle, at least in terms of the growth rate of liquidity. All money that's anywhere must be somewhere. Capital markets, all about debt refinancing. They're not about raising new cap. And we're talking about a total role of something like 50 trillion for advanced economies. But actually, this is exactly the time we should be thinking about bonds right now. That is extremely bullish in my view for the gold price. It's not about PE multiples. It's about something else, and that something else is liquidity. -
Speaker 2Michael, welcome to Excess Returns. - Justin, great to be here. - You are founder of GL Index and Cross Border Capital, and author of "Capital War: The Rise of Global Liquidity." You spent decades studying something that often gets a little less attention than earnings or valuations, and that is global and domestic liquidity, and how the flow of money through the global financial system influences markets and assets. And I think this is a very interesting time to be talking about how this area, there's this massive wave of debt that needs to be financed across many countries. We obviously have enormous amounts of capital flowing into AI, and I think that these sort of dynamics are particularly important for investors to understand right now. So today, the conversations around the global liquidity cycle, what it means for markets, and how investors should be thinking about that in the context of stocks, bonds, and other asset classes. So very happy to be discussing this. We're taping this in beginning of November, here. And October was a pretty rough period for tech stocks. And you've kind of said that the money is starting to bleed out of financial assets. And so what is global liquidity telling you right now?
Speaker 1Well, I think it's telling you exactly that. I mean, the liquidity moves in a cycle, and we've already seen the peak of the cycle, at least in terms of the growth rate of liquidity. That occurred in late 2025. And this year has already been a year when you've seen liquidity conditions progressively falter. I'm not gonna say that liquidity in absolute terms is lower, always falling, but certainly in terms of the growth rate, it's very clearly slowing. And that's making asset gains a lot more difficult. You're starting to see a lot of choppiness in risk asset markets. Some leading indicators think, things like the Russell 2000, small cap stocks, which are very liquidity sensitive. Things like Bitcoin, again, very liquidity sensitive. Gold, liquidity sensitive. Credit spreads, liquidity sensitive. All these things are starting to perform poorly. And the market is being increasingly sort of held up on the mono trade, which is AI. And that may well be coming to an end at some stage. And I think the thing to remember is that, notwithstanding the fact this is fantastic technology, we've seen a world changing. Capital intensive industries will be cyclical. And that cycle often bites because of financing conditions or an inability to fund new CapEx. And that may be the challenge that's out there that we got to consider. -
Speaker 2How do you measure global liquidity? I mean, you talked about those asset classes that are seeing under some pressure, but how do you look at global liquidity specifically and what do you measure it by? -
Speaker 1Well, I mean, the answer, the straightforward answer is the global liquidity as we define it, is the flow of money or flow of funds through world financial markets. We draw the distinction between financial market liquidity and real economy liquidity. And I think the key point here to understand is that all money that's anywhere must be somewhere. So if it's in the real economy, it's not in financial markets and simply vice versa. If it's going in financial market, it's not in the real economy. So we're focused very much on the financial market, the flows of money. And another way or practical way of sort of understanding that, which is particularly relevant in the case where you've got a refloat instead, is that liquidity represents or measures the financing capacity of the financial sector. It's the balance sheet capacity, how much space there is in a balance sheet to take on debt, to refinance it, to roll it over, to underperform, to perform transactions in financial markets.
Speaker 2What is this idea of, and I love that, that all money that is anywhere must be somewhere, but you recently wrote that Wall Street is increasingly competing with Main Street for liquidity. Can you just explain that?
Speaker 1Yeah, well, it's exactly that point, Justin. I mean, the fact is that if you've got money which is being required for, let's say, capex build-out in the AI sector, the big hyperscalers, which were, you know, let's say 18 months ago, had treasury departments that were flush with cash, the cash is now being redeployed out of the financial markets. It may have been vested in short-dated treasurers, who knows, or whatever the financial asset was. It's now being redeployed into, you know, real widgets or real things in Main Street. And it's driving the real economy. It's no longer features in financial market statistics. It's basically there in terms of real capex spending.
Speaker 3How much does stock matter with liquidity? You talked about flow before, and I think that's primarily what you measure, but I think you've also talked about stock is pretty high right now. Like liquidity is high and coming down. How much do you think about stock versus flow?
Speaker 1Well, I mean, it's a very good point. I mean, when you start to look at the impact on financial assets, you've really got to start thinking about the marginal flow, and financial assets often price at the margin. So it's critical to know the direction and the rate of change of liquidity. And you're absolutely right to say that if you look at the current level, the level is sort of kind of topping out, but it's really difficult to say that in absolute terms, liquidity has fallen. It's very near its peak. But the point is, it's very clear that the rate of change of liquidity has slowed down enormously. If you start to see an absolute fall in liquidity, then I think you're likely to see some, you know, major tunnels of risk asset pricing. At the moment, they're just sort of treading water at best. I mean, some clearly have been hit. But it's, you know, it's a little bit like the old saying, I think, of Warren Buffett's, that when the liquidity time goes out, you see you swimming naked. And I think we can argue that the tide is progressively going out. And so you'll see an increasing number of Barrett bathers out there as that water disappears. And, you know, that's really the story. So at the moment, liquidity is basically slowing down. Now, when you come to the level or the stock, a very important statistic to think about, given the fact that you need to refinance debt, is to look at the ratio between the stock of debt and the stock of liquidity. And that's a key metric that is often sort of ignored. But it's particularly relevant in a world where you've got to refinance debt. Many economists look at a statistic which is debt to GDP and, you know, argue, I mean, I think loosely and probably without any great evidence, that numbers like whatever the original number was, 80%, 100%, or whatever the figure they choose is, that is a data point. I mean, we're long past those thresholds. You start to look at Chile. You know, where the debt/GDP ratio is near 400% or Singapore, where it's very similar. And you don't get any particular tensions. The real metric, the key metric, is debt to liquidity. And so the stock of liquidity relative to the stock of debt in this case really matters. And what we've found is that if you look at a level of debt to liquidity above about 200%, you start to get really, really serious problems in terms of refinancing problems.
