A Glut of Liquidity?

We’ve heard the word "Liquidity" bantered about incessantly over the past few years. The Economist looks into exactly what this means (A fluid concept). 

Just about everyone agrees that there’s a lot of liquidity about—whatever it is

is everywhere. Depending on what you read, you may learn that the
world’s financial markets are awash with it, that there is a glut of it
or even that there is a wall of it. But what exactly is it? Again
depending on what you read, you may be told that “it is one of the most
mentioned, but least understood, concepts in the financial market
debate today” or that “there is rarely much clarity about what ‘buoyant
liquidity’ actually means…”

Globally, money looks plentiful. In the euro area and Britain, broad money growth is running well ahead of nominal GDP.
Or take the global supply of dollars, fuelled by America’s large
current-account deficit, the accumulation of reserves by foreign
governments and their recycling back to the United States. A common
measure of this, says Mr Barnes, is the American monetary base plus
United States securities held by the Fed for foreign countries. Its
annual growth rate peaked in 2004, at more than 20%. But because those
securities have continued to pile up, this measure of liquidity is
still growing at a rate of around 10% (see right-hand chart, above).
Another gauge, combining all foreign-exchange reserves with America’s
monetary base, has risen at an average rate of perhaps 18% in the past
four years. And this omits the contribution to global liquidity of the
Bank of Japan, whose low interest rates are fuelling the “carry trade”.

All this is
reflected in financial markets for everything from developing-country
debt to corporate junk, commodities and art. Global willingness to save
and lend is running ahead of investment. Ben Bernanke, chairman of the
Fed, has spoken of a savings glut. Then again, the real puzzle could be
companies’ “investment restraint”, according to Raghuram Rajan, of the
University of Chicago’s business school (and until recently chief
economist at the
IMF). Maybe, he suggests,
investment is becoming more centred on people and less on physical
capital; maybe physical investment is being switched to emerging
economies; maybe uncertainty still holds back investment abroad—as it
does not, say, investment in property at home. Whatever the cause, a
shortage of investment in fixed assets implies a shortage of debt
collateralised on them. The financing glut has thus spilled over into
markets for existing assets."

Th entire column is worth a read . . .


A fluid concept
The Economist, Feb 8th 2007

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What's been said:

Discussions found on the web:
  1. Michael C. commented on Feb 9

    Thanks, BR. Another commentary said this:

    In Australia, the M3 money supply is 13% higher from a year ago, British M4 is 13% higher, the Euro Zone’s M3 is 9.3% higher, a 16-year high, Korea’s M3 is 10.3% higher, China’s M2 is 16.9% higher, a 16-year high, and Russia’s M2 is 45% higher.

    And Mish has an article on how printing money endlessly is a win/win for everyone, until it isn’t.

    Let’s say that I invent a printing press that allows me to produce counterfeit money (let’s say US dollars) by the trillions – these dollars look EXACTLY like real ones, so no one can tell the difference, not even the government or the bank. So I start off the first year by counterfeiting $3 trillion dollars…

  2. snoopy commented on Feb 9

    Could the economist have called the top on liquidity ? deflation, here we come..

  3. Macro Man commented on Feb 9

    The central banks printing money are NOT the Fed, the RBA, the ECB, the BOE, etc. Look at the charts closely. US monetary base growth has decelerated sharply, from 10% y/y in 2001 to ~ 3% y/y now.

    The monetary base is the only measure of money over which the central bank has direct control: it is the cash in circulation plus commercial bank reserves with the CB.

    Now check out the chart on the right: the monetary base plus Fed custody holdings fore foreigners (aka foreign central banks.) That’s running at 11% y/y, having been as high as 22% when the BOJ bought several hundred billion dollars in late 2003-early 2004.

    Central banks in Asia and oil exporting countries are the source of the liquidity. They print domestic currency and spend that domestic currency to buy USD. So not only does China export DVD playerss, they also export broad money growth.

    Claiming there is a conspiracy by the Fed, etc. is just incredibly wide of the mark. If you want to finger one institution, point that finger at the PBOC.

  4. Patu commented on Feb 9

    Liquidity is what will flow over at the four seasons on 58th street at about 4:30 this afternoon.

  5. Teddy commented on Feb 9

    Macro Man, you are correct. The Fed is not printing money, but they have allowed the creation of debt at way too high a rate for way too long, but especially the last 5 years. And to point your finger at the PBOC is redundant since they have 1 trillion US dollars at THEIR disposal. And the debt that Japan is creating at way too high a rate is going worldwide and especially to the US, but the debt is owed in Yen, not US dollars, and is called the Carry Trade.

  6. OldVet commented on Feb 9

    This is funny. Everybody in the universe is trying to beat its currency down so as to be competitive with China, and the US government is strutting around and talking about a “strong dollar policy.” Macro Man is right that the generators of the “liquidity” are central banks other than the US. But the question remains: What to do about it, to avoid pure asset price inflation?

    We need a financial “Dr Phil” to call an intervention. Let the mercantilists in Asia compete on productivity and price rather than currency manipulation. (The same for the US, by the way.)

  7. diva commented on Feb 9

    Everyone likes to talk about the ‘supply’ of currency….. but, no one has a clue about the ‘demand’ for currency (including the Fed)
    Hint: check out the price of gold. The whole story is there.
    Deflation is definitely not a worry at this time.

  8. pjfny commented on Feb 9

    The Fed can impact the demand for money and speculation through restrictive money policy (higher fed funds). The FF rate controls the opportunity cost of demand for borrowing and speculation, by increasing savings rates….they have chosen not to do that and therfore put themselves in the position of increased difficulty to unwind the speculation and leverage in the system!

