Capital Wars: The Rise of Global Liquidity

by Michael J. Howell

Economic cycles are driven by financial flows, namely quantities of savings and credits, and not by high street inflation or interest rates. Their sweeping destructive powers are expressed through Global Liquidity, a $130 trillion pool of footloose cash. Global Liquidity describes the gross flows of credit and international capital feeding through the world’s banking systems and wholesale money markets. The huge jump in the volume of international financial markets since the mid-1980s has been boosted by deregulation, innovation and easy money, with financial globalisation now surpassing the peaks of integration reached before the First World War. Global Liquidity drives these it is often determinant, frequently disruptive and always fast-moving. Barely one fifth of Wall Street’s huge gains over recent decades have come from rising liquidity and investors’ appetite for riskier financial assets have propelled stock prices higher. Similar experiences are shared worldwide and even in emerging markets, such as India, flat earnings have not deterred waves of foreign money and domestic mutual funds from driving-up stock prices. Now with central banks actively pursuing quantitative easing policies, industrial corporations flush with cash and rising wealth levels among emerging market investors, the liquidity theory of investment has never been more important. International spill-overs of these rapacious cross-border flows sets off capital wars and exposes the unattractive face of liquidity called ‘risk.’ As the world grows bigger, it becomes ever more volatile. From the early 1960s onwards, the world economy and its financial markets have suffered from three broad types of shocks – labour costs, oil and commodities, and global liquidity. Financial markets spin on fragile axes and the absence of liquidity often provides a warning of upcoming troubles. Global Liquidity is a much-discussed, but narrowly-researched and vaguely-defined topic. This book deeply explores the subject by clearly defining and measuring liquidity worldwide and by showing its importance for investors. The roles of central banks, shadow banking, the rise of Repo and growth of wholesale money are discussed. Additionally, covering the latest developments in China’s increasingly dominant financial economy, this book will appeal to practitioners, policy-makers, economists and academics, as well as those with a general interest in how financial markets work.

Genres: Economics, Finance, Business, Nonfiction

ebook

Published March 24, 2020

Reviews

[James Fok · Rating 5 out of 5]

This book provides a detailed explanation of how liquidity drives markets, and of the sources of global liquidity. It is a hugely valuable guide for market practitioners, but is written in an accessible enough way for general readers with an interest in the operation of international financial markets.

[Sam Klemens · Rating 5 out of 5]

The standard economics and finance paradigms ignore money and liquidity. Markets are assumed to exist everywhere and at all times, and frictionless trade is supposed to occur. Yet paradoxically, illiquidity is the ultimate friction and without sufficient liquidity there would be a widespread market failure and no trade.

I learned how the global financial system works by listening to 100+ hours of Jeff Snider podcasts. Lots of other peripheral resources too, but Jeff was my primary guide. While I enjoyed the process, strictly speaking it wasn’t the most efficient method of instruction.

For the person who wants to learn the financial system as quickly as possible, I would suggest Capital Wars. Best viewed as a textbook, this comprehensive treatise is not always an easy read, however, if you put in the work you’ll emerge a far more knowledgeable market participant.

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PS... I originally published this review on my Substack "The Unhedged Capitalist" - please check out the original article if you'd like to see the review with images and better formatting...

https://theunhedgedcapitalist.substac...

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To kick things off, Capital Wars introduced me to a new way of thinking about exchange rates. Unfortunately I didn’t save the quote but Michael’s argument goes something like this.

* Exchange rates are not primarily determined by interest rates, as the field of economics would have you believe. Rather, exchange rates are determined by the quality and quantity of capital.
* Central banks create quantity capital, I.e. bank reserves, and this QE tends to push exchange rates down

Productivity and industrial sector output create quality capital, I.e. revenues/free cash flows from profitable businesses. This high quality capital tends to push exchange rates higher, since foreign investors want to participate in these markets.

I find this to be an intuitive and useful way to conceptualize exchange rates. Furthermore, Howell also addresses the link between high productivity, asset prices, and how liquidity flows can lead to bubbles.

Economies with strong productivity growth and net capital inflows often enjoy rising asset prices, especially when their nominal exchange rates are relatively stable. And, because appreciating capital asset prices tend to attract more investors, these moves can be amplified by further capital inflows, thereby, fueling an asset price spiral.

The refinancing system

The predominance of refinancing, as opposed to financing, was another key takeaway from Capital Wars. Howell argues that our financial system is no longer a mechanism for investing in new businesses, entrepreneurs and economic expansion. Rather, our system’s function is to rollover the massive amount of existing debt.

The fact that the modern financial system has turned from a new financing system to a refinancing system that is more than ever dependent on the supply of potentially flaky safe assets to help rollover increasingly flaky debts creates a negative feedback that highlights the inherent dangers in credit markets.

If economic conditions are unfavorable a business can put off building a new factory, or an entrepreneur may wait before they apply for financing. New capital creation can, at least to some extent, be adjusted based on market conditions.

