Key Takeaways
- Shift from fiscal policy to private sector leadership of the economy.
- Impact of decreasing government spending and increasing tariffs on liquidity.
- Necessity of interest rate cuts to stimulate the private sector.
- Impact of global liquidity cycles on asset allocation.
- Correlation between Bitcoin and global liquidity cycles.
Introduction
The post-pandemic era has been largely defined by fiscal dominance – an economy driven by government deficits and short-term Treasury bill issuance. However, we are now transitioning into a phase of private sector leadership, where the Treasury is withdrawing liquidity through tariffs and spending constraints. This shift has profound implications for interest rates and financial markets.
The End of the Debasement Trade?
The interest in the "debasement trade" peaked years ago, when Bitcoin was priced at $25,000 and gold at $2,000. Now that this trade is mainstream, we must examine the conditions that created it to determine if they will persist.
Drivers of the Debasement Trade
In our view, two primary factors fueled this trade:
- Government Spending: The Biden administration oversaw significant fiscal deficits, injecting liquidity into the economy. However, the "Big Beautiful Bill" will result in spending cuts by reducing Medicaid and Supplemental Nutrition Assistance Program (SNAP) benefits.
- Treasury QE: To finance the excessive spending, the Treasury employed a new form of "quantitative easing" (QE), funding government spending through short-term Treasury bills rather than long-term bonds.
Transition to a Privately-Led Economy
As we transition towards a Trump-led economy, the private sector will take the reins from the Treasury. This is why interest rate cuts are necessary – to stimulate the private sector through bank lending. The global liquidity cycle appears to be topping out as we enter this transition.
The Global Liquidity Cycle
Comparing the current cycle to the historical average since 1970, we observe that the current cycle is following a typical pattern. Historically, commodities are the last assets to fall, which we are seeing today in the prices of gold, silver, copper, and palladium. If liquidity is indeed topping out, we can expect investors to rotate into cash and bonds.
Debt and Liquidity
The debt-to-liquidity ratio in major economies reached its lowest level since 1980 at the end of last year. It is now rising and is projected to continue rising through 2026. This makes servicing trillions of dollars in outstanding debt that needs to be refinanced more challenging.
Bitcoin and Global Liquidity
Historically, Bitcoin has foreshadowed the peaking of global liquidity in the past two cycles. In other words, Bitcoin peaked several months before liquidity peaked, signaling a subsequent decline. We do not know if this is happening now, but we do know that the crypto cycle closely follows the liquidity cycle.
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