Global liquidity may be entering a more dangerous phase.
As bond yields rise, government debt continues to expand and the financial system becomes increasingly dependent on refinancing, Michael Howell, founder of Cross-Border Capital and author of Capital Wars, argues that investors should be paying less attention to headline interest rates and far more attention to the “plumbing” of the financial system.
Howell and I discussed Japan’s bond market, the yen carry trade, the United States surpassing $40 trillion in federal debt, Treasury-led quantitative easing, the global liquidity cycle, the potential next liquidity crisis, and the outlook for bonds, equities, commodities, gold and Bitcoin.
His central argument is that the global financial system has fundamentally changed.
“We're living in a world where capital markets have changed their structure and maybe changed their role.”
Japan has emerged as one of the most closely watched pressure points in global fixed income.
With Japanese government bond yields rising from the extraordinarily low levels that characterized much of the past several decades, investors have increasingly questioned what could happen if Japanese institutions begin bringing capital home.
Japan is one of the world's largest pools of capital, while Japanese investors have accumulated substantial foreign bond holdings over many years.
The concern is straightforward: if domestic Japanese yields become sufficiently attractive, Japanese insurers, pension funds and other institutions could eventually sell foreign assets and allocate more capital domestically.
That could put additional pressure on already-fragile global bond markets.
But Howell believes the threat posed by the yen carry trade has been exaggerated.
“The yen carry trade is a bogeyman that has spooked a lot of investors for a long time.”
He argues that while the trade is important, it is not nearly as dangerous as many investors believe.
“It’s nothing like as perilous as maybe people make out.”
According to Howell, investors need to step back and look at what bond markets are actually telling them.
The rise in yields is not simply a Japan story. Bond yields are rising across much of the world, including the United States, Japan and Europe.
Instead, Howell points to stronger nominal economic growth.
“The main reason that bond yields are going up is because real economies are actually growing pretty rapidly.”
He distinguishes between real GDP growth and nominal GDP growth. While real economic growth is not running at extraordinary levels, inflation combined with respectable economic activity is producing much stronger nominal GDP growth.
That creates an environment in which higher interest rates and bond yields become more economically justified.
According to Howell, this is occurring across the United States, Japan and, to a lesser extent, Europe.
China is the major exception.
“In China bond yields are going down, not up.”
The broader message is that investors should not automatically interpret rising yields as a sign that government debt is becoming unsustainable.
Strong economies can themselves push bond yields higher.
That does not mean Japan is irrelevant.
Howell acknowledges that rising domestic Japanese yields could act as a magnet for capital.
Japanese insurance companies and government pension funds could eventually have incentives to reduce foreign holdings and allocate more money domestically.
However, he does not expect a sudden, violent repatriation of capital to be the base case.
“The Japanese bond market is largely a self-contained market.”
Interestingly, Howell suggests that investors concerned about Japanese selling may want to look beyond U.S. Treasuries.
Japan is also a major investor in French government bonds.
“If you want to be worried, start looking at the spread of OAT bonds, French bonds, against German bunds.”
For Howell, this is another example of why investors should look beyond the headlines and examine where capital is actually moving.
And when it comes to the yen carry trade itself, his conclusion is blunt:
“The yen carry trade is a bogeyman that's been exaggerated by the media.”
The United States has now crossed the extraordinary milestone of $40 trillion in federal debt.
Yet Howell argues that the headline number itself is not necessarily the most useful way to understand the risk.
The more important issue is the interaction between the existing debt stock, refinancing requirements and the cost and volatility of funding.
This is where Howell's broader framework becomes particularly important.
Traditional financial theory assumes capital markets exist primarily to raise new capital for investment.
But Howell argues that this description increasingly fails to capture how modern financial markets actually function.
“Capital markets are there really to refinance existing debt.”
That distinction is critical.
Equity does not have to be refinanced in the same way debt does.
Debt matures.
It must be rolled over.
And in a world where governments, corporations and households carry enormous amounts of debt, the ability to refinance that debt becomes one of the central determinants of financial stability.
Howell estimates that the typical term of debt is roughly five to six years.
That, he argues, helps explain why global liquidity tends to move in similar five-to-six-year cycles.
“The point about debt, unlike equity, debt needs to be refinanced.”
This leads to one of his most important concepts: balance-sheet capacity.
