Michael Howell: AI Will Fuel Inflation, And Markets Aren’t Ready

Key Concepts

• Global Liquidity Cycle: The underlying momentum of money supply worldwide, which acts as the "plumbing" of the financial system.
• Treasury QE: The U.S. Treasury’s active intervention in markets (e.g., buybacks) to maintain stability and suppress bond volatility.
• Bare Flattening: A yield curve phenomenon where short-term interest rates rise faster than long-term rates, typically signaling a late-cycle economic environment.
• Capital Wars: The geopolitical and financial competition between the U.S. and China for global economic supremacy.
• Gold-Oil Ratio: A historical mean-reversion metric (averaging 20:1) used to triangulate potential future price levels for commodities.
• Real Economy vs. Financial Sector: The shift of liquidity from financial assets (stocks/bonds) into capital expenditure (CapEx) and manufacturing, which can drive economic growth while simultaneously pressuring asset valuations.

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1. The State of Global Liquidity

Michael Howell, Managing Director at CrossBorder Capital, argues that the global liquidity cycle has peaked and is now inflecting downward. While liquidity is not disappearing in absolute terms, its growth rate is slowing significantly.

• U.S. Dynamics: Liquidity is exiting the financial sector to fund a "buzzing" real economy, characterized by a massive CapEx boom and strong manufacturing data (ISM prints).
• The Fed/Treasury Role: The Federal Reserve and Treasury have injected approximately $600 billion into money markets since late October to maintain stability against the "headwind" of liquidity moving into the real economy.
• China’s Contraction: China has abruptly hit the brakes on liquidity creation, a move Howell finds puzzling but notes is clearly impacting global markets, particularly gold.

2. Market Mechanics: The "E" vs. The "PE"

Howell explains that while the real economy is strong (good for corporate Earnings/E), the financial markets are vulnerable to a contraction in the Price-to-Earnings (PE) ratio.

• The Conflict: As liquidity shifts to the real economy and inflation rises, the quality of earnings deteriorates.
• Fixed Income Pressure: The U.S. long bond yield is hovering around 5%. Given the nominal growth rate of the U.S. economy (7–8%), Howell suggests that long-term yields face significant upward pressure, which creates a "huge problem" for deficit funding.

3. The AI Rally and Inflation

Howell views the current AI boom as inflationary in the short term due to the "eyewatering" scale of CapEx spending.

• Historical Parallel: He compares the current AI hype to the late 1990s fiber-optic boom (e.g., Global Crossing). While technology is inherently deflationary for the product itself (prices eventually tumble), the massive upfront investment is currently driving inflation.
• Speculation: He classifies the current market as being in a "speculation" phase, having left the "calm" phase behind. He warns that while returns may be positive, they are "low quality" due to high volatility.

4. Gold, Oil, and Geopolitics

Howell posits that China is the primary driver of the gold market, using it as collateral to underpin the yuan in its "capital war" against the U.S. dollar.

• Gold-Oil Ratio: Historically, the ratio of an ounce of gold to a barrel of oil averages 20. If gold is underpinned at $4,000–$5,000/oz, this implies a potential for oil to reach $200/barrel.
• Contrarian View: While analysts dismiss this as "mad," Howell notes that the 20x ratio has held through various economic cycles since 1970. He suggests that if the global economy gains traction, current oil surpluses will vanish, leading to a supply-chain-driven price spike.

5. Methodology and Outlook

• Liquidity as a Barometer: Howell uses crypto (Bitcoin/Ethereum/Solana) as a 13-week leading indicator for liquidity. The recent downturn in crypto prices confirms his model that the liquidity cycle is rolling over.
• Late-Cycle Indicators: The combination of strong commodities, an overheating economy, and a "bare flattening" of the yield curve are classic late-cycle signals.
• Advice for Policymakers: Howell suggests that the Fed should tighten policy in anticipation of inflation, though he acknowledges the political difficulty of doing so. He draws parallels to the 1970s, where unconnected supply shocks eventually coalesced into a major inflationary period.

Synthesis

The global financial system is currently in a precarious transition. The "plumbing" of liquidity is being diverted from financial assets to the real economy, which, while fueling growth, is creating a "blowoff top" environment in speculative tech stocks. Investors should be wary of the late-cycle signals—specifically the bare flattening of the yield curve and the potential for commodity-driven inflation. Howell concludes that the era of "easy money" is over, and the market is heading toward a period of "turbulence" where traditional safe havens like bonds may be less effective than gold, provided the Chinese government continues its strategic accumulation.