#1208 Darius Dale | Bitcoin Is Falling Because Of China & Japan?

Darius Dale is the founder & CEO of 42Macro, they are one of the best sources of information I have found across asset classes, markets, and Wall Street. In this conversation, we talk about the global liquidity cycle, specifically focusing in on China & Japan -- what is going on with that monetary policy, their contribution to global liquidity, and how certain assets are responding. ======================= Pomp writes a daily letter to over 235,000+ investors about business, technology, and finance. He breaks down complex topics into easy-to-understand language while sharing opinions on various aspects of each industry. You can subscribe at https://pomp.substack.com/

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:02Anthony Pompliano?

  What's up everyone. This is Anthony Pompliano. Many of you know me as Pomp. You're listening to the Pomp Podcast, which is my effort to find the most interesting people in the world and sit with them for hours while I ask questions in an effort to learn. So it would mean the world to me if you would subscribe to the show on your favorite audio platform, watch episodes on YouTube, and tell your friends and family about the podcast. My goal is to help millions learn from the world's most interesting people. So let's get into today's episode. Darius Dale is the founder and CEO of 42 Macro. They are one of the best sources of information I've found across asset classes, markets, and Wall Street. In this conversation, Darius and I talk about the global liquidity cycle, specifically focusing in on China and

• 0:45Anthony Pompliano?

  Japan. What the hell is going on with that monetary policy, their contribution to global liquidity, and how certain assets are responding. I always enjoy talking to Darius, and this conversation was no different. Here is my conversation with Darius Dale.

• 1:02Speaker 01

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• 1:29Anthony Pompliano?

  Anthony Pompliano runs Pomp Investments. All views of him and the guests on his podcast are solely their opinions and do not reflect the opinions of Pomp Investments. You should not treat any opinion expressed by Pomp or his guests as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of his personal opinion. This podcast is for informational purposes only. All right, guys. Bang, bang. I've got Darius here with me. Darius, you and I, over the last couple of weeks, have been talking a lot about global liquidity. And obviously, there's a lot of people on Twitter, in the mainstream media, and even in the Bitcoin world that focus on U.S.-based liquidity. What's the Fed doing? What's interest rates? How's that impacting inflation? But if we go across the world, we can look at China and Japan as two Asian countries that are very, very important when looking at global

• 2:14Anthony Pompliano?

  liquidity. And so maybe what we could start with is just China and kind of what you're seeing there in that market.

• 2:19Speaker 02

  Yeah, absolutely. So let me take a step back and kind of help the audience understand why we're even talking about Chinese and Japan's liquidity cycles. And the reason for that being is because they are both key contributors to our global liquidity proxy. I think we still got this last time we were on the show in terms of the 42 macro global liquidity proxy, which is the sum of the global central bank balance sheet, the sum of global narrow money supply, and the sum of global FX reserves minus gold. And so China, in terms of its contributions to those aggregate statistics, is right around 20-ish percent, and Japan's right around 15%. So we have to understand, hey, look, if we're going to be tracking global liquidity and ultimately trying to forecast inflections in global liquidity, we need to go straight to the source of all these major economies. And so let's start

• 3:02Speaker 02

  with the Chinese liquidity cycle. I threw a chart aside, one, Jordy, if you can throw that up there, where we show China's liquidity and market cycles are reflexively and increasingly linked. And so on the left chart, I show our China liquidity proxy, which again is the sum of those three measures, but specifically to the Chinese economy relative to the Chinese stock market. And as you can see, that relationship is tight and is increasingly tight in recent cycles. And then on the right chart, we're just showing that same Chinese liquidity proxy relative to Bitcoin. And obviously, that's a pretty tight correlation in recent cycles as well. So this is obviously something we need to track and monitor and ultimately forecast in order to forecast, you know, kind of where Bitcoin prices are going.

• 3:39Anthony Pompliano?

  Now, talk a little bit about China and kind of this negative measurement that you've got here, right? Obviously, liquidity ends up being a huge, huge, huge piece of this. But when we look at liquidity impulses as an example, that's flipped negative. What is that telling us?

• 3:52Speaker 02

  Yeah, absolutely. So yeah, what we're showing, the second chart here is again, the top panel shows that China liquidity proxy is a sum of $18.4 trillion. The second panel shows China's equity market cap at about plus $10 trillion. But I'd focus your eyes on that third panel where we show a trailing three-month momentum study of that, of our 42 macro China liquidity proxy. And as you can see, you know, the big spikes in the bars, you know, in recent months, coming from those big spikes down in Q4 of last year, you know, we basically went from China, the Chinese liquidity proxy draining about $1 trillion of liquidity on a trailing three-month basis through October to adding about 1.3. Five trillion dollars of liquidity to the global liquidity matrix construct, you know, in early Q1 of this year.