In Howell's framework, investors can spend too much time obsessing over the Federal Reserve's policy rate.
The Fed funds rate remains important, but it may not be the variable that ultimately determines whether the financial system remains liquid.
Instead, investors need to understand the mechanisms through which banks, dealers, governments and other financial intermediaries fund themselves.
“What really matters in financial markets in this refinancing world is balance sheet capacity among financial intermediaries.”
This is what Howell describes as the “plumbing” of the financial system.
The plumbing includes wholesale funding markets, collateral, repo financing, bank reserves and the capacity of financial intermediaries to absorb and finance government debt.
In this environment, Howell argues that focusing exclusively on whether the Federal Reserve raises or cuts rates can miss the bigger picture.
“Don't focus too much on Fed funds, focus on the liquidity backdrop.”
That may sound provocative, but it follows directly from his debt-refinancing framework.
If the system is dependent on continually rolling over debt, then the availability of balance-sheet capacity and liquidity can become more important than the precise level of the overnight policy rate.
One of the more counterintuitive arguments in Howell's framework concerns the economic effect of higher government interest payments.
The conventional assumption is that higher interest rates suppress economic activity.
But that is not necessarily true when government debt is extremely large.
When the government pays more interest on its outstanding debt, that money becomes income for holders of the debt.
In other words, higher government interest expenses represent a transfer of income from the government sector to the private sector.
“So paradoxically, rising interest rates actually boost or help spending in the real economy, they don't detract from it.”
That creates what Howell describes as an increasingly “topsy turvy” financial environment.
The conventional relationships investors have learned to rely on can become distorted when debt levels are sufficiently large.
Another important part of Howell's argument is that investors should not assume that a major reserve-currency government will simply run out of buyers for its debt.
Governments can certainly be forced to pay higher rates.
They can crowd out private borrowers.
They can increase volatility.
But Howell believes governments such as the United States will ultimately find a way to fund themselves.
“Governments always fund themselves.”
For a country operating with a major reserve currency, the mechanisms available to maintain funding are considerably broader than those available to an ordinary borrower.
That leads directly to another major theme of the interview: financial repression versus monetary inflation.
Could governments eventually become so concerned about borrowing costs that monetary policy becomes subordinate to fiscal requirements?
Howell's answer was striking.
“Spoiler alert is already happening.”
But he does not necessarily prefer the term “financial repression.”
Instead, he believes the more accurate description is monetary inflation.
The mechanism is subtle.
Rather than explicitly controlling the entire yield curve, policymakers can influence market conditions by managing volatility, liquidity and the structure of government debt issuance.
Howell points to Treasury buybacks and other relatively small market interventions as examples.
“These tiny little tweaks through treasury buybacks...are not going to influence yields, but they will change the volatility background.”
That matters because hedge funds and other leveraged investors are major participants in the Treasury market.
And leverage is highly sensitive to volatility.
Perhaps the most provocative concept discussed in the interview is what Howell calls “Treasury QE” or “Treasury-led QE.”
Traditional quantitative easing is associated with central banks purchasing government securities and injecting liquidity into the financial system.
Howell argues that a different mechanism is increasingly emerging.
Governments are funding themselves heavily through short-term Treasury bills rather than relying exclusively on long-dated bonds.
Why?
Because banks have an appetite for short-duration government securities.
The mechanism begins with government spending.
When the government spends money, private-sector bank deposits increase.
Banks, however, must balance their balance sheets.
They therefore seek assets that match the characteristics of those deposits.
Short-term Treasury bills provide an attractive instrument for this purpose.
“If you're funding government spending, not through savings, which is the bond finance, but you're funding it through private banks expanding their balance sheets, that's money printing.”
Howell takes the argument one step further.
“It's not the Federal Reserve that's doing the QE this time, it's private sector banks doing the QE for the US Treasury.”
Hence his term:
Treasury-led QE.
Howell believes this mechanism is increasingly being adopted internationally.
Japan is already using more short-end funding, while the UK and eurozone could move further in the same direction.
And if the process expands the banking system's balance sheet, Howell believes it has important implications for inflation and asset prices.
“That's money printing.”
And what happens when money is printed?
“What happens if you print money, you get inflation.”
That, in his view, helps explain why gold and Bitcoin have performed so strongly.
