Transcript: Michael Howell: Yields Must Rise, Fed Must Hike

Michael Howell [0:07] You've had a dynamic where money's become freer than free. Let me talk about a Fed just gone nuts, all, all the central banks going nuts. So it's all acting like safe haven. I believe that in a world where central bankers are tripping over themselves to devalue their currency, Bitcoin wins. In the world of fiat currencies, Bitcoin is the victor. I mean, that's part of the bull case for Bitcoin. If you're not paying attention, you probably should be. Probably should be.

Marty Bent [0:34] Probably should be. Michael Howe, we last met in February. It is now the end of July.

Michael Howell [0:41] Happy to have you back. Well, Marty, it's always pleased to be here.

Marty Bent [0:45] Well, we were chatting a bit before we hit record. I think probably the best place to start is Kevin Warsh and this federal reserve rate decision that he's got to make or the board has to make. This week, as you were saying, many people are focused on bond yields right now. And it's actually, I didn't mention this before we hit record, but it looks like yields want to drift higher. They probably have to let that happen. Will they is another question. But one thing that I've been observing as these bond yields have been drifting higher is the MOVE index, the volatility index of the government bonds here in the US. And it looks like that's relatively controlled. And that's one thing I'm wondering is if they're watching the MOVE index more than the actual yield and trying to make sure that they can just suppress volatility on the way up.

Michael Howell [1:34] Yeah. I think unquestionably that's what's going on. There seems to be deliberate manipulation of volatility in the market. I mean, I call that yield volatility control, not yield curve control. I think there is a policy to do that. That policy basically embraces 2 things. One is issuance at the short end, which has clearly been on a roll over the last 2 to 3 years. The other factor is basically doing Treasury buybacks, which always seem to pick up in response to increases in the MOVE index. When you see a jump in bond volatility, the Treasury comes in, offers an auction to buy back more the run bonds, and lo and behold, the MOVE index comes down. I think there's a direct response there. In my view, they're doing it. Why are they doing that? Because essentially, they can encourage leveraged funds, i.e., hedge funds, through an arbitrage trade to borrow in the repo markets and basically buy the cash bond, and that depresses yields. I think that that is a meaningful factor. It's probably at least 50 basis points, if not more. off the yield on the 10-year. This is a material effect. But I think we've got to put this into perspective. And the fact is that you're looking at the pace of the US economy, which I figure is at least between growing in nominal terms, at least between 6% and 7%, if not breaking through the top of that, given the AI spend, yields have got to be a lot higher. This gap of more than 200 basis points between nominal GDP and the 10-year bond is unsustainable compared to history. Yields have got to rise, and they are trying to rise. The administration in various forms is trying to pull them back. It's struggling to do that. As you know, yields are continuing to edge up. But the fact is that history shows that it's the long end of the market that determines the short end of the market, and not as textbooks tell us, the short end that drives the long end. Ultimately, the Fed is going to have to start hiking rates. Walsh could surprise us perhaps and do it today. I mean, the market's only discounting 30% chance of a rate hike, but it's got to come either this meeting or the next meeting, in my view.

Marty Bent [3:47] Yeah. I've heard commentary around it, the dark horse bettors betting on a rate hike saying that it would be good to do it now because it would confirm this new framework that Walsh has come in with, is that they don't want to do forward guidance. So a relative surprise with a rate hike considering where the odds are right now would do that. And it will be really interesting to see if he takes the opportunity to do that. But as you mentioned before we hit record, does he have the gumption and the balls to do it?

Michael Howell [4:25] Yeah. The fact is, would he carry the rest of the FOMC? I mean, he's only one vote, but he may be persuasive enough to swing the balance. I mean, who knows? But I think it would be a decisive move. And as you rightly say, it would basically end the forward guidance regime, which I think has been a bad regime for sure. And it would basically endorse some of his thinking, which is money supply matters. Money supply is on a tear at the moment. That often tells us that inflation is a problem down the road. So these are the questions that the FOMC have got to tackle. And I think a rate hike now would basically draw a line in the sand and show the Fed is serious. And I think the firmness of the dollar, in my view, is saying that the market is starting to believe that rhetoric that the Fed is in the process of tightening.

Marty Bent [5:14] When you say the money supply is growing, what are you looking at, M2?

Michael Howell [5:20] Well, if you look at M2, admittedly, in the last 2 or 3 weeks, it's cooled down a bit, but it was— 3-month annualized rate was testing 10%. a little while ago. So I mean, that's a pretty solid growth rate.

Marty Bent [5:33] What's leading to that expansion? Is the SLR ratio changes? Is the commercial banking industry issuing more credit, or?

Michael Howell [5:41] Yeah, I think though, I mean, that's clearly having some effect, but I think that at the end of the day, this is really a response or reflection of strong nominal GDP growth. And why is the economy growing so well? And I think it's whether it's okay or not. I mean, the fact is the average is growing at a high rate. And this must be the AI CapEx spend, it must be the large fiscal deficit, it must be the pickup in exports, particularly oil energy exports following tensions in the Gulf. All these factors make a big difference. And the economy looks, looking at end GDP numbers, nominal GDP, it looks pretty solid.

Marty Bent [6:16] Looks solid. A lot of people are worried about this AI CapEx boom specifically. There's a lot of bears out there who are saying that we're in a bubble.

Michael Howell [6:24] Yeah, well, I think, yeah, I mean, in many ways it is. I mean, that's how capitalism works. And we've seen it time and time again, uh, is there's investment opportunities, uh, you are compelled as a company to invest. You don't really know what your competitors are doing, but they're copying. And so you get this massive overcapacity. Uh, we saw that with fiber optic. And you think back to Global Crossing at the end of the '90s. I mean, Global Crossing was one of the big IPOs that came in the late '90s. Uh, within 5 years, Global Crossing was in Chapter 11 because the prices of fiber optic had dropped by 80, 90%. And, you know, it could easily happen again. Déjà vu.

