Global Liquidity: A Useful Measure for Bitcoiners?

Many Bitcoiners are often focused on Bitcoin’s correlation to global money flows, also known as “Global Liquidity”. In this article, we break down what global liquidity is, whether the correlation to Bitcoin is accurate, and how it may help us understand and analyze Bitcoin’s historic price fluctuations.

What Is Global Liquidity?

In Bitcoin circles, we often hear the term “Global Liquidity” or “Global Liquidity Index”, both of which are typically closely monitored because people believe them to be useful predictors of future movements in broader asset prices.

‘Global liquidity’ itself is used as a term that refers to the amount of money available in the entire global financial system. This is most often measured by aggregating global “M2”, a measure which tracks each respective country’s liquid assets (i.e. the total cash - including certificates of deposit and money market funds - available in each and every country’s checking/savings accounts).

These M2 figures are reported (typically weekly) by the central bank of each of these countries and then tallied together to create “Global Liquidity”.

It is worth noting however, that different measurements of “global liquidity” often occur. This is due to the fact that there are ~200 countries in the world, and often only the top countries are included in the measurement of the nominal figure. This measure for example, chose only to include flows of the largest nations (such as the USA, China, EU, UK, Japan, and  Australia).

Why is Global Liquidity Important?

Conventional wisdom states that if there is more money in the system, individuals and corporations are likely to spend that money investing in assets (stocks, real estate and Bitcoin). As such, larger amounts of global liquidity should result in higher asset valuations, as more buyers ‘bid up’ the price of assets across the globe.

In layman's terms, the main reason people track global liquidity is to attempt to ‘frontrun’ the future directional movement in Bitcoin’s price. If we know that there is a likely increase in liquidity incoming, we can position ourselves accordingly to benefit from such a future move in Bitcoin’s price. In reality however, this is vastly more complicated. There are many reasons for this, which include: 

1. The exact definition of “global liquidity” is incredibly difficult to measure given global flows are both relative and often not uniformly reported/tracked by each country; and
2. Bitcoin’s correlation to global liquidity differs depending upon which time horizon you are analyzing.

Instead of analyzing the overwhelming details of measuring Global Liquidity, many people typically stick with Global M2  as their approximation. However, even with this oversimplification, people still make the mistake of focusing solely on the nominal figure of global liquidity (currently at $177 trillion) and infer that “if the number goes up, stocks and other risk assets will similarly increase in price, and vice versa”.

In reality though, they should be focused on the following:

1. The rate of change of global liquidity (rather than just the number itself); and 
2. The relative expansion/contraction of individual countries’ balance sheets.

Assume an Australian-based individual is tracking global liquidity, seeking an edge on whether to make a buy/sell decision. Instead of asking “whether global liquidity is increasing or decreasing, he should be focused on whether the Australian central bank’s monetary policy is relative to the Fed and ECB.

How to Measure Global Liquidity?

Though the typical measure for Global Liquidity is an aggregation of various country’s “M2” (as mentioned above), there are a few other related measures of global liquidity worth noting, namely:

1. The Global Liquidity Index:

This is a metric from Tradingview that incorporates not only M2, but also other relevant measures of a government's “money” reserves such as:

• Central Bank Balance Sheets (a measure of how much cash banks hold). More cash on central banks’ balance sheets results in greater global liquidity.
• US Treasury General Account (a measure of the US Treasury’s checking account). A decreasing balance indicates more liquidity is being injected to the system as the US Treasury “spends” its cash balance.
• Reverse Repurchase Agreement “RRP” Account (a measure of overnight lending between local banks and the central bank). Central banks use RRP's to manage liquidity; a decreasing RRP indicates that a country's central bank is increasing liquidity by net purchasing securities, thus adding cash into markets.

2. ‘Source of Funding’ Liquidity Definition:

This definition by Michael Howell measures global liquidity by incorporating “funds from the assets side of the private sector balance sheet”.
His measure of global liquidity comprises:

• Short term liabilities of credit providers (banks and shadow banks) +
• Cashflows held by households and corporations.

For this reason, his measurement of global liquidity currently stands at ~$177T which is substantially different from the ~$270T captured by the Global Liquidity Index above.

Assessing Bitcoin’s Correlation to Liquidity

When assessing an asset’s correlation to another asset, we know that the higher the correlation, the closer the two assets track each other. Similarly, we can measure how closely the price of Bitcoin moves in sync with increasing/decreasing global liquidity.

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Conventional analysis shows two such examples (below) of global liquidity being tightly correlated to Bitcoin’s price. The first (green arrow) represents the post-pandemic balance sheet expansion by the Fed, followed by the Fed’s aggressive rise in interest rates creating subsequent balance sheet tightening (red arrow).

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However, the relative correlation of two variables (in this case “Global Liquidity” and “Bitcoin”) is in fact measured both in terms of:

1. Direction (does asset A go up when asset B goes up?) and 
2. Magnitude (if asset A goes up 2x, does asset B go up more or less than 2x?)

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The latter is often ignored. As Lyn Alden correctly points out in her analysis, this is precisely where Bitcoin shines relative to other traditional financial assets (stocks, gold, bonds etc.).

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She found that Bitcoin’s correlation to global liquidity over shorter time frames is relatively weak, however over longer term time frames, Bitcoin’s price aligns more closely with the direction of global liquidity than any other major financial asset.

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Conclusion:

In summary, global liquidity is an essential metric that can help us better understand Bitcoin’s historical price movements. The term, however, needs to be clearly defined before being utilized to infer any statistically useful correlations to Bitcoin price.

What is evident however, is that Bitcoin remains a high-beta asset correlated to global liquidity over longer term time frames. With this in mind, the logical bet that one needs to consider is the probability of global liquidity increasing rapidly over the longer term.

This is a considerably easier decision to make given the limited viable options governments have in order to debase the significantly growing debt burden, which many have suggested has now hit critical mass (i.e. the point at which governments are mandated to continue servicing the debt with newly created debased currency rather than by implementation of prudent fiscal austerity policies).

For this reason, we have seen an increasing number of powerful, well capitalized financial firms such as Blackrock lead the charge by enabling their clients to allocate to Bitcoin as a macro asset, thus helping their clients make the long term bet that “global liquidity will continue to rise at a rapid pace, and thus so too will Bitcoin’s price”.

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