In the world of global finance, the concept of liquidity is often bandied about with a sense of gravitas. It’s the lifeblood of the financial system, the fuel that keeps the engine of the global economy running. But what exactly is global liquidity, and why does it matter?
In a recent interview on the Public Podcast, Michael Howell, Managing Director at Crossborder Capital, provided a comprehensive overview of global liquidity and its economic impact. He described global liquidity as the amount of money, funds, and credit flowing through world financial markets. It’s the juice that drives the system, and understanding its ebbs and flows is crucial for investors.
The global liquidity landscape is dominated by two major players: the U.S. Federal Reserve and the People’s Bank of China. The Federal Reserve, with its influence on financial markets, and the People’s Bank of China, with its impact on the real economy, shape the global liquidity dynamics. Other central banks, such as the European Central Bank, the Bank of Japan, and the Bank of England, while significant, tend to follow the lead of the Federal Reserve.
The creation of global liquidity hinges on three inputs: central bank activities, offshore deposits (often referred to as the Eurodollar market), and the pool of collateral worldwide. The latter, a concept that has gained prominence since the global financial crisis, refers to secured lending where lenders demand collateral like U.S. treasury bonds or German bunds.
The current global liquidity scenario, according to Howell, is at a trough. This is evidenced by recent bank failures and the stealth Quantitative Easing (QE) by the Federal Reserve. The future, however, is likely to see a resurgence of QE as central banks step in to bail out governments grappling with skyrocketing mandatory spending and a shrinking tax base.
This scenario presents a paradox. While the U.S. is seen as the “cleanest shirt in the laundry” in terms of fiscal situation, it is still facing a spiraling debt crisis. The Congressional Budget Office data shows a rising deficit and spiraling debt, with interest payments taking up a significant portion of total debt issuance in the next decade. The question then arises: who will buy this debt?
Foreigners, who currently own about one-third of American debt, may be less inclined to hold so much U.S. debt going forward. The domestic private sector may not be able to absorb the one to two trillion dollars of debt being issued every year. This leaves the Federal Reserve, which will likely have to take up a large part of this debt, leading to a resurgence of QE.
For investors, this landscape presents both challenges and opportunities. Equities, particularly those of large companies with pricing power, and traditional monetary hedges like gold and crypto, may serve well in the future. Fixed income, however, may face challenges due to the volatility in the bond markets.
In conclusion, the dance of global liquidity is a complex tango involving dollars, debt, and QE. As the music plays on, investors must stay attuned to the rhythm and make their moves accordingly.