• 4:35Speaker 02

  That number has kind of waned in recent months and now we're a little bit negative for the second consecutive month here. So it's our view, based on some of the dynamics we're kind of, you know, studying in the Chinese economy, specifically as it relates to the PBOC's reaction function to what has become a disappointing, you know, kind of growth recovery in China. It's very unlikely that we see another big massive wave of liquidity in the very near term. We think it's coming because ultimately we've been very consistent in our view that when the Chinese economy reopened from zero COVID, that it was going to reopen back into the structural liquidity trap that the economy was mired in in 2019. I think a lot of people forgot where China's economy was in 2019 prior to COVID. And without the large scale fiscal stimulus that they ultimately decided not to implement,

• 5:21Speaker 02

  they basically woke up back into what was a nightmare prior to COVID. So, and it's our view that we're going to get another wave of Chinese liquidity. But based on some of the recent measures that they've implemented this morning, they've, they cut the deposit rates by five to 10 basis points for the major banks. And then they implemented a few macroprudential easing measures last week. It's not likely that we're going to see another wave of liquidity on the immediate term because they're going to want to see how these things play out. They're not going to work, so that liquidity is coming, but it just might not come for another few months.

• 5:50Anthony Pompliano?

  Let's talk about the public sector liquidity provision. I actually have no clue what the hell that is. Explain what you're talking about here and then why is that so important to China? And you think it's unlikely that they're actually going to step in?

• 6:00Speaker 02

  Yeah, absolutely. So that's a great question you ask, Pom, because I think a lot of times, certainly in the Twitter sphere and, you know, the lesser, let's say in institutional finance, but certainly in kind of the crypto sphere and the Twitter sphere and Fintwit, there's this sort of over, big overt fixation on central bank liquidity. And when you amalgamate, and it's a fine thing to fixate on because, you know, it tends to be the counter cyclical aspects of liquidity that we're all trying to front run as it relates to putting on big positions in asset markets, i.e. Bitcoin, et cetera. But the reality is, That's only half the battle. When you sum the central bank balance sheet and their FX reserves minus gold, it's roughly about the same size of global narrow money supply.

• 6:41Speaker 02

  And so there's a private sector liquidity component as well that comes from commercial banks that tends to be pro cyclical, whereas the liquidity that comes from central banks tends to be counter cyclical. And so when I say we'll try to step up its public sector liquidity provision, I'm basically asking, is the public sector in China, is the central bank going to supply us liquidity over the medium term? And the answer to that question is unlikely. And here's why. On the left chart in slide three here, we showed the trailing 10-year correlation to the year-over-year rate of change in the 42 macro China liquidity proxy across a variety of different leading indicators. And so the blue bars show the stock market, the red bars are the real 10-year yield on a year-over-year basis. The green bars are the Chinese renminbi on a real effective exchange rate basis.

• 7:25Speaker 02

  The pink bars are China's OEC combined leading indicator. The blue bars are China's core CPI, and then the purple bars are that inflation rate. And what we find is when we test this on various coincidence leads and lags is that on a three to six month lead basis, the Chinese equity market is actually the best leading indicator for the China liquidity proxy. And here's why. Because the locals in the Chinese market know when the PBOC is about to step its foot on the gas or it's about to step its foot on the brakes. And so right now, if you look at the chart on the right, where we show the latest value for each of those particular indicators on a Z score basis, the collection of bars on the left is a trailing three-year Z score. That's a cyclical look at it. The bars on the right is a trailing 10-year Z score. That's a structural look at it. And in both instances, the Chinese stock market is declining.

• 8:09Speaker 02

  And so it's telling you that the global liquidity proxy in China is probably going to be declining over the next three to six months because the locals don't believe that we're going to get a wave of liquidity out of PBOC either through guidance, et cetera.

• 8:22Anthony Pompliano?

  When we look at China, it's very clear that you have this kind of link between liquidity, stocks, Bitcoin in that specific market. If we switch over to Japan, it seems like that same link still exists. Is that many of the same drivers or there's something different going on in Japan?