Speaker 2You were gracious. You were generous enough to share a number of charts with us. And this first one sort of goes back to 2000. And it's charting global liquidity and the world business cycle. And it looks like it's kind of shifting or moving roughly every five to six years. So can you just kind of walk us through what
Speaker 1we're looking at here? Yeah, sure. I mean, the idea behind that, and that goes back to the sort of the adage that all money that's anyway must be somewhere. And what I really argue there is that if money is in the financial center, the real economy is simply vice versa. And so if you look at those two lines on the chart, what you can see is that when liquidity is strong, the real economy is weak. And when the real economy is strong, liquidity is weak. And that's really thinking about a flow of money really moving between two separate spheres. And those two separate spheres are basically, respectively, the real economy and the financial markets. And global liquidity is measuring the flow of money in financial markets. So what we see right now is that liquidity in financial markets is going down. That index is measuring a rate of change, devouring momentum. And what you see on the real economy line is progressive strength. And that's saying that the real economy worldwide, but particularly in the US, is on a roll.
Speaker 2Walk us through the four phases of the global liquidity cycle and how you kind of think about those in terms of their progression.
Speaker 1Well, what we like to think about is that we want to be, you know, approximately right, not precisely wrong. And so liquidity is evolving all the time. But what we try and do is to say that we're in a particular regime, rather than saying we're trying to pinpoint exactly where on the cycle we are, because by definition, you're going to be wrong. And we say that we're approximately in a region. And that region is characterized by certain features. Now, the four regions that we think about are rebound, which is where the liquidity cycle is at, is at its bottom but beginning to improve. prove. Calm, where liquidity is above average and accelerating. Then we go to speculation when the cycle has rolled over and liquidity is beginning to tighten. And then finally, the turbulence phase at the bottom of the cycle, when we're really at the trough of liquidity, but liquidity is falling into that trough. Now, those four phases are not in equal length. Calm reassuringly tends to be the longest. And turbulence tends to be quite a short phase, or speculation and turbulence tend to be shorter phases. But broadly speaking, right now, we think we're on the cusp between speculation and turbulence. And as the names suggest, speculation is a time when you can probably still make money, but the returns that you're earning are low quality. So what you're looking at is basically high volatility returns. And then when you get to turbulence, that's when you're at the bottom of the cycle. And then when you get to turbulence, that's not a great time for risk assets. You tend to find that you can make losses very easily. It's very difficult to move out of positions. You get sort of stuck in a deteriorating asset class. And the best assets for that regime tend to be things like government, long-dated government bonds, which is exactly the type of asset that most of the media were sort of pouring scorn on not four weeks ago. So these are the sort of assets that should do pretty well in that phase. If you're in the calm phase, or maybe even the early rebound phase, you can just buy risk assets. I mean, you want to lever up as the cycle improves, but you're already looking at things like equities, corporate debt, et cetera. They tend to excel during that phase. And during the upswing, technology stocks tend to do really well normally.
Speaker 3How do you think about, how is the length of this liquidity cycle? Does it change over time? Because one of the things I was thinking back to is this idea that people have talked about, like the stock market moves a lot faster, it seems like now than it has in the past. Fair market. Fair markets have been faster. Like, is that true of the liquidity cycle too? Or is it pretty consistent over time, the length of it?
Speaker 1Well, I think it's a great question. I mean, the fact is that if you look at the data, we've got data going right back to the early 1960s. And if you look at that, you find that there's actually a fairly constant cycle that lasts in length, that lasts about 65 months, or it lasts 65 months on average, which is between five and six years. Now, the two things to say about that is that it's a fairly constant cycle. Number one, why five to six years? I mean, that's a bit of a head scratcher in itself. I mean, our rationale is that that represents the average maturity of global debt. So debt is issued with a term, and that term or that maturity of debt tends to be of that sort of average magnitude, five to six years. And so what you're looking at with liquidity is it fundamentally is a debt refinancing cycle. The other thing which is, you know, to give further reassurance is the organization called the Foundation for the Study of Cycles, which is a U.S. cyclical or a U.S. fiscal body who researches, the name suggests, cycles and debt, asked to look at our data about 18 months ago. And they've got much more sophisticated computer algorithms to analyze cycles. And they took the data away, came back with exactly the same conclusion. This looks like a robust 65-month cycle. So we're reassured by independent verification, but our analysis shows us that it's a debt refinancing cycle. So we're reassured by independent verification, but our this is a five to six year cycle. And it seems to line up with, you know, recent events. The cycle bottom in around September, October of 2022. And that was pretty much the sort of starters gun for the bull market that we've seen. And it peaked out sometime in, let's say, Q4 last year, which was pretty much coincidental, a little bit ahead of where Bitcoin peaked and then slumped. And Bitcoin is the most liquidity sensitive asset on the planet. So it's not surprising that that has, you know, good traction from liquidity.
Speaker 3How much do policymakers play a role in this? I was just thinking, like, if you think about, like, REITs being held down for a really long period of time, like, did that extend the liquidity cycle? How much do things like that play a role in this? Well, again, it's a good question.