On the other hand, refinancing is mandatory. If a company can’t rollover its debt it could go bankrupt even if the business has a good revenue stream. Howell repeatedly makes the point that the most important factor in our financial system isn’t interest rates (the cost of borrowing) but rather, balance sheet capacity (the ability to borrow).

M2 we hardly knew you

Michael takes a dismissive view of traditional money supply measurements like M2.

It is our contention that ‘modern money’ really starts where conventional definitions of money supply end. In other words, the well-known monetary aggregates, e.g. M0, M1 and M2, are only the tip of the growing iceberg of short-term claims that, as the 2007-2008 GFC shows, can severely disrupt the markets. - M2 money, the broadest official US monetary measure, comprises notes and coins, as well as insured household deposits.

It excludes the uninsured claims of institutional money managers, corporations and Forex reserve managers, as well as offshore Eurodollar balances. Together this combined broad funding pool stands close to US$26 trillion, easily dwarfing the US$15 trillion that makes up M2 money supply.

I am not qualified to comment on the precise flaws of M2, but I do have a good understanding that this metric fails to take into account many assets that we use as money.

A small example: Tether. The USDT stablecoin has a market cap of $68 billion. While this is only a drop in M2’s bucket, it is a drop nonetheless and as far as I know, M2 does not account for stablecoins.

A more pertinent example could be the $80 trillion in dollar swaps the BIS recently dug up. While I understand that these aren’t money in the traditional sense, the existence of these FX swaps has an effect on the demand for dollars, and hence the dollar’s value.

Howell charred mainstream economics with that previous quote, but in the following passage he turns up the heat and burns econ to a crisp.

A plausible reason why liquidity is shunned in the traditional literature is that it is perceived to be both hard to measure and difficult to define. But just because a task is challenging, there is no reason not to try.

Economics is itself often guilty of raising to heights of great importance factors that are easily measured. This fallacy can be colourfully described by the tale of the drunkard searching for lost keys under a streetlamp: not because this is where they were lost, but simply because that is where the light is better! Often economic truths lie in the shadows where they can be hard to see.

CREAM

The forensic accounting firm Wu-Tang summarized the state of the economy adroitly with their catchy rallying cry of CREAM: Cash Rules Everything Around Me. It’s all about the cash, and Howell provides a perfect summary of why the American dollar squeezes higher during periods of crisis.

The huge US current account deficit, sustained over two decades, which persuaded many experts ahead of the GFC that the US dollar would slump, actually hid a massive build-up of short-term offshore gross US dollar borrowings by foreigners that required all too frequent refinancing. These were offset by foreign holdings of longer term US ‘safe’ assets, such as US Treasuries.

Not surprisingly, the unfolding of the GFC was accompanied by a sharp US dollar appreciation, as those foreign financial institutions that had also used short-term dollar funding to invest in riskier long-term dollar assets were forced to hurriedly deleverage.

I recently published an article about why the dollar isn’t going to be replaced anytime soon, and Brent Johnson has been making the same point for years. There are tens of trillions in foreign held, dollar denominated debt. The interest payments on this debt creates a constant demand for dollars, especially during bouts of volatility. Betting against the dollar is like going to Vegas and betting against the house. You might win all afternoon, but as the night thickens the odds weigh heavy on your shoulders.

Finale

I’ve provided a decent cross-section of Capital Wars in this review, but it’s just scratching the surface. If you’re ready to take your financial acumen to the next level then this is the book for you. I read Capital Wars over the course of five months, but I think with diligent effort, enough coffee, and an attention span that hasn’t been ravished by Tik-Tok you could get through it in a month or two.

[Mike Sanders · Rating 5 out of 5]

I'd argue this distillation of Howell's work is one of the most important works of economic understanding in the current context of the global economy. Concepts ranging from how to measure liquidity, and how that said liquidity translates across different paradigms helps explain a lot of the global financial system, including and particularly global debt markets, and the monetary story behind them. A definite reread until its made irrelevant by changes in the world.

[Thilina Panduwawala · Rating 5 out of 5]

Key to understanding why current financial system is built for large refinancing needs than raising new financing. Also provides a framing that connects with other authors/thinkers on the global financial system. Definitely a book to spend time reading through. Can't be rushed through.

[Angel Velez · Rating 5 out of 5]

great insightfully read

I thought the book was well written and for someone not too versed in a financial background, it gives you a very clear view of how global liquidity and its underlying subsets are the real movers of the world economy

[Richard Marney · Rating 3 out of 5]

A passable review of the topic. A well read market participant will race through the material.

[noblethumos · Rating 5 out of 5]

Michael J. Howell’s Capital Wars: The Rise of Global Liquidity (2020) offers a comprehensive examination of the pivotal role that global liquidity plays in shaping economic cycles, financial markets, and international capital flows. Drawing upon extensive empirical data and historical analysis, Howell provides a nuanced understanding of how liquidity dynamics influence inflation, bond yields, risk, and volatility in the global economy.