Marty Bent [6:59] Yeah, that's the thing. It's, well, is it déjà vu? Is it like, is this time different? It's like famous last words.

Michael Howell [7:07] You should quote yourself, please.

Marty Bent [7:10] That's like, I've been really trying to wrap my head around this because as somebody like we were just discussing too, we've been using, you were using the tool I was mentioning the newsletter that you released today about Bitcoin and cryptocurrencies and where they may be in their cycle. But you were mentioning that you ran an analysis using these AI tools. I've been using AI here at TFTC pretty vigorously. My usage is going up considerably as I find more things that I can do with it. And that's a lot of people basically tying it to the dot-com bubble. It's like, is it really? And then you look at the PE Forward PE ratios of the memory stocks specifically out of South Korea, and they're only trading at like a four. If you look at the the revenue and profitability and margins, they're going up considerably. And it's like so how what I agree with you. This is how markets work and capitalism works. I guess the better question is like what stage of the bubble are we in? Even though we've had incredible sort of runs in the stock market for individual stocks, obviously Korean stock market's getting hammered. this week, but before then, like, is this just a correction, um, in a longer-term bull market?

Michael Howell [8:28] Yeah, I mean, I think it's still above its 200-day moving average. It still looks as if it's, you know, potentially in a bull market despite the spike in the, um, in the index. But, you know, I think you've got to separate out earnings and you've got to separate that from valuations. And, you know, we're probably jointly in a valuation bubble and an earnings bubble. The earnings bubble may go on, uh, as you correctly say, for, you know, some time, uh, because the momentum is there.

Marty Bent [8:51] People spending.

Michael Howell [8:54] Um, AI is a reality. Uh, I'm using it, you're using it, a lot of people are using it. Uh, it's going to be a must-have and a must-use in the future. Uh, will it have big productivity benefits? I'm, I'm not, you know, I'm not sure about that. I mean, probably the answer is yes. I'm not, you know, fully qualified to answer the question, but the fact is that it's inflationary in the near term because of the scale of the capital spending. And we know that capital spending booms are always inflationary. And yet we've got another one here, which is basically pushing up in GDP and ultimately inflation. So I think those are the factors to watch. And then if you look at valuation bubbles, I mean, those are always ended by central bank tightening. So we revert to what Kevin Walsh is likely to do. But I think his hands are largely tied by the bond markets. And the bond markets, in my view, drive what happens at the policy end. And the bond markets are telling us that you're going to be seeing monetary tightening.

Marty Bent [9:48] Has this CapEx, this AI CapEx boom, have you noticed it affecting the Global Liquidity Index or trends in it?

Michael Howell [9:57] Yeah, I mean, there's no mistake that it has. I mean, you know, I can revert to— let me put a slide up and try and show that if we can see. Hopefully you can see the deck. What this shows is the global liquidity cycle. This is a measure of momentum of money flow through the world economy. Uh, it's not M2 or any of these, uh, what I would call retail-based or real economy measures of money. This is money going through financial markets. And what you can see is an inflection that occurred around the end of Q3 of last year. Uh, bear in mind, this is a growth rate, not a, not a level. But the growth rate has clearly slowed down a lot. And that slowing was not because central banks were tightening, because they haven't really started to tighten yet, as we know, just on that point. It's really turning down because all money that's anywhere must be somewhere. So if it's in the real economy and it's fueling strong economic growth, it's not there for asset price appreciation in financial markets. And that's really the reality. And so what you're seeing is a downswing of the cycle. as you would expect at a time when the real economy is picking up, and things like commodity markets, hard commodities have got momentum. And that's a very normal cycle. And what you'd expect to see through this phase on top is flattening yield curves, which is exactly what we're beginning to see. So everything, the dots join up. And you could always argue on top of that, that you get bubbles around the peak, and maybe the The semis or whatever bubble, or even the Mag 7 bubble a bit earlier, are symptomatic of that excess liquidity.

Marty Bent [11:43] Yeah. In February, you said it looks like we're going to trough in mid-2027. It looks like we're right on trend.

Michael Howell [11:49] Yeah, it's looking that way. I think there's another chart I can show you, which is actually a lot— I'm going to come back to these other ones, but which I just wanted just to touch on, which I think is an important one, a little bit further up. This is 2-year yields and SOFR rates. What this is basically telling us is that the orange line is what the Treasury market, the 2-year note, is signaling in terms of yields. That pretty much embeds expectations for Fed policy rates over the next 2-year period by definition. The black line is looking at overnight SOFR rates, which is effectively the rates in the repo markets. Now, that difference is an interesting difference to note, because the orange line tends to be a lead indicator of movements in SOFR rates, overnight rates. You can read the overnight rate as equivalent to Fed funds. That's pretty much what the Fed is seeking to guide. If that's the proxy for Fed funds, the orange line is a proxy for what the market is expecting the direction to be. Now, I actually ran this data, talking about AI systems, I ran this through an AI system. And I said, if you look historically, uh, how many times has that orange line, uh, on the upside or the downside, when it breaks through the black, proved a false flag? And the answer was it basically, uh, is a false flag only 10 to 15% of the time. Now, that's kind of interesting. So in other words, 80 to 85%— sorry, 85% of the time, let's say, to 90% of the time is correct. And That's an interesting point when you look at this chart. This is looking at the history of what happened in 2021-22. The black line is the same difference between the SOFR and the 2-year yield. In other words, if you subtract on that earlier chart, the one I just put up, if you subtract the black line from the orange line, you get this one, which hopefully you can see now. Right, so now this says, so for less 2-year yields. So this is just subtracting one from the other. And the orange line is the current period, the '24-'26 cycle. And the black line is what happened in 2020 to '23. And you can see the path of what happened in 2021-'22, where the black line starts to crater lower. And that is basically saying that the 2-year note is flagging. correctly increases in interest rates as the Federal Reserve tightens policy. You can read anything below that dotted line as being a monetary tightening, and anything above that dotted line as being a monetary easing. Now, if you look at the path that we're on, we're pretty much tracking what happened in late '21, early '22, where you start to see an acceleration now in monetary tightening, I think that is more or less what the Federal Reserve is suggesting from what we know, the non-forward guidance forward guidance. If that's the case, just recall what happened. The S&P was down 25% through that period in '21, '22, and things like crypto were down 75%. Now, crypto is already down heavily. It could fall further, but I think we're getting nearer the lows on those assets. But generally speaking, this is not going to be good for other risk assets like stocks that certainly haven't discounted this move yet.

