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the framework is adapted from Michael Howell’s book titled Capital Wars and his subsequent interviews.
Today’s financial markets increasingly have to serve as refinancing mechanisms rather than as new financing mechanisms, making the capacity of capital, i.e. balance sheet size, more important than the cost of capital, i.e. the level of interest rates.
The wealth of modern capitalist societies appears as an immense collection of stocks, bonds and short-term liquid instruments.
In an era of geopolitical rivalry, large-scale fiscal spending and cyclical, often aggressive Central Bank policies, a flow of funds approach is an indispensable tool to understand the forces truly shaping markets and an essential lens through which to understand the modern World economy. We argued that:
We focus on three liquidity components - each transmitting through key channels:
First, the sum of domestic central bank and private sector liquidity tends to affect the relative price of 'safe' assets.
Second, the exchange rate channel reflects the changing quality-mix of liquidity between the private and public sector.
Third, liquidity in core economies spills over into global markets via offshore funding and policy responses in peripheral economies, amplifying global liquidity and investor risk appetite.
as of august 2025, Global liquidity stands at US$183 trillions, nearly two thirds bigger than world gdp.
In essence, liquidity can be expressed algebraically through the standard budget constraint, which captures the private sector’s funding decisions: Income = spending + net acquisitions of financial assets
banks and non financial institutions create liquidity through credit expansion, leverage and refinancing. credit providers' willingness to lend sets the tone for overall balance sheet capacity; mainly funding liquidity (measure of cash flow) and market liquidity (measure of market depth)
central banks enjoy a unique priviledge: they can supply liquidity at will, at a fixed policy rate, via two channels: interest rates and 'forward guidance' policies & changes to the size and composition of the central bank's balance sheet.
The US dollar’s dominance in pricing both global trade and capital means that dollar shocks transmit rapidly across borders. Many emerging markets, especially China, peg or shadow the dollar, amplifying the impact of US monetary expansions and contractions. Dollar-based carry trades further intensify these dynamics, reinforcing the procyclical effects of global liquidity through cross-border capital flows.