Speaker 1I think the thing is, is that, you know, liquidity is not just about central banks. Central banks play a big role in that. There's no question. But you've got to factor it. Other things like, you know, what about the private sector? We live in a world now where the collateral repo markets are really at the center of credit creation. You know, looking at World Bank statistics, their figures tell us that something like 77% of all global lending now is collateral based. So understanding the repo collateral markets is really key. And those markets are, I'm not going to say outside of what the Federal Reserve does, but the Federal Reserve does, but doesn't control those markets. And you've got to look at things that are more relevant to the private sectors, you know, like sort of maybe sentiment among bankers, things like, curiously, the volatility of collateral is a very important element. So if you're borrowing money against collateral that you post to a dealer bank, and that collateral, say, a treasury bond, is very volatile, the ability for you to borrow against that security becomes more challenging. So these things will impinge on credit creation as well. So the private sector is key. You've got cross-border flows. And you can go back and think of things like the euro-dollar markets, you know, maybe 10, 20 years ago, when they were a lot more active, as being very important sources of liquidity. So those factors are clearly important. If you start to think of smaller markets, like emerging markets, that cross-border flows are really one of the critical elements. So that's another element. And then you've got, you know, you've got, you know, you've got the central banks themselves. And the central banks are operating not simply through interest rates. And, you know, one of the things that we've made, you know, tried to make the point about is if you look at the current Fed, what is the Fed currently doing? I think it's doing a lot more than setting Fed funds rate. And it's operating a lot beneath the surface in the repo collateral markets. And it's acting alongside the treasury. And, you know, two of the most important factors that are going on in terms of policy right now in the U.S. would be, first of all, maintaining ample reserves among banks. So we've moved away from what was originally a scarce bank reserve regime prior to the GFC. We've been in the period since the GFC until relatively recently on what was called an abundant reserve regime. And the Federal Reserve has more recently moved to an, what they call an ample reserve regime, where they seem to be targeting a sort of minimum level of reserves among the banks of certain banks. And so, you know, the Fed is now trying to do a lot more than just a small amount of reserves. And so, you know, the Fed is now trying to do a lot more than just a small amount of reserves among the banks of certain banks. And that is, you know, I would say a managed level. What they don't want to do is to disrupt the repo collateral markets. They want funding to be maintained. And the other thing that the other policy sort of, the other policy conduit that's being used are things like controlling volatility or trying to control volatility in the markets through things like treasury buybacks would be one example of that, or doing a lot of issuance at the front end of the market. And so, you know, generally speaking, move away from Fed funds, it's not a great indicator. It doesn't really tell us very much about what policy is doing or what monetary policy is doing. These other dimensions are critical. And what's more, they're really important when you consider or we consider the policy generally in the US has changed away from the provision of what we used to call Fed QE, something we now think of as treasury QE, where the treasury is really trying to fund its real economy spending. And so, you know, the Fed is now trying to do a lot more than just a small amount of money spending through funding at the front end of the market, through bill finance.
Speaker 3Do you think people like me, because I was thinking before you answered that question, like I would have probably said to someone who doesn't know a lot about this, like Federal Reserve and central banks are one of the most important things in terms of liquidity. Like, do you think people like me overstate their importance in terms of the types of, in terms of liquidity in your work?
Speaker 1Well, I think, Jack, it depends on which day of the week it is. So, you know, if it's, if you've got a financial crisis, then the Federal Reserve is all important. There's absolutely no doubt about that. If you've got a more benign environment where the Federal Reserve is sort of stepping back and letting the private sector get on with it, then the Federal Reserve's role is, I'm not going to say de minimis, but it's much, you know, it's much smaller. And you've got to say that the private sector is already in control of credit creation. And if you come back to one of the major dynamics of liquidity creation, it's things like what we call the collateral multiplier, which is basically say, you know, the more collateral you have, the more collateral that you can post to a dealer bank, and the more liquid or the more able, let's say, the financial markets, it's more able to dealer bankers to borrow within the financial markets, the much greater you can see liquidity expanding. So you've got a big collateral multiplier, and that isn't necessarily the direct action of the Federal Reserve. But the Federal Reserve is clearly sort of, you know, making the environment benign in that regard. But they're not, they're in a financial crisis, they clearly all hands, you know, to the pups, or everybody on deck to try and, you know, sell shit. I think that that's a different regime.
Speaker 3We've been talking a lot about the change in Fed chair, the change in Fed regime on the podcast, like in terms of your work, does the movement towards Walsh and the new policies, does it change a lot in terms of how you think about liquidity? It's a good question.
Speaker 1I think that, you know, my view is that Walsh is operating much more closely with Treasuries, like the Besson, the Powell did. that the treasury and the fed are really i'd say joined at the hip um you know i mean i suppose de facto they always were but i mean i think it's more explicit now and i think they have a clear goal i think that goal is probably best uh you know sort of encapsulated the idea that uh besant said uh whatever it was a year maybe it was over a year ago the wall street's had its sort of day in the sun it's now main street's turn and you could see policy really moving in that regard i think the federal reserve is trying to accommodate that by policy changes that it's an anti and when i say that i'm saying that there's more of a bias towards looking at the looking at monetary provisional reserve provision uh there was before uh you know one of the one of the errors that they made uh late uh in 2025 was this you probably remember the sort of drumbeat about let's shrink the fed balance sheet is sort of it's uh you know it's it's the big bogey out there we don't like that so they wanted to get it down they allowed the fed balance sheet bank reserves more specifically to drop by about 400 billion uh in late 25 and you saw the repo markets blow out uh in terms of repo spreads just jumped enormously and the federal reserve had to work overtime uh they you know canceled all leave for the fed acronym department and they had to come up with a new acronym which they called uh rnv uh reserve management uh purchases and that's just another form of qe and so what they did is they injected liquidity back into the system and they managed to right the boat and uh you know ever since then we've seen relatively stable bank reserve uh figures and a repo market that's been falling test and purpose is pretty stable so they they do react to these things so i think the i think the wash bed is operating in a different you know through a different avenue um and you know at the end of the day i mean i suppose what i would conclude is this is a federal reserve that is reluctant to tighten uh and i think they're reluctant to tighten because they've got a better understanding of the risks there that if they tighten in a world where we've got enormous amounts of debt uh you know we could derail very easily and so they don't want to push it too fast you alluded to this
Speaker 3a little bit earlier but i want to put up this chart on asset allocation cycle and here we're looking at the liquidity cycle and we're looking at overlay of asset allocation cycle so you can can you talk about how these two things work together yeah let me try