Marty Bent [15:28] Yeah, it's interesting. We're seeing the spreads here between SOFR and the 2-year blowout. And then if you look at just corporate debt CDS, it looks like rate spreads are exploding there as well, particularly at some parts of the AI sector on the infrastructure side. So it looks like what we're seeing at the Federal Reserve is happening in the private market as well.

Michael Howell [15:55] So, what that's basically showing is nominal GDP growth in the US. Let's just run through this, because I think this is critically important to understand. So, what you've got is a very long-term history here of US 10-year interest rates. So, this is a 10-year Treasury note basically shown here as the orange line. It says risk-adjusted. What I've done here is I've taken out term premium, because this gives you a clearer idea of what the underlying interest rate expectations are. The black line is looking at nominal GDP growth, so NGDP. I've used here a 4-year moving average. In other words, what that's showing is the trend in the economy. Now, the point about the chart is that you can see that long-term history from 1955 onwards. That was pretty much the period just after the Treasury-Fed Accord when the Federal Reserve had a lot more independence in terms of monetary policy. You start to see the US long bonds starting to catch up, the yields starting to catch up with the underlying growth in the economy, normal growth in the economy. Then you see the overshoot back around in 1980 when Volcker— '79, '80 when Volcker came in. And then you see a long period of decline in both yields and nominal GDP, but yields basically are running above nominal GDP. And you get to the current situation where there probably was an inflection in that curve again around the GFC, where you start to see the black line, which is driving the whole system, which is nominal GDP, starting to move up strongly. And what I've done here is I've added latest data to the nominal GDP and extrapolated it using consensus projections. What we're looking at is probably an average rate of growth somewhere around 6% to 7%, or let's say, to be generous, between 6% and 8%. You can see where the long bond is currently trading, and the dotted line indicates the direction of travel. It looks as if you're going to have to see higher yields. And if you don't see higher yields, you're going to see much slower NGDP growth. But it seems to me, given the fact that the fiscal taps are open, that there's a big amount of AI spend still to go, and the economy looks pretty robust in my view, NGDP or underlying economic growth is not going to fade at all. So, we're looking at upward pressure on the bond market. And if that's the case, the Fed is going to have to struggle hard to basically keep yields down. That will require a lot of yield suppression at the long end if they manage it. It will require keeping the front end very liquid and pushing a lot of borrowing into the front end, but that's going to put a lot of pressure on front-end rates like repo rates. That's going to be incompatible with the Fed funds target of where it is now. It looks as if, by my reckoning, The strong economy is going to be driving the Fed towards higher rates. And we can already see that trend towards monetization in the M2 data, where, as I said, the M2, whatever it was a month or 6 weeks ago, was on a roll, was on a tear at nearly 10% 3-month annualized growth. That's telling you a lot about the state of the economy and inflation pressures. And if Walsh pays attention to money, which he says he does, he thinks money has a role in monetary policy. then the FOMC are going to take this on board.

Marty Bent [19:32] Yeah. Well, that begs the question, what is the fiscal side? What does the Treasury think of all this? Because they have to manage the interest expense on the debt. Obviously, we're approaching $40 trillion and have a ton of debt to roll over. And so it's like this weird situation where the economy's hot, we've got to invest. I mean, it seems that the administration here in the US and over across the Pacific in China view this race is existential. So it seems like they're going to throw everything they have at winning the race towards AGI if that ever manifests. At least that's the narrative right now. And so it seems like you have a situation where you have to put your pedal to the metal to keep this build-out going in this infrastructure and reindustrialization effort going, but you also have the looming debt situation, which you could see spiraling out of control and the interest expense going up pretty rapidly and hitting levels that were unfathomable a decade ago.

Michael Howell [20:41] Yeah, I think absolutely, I agree 100%, Marty. I think that we're in a regime change. And I think that regime change is probably colored by the whole notion of either you call it trade wars or more accurately capital wars. And the whole point here is that under a capital war regime where there is competition between capitals, you are likely to see much, much higher end GDP growth. In other words, the underlying economy in nominal terms is expanding at a rate probably at least 200 basis points, in other words, 2 percentage points higher than where it's been in the past. And governments are deliberately pushing this because they want AI, they want competitiveness, they're going to restrict whatever exports they can to rival capitals, which is clearly in train. They're going to try and preserve what access they can to energy, which is clearly a vital resource. I think we're seeing that play out. And what that means is there's got to be a lot more CapEx spend generally, whether it be on aggressive moves like AI or defensive moves like securing resources, holding higher inventory, warehousing more, whatever it may be, onshoring. And that is going to mean faster NGDP growth, and it's going to mean higher bond yields. And that's the problem you've got in the system right now. And the reality is that if you've got strong economies, red-hot economies, or probably I exaggerate by red-hot, you've got strong economies. The fact is that going back to the adage, all money that's anywhere must be somewhere, if it's in the real economy driving growth, it certainly is not in the financial economy driving assets. So we've got to be very conscious that it may be an air pocket in risk asset prices.