At the heart of Howell’s analysis is the assertion that economic cycles are predominantly driven by financial flows—specifically, the quantities of savings and credit—rather than traditional indicators such as consumer price inflation or interest rates. He introduces the concept of “Global Liquidity,” a vast and rapidly moving pool of capital estimated at approximately $130 trillion, which traverses international borders through banking systems and wholesale money markets. This liquidity, according to Howell, serves as a determinant force in financial markets, often leading to disruptive consequences when mismanaged or misunderstood.


The book is methodically structured to guide readers through the complexities of global liquidity. Howell begins by defining and measuring liquidity on a worldwide scale, emphasizing its critical importance for investors and policymakers. Subsequent chapters delve into the roles of central banks, the shadow banking system, the rise of repurchase agreements (repos), and the expansion of wholesale money markets. A notable portion of the text is dedicated to analyzing China’s burgeoning influence in the global financial landscape, underscoring the nation’s impact on liquidity and capital flows.


Howell employs a multidisciplinary approach, integrating insights from economics, finance, and international political economy. His analysis is grounded in a robust empirical framework, utilizing data from various financial markets and institutions to substantiate his claims. By tracing the evolution of global liquidity from the 1960s to the present, Howell identifies recurring patterns and shocks—such as those related to labor costs, commodities, and financial crises—that have profoundly impacted the world economy.


The scholarly community has recognized Capital Wars for its insightful and timely exploration of global liquidity. Melissa Davies, in her review for the Society of Professional Economists, describes the book as “a must-read for anyone trying to navigate the vagaries of inflation, bond yields, risk, and volatility in global markets.”  Similarly, John Plender of the Financial Times commends Howell’s work, stating that “as a description of the workings of the modern global financial system and the interrelationship of finance and the real economy, it has no current rival.” 


However, some critiques have emerged regarding the book’s accessibility to a broader audience. The depth and complexity of the subject matter, while providing a thorough analysis, may pose challenges for readers without a background in finance or economics. Nonetheless, for professionals and academics in the field, Howell’s detailed exposition offers valuable insights into the mechanics of global liquidity.


Capital Wars makes significant contributions to the understanding of financial globalization and its implications. By demystifying the concept of global liquidity and elucidating its far-reaching effects, Howell equips investors, policymakers, and scholars with a framework to interpret market behaviors and economic trends. His exploration of the interplay between liquidity and financial stability offers a fresh perspective on the root causes of economic volatility and the potential pathways to mitigate systemic risks.


In Capital Wars: The Rise of Global Liquidity, Michael J. Howell delivers a seminal work that sheds light on the often-overlooked force of global liquidity in shaping economic and financial landscapes. Through meticulous research and clear articulation, Howell provides a foundational text for those seeking to comprehend the underpinnings of financial markets and the global economy. While the complexity of the subject may require a concerted effort from readers, the insights garnered are indispensable for navigating and understanding the intricacies of today’s interconnected financial world.

GPT

[Mike · Rating 1 out of 5]

Written in very dense academic language, so the layman is definitely not the target audience, which is a shame as the ideas have the potential to become more impactful. But clearly the author is trying to address academia.

[Wenting Liu · Rating 3 out of 5]

This book is not accessible to general readers
You need to be a central banker already to understand all his jargon as he assumes you know all the plumbing already.
You can also go through with help of ChatGPT but I found it very difficult to understand.

It feels like he’s thinking aloud in shorthand, assuming the reader already lives inside the liquidity system the way he does. There’s no emotional rhythm, no storytelling, and little structure — just a dense stream of jargon (“shadow funding,” “liquidity inversion,” “cross-border collateral chains”) with minimal connective tissue.

One of the least enjoyable book ever

[Joel Haowen Tong · Rating 5 out of 5]

excellent book covering how liquidity works, a much needed read for 2025.

[Anton · Rating 3 out of 5]

This book explains arguably one of the most important drivers of financial asset prices. Unfortunately, it is written like a 300-page research paper, making it a very tedious read.

[Amir jalali · Rating 2 out of 5]

متن این کتاب به زبان انگلیسی برای غیر انگلیسی زبان ها متن سر راست و آسونی نیست. به نظر من نویسنده خیلی توی جو آکادمیک هست. اطلاعاتی که ارایه میکنه شاید ارزش آکادمیک داشته باشند ولی برای استفاده به صورت عملی احتمالا مفید نباشند.تا حدود زیادی دید سیستمی لازم برای نگاه به بازار رو توی متن نویسنده ندیدم و توصیفاتش خیلی وارد جزییات آکادمیک میشه که خوب شاید برای کسانی که جهت استفاده از کتاب در بازار مالی
اون رو میخونن به درد بخور نباشه

[Felix · Rating 5 out of 5]

Une lecture peu accessible, mais d'autant plus importante comme nous avons réalisé une transition entre un monde où les marchés financiers avaient pour objectif de créer du crédit pour l'investissement productif à celui de refinancer le crédit déjà alloué. Ce qui redéfinit la place de la dette, l'accès à des collatéraux de qualité, la politique monétaire (taux d'intérêt vs QE), etc.