As economies recover from the Covid-19 crisis, underpinned by massive central bank and fiscal support, Michael J. Howell’s Capital Wars: The Rise of Global Liquidity is a must-read for anyone trying to navigate the vagaries of inflation, bond yields, risk and volatility in global markets.

With old models of central banking and inflation falling by the wayside and a new macro consensus yet to emerge, Howell’s book provides a timely deep-dive into the nature of liquidity in the modern economy and the risks embedded in an increasingly opaque and complex global monetary-financial system.

Howell defines liquidity as follows: “a source of funding that measures the gross flows of credit and international capital feeding through the world’s banking systems and collateral-based wholesale money markets. It is determined by the balance sheet capacity of all credit providers and represents the private sector’s ability to access cash through savings and credit.” Liquidity sources include central banks, the private sector (in the form of savings and new loans) and cross-border claims. It is global, not national; and gross, not net. It goes far beyond the traditional monetarist definitions of commercial bank deposit liabilities. As Howell notes, “Economics is itself often guilty of raising to heights of great importance factors that are easily measured”. A truly useful measure of liquidity encompasses elements that do not routinely appear in standard economic statistics, but can be constructed from richer datasets including the Flow of Funds and data proffered by the Bank for International Settlements.

Howell stresses a point that cannot be overstated in this cycle – a cycle where the lines between monetary and fiscal policy have become truly blurred and the transmission from policy rates to banking behaviour has been flipped on its head – “interest rate levels have become much less relevant than the volume of liquidity and the size of balance sheets”. Not only this, but private sector pools of cash – ‘Corporate and Institutional Cash Pools’ – are becoming major drivers of liquidity trends and the global reach for yield. Private sector savings have only increased in size in the wake of the Covid-19 crisis, creating ever-larger cash piles in search of a return.

Howell’s liquidity framework seems only too relevant in 2021, helping to make sense of increasingly effervescent and self-reflexive markets – soaring commodity and crypto markets; Tesla ploughing $1.5bn of cash into bitcoin; and the proliferation of listed ‘Special Purpose Acquisition Company’ (SPAC) vehicles designed to accumulate equity capital and deploy it with diminished oversight. To paraphrase the author, while central banks have been fixed on generating CPI and wage inflation, they have had much greater success in generating asset price and commodity inflation – where prices move more freely – while also building up potentially huge financial stability risks.

At the crux of Howell’s argument is the idea that the modern financial system has moved away from providing primary financing, and instead to ever more complex and opaque vehicles for refinancing. A shortage of safe assets globally has pushed footloose capital into substitutes which do not perform as expected in difficult times. Taking Howell’s arguments to a logical conclusion, massive central bank balance sheet expansion and government debt issuance in the Covid era has arguably increased the supply of these safe assets, but it has concomitantly increased their demand. Gross exposures and, hence, refinancing risk, are therefore only growing in size.

Capital Wars ends with the suggestion that we could be reaching the higher-water mark of global liquidity, or ‘Peak Liquidity’ as globalisation cedes regionalism and China attempts to carve out its own sphere of influence in the realms of technology and capital, summed up by its advanced experimentation with a central bank digital currency. Whether these efforts are successful, their implications for the dollar, inflation and financial stability, may turn out to be one of the defining questions of this new cycle.