Marty Bent [22:23] Yeah. What are your thoughts on the quasi— I mean, it's like wartime footing here in the United States. The Trump administration is taking equity stakes in a lot of these companies. And that signals to me that this is very much existential. The government's getting To build on that last comment you make, the air pocket in risk assets and equities particularly, it's just, again, regime change, inflection point, fourth turning, put whatever label you want on it. It's just trying to wrap my head around how much liquidity they could bring to the markets. You could see a situation where they need to facilitate the CapEx boom and the expansion of NGDP. But at the same time, you have the government sort of backing Dell, Intel, rare earth metal companies, and I'm sure the list of companies that they've got direct equity stakes in is going to grow at some point in the future. And so it looks like they're trying to backstop the companies that are critical to this buildout as well. And I'm just trying to figure out if The government doesn't care really what the stock's trading at, but they want to signal to the market like, hey, we're going to be backing up these companies by doing whatever it takes. Yeah.

Michael Howell [23:53] And China's doing the same and Japan is doing the same. I think these are really the leaders. Europe has got to wake up to this. Europe hasn't embraced this model yet, but they're going to have to at some stage. But this is it. You're building national champions. And you'll be owning security. And I think the US being first and foremost in that race, or actually maybe arguably China was first and the US is copying, but the US has got a lead at the moment in many areas. But clearly it's a competition.

Marty Bent [24:23] So with that competition in mind, comparatively with the 3 players that you mentioned, Japan, China, and the US, how would you rate the success of the strategy of each individual country?

Michael Howell [24:41] Well, I think that it's a difficult question to evaluate how this is going to fall into line. But the US has clearly got, at the moment, an advantage in AI and in energy, or generally technology and energy. China is catching up on the technology area fast. It's going to be hard pushed to secure energy, but then it does have another advantage with rare earth minerals.

Marty Bent [25:07] Yeah.

Michael Howell [25:07] So that's a factor. And we know that China's got this huge, I say, dormant labor force that it can still engage and basically mass-produce manufacturing at low cost. And that's clearly a threat. What does Europe have? The answer is Europe has pretty much nothing. It has history, and that's it. Japan basically has the ability, I think, after some restructuring, to be a bulwark against China in the region. But at the end of the day, we've got to accept the fact Japan probably is too small to make that much difference. But it's clearly there, and it's having an effect, and the Japanese economy is being restructured. But you can see the impact that's having already on the Japanese bond market, where yields have jumped at the 10-year level by over 200 basis points in the last couple of years, from 0.5% to 50 basis points. to over 2.5%. That's a big move in the bond market. That's clearly going to have an effect because when I was at Salomon Brothers, the adage was always in financial markets, there's no unrelated event. If you've got rising yields in Japan, that's going to be a magnet for capital to pull that elsewhere, pull that out of other places. The public pension fund was already being directed to invest more in Japanese bonds. That could have a material effect globally.

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Michael Howell [28:54] Yeah, I think that could be the case. I mean, I'd say that I think the whole idea of the yen carry trade was always exaggerated. I mean, it was big a couple of decades ago. I mean, I think it's— in my view, it's a lot smaller than it is now. It's not really the force it was. That's not to say that the Japanese are not big investors internationally. They clearly are. But they have a big impact on European markets. They are, I think, the biggest foreign investors in France. And if you look at the OAT market, which is the French government bond market, the OATs are trading at increasing premiums to German bunds. And that may tell us something about the risks of Japanese investors pulling out. So there are no unrelated events in financial markets, and there are even fewer in the bond markets. These things are joined up. These markets are joined at the hip. And therefore, if yields start to expand, they're going to have a knock-on effect. And that's what I think we're seeing. So you can't, you know, can't take the US or Japan or whatever as isolated examples. Bond yields generally are rising everywhere, with the one notable exception being China, uh, where China is basically— where yields are still depressed. But that really reflects the fact that the Chinese economy is on its back, um, and it's struggling to survive. I say it's trying to survive, overrating it, but it's struggling to grow at a decent pace. And it's wholly dependent on export growth.

Marty Bent [30:12] And so do you think Trump's tariffs and export controls are having an effect there, or is it a number of things?

Michael Howell [30:22] Yeah, I think that's right. I mean, it's, you know, they clearly, they clearly are having an effect. And yeah, and what's happening is that China is being forced to go elsewhere into Europe or into Central Asia or whatever, so-called, or Latin America. Africa as well. But these are increasing tension points. And Europe is facing the full thrust of Chinese competition. And that's not going to be a happy place in the next 2 or 3 years. You're already seeing a lot of instances of big German companies, Volkswagen being the latest, to announce large labor layoffs. And this just can't go on.

Marty Bent [31:02] No. I mean, if you think of the buying capacity of those other countries that China's going to have to go to, it's nowhere near US consumer buying capacity. Yeah, correct. Yeah. I mean, yeah, it makes sense that it would be on its back. And so what are your thoughts on Europe? Has Europe woken up to the fact that it has been woefully behind and severely underinvested in critical industries and is very much overregulated, preventing European entrepreneurs from competing Well, I think tick all those boxes.