Speaker 1and do that i mean if you're the the the idea behind this is that if you're in an upswing of the liquidity cycle when there's a lot more funds which are flowing through financial markets you basically want to be a risk on in other words money would tend to go into risk assets now if you think about the reasons for why uh the reasons for why is that this is a this is a time when you're not going to get defaults there's no there's very little systemic risk uh people will always get funded and so you're more likely to see leverage increasing and people extending uh into higher risk areas and so risk on tends to be a great strategy and you can be a little bit uncertain of the first inflection uh whether that you things are going to move up as you think but as momentum expands then you start to get more and more money going to risk assets and so you know initially it may be corporate debt that tends to move first then you start to get some equity markets and then you start to get more and more money going to risk assets and so you know it will be areas like longer duration equities like technology which tend to be early movers and then as the cycle expands you tend to move more into cyclicals and then you get commodity stocks around the top of the cycle now the reason for moving more towards earnings related areas or cyclicals later in the cycle is that by the time you've had several months or several quarters of liquidity expansion by that stage the real economy would start to feel some of the over effects from extra liquidity uh whether it be wealth effects or liquidity directly spilling over into real purchases and the real economy tends to get traction so you get inventory build commodity prices start to rise capex spending goes up etc and then you start to get these commodity areas picking up around the top of the cycle now the uh the pickup of the real economy are then the seeds of the decline in the financial sector because liquidity gets drawn away from financial assets into feeding a stronger real economy and then you start to see pressures uh on things like uh the yield curve the term structure will start to inflect the yield curve will begin to flatten uh etc we get tiny conditions credit markets will start to find it more difficult small cap areas which are very liquidity sensitive will start to struggle and then as the liquidity cycle continues to tighten um so risk assets will increasingly underperform and you'll move to an area where things like government bonds uh will then start to fall very strongly because by that stage the fall up in liquidity may have started to hurt the real economy and economic growth will be faltering and so you move back to the safety of government bonds and very tight liquidity at the bottom of the cycle will itself increase systemic risk and so you don't want to be in anything uh which is like is a default so you go to the safety of government debt can you
Speaker 3talk more about what you're seeing now in terms of the sub-assets like i think you've written that small caps and emerging markets will keep acting and we've obviously seen some some issues in tech recently can you talk about like at the sub-asset level of what you're seeing behind the
Speaker 1scenes now yeah i think if you if you go back and you look at these two separate cycles the financial cycle of the real economy cycle and you start to think about where different assets uh sort of fit in now what i would say is that bond markets tend to relate very closely or more closely to the financial uh to the financial sector so flows of liquidity uh into and out of the market really are going to be really directly affect the slope of the yield curve uh which is really the main way that you get your bond return and this cycle has been in many cases an absolutely plain vanilla cycle you know when it comes to uh looking at bonds uh bonds are behaved absolutely normally very a very very orthodox way uh you know even to the extent that you know you've had this uh sort of create from a lot of the financial media uh sort of in the last few months saying bonds are terrible terrible investments nemo never touched them but actually this is exactly the job you should be thinking about bonds right now uh because we're moving very late cycle so as regards bonds as i say very orthodox you look at the real economy cycle you look in particular commodity markets again that's been very orthodox you've had this tremendous run-up in commodity prices now they're beginning to inflect a little bit or weaken a tad certain some of them uh and moving up being a good example of that uh soy has come back etc uh iron ore has been actually quite weak but that may be china related but you've had this commodity boom through the year where the commodity indexes are up sort of 40 50 percent for the year which is you know astonishingly big gains so if you look at the commodities like that's been absolutely as you would expect if you come to equities it's a little bit more mixed a little bit more nuanced and equities kind of fall in the middle of these two stalls so if you think about the p e driver of equities uh the p e multiple has moved exactly as you would expect so what we've seen is a big expansion in p e's when liquidity was rising and you see the contraction beginning in p e's as the liquidity cycle has rolled down that bit's correct it's the earnings component which is very unusual and what you've got in the uh in equities is the earning cycle has come through much later and more strongly than in plant cycles probably because of the ai boom um and what we've had is if you like a second winded technology an unusual second wind and then you've got the equity cycle the first wind was when interest rates came down technology stocks boomed because they're effectively what are called long duration instruments and so they tend to get a lot of traction from lower interest rates in other words if you think about their earning streams over the long term if interest rates come down you discount that earning stream at a much much lower rate and so it looks more valuable but what's also come through are very strong earnings late in the cycle as a sort of second wind so let's launch the sort of second wave in tech and the interesting question to you know to pose right now are those earnings that we're seeing in tech trend earnings or are they genuinely cyclical and my my leading is towards that being cyclical because i remember past cycles and even going back to y2k when everyone said you know all these stocks are going to grow to the moon and of course they never did uh and we we we soon learned quite rapidly that they were um cyclical earnings um and so i think it's a good and so i think the same is going to happen again but you know proof of the puttings of the eating let's see i may be you know i may well be could well be proved completely wrong but that's what i think is going on so if you look beneath the surface of the stock market the reason that you're getting a sort of fraying at the edges is a lot of the other non-ar related stuff uh is beginning to get hurt now um from let's say disappointing earnings or more and more disappointing earnings expectations which are beginning to get hurt um and so i think it's going to happen again yeah it's interesting we've
Speaker 3had some people we i've seen some people talking about this idea that semiconductors are no longer cyclical and then you could probably say that's a pretty late cycle sign uh because at least it appears semiconductors have always been sick yeah but
Speaker 1yeah exactly but it's i think that's a fair point i mean they've got all these companies have got high operational leverage uh you know any capital intensive business is cyclical which is what people forget uh they have high operating leverage and they have high financial leverage and you know The fact is that one of the problems that you often get particularly in big technology booms, is not the credibility or the usefulness of the technology. It's more the fact that can you fund the capital investment boom that results from it? And so often the case is not. Every major technology boom that you look back in history has always ended with some sort of financial crisis in some shape or form. And it's not because the technologies fail. It's simply because of the funding requirements that have really been associated with that boom.
Speaker 3Is there typically a relationship between the earning cycle and the liquidity cycle? I was just thinking when you were giving that answer before, it seems like maybe that's deviating now, but is there typically a relationship? And did that deviate this time from what it typically would be?