The next question is perhaps the most important for investors:
Has the global liquidity cycle peaked?
Howell's answer requires an important distinction.
He does not believe global liquidity is necessarily declining in absolute terms.
Instead, he believes the growth rate of liquidity has peaked and slowed materially.
“We look at the growth rate, the underlying growth rate of that liquidity cycle.”
The five-to-six-year liquidity cycle is central to his framework.
While the total amount of liquidity continues to inch higher, its rate of expansion has slowed.
That distinction can be extremely important for financial markets.
Asset prices can continue rising when liquidity is still increasing.
But when the rate of liquidity growth slows, financial markets can become much more vulnerable to shocks.
Howell believes some of those pressures are already visible in bond markets.
The current market environment presents an unusual combination.
Economic activity remains relatively strong.
Commodity prices are firm.
Yet bond prices are under pressure and yields are rising.
According to Howell, this is not contradictory.
It is exactly what one would expect during this stage of the economic and liquidity cycle.
“Very strong commodity markets [are] associated with rising bond yields.”
Equities occupy an interesting middle ground.
Stocks derive their earnings from the real economy, but their valuation multiples are heavily influenced by financial conditions.
Howell describes equities as effectively “straddling two horses.”
The danger comes if bond yields continue to rise.
Higher yields can put downward pressure on equity valuation multiples even while strong economic growth supports corporate earnings.
That creates a tug-of-war between earnings growth and valuation compression.
And the later the cycle becomes, the more dangerous that balance becomes.
If the global liquidity cycle has indeed peaked in growth terms, what would a genuine liquidity crisis look like?
Howell's answer goes back to the same fundamental relationship:
Debt needs liquidity, while liquidity itself depends on good-quality debt.
Modern lending is heavily collateralized.
Howell cites a World Bank figure suggesting approximately 77% of lending worldwide is collateralized.
That means collateral is not merely an asset held for investment.
It is part of the infrastructure of the financial system.
Government bonds, for example, can be pledged as collateral to obtain financing.
With a sufficiently low haircut, the same collateral can support significant amounts of leverage.
And this creates a crucial vulnerability.
If the value, liquidity or volatility characteristics of supposedly high-quality collateral deteriorate, the consequences can spread rapidly through the financial system.
This is where the repo market enters the picture.
The repo market is a critical source of short-term funding for the financial system.
Howell estimates that the U.S. repo market alone represents approximately $14 trillion.
The sheer scale is important.
These are not marginal markets.
They are central to the functioning of modern finance.
Howell draws a direct comparison with the global financial crisis.
The Lehman crisis was heavily influenced by the inability of financial institutions to secure overnight financing.
“Lehman and others couldn't get this overnight financing.”
The system has since become more complex, and these markets have grown.
Therefore, the next liquidity crisis may once again reveal itself first in short-term funding markets.
Howell's warning is clear:
Watch the repo market.
One of Howell's strongest challenges to conventional economic analysis concerns the obsession with debt-to-GDP ratios.
Economists frequently point to the enormous debt burdens of Japan, China and the United States.
But Howell argues that high debt-to-GDP ratios alone do not necessarily trigger crises.
Japan, for example, has maintained an extremely high debt ratio for many years without experiencing a conventional sovereign debt crisis.
The more important variable, in his framework, is the relationship between debt and liquidity.
“What matters is debt to liquidity because debt needs to be refinanced.”
Historically, financial crises have tended to occur when the debt-to-liquidity relationship deteriorates sharply.
That changes the way investors should think about systemic risk.
Instead of asking simply how much debt exists, the more useful question may be:
How much liquidity is available to refinance that debt?
For investors attempting to identify a genuine liquidity crisis before it becomes obvious, Howell highlights several indicators.
A sudden rise in overnight funding costs relative to the Fed funds rate could signal growing stress in the financial system.
A sharp rise in Treasury-market volatility could indicate that the world's most important collateral market is becoming unstable.
Spikes in repo funding costs could be an early warning that financial institutions are struggling to obtain short-term liquidity.
Rapid widening in credit spreads would indicate that counterparty and default concerns are spreading.
Continued increases in yields could create additional pressure on equity valuations and government financing costs.
Howell summarizes the warning signs simply:
“You'd see bond volatility jumping significantly, and you'd start to see as well the repo market spike and probably credit spreads blowing up.”