Michael Howell [31:36] And it's overtaxed as well. And it's got an overly generous welfare state system. And at the end of the day, this is incompatible. I mean, you simply can't do it. It ticks all those bad boxes. I think that's for sure. But I mean, we're at a stage where the whole welfare system of the West has got to be radically rethought. And we've inherited a system whereby it's the aged who get income support, it actually should be the young who get income support. Because you go back 50 years when the Social Security net was first put in place, if someone retired age 60, 65, they probably had maybe a handful of years to live with no income at all. And so the whole notion of pensions made tremendous sense. Now, they've got large pension pots. They're very generously catered for. They're among the wealthiest in society. Paying them additional pensions seems to be not the right thing to do, whereas younger people, new entrants of the labor market, graduates, et cetera, find it very difficult to make ends meet. They can't get jobs. They're being forced out by AI. They're the ones that should be getting income support. So we've got to rethink that. But the whole issue is that nobody in the political sphere is keen to do that for the simple reason that there's an awful lot of gray votes out there. Yeah.

Marty Bent [32:58] Yeah. As a millennial, I feel fortunate to be in the position that I am. And I think millennials are better off than Gen Z. And it's something I've been observing for years and it's been bubbling up here in the United States, obviously in Europe as well. But you have this disenchanted generation of young people who— I mean, millennials who are already the first generation who will, I mean, as of right now, end up worse off than their parents. And it seems like Gen Z is going to be even worse in that regard. And just trying to think of the— I mean, taking all the numbers out of it and just thinking of the social side, the psychological side, it's one thing I worry about is this rising populism of the younger generations. And I think we're seeing a big bifurcation of the flavor of populism where you either have hardcore Nationalism, send them all back. We have hardcore democratic socialism, which is confiscate all the all the wealth and redistribute it.

Michael Howell [34:02] And yeah, you can just feel Europe. We're caught between both stools because there are big constituencies for both of those ideas, and I'm not too sure which way it's going to lean. But this polarization of politics is what we've seen many times before. You go back to the 1930s, and you know if you think about. the fascist regimes, were they right-wing or were they left-wing? I mean, there's some of each, but you go, you go to extreme politics in that environment. And that's the sort of, uh, you know, this is the economy that we're currently building, certainly in Europe. I think, uh, the US may be a different, a different shape, but I mean, I think the whole K economy, uh, speaks to this problem as well.

Marty Bent [34:40] Yeah. And then it doesn't help that you have the, the leaders of the AI, the leading AI companies saying, yes, not only is this going to take all your jobs, but this technology is extremely dangerous and we need to make sure that we get regulatory moats so only we can build it and distribute it and have these vertically integrated surveillance tools to bring in your AI overlords. So the narrative from the leading frontier labs is very perplexing and I don't think it's good for for their brands, and obviously not good for affinity from— if you're trying to build affinity with younger generations specifically. Yeah.

Michael Howell [35:25] But I think what this then comes back to is the $64,000 question about what next. And you basically find that if governments are unable to cut back on the state, which Turkey has never voted for Christmas, of course, so they don't want to do that. They're reluctant to reform Social Security or welfare payments because there are too many votes behind it. The bond markets are pretty much saying that they're fed up with issuance. They're not going to support any great increase in bond issuance going forward, or there are limits, or there's a price for everything, but there are limits clearly. taxation at a rate way too high, tax rates are way too high, then the path of least resistance is basically printing money. Now, this is what we're seeing more and more evidence of. It's coming in a very subtle form. It's coming in a form which is wonkish in the sense that you've got to be caught in the weeds to understand what's going on. But broadly speaking, what you're seeing is more and more evidence. This is led by— this was originally the policy of Janet Yellen, was to do so much funding at the short end of the market. And so what the, uh, what the US Treasury has been doing has been basically funding the deficit, uh, the growing deficit of course, with more and more bills. So you've got 80% of US gross issuance now which is under 2 years, which is an eye-wateringly large figure. And it means that every week the US government has to auction, uh, something like half a trillion dollars plus, uh, of, uh, of, um, of debt. bills and coupons. And that is a big ask for the financial markets. Now, that's only going to get bigger. But the point is, the question, the key question to ask is, who buys that? And the answer is, it's largely banks, because banks love short-dated government paper because it matches the liability duration of their balance sheets almost perfectly. So if you're running a big fiscal deficit, which everybody is, bank accounts are being swollen because the government's issuing checks. The banks have got to find some asset to offset that, and what better than a short-dated government paper? That's what they're buying. Bank balance sheets are expanding alongside fiscal policy expansion. If the bank balance sheets are expanding, that is called monetization of debt. That is exactly what's going on. That's printing money. It's just a rather more prosaic version of the printing press's worry, but it's the same thing. And that's why you've got strong monetary growth figuring, and that's going to be a feature of the landscape in the next few years. Now, the question is, and this is the point that you mentioned in a Substack we wrote today, is to say, well, okay, if you're an investor, how do you protect yourself against this future monetary inflation? And monetary inflation, just read that as devaluation of paper money, destruction of paper money, which is going on. And as I say, this is not just hitting the US because everyone's on the same game. The US tends to be leading. As I say, it's 80% of gross issuance. In Germany and France, it's 45% to 50%. In Britain and Japan, it's about 25%. But that 25% number is going to be a lot higher in 2 or 3 years' time in both economies. So we're moving in the same direction towards more and more bill issuance, front-end issuance, printing money, monetary inflation. is a big problem. That's how your wealth is destroyed ultimately. So, you need protection. And the best protection happened to be cryptocurrencies, because they tend to have the greatest sensitivity of any asset, even more than precious metals, to money printing. And that's what they've demonstrated in the last 15 years.