Speaker 1Yeah. And the answer is yes and yes, because the real economy cycle follows the liquidity cycle by around about 15, maybe 18 months. Earnings are keyed off the economic cycle very closely. And therefore, you can say that liquidity cycle follows the real economy cycle. And therefore, you can say that liquidity cycle follows the liquidity cycle by around about 15, maybe 18 months. Earnings tend to move sequentially with liquidity leading and earnings that are following through. And this cycle, what you've seen is you've seen that earnings cycle differ because what you're getting is much, much stronger earnings later in the cycle.
Speaker 3How do you think about comparing past booms in terms of liquidity cycle? We've talked a lot in the podcast about comparing the late 90s to today. Do you think that's valid too in terms of liquidity, thinking about that and using that as sort of a guide for what we're going through now?
Speaker 1I think there are instances. Yeah, I think there are parallels. The parallels, I mean, you can draw several parallels with liquidity. I think the late 90s were a pretty good period to look at when it comes to liquidity. And we've done timelines which seem to be, which seems to have lined up pretty much exactly with that. You can push the envelope too far on that because, you know, the nature of the financial system has changed. Particularly since 2008. And, you know, it's not quite the same financial system that we used to see before that. The cycles seem to be, you know, similar, maybe length and amplitude. I mean, that's on the face of it. But the actual mechanics of the drivers differ. And what I'm saying earlier on is the necklaces by which the Federal Reserve controls the system are different. And it may well be that the Federal Reserve is less keen now to sort of to trigger a recession. And, you know, in another guise, you know, I wrote a book some years ago called Capital Wars, which was all about the sort of the struggle between the U.S. and China for financial dominance. And if that capital war is still being engaged, which clearly is, it would be, you know, let's say reckless or short-sighted for the U.S. authorities to create a recession and, you know, give China an advantage in that respect. So I think that they'd be very loathe to try and, you know, derail the economy deliberately for the sake of one percentage point lower or inflation or whatever they want to do. And I think if you come back and you look, you know, look at it in the cold light of day, I mean, at the end of the day, you know, I mean, my old boss, Henry Calpness, Allen Brothers, used to, you know, said a couple of years ago, look, this is very clearly a Federal Reserve. And he's seen quite a lot of Federal Reserves. This is very clearly a Federal Reserve. It doesn't want to, doesn't want it going. And I think you just look at the evidence of missing the inflation target for, what is it now, five years? Getting on six years. I mean, you know. Are they really that serious about a 2% inflation target? I mean, clearly they're never going to fess up to the fact that they're not. But, you know, it proved the puddings of the ET.
Speaker 3We've been talking about bubbles a lot in the podcast and also whether it's even valuable to try to call something a bubble. But do you see something unique in the liquidity when we have a bubble, like in the late 90s or in other periods where we're in bubble-like periods? Is there something unique that goes on in liquidity relative to other periods? Well, there's something very unique about the current one.
Speaker 1Yeah, absolutely. There's a lot of unusual characteristics when it comes to the nature of the bubble. I mean, one of those is that we've seen since the GFC, the response of the authorities to any crisis has been through liquidity of the system. Now, that may be simply a function of the fact there's a lot of debt out there that needs to be rolled over. And, you know, one of the things that, you know, we maintain in our work is that, you know, capital markets have changed their nature. They're no longer new capital racing mechanisms, as the textbooks tell us. They're now basically debt refinancing mechanisms because there's so much debt out there. So, clearly, the nature of the financial system has changed. And if you're refinancing debt, the interest rate doesn't matter so much. I mean, just think of a home mortgage. I mean, if you've got to, you know, refinance your home mortgage, you want the role on the mortgage. You're not so worried about the interest rate. I mean, clearly, interest rate matters. If you don't get the role, you're homeless, right? So, that's the same thing with debt. You need the role in the world of lots and lots of debt. You need to refinance. And so, financing capacity is really crucial. And so, liquidity is really a key factor in terms of understanding that part of the equation. The other thing that is an interesting corollary of the recent policy responses is that interest rates have also been slashed. And in, well, that was in Salomon Brothers. One of the insomnia, which is called a history of interest rates by Sidney Homer, which goes back 5,000 years and tracks the history of interest rates through, you know, Greek and Roman civilizations and whatever else. And nowhere in those pages is there any reference to zero, ultra low, or even negative interest rates. So, what we've been through over the last few years, the last five years, has been completely unprecedented. And the central banks did, I think, a reckless thing by slashing interest rates. Because what the low interest rates do is, they're not slashing interest rates. And so, they incentivize us to take out debt, right? It's exactly what we don't want to be doing. We should be paying back the debt, not taking out new debt. And it wasn't just the fact that you got new debt taken on. You also got terming out of existing debt. So, basically, a lot of businesses, a lot of households, even governments, refinance their existing debts in 2020, 21, 22, and term them out to later in the decade. So, what we've been doing is, we've been taking out new debt. And so, what you're getting now in the system is something called the debt maturity wall. So, the debt maturity wall is not new debt. It's actually old debt coming back into the system to be refinanced. And these numbers are awesome. And we're looking at, you know, at least $4 to $5 trillion a year of increase, not absolute amount, but increase each year in the amount of debt that needs to be rolled. And we're talking about a total roll of something like $50 trillion for advanced economies. So, you know, capital markets, just think about this, capital markets, all about debt refinancing. They're not about raising new capital. I mean, Pache, you know, the latest AI boom, which is unusual. But basically, for decades, they've been refinancing debt. So, you've got to do this refinancing on top of $2 trillion every year of federal debt, at least $1 trillion probably of AI hyperscaler debt, which is coming through. So, the numbers are already starting to compound. And the question is, if you've got debt, which is growing exponentially, and you've got liquidity, which is inherently cyclical, you can see there's a problem.
Speaker 2So, you know, Michael, one of the things that happened here in the US is when everyone that owns homes, including myself, you know, refinanced at, you know, 2% to 3% interest rates. It's like everyone now is like locked in to those super low interest rates. No one wants to move because of where rates are on new mortgages. And so, just in terms of household ownership, then people being able to downsize and things like that, it really has affected the housing market here in the US too.
