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
This in-depth interview with Michael Howell, the "godfather of liquidity" and founder of Global Liquidity Indexes, reveals alarming warning signs for global financial markets. Howell's comprehensive analysis of over 90 central banks worldwide shows that global central bank liquidity is deteriorating, primarily driven by the Federal Reserve's tightening measures. (02:32) His proprietary Fed liquidity measure is weakening due to the complete drainage of the Fed's Reverse Repo facility, though this is partially offset by U.S. Treasury's massive short-duration bill issuance and China's unprecedented 7+ trillion yuan liquidity injection. (45:00) The conversation explores the growing East-West monetary divergence, with China backing its currency with gold while the U.S. pursues digital asset collateralization.
- Core theme: The global liquidity cycle is approaching a critical inflection point, with potential implications for all major asset classes including stocks, bonds, gold, and Bitcoin by 2026.
Speakers
Michael Howell
Michael Howell is the founder of Global Liquidity Indexes and the Capital Wars Substack, known as the "godfather of liquidity" for his pioneering work in tracking global capital flows. He began his career at Salomon Brothers in the 1980s and has spent over three decades developing sophisticated models that track liquidity data from 90+ financial systems worldwide. Howell successfully called the market bottom in October 2022 and the subsequent bull market in stocks, gold, and Bitcoin using his proprietary liquidity analysis.
Jack Farley
Jack Farley is the host of Monetary Matters podcast and previously hosted Forward Guidance. He specializes in monetary policy analysis and has been following Michael Howell's liquidity research for years, incorporating these insights into his investment approach. Farley focuses on connecting complex macroeconomic concepts with practical investment implications for his audience.
Key Takeaways
Fed Liquidity is the True Market Driver, Not the Balance Sheet
Rather than focusing on the Fed's total balance sheet size, investors should track "Fed liquidity" - the specific balance sheet components that actually create liquidity in the financial system. (06:33) Howell explains that Fed liquidity has been rising since late 2022 despite official quantitative tightening, but is now genuinely declining. This measure includes factors like the reverse repo facility, Treasury General Account, and other "wonkish conduits" that create or drain liquidity. The key insight is that markets respond to liquidity flows, not just policy announcements, and Fed liquidity typically leads the S&P 500 by about 25 weeks or six months.
The Debt-Liquidity Nexus Drives Modern Finance
Today's financial system operates on a fundamentally different model than textbooks suggest - it's built for debt refinancing, not new capital formation. (17:37) Approximately 70-80% of all financial transactions involve rolling over existing debt rather than funding new investment projects. This creates a critical dependency: debt needs liquidity for refinancing, while liquidity needs debt as collateral for expansion. When this balance breaks down - specifically when the debt-to-liquidity ratio exceeds roughly 2:1 - financial crises emerge. Understanding this structural reality is essential for anticipating market stress points.
China is Engineering a Controlled Yuan Devaluation Through Gold
China is deliberately targeting higher gold prices in yuan terms as part of a strategic currency devaluation aimed at maintaining export competitiveness. (53:33) Rather than directly weakening the yuan against the dollar (which would anger trading partners), China is injecting massive liquidity and driving up gold prices to achieve real exchange rate devaluation. This explains gold's relentless rise to over 30,000 yuan per ounce. China views gold as partial collateral backing for its monetary system, contrasting with the U.S. approach of using digital assets like stablecoins to support the dollar.
Treasury Bill Finance is "Stealth Monetization" of Deficits
The U.S. Treasury's shift toward short-duration bill issuance represents a form of quantitative easing that operates outside the Federal Reserve's official programs. (10:21) When banks purchase government bills (rather than individuals buying from savings), this constitutes balance sheet expansion and effective money printing. This "Yellenomics" approach creates liquidity by design since short-term bills are much more liquid than long-term bonds. The Treasury is essentially taking over monetary stimulus functions from the Fed, directing liquidity toward the real economy rather than financial markets.
Repo Market Tensions Signal Approaching Liquidity Crisis
Growing volatility in SOFR spreads (the gap between repo rates and Fed funds) indicates dangerous tensions in money markets that could trigger broader financial instability. (22:59) Howell's analysis suggests bank reserves are about $250-300 billion below adequate levels, causing increasing frequency of repo market spikes. While the magnitude of individual spikes matters less than their increasing frequency, this pattern historically precedes liquidity crises. The Fed's reluctance to restart QE despite these warning signs creates a potentially explosive situation where markets depend on debt refinancing but lack sufficient liquidity infrastructure.
Statistics & Facts
- China has injected approximately 7-8 trillion yuan into its money markets over the past year, representing one of the largest liquidity operations in modern history. (52:58) This massive stimulus is driving both the Shanghai stock market surge and the relentless rise in gold prices denominated in yuan.
- Approximately 77% of all global lending is now collateralized, a fundamental shift from pre-2008 trust-based lending according to World Bank data. (18:26) This transformation means the entire financial system depends on sufficient collateral and liquidity for debt refinancing operations.
- The U.S. structural deficit is projected to push debt-to-GDP held by the public from about 100% to 250% by the mid-2050s, based on Congressional Budget Office data with defense spending adjusted to NATO's 5% GDP target. (70:06) This exponential debt growth trajectory underlies Howell's projection for gold potentially reaching $10,000-25,000 per ounce over the next 25 years.