For years, investors have heard the phrase “cash is trash.”
Inflation erodes purchasing power, while risk assets generally provide better long-term returns.
But Howell believes that equation changes dramatically during a genuine liquidity crisis.
“In the short term, in a financial crisis you want cash.”
He goes even further:
“You wanna hold as much cash as you can because cash is king in that situation.”
The reason is simple.
When financial institutions become concerned about counterparty risk, they stop wanting to lend.
Liquidity becomes scarce.
Investors begin hoarding cash rather than deploying it.
This can create a self-reinforcing cycle.
The less willing investors are to lend, the scarcer liquidity becomes.
The scarcer liquidity becomes, the more investors hoard cash.
Howell compares the resulting dynamic to a kind of financial “black hole.”
But liquidity crises create a paradox.
The same system that desperately needs liquidity can also generate enormous opportunities once central banks intervene.
Howell argues that the ultimate role of central banks is not simply to fight inflation or maximize employment.
Instead, he sees their deeper function as preserving the integrity of the debt system.
“Central banks are there not really to fight inflation or not really to create employment. They're there to maintain the integrity of debt markets.”
That explains why central banks have repeatedly abandoned previous policy positions when financial stability comes under serious pressure.
Howell points to the Global Financial Crisis, the COVID crisis and the 2019 U.S. repo episode as examples.
When the financial system begins to seize up, central banks can provide liquidity extremely quickly.
“They come in fast and they provide liquidity.”
And then:
“They print money.”
The objective is to make sure the system “reliquefies.”
And that is where the investment implications become especially interesting.
Howell believes the initial phase of a liquidity crisis could be extremely painful for risk assets.
But once policymakers intervene and liquidity returns, the direction can change dramatically.
During the initial panic, investors may rush into cash and the safest assets available.
But during the subsequent reliquefication of the system, risk assets can reprice rapidly upward.
“Gold will go up, bitcoin will shoot higher.”
This produces a two-stage framework.
Investors hoard cash.
Counterparty risk rises.
Credit spreads widen.
Repo markets come under pressure.
Bond volatility rises.
Risk assets can fall sharply.
Central banks intervene.
Liquidity is injected.
The debt system is stabilized.
Risk assets reprice.
Gold and other monetary hedges can move sharply higher.
Understanding the transition between these two stages may be more important than simply predicting whether markets will rise or fall.
Among the strongest statements of the interview was Howell's outlook for gold.
He accepts that precious metals could experience significant volatility if monetary policy tightens.
But he sees any meaningful pullback as an opportunity rather than a reason to abandon the thesis.
“Absolutely 100% this is a buying opportunity. If gold comes back, buy it.”
His reasoning is fundamentally monetary.
Gold, in Howell's framework, is a hedge against monetary inflation.
Governments continue to accumulate debt.
Politicians have little incentive to embrace austerity.
And because the debt burden is already so large, Howell argues that policymakers ultimately have limited choices.
“There's no way they can get off this debt binge.”
The political dimension is central to Howell's long-term argument.
He believes austerity is increasingly incompatible with the geopolitical environment.
Governments are simultaneously dealing with economic competition, national-security concerns and increased defense requirements.
That makes significant fiscal retrenchment difficult.
“Austerity cannot exist in a world of capital wars.”
Governments therefore continue spending.
Debt rises.
And, according to Howell's framework, liquidity must ultimately rise alongside it.
That is the foundation of his bullish long-term thesis for gold.
Howell ends with an intriguing observation about China.
In his view, China may have the world's biggest debt problem.
That does not necessarily mean China is on the verge of collapse.
Rather, it means China faces the same debt-liquidity dilemma from a different angle.
Howell believes China will need to expand its money supply.
And there is an important cultural and financial characteristic that makes his conclusion particularly interesting:
“China has to print money and the Chinese love gold. That's all you need to know.”
For Howell, this creates another structural tailwind for the precious metal.
The outlook for equities is more complicated.
Howell had originally expected Wall Street to remain broadly range-bound because he anticipated pressure from the bond market.
His thesis was that rising bond yields would push equity valuation multiples lower.
But strong corporate earnings — particularly among major technology companies — have so far offset that pressure.
“Because the real economies were so strong, you get a big earnings boost.”
That dynamic could continue.
But it creates an increasingly delicate balance.