Speaker 1Yeah, I think absolutely. But then if you're, you know, if you're a corporation, or even a government, you don't have the luxury of a 2015 or 20 year mortgage, right? You've got to refinance now, or very soon at much higher interest rates. And you think if you are refinancing at 1% for five years, and then you're coming in, you've got to do that seven, that focuses the most. Yeah, I think that's a really good point.
Speaker 3On this idea you're talking about of whenever anything goes wrong, we kind of just shoot the liquidity bazooka at it. Like, how do you think about like, one of the things I think about all the time, really, what are the consequences of that? Or what are the limits of that? It seems like anytime something goes wrong, we shoot the liquidity bazooka at it, and we overcome the problem fairly quickly. Like, how do you think about the limits and consequences of that approach?
Speaker 1Well, I mean, the first question, and the first question or way to answer that is to say, why do we do that? Okay. And I think the reason being is that we live in a credit money world, where basically new credit rests on the integrity of old debts. Okay. So in other words, the old debts are the collateral that we're using to borrow against. And those old debts may be US Treasury bills or bonds or whatever. Basically, you need that, if you like, the integrity, or a solid foundation. And so you simply cannot default debt. I mean, that's impossible. Okay. So you've got to start with that premise. If you default, defaulted debt, the whole the world economy would just disappear. I mean, we got a little whiff of that in 2008. But it's just impossible to do. So what they the only thing they can do is to enhance the ability to refinance. So what that means is either governments come in and buying some of that debt. So improving the average credit quality, which is actually what the Fed did in 2008. So they basically bought corporate debt, they bought MBS, etc. And the other thing they do is they pump in liquidity. So it's much easier to do the refinancing. So those are the solutions. So the question is, will we get another debt refinancing crisis? My view is yes, because that's the nature of the system. Liquidity is cyclical, debt is growing exponentially, so it's going to happen again. What will their response be? Their response will be to probably more liquidity, okay? They've got no choice. They have to do that. What will that mean? Well, it will mean that monetary inflation hedges perform well, okay, as they always do. And that will mean the gold price goes up significantly. It will mean that among paper currencies, initially the dollar could do very well, but then if the Federal Reserve is at the forefront of doing the monetary printing, which maybe it has to do because of the dollar throwing the world economy, then the dollar will weaken again afterwards. So you can see a lot of volatility in the paper currencies. And then you get things like Bitcoin. Which, you know, presumably, I said presumably, one doesn't know always, you know, with Binance and fraud and North Korea and whatever else, who knows? But you would expect that Bitcoin would be a very strong performer because it really came out of the last financial crisis when there was, you know, concern about the integrity of paper money. And so you're going to do it again. Surely Bitcoin's going to do well.
Speaker 3I want to throw up this chart because it gets at a lot of stuff you've been talking about, this idea of advanced economies, debt to liquidity. I know you've called this one of the most important ratios. Like, can you talk about this chart and what we're seeing and why this is so important? Yeah, if you look at this chart,
Speaker 1what it's basically saying is that to come back to the idea that financial markets have sort of changed their spots, okay, that it's not about raising new capital for new capital projects, okay? That's the textbook model, the ideal model that effectively, you know, was probably applicable to the 1950s, 1960s, et cetera, that period. The more debt that we've taken on, the more that capital markets are focused on rolling over these huge piles of debt, okay? If you're going to roll over debt, what matters is balance sheet capacity. If you're going to finance new capital spending, what matters is your cost of capital, right? In the old world, in the new world, balance sheet capacity is important. And balance sheet capacity is liquidity under our definition. And because liquidity is fungible, you've got to look at global liquidity, which is our concept. Now, if you then start to think about what really matters, the amount of debt that is out there, assuming it has a constant maturity profile, will mature, you know, obviously each year, a certain amount will mature each year. And so you've got to have the balance sheet capacity to roll that debt over each time. So if you look at the ratio between debt and liquidity, which is what the chart you're looking at does, it basically tells you when you get pressure points in the system. Now, we've done a little bit of an exercise to actually try and adjust for changing maturity profiles of debt in that chart, but let's not get too complicated, get trapped in those weeds. Let's just think of the straightforward debt to liquidity ratio, which is what we can think about this. What it basically shows is when you get peaks in that chart, in other words, very high levels of debt compared with low levels of liquidity, you get refinancing tensions. It's more difficult to roll the debt. There's not the liquidity capacity there. Credit providers have to scramble the funds. Repo rates start to go up or interest rates start to rise. You get trade fails, all these things. And if you get a default, that may cascade through the system. Because you get in financial markets interlocking balance sheets. So I lend to you, you lend to Justin, Justin lends back to me, et cetera, et cetera. So if I default, everybody defaults. And so what you've got is effectively a problem there. So you've got to avoid this default. And what central banks do is when you get a financial crisis, they tend to throw more liquidity at the system. And that's what creates the liquidity boom. And then you go shooting down the other side. The debt liquidity ratio then starts to go right down. You get excess liquidity because it's very difficult to control how much you're, when you're, you know, when you're firing the hose at a blaze, you don't know how much water you're going to put on. You overdo it. And so you get more liquidity and that more liquidity finds its vent in asset markets. And so you get an asset market boom on the downside. And then, you know, if you look at the chart, we've labeled those, annotated that chart with various, various booms and busts. And the latest one I've called the everything bubble. And the everything bubble really combined two things that I alluded to earlier on. One is this sheer liquidity response to the GFC, to the COVID crisis, et cetera, plus the zero interest rates or low interest rates, which caused people to term out their debt. So as they termed out their debt, the effective amount of debt that was coming to the market to be refinanced disappeared for several years. It was being pushed out there into the late, the late 2020s. And what we see now is that the time where that density is coming back, the echo effect, if you like, but the COVID crisis coming back with this termed out debt, the people who issued it 2021, 22, 23 for five or seven years or whatever the term was, is that coming back into the system to be refinanced on top of all the other debt that's being, uh, that's being taken up. Uh, and the liquidity cycle is faltering, uh, not necessarily because the Fed is tight, because the real economy is just eating enough, uh, because it's got a huge appetite too. So there are so many demands on liquidity in the system now.