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Michael Howell [42:21] Let me just try and see if I can do that with a— that should be there.

Marty Bent [42:25] Yes.

Michael Howell [42:26] So what that is, is this is looking at weekly changes. It looks a very busy chart, but this looks at weekly changes, 6-week changes, in fact, in global liquidity, which is the GLI dollar side. And BES, which is Bitcoin, Ethereum, Solana, in a 60%, 30%, 10% weighting. So that gives some broad measure, imperfect but broad measure, approximately right measure of the crypto universe. And what that's showing is the 6-week changes compared. And what I've done is to advance the global liquidity line, the black line, forward by 13 weeks, i.e., 3 months, to show that it's a predictive indicator. What that shows is that the tracking is remarkably good. It's good until it isn't, of course, but it's been not a bad steer so far. What that indicates is that the 2 assets have moved very closely together. Now, if you look at the sensitivity of that basket, the BES basket to liquidity, in comparison, the sensitivity of gold would be about 2 times, gold and silver, let's say, on average about 2 times. In other words, every 10% increase in liquidity means something like a 20% increase in precious metal prices. In the case of these assets, crypto, it's about 8 times. So, what you find is that for every 10% move in liquidity, you get 80% move in cryptocurrencies. And that's what history has shown. That's been remarkably stable. So, it isn't just a sudden experience. It's been remarkably stable over time, as we show in that report. And the key thing is, if that is sustained, assuming it is, you need very little crypto in a portfolio to give you pretty comprehensive coverage or protection against monetary inflation. You only maybe at most 5% of a portfolio in crypto, and that gives you a pretty good insurance policy. And 5% is probably something that people are prepared to risk anyway. But there could be quite a lot of upside if you get a monetary inflation boom, which I think is inevitable given the fact that governments have basically run out of money. They can only print it, and they can print money. If you're comparing dollars with yen, or dollars with Swiss francs, or dollars with pound sterling, you don't want to see that move particularly. But if you start looking at dollars against things like gold, or commodities, or hard assets, you'll see it immediately. But the best hedge is going to be, from experience, is going to be cryptocurrencies. That's what the data says.

Marty Bent [45:10] Can you walk me through this? You wrote today, the R-squared exceeds 32%, implying that almost one-third of the variation in the crypto basket can be linked directly to changes in global liquidity.

Michael Howell [45:20] And so, yeah, so that, that's what this data is showing. And what it says is, I mean, in statistics, um, you can clearly never— you can never prove causation, you prove correlation, or you can establish correlation. We've tried to prove causation through another mechanism called— which is a wonkish idea, but it's called Granger causality testing, which is showing whether you get consistent leads in the data from a shock to liquidity, whether it comes through, passes through into crypto. And the answer is it does. But the R-squared is more a test of correlation. or association. And the way to read an R-squared figure— and that's just the R correlation coefficient squared— is to say that gives you an idea of the extent of the variation in the data that is explained by the other variable. So if you've got an R-squared of 50%, 50% of the variation would be joint variation between those 2 factors. So you've got commonality if you like. What this is saying is a 30% or so R-squared is saying there's a common factor which you can associate, which is driving those 2 factors, those 2 variables. It looks as if global liquidity is a key driver, consistently key driver of crypto. Now, although people may pick me up and say, well, of course, 30% is not 100%, and I fully take that, anything that in financial markets, anything beyond about 5% to 10% is considered to be extremely extremely powerful, you can make money out of that consistently.

Marty Bent [47:01] That's going to— well, do you have any inclination of what the other drivers are outside of just natural adoption?

Michael Howell [47:07] Yeah, we did an analysis some time ago of actually looking at what goes on. And broadly speaking, the other factors, the other important factors, if you broke down the degree of variation in these things, the other factors were risk appetite, And we proxied that by looking at something like NASDAQ to say that if there's a euphoria towards tech or whatever it may be, you can find that will influence crypto. And the other factor, which— or the other 2 factors, in fact, were both associated with gold and precious metals. And what they basically said was that if you get— and this is a mathematical result, But he said there's like an error feedback system with gold. And what it basically means is that in the long term, gold and Bitcoin and other crypto are correlated very strongly. So, in other words, they both trend together. But in the short term, they're negatively correlated. So, it means that they trend together, but they cycle apart. So, those are the other factors that come into it. So, you've got, if you like, 4 factors in that cocktail. You've got global liquidity, which is the dominant part. that accounts for about 45% or thereabouts of that total variation, or that pie chart, if you like, of the variation. Then you've got gold in the short term, the anticyclical effect. Then you've got gold in the long term. And then you've got risk appetite effects. So those are the 4 factors that we found were dominant in the case of crypto.

Marty Bent [48:46] Yeah, we saw confirmation of one of those factors in February, March of this year when gold was screaming. above 5,300, and Bitcoin was crashing.