If economic growth remains strong, earnings can continue supporting stocks.
If bond yields rise too far, valuation multiples can contract.
The question is whether earnings growth can continue to compensate for higher discount rates.
Howell believes policymakers will attempt to prevent a major equity-market breakdown.
“I think they'll try and do that as best they can.”
But being late in the cycle means the risks are accumulating.
Howell's view on bonds remains relatively bearish.
His argument is again based on nominal GDP growth.
If nominal economic growth is running significantly faster than it has for decades, then bond yields may still be too low relative to the underlying economy.
Howell estimates that bond yields across major markets could be approximately 100 basis points below where they should be.
“Bond yields are about a hundred basis points...below probably where they should be.”
That implies continued upward pressure on yields.
Governments may attempt to suppress that pressure through various funding and liquidity-management techniques.
But Howell expects the underlying tendency to remain upward.
That creates a potentially difficult environment for traditional fixed-income investors.
The same economic strength that pressures bonds could support commodities.
Howell expects commodity markets to remain relatively strong because of continued real-economy activity.
That reinforces the broader market configuration he describes:
Strong economy → stronger commodity demand → higher inflation pressure → higher bond yields.
Equities sit between the two worlds.
They benefit from strong earnings but face pressure from rising discount rates.
Gold occupies a different position.
It is less dependent on conventional corporate earnings and more directly linked to monetary conditions, real yields, currency confidence and liquidity expectations.
Perhaps the most important takeaway from Howell's framework is methodological.
Investors are bombarded with headlines about central-bank decisions, government debt, inflation figures and geopolitical developments.
But Howell argues that these individual headlines can be misleading if they are not placed within the broader liquidity cycle.
His framework is based on several interconnected ideas:
Debt must be refinanced.
Refinancing requires liquidity.
Liquidity depends on financial-intermediary balance sheets.
Collateral supports enormous amounts of leveraged lending.
When liquidity disappears, repo and credit markets can come under severe pressure.
When the system begins to break, central banks ultimately intervene to restore liquidity.
And once that liquidity returns, the assets that initially suffered may become some of the strongest performers.
That is why Howell believes investors should monitor the financial system's plumbing rather than relying exclusively on headline interest rates.
What makes the current environment so difficult is that many traditional relationships appear to have changed.
Higher rates can increase government interest payments and therefore private-sector income.
Strong economic growth can be negative for bonds.
Government deficits can increase bank deposits and stimulate demand for short-term Treasury bills.
Private banks can effectively expand their balance sheets to help finance government spending.
Central banks may tolerate inflationary pressure because the alternative — allowing the debt system to contract violently — could be far more destabilizing.
Howell describes the result as a world where financial relationships have effectively “reversed polarity.”
That may be the central challenge for investors.
The models that worked during an era of low debt, low inflation and abundant central-bank liquidity may not work in exactly the same way in a world dominated by government refinancing requirements.
Michael Howell's thesis is ultimately not a prediction about one market.
It is a framework for understanding the interaction between debt, liquidity and financial-market plumbing.
Japan matters because its domestic yields are rising and Japanese investors hold enormous foreign assets.
The United States matters because its debt stock and refinancing requirements are enormous.
The bond market matters because it represents the collateral foundation of the modern financial system.
The repo market matters because it provides critical short-term funding.
Central banks matter because they are ultimately forced to maintain the integrity of the debt system.
And gold matters because Howell believes the long-term response to an ever-growing debt burden will be continued monetary expansion.
The biggest risk, therefore, may not be the absolute amount of debt.
It may be what happens when the system suddenly requires more liquidity than the financial intermediaries are capable of providing.
That is when the “debt-liquidity nexus” becomes critical.
And if that nexus breaks, investors may initially run toward cash.
But if history is any guide, the policy response could eventually unleash another wave of liquidity — potentially creating powerful opportunities in gold, Bitcoin and other risk assets.
Howell's message to investors is therefore less about predicting the exact date of the next crisis and more about knowing what to watch when it begins.
Don't focus only on the Fed funds rate.
Watch the plumbing.
Watch repo.
Watch SOFR.
Watch bond volatility.
Watch credit spreads.
And above all, watch the rate at which global liquidity is expanding.
Because, as Howell argues throughout the interview, in a debt-driven financial system, liquidity is ultimately what keeps the entire structure standing.
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