• 8:39Speaker 02

  No, no, great question. No, it's all the same drivers. So we, we, so we run this global liquidity proxy. So again, our global liquidity proxy amalgamates central bank balance sheets, narrow money supply and global FX reserves minus gold, minus gold. And then we do this for all the major economies in the world so that we can have a better handle on forecasting, you know, global, global liquidity. And so in Japan, you know, it's, it's less of a tight correlation with its own stock market, or it has become more tight in recent cycles, but it's still a pretty tight correlation with the Bitcoin cycle, particularly in the last two. And so, you know, this telling us that, hey, look, you got to monitor Japanese liquidity as well, because again, if we look at this slide, the next slide, where we show Japanese liquidity impulse being currently neutral, you know, it's a big deal. And so what again, what I'm showing in this slide here, the

• 9:23Speaker 02

  top panel is Japan's liquidity proxy, BOJ's balance sheet, Japan narrow money supply, BOJ FX reserves minus gold, and it skipped down two panels, but back to that third panel there where we show that trailing three month momentum study. You look at that trundling momentum study, look at the size of the bars, the swings in the bars that we saw kind of in late Q4 and early Q1. And on a trailing three month impulse basis, our 42 macro Japan liquidity proxy was showing that the Japanese economy was sapping $1.5 trillion out of the global liquidity matrix, you know, kind of in October of last year, kind of around the lows of risk assets. By the time you got into Q1 of this year, it was plus $2 trillion. So we basically had a $3.5 trillion

• 10:05Speaker 02

  swing in the impulse that we, that the markets were sort of feeling from the Japanese liquidity cycle. Well, if you go and look at it today, it's flat. And it's been sort of flat to down in the last three months. And so this goes back to the question we're sort of trying to ask with our research, which is, you know, the next slide, is Japan going to step up its public sector liquidity provision over the medium term? And the answer to that question is unlikely. And the reason we say it's unlikely is again, we're, we're looking at various indicators of, you know, kind of various leading indicators of the Japanese liquidity cycle, again, looking at the stock market change, the change in the real interest rate, change in the yen on the real effective exchange rate basis, the, the growth cycle in Japan, core inflation cycle, and then obviously the employment cycle. And when we look at those different indicators,

• 10:49Speaker 02

  On various leads, the inflation cycle, the light blue bars tend to have the highest correlation in terms of projecting the Japanese liquidity cycle. And as we can see in the right chart, you know, where we showed the Z scores of those selecting indicators of the 42 macro Japan liquidity proxy, inflation is still very high. You know, when you look at a trailing three years E score basis, the 1.4 sigma on a trailing 10 years E score basis is a two sigma. And so it's suggesting that, hey, look, if these bars are pointed up, then the liquidity proxy should be pointed down in Japan over the next three to six months. And that's historically, you know, that's kind of been the relationship. So in summary, you know, again, what we're trying to do when we look at these individual country composites to identify where their respective liquidity proxies are moving.

• 11:34Speaker 02

  We're trying to, you know, get a real good handle on what actually drives their liquidity cycles so that we can actually forecast the global liquidity impulse, which you and I have talked about for over a month now, is actually currently negative. And this is my opinion, one of the reasons why Bitcoin is yet to kind of recover its year to date high.

• 11:50Anthony Pompliano?

  So when you see these things changing, how long is the lag, right? It's almost, I think, like kind of inputs, outputs. And so when you see inputs changing, you know, it's kind of going into the machine, right? It's complex and it's got to kind of work its way through until we actually see kind of the values changing or liquidity changing in an output type manner. What does that timeline look like? Are we talking about, hey, something happens on the input side and a week later, you can start to see the impact on liquidity or kind of output? Or is it six months? Like, what is that timeline?

• 12:48Speaker 02

  Yeah, no, that's a great question. So it varies by economy. What we're trying to do again in this analysis is identify which are the particular factors that give you the best lead time to anticipating a change in the reaction function for these respective central banks or the change in the reaction function from the respective commercial banks. And so, you know, specifically with an economy and, you know, if there's an economy that's, you know, much closer to the bottom of its growth cycle, i.e. when the purple bars are rising, i.e. you have the unemployment rate rising on a year-over-year basis point delta basis, or the pink bars are towards the bottom of the chart, i.e. the growth cycle is very low on a cyclical and structural basis, that's when the lead times are a lot closer. You know, the central bank is much more concerned about doing something now. Whereas you have other factors like the stock market that may be

• 13:31Speaker 02

  a leading indicator, real interest rates in China, those are the number one and number two leading indicators in China, those factors may not be as sort of, you know, they may not cause the same sort of trigger or sense of urgency out of the PBOC as, you know, some other factors would in a different economy. So that's a great question to ask. You know, it's not a perfect answer to the question, but the reality is this, to my, what I can see, this is certainly the best, you know, effort at trying to actually understand these dynamics as opposed to just monitoring liquidity on a coincident basis. Because again, you and I have talked about this before. You can't just look at a chart of liquidity and saying liquidity is rising. That's not how you invest. You invest by looking at the chart of liquidity and forecasting where it's going over the medium term. That's what we're trying to do here with this analysis.

• 14:13Anthony Pompliano?