  9. Charles Butler commented on Feb 9

    “Maybe, he suggests, investment is becoming more centred on people and less on physical capital;”

    Anyone have a clue what Mr. Rajan means by this?

  10. spencer commented on Feb 9

    If your favorite measure of liquidity does not have a good correlation with changes in the stock market PE I would seriously question if what you are measuring is relevant.

  11. OldVet commented on Feb 9

    From the article: “Mr Barnes concludes that it is too early to worry about liquidity: with inflation low, there is little prospect of a monetary squeeze; and American households and businesses’ balance sheets (but not those of pension funds and mutual funds) are fairly liquid. Were there a market scare, he thinks, central banks would ease policy. One day, they may be tested.”

    I don’t know what households he’s talking about in which America. Cash as a % of total HH assets moved from 26% in 1945 down to abt 14% in 2006. HH cash less liabilities was positive from 1946 until about 1998, then started dropping to ($3,500) per HH today. HH liquidity (broadly defined) dropped from 250% of liabilities in 1952 to 75% in 2006.

    There’s plenty of liquidity, but not in US households on average, which is the problem with the Real Estate market.

  12. BDG123 commented on Feb 9

    Many prescient comments on here about the Fed. I find it ludicrous that people never quit squawking about the printing presses of the Fed. There are many monetary dynamics in play this cycle. Some are mentioned above. None have to do with the Fed printing money in their secret room. Mish is a good read but he’s quite clueless on this topic. And, it never seems to go away from the crowd of those in need of strong medication to curb their paranoia. Whether you are untrusting of government or not, our government is out to destroy our society and way of life. But, let those who believe in such delusions continue their feelings of bliss.

  13. BDG123 commented on Feb 9

    Oops, is NOT out to destroy our society

  14. tmcgee commented on Feb 9

    yep, look to the PBOC. the rise in fed custody holdings of treasuries/agencies for foreign c.banks has been on a non-stop upward trajectory even since the BOJ stopped intervening in march 2004. and yep, the oil exporters as well.

    the irony with the BOJ is that it’s being blamed for low rates and the carry trade now, while just about a year ago the end of quantitative easing — and the subsequent fall in japan’s monetary base from the drop in bank reserves after the BOJ stopped force-feeding them with cash — was blamed by some analysts/economists for the hit to emerging markets and stocks last summer.

    but i suppose it’s not a surprise that some analysts/economists like to have it both ways. nor that journalists and the analysts they quote like to flaunt words like liquidity (or the “carry trade”) to explain events they’re having trouble coming to grips with.

    as for the fed, it’s balance sheet — fed bank credit, or just what it supplies to maintain the current fed funds rate — is growing all of 4% yr/yr, and it’s been around 3-4% the last several months. hardly what could be called spewing cash.

  15. bearing commented on Feb 9

    What about the credit created by the investment banks and hedge funds via CDS/CDO market? Anyone care to commnet on this expansion? The last bubble resides in the professional speculator community where endelss capital is deployed in the name of portable alpha.

  16. DavidB commented on Feb 10

    Printing is a giant confidence game that works only to a point. When people start to ‘get it’ then they will start swapping all those paper dollars for assets.

    They tried to swap them for shares in the 90’s only to discover to their horror that most of those shares were just different forms of paper for the most part. Looking past the year 2000 they tried to swap their paper for harder assets called real estate but even that is proving to be a fleeting investment as it reaches its peak.

    What they do next is what we who have studied them for years are wondering. There are not too many places for them to store their paper. This may be a big lesson in human mass psychology at work as we see people flooded with liquidity with nowhere to put it.

    Although the main stream media ‘leaders’ aren’t preaching it I have to think the some of it will start to push up gold and other commodities but that is a market that is relatively so tiny that it will not take long to fill up the bucket.

    The only other place left for them is to pay down debt. That is a guaranteed return on investment for anybody who has studied the issue. It is not what the establishment preaches because their machine runs on debt. It’s how they exploit and enslave the people. It is the beast itself

    If the people were to get it into their heads that paying down debt and truly buying the assets they’ve enslaved themselves for is the way to go it could start a revolution in this world but I see it as the only solution that people have left for all that paper that is flooding their world. Let’s hope they learn to give back the paper to those that are creating it

    After that who knows. Maybe then we’ll go back into a hard asset boom. The buckets are filling up fast though and pretty soon they will start spilling over. At that point the printing confidence game neutralizes itself as people trade it back as fast as it comes out of the machine and paper money velocity reaches it’s virtual peak

  17. Fullcarry commented on Feb 10

    I am with Diva. What is important but hard to measure is dollar demand which has held up remarkably well in the face of the credit expansion we have had. I wonder how dollar demand will hold going forward if foreign central banks for some reason pull back.

    In terms of dollar supply it isn’t that the Fed has been running the printing presses lately that is disconcerting. It is that they have allowed such credit growth that they will eventually have to monetize.

    That’s why what is happening right now is so inflationary. Paper money credit/debt expansions are always eventually inflationary.

  18. Ken Jarboe commented on Feb 11

    To answer Charles Butler’s question about Rajan comment on investing in people, see his speech of last November “Investment Restraint, The Liquidity Glut, and Global Imbalances” (http://www.imf.org/external/np/speeches/2006/111506.htm) where he gives a number of reasons why there is underinvestment, including:
    “A second explanation is that the nature of investment may have changed — from hard physical assets like plant and equipment to items like training and research and development that are expensed and not as easily tracked. But if such expenses were high enough to compensate for the “missing” physical investment, profitability would be low — however, corporate profitability is high the world over.”

    One example of how the changing economy is changing the rules of the game (for more, see my blog – http://www.intangibleeconomy.org

  19. chuk1 commented on Mar 21

    hmm do you really think your blog really tells how the changing economy is changing the rules i think it is best to go to wiki.

Read this next.

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