[OPE] Liquidity problems...

From: Jurriaan Bendien (adsl675281@tiscali.nl)
Date: Mon Apr 28 2008 - 16:56:59 EDT

Wolfgang Münchau (Global adjustment will be long and painful, FT April 27 2008) argues:

"The economic part of the story started more than a decade ago with a liquidity-driven global boom. Property, credit and equity bubbles were all part of this. So was a Ponzi scheme that later became known as Bretton Woods II, a gravity-defying design that allowed the US to run persistent current account deficits. The dollar surplus in the newly industrialised countries was recycled back to the US and European markets, where various categories of asset prices were driven up and banks lured into excessive risk-taking. It could not last, and did not. If excess liquidity was the ultimate cause of this crisis, the real estate sector was its most important driver." http://www.ft.com/cms/s/0/ef6f6a22-1480-11dd-a741-0000779fd2ac.html

Martin Hutchinson (The rising protectionist tide, Asia Times, 23 april 2008) then argues that:

"A further need is for higher worldwide interest rates and lower worldwide liquidity. Much of the recent run-up in commodity prices has been due to excessive economic expansion, combined with over-abundant capital for speculators seeking to exacerbate price movements. A global tightening of interest rates, beginning in the United States, where the economic imbalance is greatest, will rapidly reduce the fever in commodities markets, thereby reducing the temptation towards autarky. It will also rebalance the US trade deficit, which will lessen the non-market central bank demand for Treasury securities, forcing a tightening of the excessively expansionary US fiscal position." http://www.atimes.com/atimes/Global_Economy/JD23Dj02.html

But it seems to me that higher interest rates will not necessarily cancel out the liquidity problem, and might even increase it while it affects output levels. It will more likely just shift the liquidity problem from A to B. Why does the excess liquidity exist in the first place? Partly a deliberate policy, but partly simply because investors do not invest sufficiently in illiquid assets, and why is that? I assume they would do that only if it turns out that illiquid assets hold their value better than liquid assets, i.e. if liquid assets do not hold their value sufficiently. The easy convertibility of assets was a mainstay in the neoliberal idea of better market functioning (the ability to trade freely without restrictions), and indeed Paulsen boasted that the US has "the most liquid markets in the world". It is therefore ironic that liquidity now turns out to be a problem.

Any comment?


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