Michael Howell [48:55] Yeah, and that's right. So what happens is that there seems to be an arbitrage between the two. Now, the way that I would read that, or the way that I would say all that is that— and maybe I can demonstrate— what that chart should be looking at is 2 lines, an orange line, which is the gold price in US dollar terms. That's now a little bit out of date, but it's not bad, actually. It's measured on the right-hand scale, but it's measured in, um, uh, in renminbi. And the black line is looking at PBOC liquidity. So that's the People's Bank of China's liquidity injections. Now, basically what that is trying to demonstrate is that the two are very closely linked. And what it says is that as you get an increase in Chinese liquidity— Chinese liquidity is the key driver by far of the gold price. So a lot of the debate that one was hearing in the markets earlier on this year was to say that the gold price is being driven up by the great debasement trade. And everyone was jumping on this bandwagon to say it's because governments in the West are printing money that the gold price is soaring. And that's just simply not true. Because in actual fact, governments weren't really printing money to any great extent. And what money that was out there was being increasingly siphoned away into a stronger economy. Which was exactly what Bitcoin was telling us. Now, what was driving the gold market was China. And China was basically pumping in lots of liquidity, as you can see here by the black line. And that was driving the gold price up. Now, why are the Chinese doing that? The Chinese are doing that for 2 reasons. Number one is that they need to devalue the yuan currency, their RMB currency, the yuan, internally because of their huge debt problems. So, what they need to do is to get the price level and the wage level up to basically devalue debt. And that debt is a millstone around the Chinese economy's neck. And that's one of the reasons that the Chinese economy is so sluggish right now. The other thing that they're doing is they're trying to rival the US dollar externally. So, you've got to think of China as having 2 almost independent exchange rates, an internal exchange rate and an external exchange rate. And that external exchange rate is protected by capital controls, protected by the big forex reserves that China has, and protected by compliant state banks who do a lot of the intervention. And what that means is that they can keep— they can have their cake and eat it, in other words. Now, the reality is that they can therefore print money domestically, which is reflected in a rising gold price. Recall that Chinese are not allowed to buy crypto. That's illegal. and it's been made illegal. And the Chinese have doubled down on that this year. And that means that money finds it very difficult to seep out of China. So, where the vent is, clearly the gold price. So, China is driving the gold price, but the US and other countries through global liquidity are driving crypto. And because liquidity globally is going down, that's why you've got that Picture now, I'm going to show you one more chart if I can, which is basically looking at what has happened. Hopefully, you can see this chart, which is looking at what the People's Bank of China has been doing on a granular daily basis. Now, if you like conspiracy theories, Marty, this is this one's right up there, and what it says is that if you look at the size, the daily size of the Chinese. People's Bank's balance sheet, which is measured here as this solid line. The dotted line is simply a moving average, a 50-day moving average to show the trend. That shows you what is happening to their balance sheet every day, basically since late last year. It peaked essentially 2 days after the tensions in Iran Began, right? It then dropped to a low point, which was more or less on the on cue with the signing of the MOU. Whether MOU still exists or how fragile it is is a moot point. But that's when they started to change direction. So it looks as if for that virtual three-month period, they cooled deliberately cooled their economy. Now the Chinese have form here because they did exactly the same thing in 2008 ahead of the Beijing Olympics. Well, they wanted to cool the economy to slow pollution, which was likely to spoil the showcase event. So, they slowed the economy deliberately. And they're doing it again now, or they have been doing it again, presumably to preserve oil and to reduce their oil import bill by cooling the economy down. And that seems to be what they've done. And if you look through that period, what have you seen? You've seen very weak Chinese financial markets. You've seen bond yields crater. You've seen the stock market sell off. You've seen economic data coming weaker. And it looks as if now they're starting to goose the economy once again by printing more money. And that may have been a short-term interregnum that was agreed with the Trump administration that China would do this. I simply don't know. But it looks as if that's what they've been doing. And therefore, if this is correct, what you should start to see now is evidence that the gold price should be beginning to form a bottom. Now, proof of the pudding will be in the eating, but let's see.

Marty Bent [54:35] Yeah. And talking about seeing, you just pull it up now because I was looking at it while you're doing that. It looks like, I mean, we're here hovering around $4,000. Looks like $4,000 is good support for it right now since going back to late June. So July, it's been relatively flat, which is interesting.

Michael Howell [54:53] Yeah, so that pretty much accords with that signing of the MOU. What I would say is that let's not be too hasty, but at the end of the day, you want these monetary inflation hedges, and gold may be the leader because China is injecting liquidity right now and trying to support that. If you look at the announcements that the PBOC is making, it seems to be deliberately trying to get more liquidity into their money markets. And they make announcement after announcement each day to say they're adding more funds. So I think there's a clear remit there to do something. So I'd be watching the gold price because I think that's a pretty good barometer of that.

Marty Bent [55:30] And you alluded to, I like to dabble in conspiracy theories from time to time, Michael.

Michael Howell [55:36] And we all do.

Marty Bent [55:38] I think it's interesting if you view everything going on in the world right now, whether it's AI, Iran, as a proxy between the US and China, That is an interesting lens I like to put on just to think about what may actually be happening. And if you consider the flip-flopping on the MOU specifically, maybe it's Trump trying to just throw a wrench in the Chinese trying to turn their economy up and play that game. And that's the question, who's reacting to who? Is China reacting to the US? Is the US reacting to China? I think based off of that chart, it would be clear to me that China's reacting to what the US is doing. And if Trump knows that, is he using this war as a way to push China around to an extent. Could be. Yeah. Yeah. Bringing it back to Bitcoin, I think you wrote in today's newsletter, may have a couple to a few more months to find a bottom, but then all these monetary factors that we've been discussing for the better part of an hour now, should express a higher Bitcoin price after that. Yeah.