Speaker 3So you've continued the line of forward to 2030. The idea here is we would expect this line to continue going up steeply unless something goes wrong. Is that the idea?
Speaker 1Yeah. I mean, unless the federal reserve or other central banks come in and they start to pump more liquidity into the system, that line's going to go up. And if that line goes up, uh, it's telling us that it's going to become, uh, they're going to swap us again. There'll be another financial crisis. Now, you know, it's not saying this is going to happen tomorrow, but it's saying that probably in the next two years, three years, you've got a real chance
Speaker 2of a major financial crisis. Is this sort of what's going on in like France? Is this playing, is this play kind of into that whole what's happening over there? Well, no, it's not unconnected, Justin.
Speaker 1Yeah. Because what you've got is a situation where, uh, it's, you've got debt. I mean, debt compounds, because the interest rate is high. Nobody ever, you know, pays debt back. So the, so debt will compound at a high rate. Uh, you've got, you know, you, you know, the experience in the U.S., you've got a high interest rate and you've got a primary, uh, primary deficit, primary budget deficit, which is pushing the, uh, overall federal deficit up at, you know, uh, whatever, at 6% of GDP. So this is telling you that, uh, with a hundred percent debt GDP ratio, debt is growing at least 6% per annum in the U.S. Uh, and that compound rate is causing an issue. And it means that, uh, whereas you should be, and this is particularly true in France, you should be cutting back spending. Okay. Government spending, um, to try and reduce the growth of debt because you know, there's a real problem in ultimately refinancing. Um, as you start to come back spending programs, people start to complain. And that's what's going on. And you know, the, the, the problems in France are problems that have become similar problems in Germany, problems in the UK, but the, you know, the, the, uh, the Brits are a little bit less. So they, they do their politics, you know, not on the streets, uh, so much, but they complain just as much, I'm sure as the French or the Germans do about these things. I mean, you're looking at fiscal problems, which are just eye-watering at large. And this is, this comes back to the thing. You just simply cannot afford, uh, the levels of government spending, uh, that are going on, but no one is putting their hand up and say, we're going to follow austerity policies. Nobody at all. I don't know.
Speaker 2It might've been like 10 years ago. Remember the pigs, it was Portugal, Italy, Greece, and Spain, I think. Um, did those countries actually like kind of take on measures to, to, to improve their fiscal? Cause you know, I think their rates might even be lower than places like the UK now. Well, you're right.
Speaker 1But they, but what happened was that they did engage in austerity. What happened to Greece? I mean, basically there was uproar about the, uh, the fact that a democratically elected government was overruled by, uh, the, the EU or the ECB, uh, and pushed into these cuts. Uh, but those people have forgotten those politics, but that's the reality. But you, you can see so often that the debt markets are kind of crucial. Um, there are, yes, there are, uh, entities out there called bond vigilantes that basically make sure ultimately the uh, the control and think back to, you know, what happened, uh, you know, in the UK, in the Liz Truss moment where, uh, the bond market certainly didn't like the budget that was being put forward. And so, you know, you could see that instance, I mean, a classic case where the Bank of England that was doing a QT, quantitative tightening policy, uh, shipped it with a lacrogy overnight from QT to QE. Okay. Because what they need to do is to protect, um, protect the sovereign debt markets. And that's their ultimate goal. I mean, if you get the inflation or employment mandates, it's all about maintaining, uh, maintaining a sober government bond bucket.
Speaker 2What's your view on the tenure here in the U.S.? Do you think more of that rise has been driven by higher inflation expectations, higher growth, or maybe even perhaps investors demanding more, you know, a higher payment because of the U.S.'s fiscal, I guess, state? Well, it's 100
Speaker 1percent the first two and zero percent the last. There's a lot of, you know, misguided comment, particularly the media, especially the media, coming, you know, about this whole issue that it's whether it's a Trump phenomenon or a Besson phenomenon, whether it's all to do with, you know, fragile fiscal finances. No evidence of that at all. If you look at term premium in the U.S. bond markets, they're basically flat to declining. And if there was a serious problem with concern over debt or fiscal fragility, you'd see term premium rise, and they're simply not. The dollar's been firm, another good indicator. So, the evidence is against that view and much more in favor of saying, well, it's all about strong economy. And if you look at, you know, data on, let's say, NGDP, nominal GDP growth, ultimately, the bond market, the yield on the, let's say, the 10-year, should pretty much match the underlying growth rate of nominal GDP. And in the case of the U.S., it is. I mean, there's no question about that. So, you could actually argue, and this is my, you know, my sort of back of the envelope projection. If you think the underlying nominal GDP growth in the U.S. is really at about 6%. I mean, the latest data is higher than that. But let's say the underlying level is about 6%. You should think the long bond should get to 6, plus or minus the term premium, which is your risk premium element you spoke about. And actually, at the moment in the U.S., that's about minus 50 bit. So, you could say somewhere between, you know, five and a half, six is probably the top side for yields. Certainly, at the moment, unless the economy changes, it's going to move in that direction radically. So, that's where I think it's going. There are other countries where you've got positive term premium. France is a good example. Britain is another. Germany has the luxury of being a safe asset haven still. So, it can get away with much lower yields. But, you know, the interesting question is, if you extrapolate from those comments and you say, well, okay, let's look at nominal GDP, bond market, bond yields. Think about China, okay? Well, okay, U.S. yields are circa 6%. Sorry, circa 5%, 5 and a bit, or thereabouts. So, around the 5% area. And nominal GDP growth, I said, is about 6%. What are yields in China? Yields in China are 1.5%, okay? So, if you're generous, you could say, well, okay, maybe the Chinese economy is growing nominally at 2.5%, 3%. Well, the authorities tell us that in real terms, it supposedly is growing near a 5%. So, that will do. There's no way the Chinese economy is growing at 5%. Okay. It's basically, you know, it's hit a wall. And what the bond markets in China are telling us, the big gap between U.S. bond yields and Chinese yields is telling us that the U.S. economy is doing famously relative to China. And China is suffering really badly. And it's probably seeing debt deflation, which is what the stock market is clearly screaming at us right now. So, has the U.S. won the capital war, at least at this point with China? It's only won it in 2026, Justin, yeah. I mean, for the next five years, that's maybe a moot point,
Speaker 2yeah. A non-liquidity question here, and I'm sorry, I'm kind of jumping all over the place. But as a non-U.S. investor, when you look at our technology industry and specifically like the AI companies and the AI technology coming out of the U.S., and then you look at like what's happening in your home market or Europe, like how do you, we had a guest on that was like, you know, you're seeing AI, great AI companies coming out of Europe. And just given the way that the EU's regulations and everything like that, it's like, and you won't see any great AI companies coming out of Europe. But how do you think of like our companies? Are people like envious of these AI companies in the U.S.? Or what's your view?