  The last question I have for you is around guidance. Obviously, here in the United States, everyone wants to know what is Jerome Powell saying? And then what is Jerome Powell doing? And what they want to really read into is, what is he saying at press conferences? What is he saying in interviews? What is he saying in terms of that forward-looking guidance? Now, guidance does not necessarily mean that is what they're going to do. As we saw, many people thought they were guiding towards 0% interest rates for a very long time, and instead they jacked them up to over 5% and basically made many of the banks insolvent before they had to step in and backstop them. What are we seeing from a guidance standpoint in Asia? And are there things that we can take away that help in terms of that forward forecast of where we think liquidity is going to end up over the next maybe six to 12 months?

• 14:53Speaker 02

  Yeah, great question. So I'll start with China specifically. So, you know, one funny thing that I don't think the average investor realizes about the PBOC is that the governor of the PBOC does not set monetary policy. The folks in China who set monetary policy are the Politburo, the Standing Committee in the Politburo. And their guidance on monetary policy actually hasn't changed in years. It's just been, you know, we're going to maintain, you know, adequate liquidity. Not, we're going to give ample liquidity, or we're going to support the economy, we're going to do this. It's just going to maintain a flexible amount of liquidity. So, you know, in my opinion, I think that the lack of change in guidance suggests that they're probably not too freaked out about, you know, kind of the disappointing nature of their, of their business cycle. Now, that may change, you know, I've obviously monitored this stuff on a daily basis for the macro, but we have not seen any real change in the actual policy guidance.

• 15:38Speaker 02

  If anything, go back to what we got in March, right? Because to me, I think the guidance in the Monetary Authority is sort of underneath the guidance from the broader Politburo as it relates to the economic targets. They launched in, in March of this year, the outgoing Premier Li Keqiang announced a 5% GDP target that was well below consensus. They announced a 3% budget deficit as a percentage of GDP that was tighter than consensus expecting. And so what I took from those signals is that this is a Politburo that does not want to sort of, you know, go back to the wood in terms of, you know, chomping down or creating a big, you know, sort of big impulse, a growth impulse in China that's due to kind of this investment boom. That's what they used to do, right? And that's part of the reason they're in this structural liquidity trap now is they got an overhang of private sector debt

• 16:24Speaker 02

  on Chinese, on Chinese balance sheets that's kind of preventing, you know, kind of a real rapid and, you know, very, you know, forceful growth recovery. If you look at private sector debt in China as a percent of GDP, it's 220%. And that compares to, I want to say, 154% in the US and 167% in the Eurozone. So China, and this is, and China's not a advanced economy with, you know, the income that could support that level of debt. And so I think naturally President Xi, you know, being kind of the thoughtful leader that he's, you know, proven to be in, in recent, in recent episodes, I think he's sort of trying to avoid at all costs another kind of large-scale stimulus program in China that leads to another investment boom

• 17:04Speaker 02

  that leads to an accumulation of even more debt that puts them back to where they are today, which is an economy that's struggling to grow because it's too indebted. I think that, I think they understand these, these dynamics shifting to Japan. We so obviously we got a new governor, the Bank of Japan governor, because we'll wait a couple of months ago, and he's been very much kind of against the speculation that the Bank of Japan is going to change yield curve control. I've had the view that, you know, part of the reason he was against it is because if he says he's not against the speculation, then there's just going to be more speculation. So part of it, which could just be him sort of trying to tame down market expectations. But there's another situation that's unfolding in the Japanese economy. We actually got data this morning for specifically, if you look at their wage data, because he's been sort of anchoring on the wage data and

• 17:49Speaker 02

  the lag and how much it's lagged core CPI data in Japan, going back to that chart six, how much it's lagged the movement core CPI as a reason for the Bank of Japan to not be in a hurry to revise its yield curve control framework. And if they're not in a hurry to revise the yield curve control framework, then it ultimately means that we're probably not going to see as much speculation against the yield curve control framework that we saw in Q4 and early Q1 that really caused him to have to defend that peg, that interest rate peg with rapid balance sheet expansion. And so, you know, you put those two things together, it just looks like, you know, we're not making the call that liquidity is going to be as nasty as it was in this 2022, but we're certainly making the call and have been for six weeks now that liquidity is not accelerating globally anymore. And obviously,

• 18:32Speaker 02

  we have two very large contributors to that, to that, to that construct moving in the wrong direction.

• 18:36Anthony Pompliano?

  Darius, you've been all over global liquidity now for weeks. I really appreciate and I always learn something when we talk. Where can we send people to find you on the internet or learn more about 42macro?

• 18:45Speaker 02

  Well, I was gonna joke, say morganstanley.com, because every time I create a liquidity proxy, it winds up on their, in their research, but that's neither here nor there. But no, definitely come check us out at 42macro.com. This won't be the last liquidity proxy we create that finds its way across global Wall Street.

• 19:02Anthony Pompliano?

  Awesome. Thank you so much. We'll definitely do it again in the future.

• 19:04Speaker 02

  Cheers, man.