- Global liquidity is a hidden force that can make or break a tech company's growth trajectory.
- Understanding the interplay of debt, central bank actions, and capital flows is crucial for navigating today's economic currents.
- A weaker dollar cycle could be on the horizon, presenting both challenges and opportunities for tech leaders.
When strategizing for growth, most technology leaders focus on product development, marketing, and sales. They rarely consider a less obvious factor influencing their success — global liquidity. Yet, the ebb and flow of funds through global markets can significantly impact a technology company's ability to secure funding, navigate economic fluctuations, and achieve its growth objectives.
“Debt needs to be refinanced,” explains Michael Howell, Managing Director of CrossBorder Capital, a leading advisory and research firm focused on global liquidity flows. “And in order to refinance, you need balance sheet capacity. And that's what we think of as liquidity.”
Many investors, particularly those focused on equities, may not fully grasp this concept. As Michael points out, “If you have come from a fixed income perspective, you understand that debt is a finite instrument, and it needs to be refinanced.”
Michael's career began at Salomon Brothers in the 1980s, and he's since become a recognized authority on global liquidity. He brings a unique perspective to understanding market cycles, emphasizing the often-overlooked impact of central bank actions, capital flows, and the dynamics of debt refinancing.
We invited Michael to join in another Global Macro edition of Top Traders Unplugged for a deep dive into these critical topics. We discussed inflation, interest rates, the U.S. Dollar, China, and more. Here are just a few highlights.
Liquidity: The unsung hero (and villain) of market cycles
Michael's central thesis revolves around the power of liquidity — the lifeblood of financial markets. He argues that liquidity, or the flow of funds through markets, exerts a more powerful influence on asset prices and economic cycles than many traditional economic indicators. “Broadly speaking,” Michael explains, “credit is extended into markets by the financial sector in a very broad sense. It's not just banks; it's also shadow banks that are important.”
This flow of money, both in the form of central bank actions and cross-border capital flows, creates a ripple effect that determines which assets rise, which fall, and the overall tempo of economic activity.
Michael highlights the interconnectedness of the global financial system, stating that “this has become a global phenomenon and it's facilitated leverage. And there's sort of the whole range of instruments that are available. So it's become a lot more sophisticated, but at the heart, it's really a flow of money or liquidity into markets.”
Understanding this flow is crucial for investors. Michael emphasizes that it's the momentum of liquidity, rather than the stock, that truly drives markets: “I've always come from the school that it's flows that are more important because markets are priced at the margin,” he says. “And so, what you need to look at is the flow of new money coming in or exiting a market. And that is what makes a big difference.”
To illustrate this point, Michael points to recent market volatility, particularly the sharp fluctuations in the Japanese Yen. While many attributed this to the unwinding of the Yen carry trade, Michael suggests a more nuanced explanation.
He believes that the Yen's rapid decline in early 2022 was likely an engineered move, possibly orchestrated to pressure the Chinese financial system. The subsequent rally, he speculates, could signal a “tacit deal done on currencies,” leading to a shift in the dollar's trajectory and a potential easing of monetary policy by the Fed.
The debt dilemma: A looming threat or manageable risk?
While liquidity fuels market cycles, Michael also expresses concern about the increasing mountain of global debt. He warns that this accumulation of debt, driven by factors like aging populations, rising healthcare costs, and increased defense spending, poses a significant risk to long-term economic stability. “The [global financial crisis] increased debt,” Michael observes, “COVID amplified that dramatically, and the aging demographics are rising. Government debt is going to increase significantly.”
The challenge lies in refinancing this massive debt load. As Michael explains, “You've got 350 trillion of debt in the world economy with an average maturity of five years. Which tells us you need to refinance 70 trillion dollars of debt every year — just to stand still.”
This refinancing burden necessitates a continuous injection of liquidity, leading to monetary inflation. He argues that if debt continues to grow at a faster pace than the real economy, as projected by data from the U.S. Congressional Budget Office, global liquidity will need to expand at a similar rate, effectively creating a perpetual cycle of monetary expansion.
He questions the prevailing belief that central banks can smoothly withdraw stimulus without causing market disruptions. Citing China's experience with quantitative tightening (QT) as a cautionary tale, Michael argues that the true impact of QT in the West might be masked by the U.S. Treasury's shift to shorter-term debt issuance.
“There's been no QT in the U.S. for 18 months,” Michael contends. “They've been pushing liquidity into markets.” This, he suggests, could create hidden vulnerabilities as large amounts of debt come due for refinancing in the coming years. He points to record low levels of term premium in the bond markets and the unusually wide spread between U.S. agency mortgages and 10-year bonds as evidence of this potential manipulation.
Furthermore, Michael highlights the potential social consequences of relying on monetary inflation to manage debt. He warns that this approach can exacerbate wealth inequality, as “you're increasing wealth for asset holders and wage earnings are losing out on the wealth.” This dynamic, he suggests, could lead to social unrest and political instability.
The dollar's reign: How long can it last?
The U.S. dollar, long the world's reserve currency, has enjoyed a period of remarkable strength. But Michael believes a weaker dollar cycle could be on the horizon. He sees the potential for a shift in the dollar's trajectory, driven by a combination of factors, including a potential easing of monetary policy by the Federal Reserve and a rebalancing of global economic power.
Michael points to historical parallels, such as the Plaza Accord of 1985, where a coordinated effort among major economies led to a deliberate weakening of the dollar to address trade imbalances. He speculates that a similar dynamic could be at play today, pointing to the recent rally in the Japanese Yen as a possible sign of a tacit deal among global policymakers.
“It could equally be,” Michael suggests, “that there was a deal struck that said enough is enough. We've achieved what we want. The Chinese have basically agreed to something. We don't know what, but it basically means that the dollar now should begin to weaken.” His skepticism about the Yen's rapid moves stems from his extensive experience: “In my experience, I've never seen a move as dramatic as that in a G7 currency.”
He also emphasizes China's crucial role in the global dollar system, highlighting the complex and often counterintuitive relationship between Chinese trade surpluses and the dollar's value. “The more that the Chinese use non-US banks to recycle their funds,” Michael explains, “the less efficient it will be and the lower the elasticity of dollar supply, which underpins, in the medium term, a rising dollar.”
However, he also acknowledges China's efforts to reduce its reliance on the dollar, noting that they've made progress on it. But the question of who wants to hold the Chinese currency remains. He believes that the Yuan's path hinges on whether it starts to appreciate, possibly due to Fed easing, or if China engages in significant money printing.
While Michael believes a weaker dollar is likely, he doesn't anticipate a sudden collapse. He states, “I don't think it's going to be a big inflection because I think there's a lot of factors underpinning the dollar in the medium term.” This suggests a gradual shift rather than a dramatic devaluation.
Riding the liquidity wave
As Michael's insights demonstrate, global liquidity dynamics play a pivotal role in shaping market trends, influencing investment decisions, and driving economic cycles. For technology leaders, understanding these dynamics is no longer optional; it's essential for navigating the complexities of today's interconnected world. By adopting a liquidity lens, tech leaders can anticipate market shifts, identify emerging opportunities, and make strategic decisions that position their companies for sustainable growth.
It comes down to this: adapt to the liquidity current or be swept away by it.
This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes.