Speaker 1Well, I think the, I mean, the answer must be yes. But I think that, you know, equally, I think that a lot of people don't understand the, you know, what the AI revolution really means. Or how revolutionary it is. I mean, that may be true in general, general statement anyway. But I think particularly in Europe, that's true. I think that if you look at Europe, there is an ability to invent things. And that's certainly true in the U.K. You know, I mean, I think a lot of deep mind came out of, out of the U.K., for example. But the ability to innovate is zero or very, very low. The reason is it's a small market, it's a fragmented market. And what's more, government regulation is really against that. I mean, if you've got, you know, I mean, without being, without being too pointed about it, if you've got a socialist regime that's taxing everybody, I mean, clearly, you're not going to get a lot of innovation. And the best entrepreneurs, the best minds are going to leave and go somewhere else. And I think that's the challenge that is facing Europe in particular. But, you know, the U.K. is, is different because at least in the U.K., it's easy to, it's easier, qualify that, it's easier to, to make a startup business. In most of mainland Europe, it's really, really difficult to do startups. So I think you've got, the whole thing needs to be shaken up dramatically if Europe is going to compete. And, you know, they're going to have to do that pretty fast as far as I can see. But I mean, the inertia there in the system is just, you know, it is mind boggling.
Speaker 2What are the most important things that you're paying attention, as we come into the end of the year here, and we look at 2027, in the context of global liquidity and the things, and the indicators, that you're paying attention to? What are the indicators that you look at? What are the, what are the most important things you're paying attention to right now that you think investors should know?
Speaker 1I think, I think Tim, I mean, maybe let's say three things, because one of my, one of my, one of my points would be, you know, what happens, you know, after, after Tuesday and the U.S., the U.S. elections, what is that going to mean? What is, you know, what's the administration's response going to be? You know, that may be an interesting callback. It might sell, but I'm going to defer on that because I'm not an expert, but I think it could be clearly an issue about whether they, you know, whether they demand major cuts from the Democrats or whatever it may be. I mean, who knows? But let's leave that on one side. The two big issues, I think, are outside of that. Number one, what is the tempo of the U.S. and the world economy looking like into '27? Given the fact that you've had interest rates, bond yields rising, you've had oil prices going up. You've had oil prices going down. You've had oil prices going up. You've had oil prices going up significantly, particularly diesel and product prices. And you've also got a dollar which is firmer. And by any accounts, that should mean that you've got a slower growth picture for next year. I'm not, certainly not saying recession, but you've definitely got a slower growth environment, okay? And that will have implications for bond yields by itself. The second factor which is left field is China. And China has a huge, huge debt problem. If you think America's debt problem is awesome, you think of Europe's as I'm watching, China's is off the scale. China needs to do something about debt. The economy is basically not growing. It's hit on war, returns on capital have collapsed. They simply can't continue to create growth with this amount of debt. They need to write it down in some way, restructure it, or more particularly, devalue it. And we saw that in the case of Japan. It took Japan 20 years to bite that bullet. China can't afford 20 years. So it's got to do something sooner, in my view. And that means somehow devaluing that debt. So they've got to stop printing money as if it's going out of fashion. And that means a significant devaluation of the yuan internally, which means domestic wages and prices have got to rise in China somewhat significantly to actually devalue this debt. That is extremely bullish, in my view, for the gold price. I'm not going to say that's going to happen overnight. And I may be wrong, and it may take, like Japan did, 20 years, but it's going to happen. And that's, I think, a good heads up as to how to allocate assets. Does it mean the Chinese yuan would devalue against the US dollar? Not necessarily, because I think they've got sufficient policy checks in place, like capital controls, like huge forex reserves, and world state banks probably to keep the cross rate largely where it is. But internally, there'll be a devaluation, in my view.
Speaker 2We got through a lot, and we had a lot more to get through. But maybe we'll have to have you back on, Michael, and talk about some of the stuff we didn't get to. But we like to end all these conversations with a standard closing question. And that question is, based on your experience in the markets, what's the one lesson you teach your average investor?
Speaker 1The one thing would have to be, you've got to think of markets outside of the way the textbooks tell you to. And that means that, by all means, look at a P/E multiple to evaluate stocks at the micro level. But if you start to think about P/E multiples at the aggregate level, you're going to fail badly. I mean, every year, I've been in this business since the mid-1980s. People have told me that European stock markets are cheaper than the US, but every year, pretty much consistently, they learn to perform. And that tells you it's not about P/E multiples. It's about something else. And that something else is liquidity. And that's what we focus on. So you've got to watch money flows. Thank you very much, Michael. Great pleasure, gentlemen.
Speaker 4Thank you. Thank you for tuning into this episode. If you found this discussion and interesting and valuable please subscribe on your favorite audio platform or on youtube you can also follow all the podcasts in the excess returns network at excessreturnspod.com if you have any feedback or questions you can contact us at excessreturnspod at gmail.com no information on this podcast should be construed as investment advice securities discussed in the podcast may be holdings of the firms of the hosts or their clients
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