The Liquidity Divergence Between East and West | Michael Howell on Deteriorating Federal Liquidity While People’s Bank of China (PBOC) Injects Stimulus and Pumps Gold
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Podcast Summary
In this episode, global liquidity expert Michael Howell of GL Indexes and Capital Wars Substack delivers concerning news about deteriorating liquidity conditions. (02:23) After successfully calling the market bottom in October 2022 and maintaining bullish positions throughout 2023 and 2024, Howell now warns that global central bank liquidity is weakening, primarily driven by the Federal Reserve. (02:40) His data from over 90 financial systems worldwide indicates that Fed liquidity is declining as the Reverse Repo facility drains and tensions emerge in US repo markets. (03:47) This analysis comes at a time when China continues massive liquidity injections of over 7 trillion yuan, creating a growing divergence between East and West monetary policies. (45:00) Howell's comprehensive assessment suggests that 2026 "won't be a great year for financial assets," marking a significant shift from his previously bullish stance that accurately predicted the current bull market run.
- Main themes: Global liquidity deterioration led by Fed tightening, China's massive monetary expansion driving gold prices, growing East-West monetary policy divergence, and warnings about potential financial market stress in 2026
Speakers
Michael Howell
Michael Howell is the founder of Global Liquidity Indexes and author of the Capital Wars Substack, known as the "godfather of liquidity" for his pioneering work in tracking global money flows. (30:16) He began his career at Salomon Brothers in the 1980s and has spent over three decades developing sophisticated systems that monitor liquidity data from more than 90 financial systems worldwide, incorporating AI and daily nowcasting capabilities. His expertise in cross-border capital flows and liquidity analysis has made him one of the most accurate forecasters of major market turning points, including his precise call of the October 2022 market bottom.
Jack Farley
Jack Farley is the host of Monetary Matters podcast and formerly hosted Forward Guidance, focusing on macroeconomic analysis and market commentary. He has been following Michael Howell's liquidity research for many years and regularly interviews leading financial experts about monetary policy, capital flows, and market dynamics.
Key Takeaways
Federal Reserve Liquidity is Genuinely Declining for the First Time Since 2022
Unlike the period from late 2022 through 2024 when the Fed appeared to be doing quantitative tightening but was actually injecting liquidity through hidden mechanisms, Howell's data shows Fed liquidity is now genuinely falling. (03:34) The key difference is that the Reverse Repo facility has been largely drained and other "not QE" mechanisms are no longer offsetting the balance sheet reduction. This represents a fundamental shift from the liquidity-supportive environment that drove the bull market since October 2022, creating real tensions in repo markets as evidenced by widening SOFR spreads against Fed funds rates.
China is Using Gold to Decouple from the Dollar System
China has injected 7-8 trillion yuan into its money markets over the past year as part of a deliberate strategy to create a "gold content system" rather than a gold standard. (48:47) Howell argues this is China's response to the threat of stablecoins and Western asset sequestration, allowing the country to back its currency with gold collateral while encouraging trade with commodity producers. The yuan-gold price has exceeded 30,000 yuan per ounce, surpassing Howell's earlier target of 26,000, as China deliberately devalues its debt burden against real assets while building an alternative to the dollar-dominated financial system.
The Global Financial System is Built Around Debt Refinancing, Not New Investment
Howell reveals that 70-80% of all financial market transactions are about refinancing existing debt rather than raising capital for new investment projects. (17:08) With 77% of all global lending now collateralized since the Global Financial Crisis, the system requires a debt-to-liquidity ratio of approximately 2:1 for stable refinancing. When this ratio becomes imbalanced, it leads to either financial crises (insufficient liquidity) or asset bubbles (excessive liquidity). Currently, this ratio is moving toward the crisis threshold as debt accumulates while liquidity growth slows, creating systemic vulnerability.
Monetary Inflation is Different from Cost Inflation in Modern Markets
Howell emphasizes the critical distinction between asset price inflation (monetary inflation) and consumer price inflation (cost inflation), noting that AI and technological advances are deflationary forces for costs while monetary expansion drives asset prices higher. (107:04) This explains how markets can experience significant asset price appreciation even during periods of low consumer price inflation. The current environment features both technological deflation in the real economy and monetary inflation in financial markets, requiring investors to understand this dual dynamic when making allocation decisions.
Interest Rate Policy Effectiveness is Diminished in a High-Debt Environment
Traditional monetary policy transmission mechanisms are breaking down because the federal government has become such a large recipient of interest payments, which function as transfers from the state to the private sector. (105:49) When the government pays high interest rates on its debt, those payments become income for bondholders, creating a stimulative rather than restrictive effect. This means lower interest rates might actually reduce private sector income by cutting these transfer payments, challenging conventional wisdom about how monetary policy affects the economy. The focus should be on liquidity provision rather than interest rate manipulation.
Statistics & Facts
- China has injected 7-8 trillion yuan into its money markets over the past twelve months, representing one of the largest monetary expansions in recent history. (52:38) This massive liquidity injection is part of China's strategy to reduce its debt-to-liquidity ratio and support asset prices, particularly in real estate and equity markets.
- 77% of all global lending is now collateralized, according to World Bank data referenced by Howell. (18:03) This represents a fundamental shift since the Global Financial Crisis, where lending is no longer based on trust but on collateral, making repo markets and the debt-liquidity nexus critical to financial stability.
- 70-80% of all financial market transactions are focused on debt refinancing rather than raising capital for new investment projects. (17:08) This statistic reveals how the modern financial system has evolved away from the textbook model of capital formation toward a refinancing-dependent structure that requires constant liquidity provision.