Michael Howell [56:49] My view is, look, there's no alternative but monetary inflation. And at the end of the day, one can be cynical and say, look, if you're a politician, would you accept a regime, a future regime where you've got, let's say, 100 to 200 percentage points faster Main Street inflation? Um, you probably would. Uh, you could disguise that in various ways, or you could dumb it down in terms of your rhetoric and try and pretend, um, you know, extend and pretend and whatever, and say it's around 2 to 3 or whatever they, they come out with. But in reality, it's a tad more. And I think that's the reality we've all experienced over the last 5 years, that inflation simply ain't the 2% that the Fed has been targeting. Uh, it's higher than that. It's probably appreciably higher. But what that means is that if Main Street inflation is running at, let's say, 4 to 5, monetary inflation or asset price inflation is running at a figure which is another 200 to 300 basis points higher, maybe 7 to 8% per annum. But after all, that's the likely growth rate path of US federal debt. Now, US federal debt has been a great proxy for the gold price over the last 25 years. So if you look to what the debt load has done, I mean, the debt load is up, you know, whatever it may be, 12 times over that period, uh, over the last 25 years. Uh, the gold price is up a similar amount, if not a tad more, uh, and Bitcoin is up considerably more. Now, what I'm trying to say here is that the trend— you know, you've always got to pay attention to cycles in markets for sure, but you've also got to think about the long-term trend, uh, particularly if you're a younger generation. You've got to think about this, and you need ways of protecting your wealth. Now, monetary inflation hedges in a world where we're likely to get monetary inflation, a lot more of it, uh, for the reasons that I've already suggested, uh, has clearly got to be part of your investment outlook. And, uh, you don't need to have 100% in gold, uh, you need to have 100% in Bitcoin, but you need to have both those assets. And you probably need to have a decent amount in crypto because that is the best monetary inflation hedge according to recent history. it's 4 times better than gold or silver. So, that's what I would be thinking about. And buy the weakness. No one's ever going to get the bottom. Clearly, it's dangerous, as they always say, to catch a falling knife. But once you start to see some stabilization, it's worth going back in.

Marty Bent [59:14] Yeah. And it's funny how emotional people get. I've been in Bitcoin for 13 years now. I've been through many of these cycles. It is It is funny how people will just discard it and throw it away once the price falls a little bit. We're down, what, like 40%, 45% from the top of last October, November, and it's not even been that long. I mean, a year in markets is not that long, and it's funny that people will give up on something after a bit of a correction. We're actually looking at this bear cycle on Bitcoin it's shallower. And if we are forming a bottom here and going to begin climbing higher this fall and winter, it would be probably one of the shortest bear markets in history too, if that does manifest. Yeah. Last question. Do you think there's a— when we hit $40 trillion in national debt here in the United States, do you think that level has a psychological trigger that sends people, or do you think it's just a another number that we hit and nobody really cares.

Michael Howell [1:00:18] I think it's another number. And what it means is we're going to get to $50 trillion in a shorter space of time. I mean, that's the reality. The fact is that there's no way to curtail debt unless there's a radical overhaul of government. And that's simply not going to happen because we're in an era where we need big states for the reasons that I've said, capital wars are there, and you need an active state. China has an active state and others are copying that same model in many ways. Call that a state-led capitalist system. I don't know whatever you label it, but it's a reality. It means the state's got to be bigger and more active. It's got to take bigger stakes in industries. It's got to have its fingers in many more pies. It's got to direct trade. It's got to encourage investment, et cetera, et cetera. And at the same time, it's got to pay the welfare bills, and the interest bills, and the defense bills. And that's going to take either more taxation, um, more debt issuance, or more money printing, and you choose. And my view is that the path of least resistance to our politicians is printing more money. And they can do that either directly or they can do it subtly. And they do it subtly by issuing lots of short-dated bills, lots of Treasury bills. And that's exactly what they're doing. So bear in mind that 80% of US gross issuance now is under 2 years duration maturity. And it was, I think, 3 to 4 years ago that Stanley Druckenmiller, in one of his speeches, said, this is crazy. These are the numbers that you would apply normally to a Latin American economy. And here they are in the US. Well, that was 4 years ago, 4 or 5 years ago. We're now even more so. And in actual fact, the paradox is that some of the Latin American economies have actually cleaned their act up. So the US is going out alone, but the US is dragging everyone else with it. So Japan is doing the same, Germany's doing the same, France is doing the same, Britain's doing the same. Um, they're just a step behind, but that's— this is the new reality.

Marty Bent [1:02:14] Yeah. And I think the base— I mean, again, the, the stat that I mentioned before we hit record out of the UK, which is they've lost something like 600,000 millionaires since 2021, falling from above a million to below 500,000 in a 5-year period, is insane. So like to the 3 levers that you pull there. If you pull the taxation lever, you're just going to have an exodus of talent.

Michael Howell [1:02:38] And that's exactly what the UK has found.

Marty Bent [1:02:40] Yeah, exactly. Yeah. So debasement is the way. Better have hard assets. Michael, it is always a pleasure. Thank you for doing what you do. I mean, I say it every time you come on, but I will not relent in saying it. I love your newsletter, your Substack. Capital Wars is a must-read. I read it every time. It drops and it is a very calming, a calming force in my life just to zoom out and look at the overall trend and the cycle. So thank you for writing it and thank you for coming on.

Michael Howell [1:03:11] Well, it's nice to know. Thanks, Marty. Enjoyed it enormously.

Marty Bent [1:03:13] Thank you. Peace and love, freaks. Thank you for listening to this episode of TFTC. If you've made it this far, I imagine you got some value out of the episode. If so, please share it far and wide with your friends and family. We're looking to get the word out there. Also, wherever you're listening, whether that's YouTube, Apple, Spotify, make sure you like and subscribe to the show. And if you can leave a rating on the podcasting platforms, that goes a long way. Last but not least, if you want to get these episodes a day early and ad-free, make sure you download the Fountain podcasting app. You can go to fountain.fm to find that. $5 a month gets you every episode a day early, ad-free. Helps the show, gives you incredible value. So please consider subscribing via Fountain as well. Thank you for your time, and until next time.