LIQUIDITY ANALYSIS. THE IRRESISTIBLE ALLURE OF THE NEW BRETTON WOODS

[Latest Global Dollar Liquidity Measure: +13.84% annual growth rate; latest Endogenous Liquidity Index: +12.27%]

The New Bretton Woods proposition, the key factor in the current liquidity boom, is sometimes misunderstood as an instance of (misguided) support for the Bush administration. In reality, it is much more than that. Having lived myself in "emerging" countries, it is perfectly clear to me that the key to understand the phenomenon is the high cost of capital resulting from weak property rights. These countries are thus virtually forced to compete à la Chinese: by systematically undervaluing their currencies and accumulating dollar-denominated FX reserves.

Look at the China-Blackstone deal. According to the Financial Times, "China's decision to buy a stake in Blackstone's IPO rather than in one of its buy-out funds, which are more volatile and risky, is a sign of Beijing's cautious approach to private equity". Let me get this straight: the Chinese do not trust the solidity of ... their own financial markets! And there's more. According to Thomas Barnett, Iran is studying the ... Chinese model. Here, readers of Dooley, Folkerts-Landau and Garber will recognize one their key insights: many more countries are likely to join in!

Meanwhile, down in Buenos Aires, Fed governor Randall Kroszner tells it like it is:

The financial systems in many developing nations are relatively weak and are not effective at directing saving toward appropriate investment projects. That failing leads to inadequate investment, particularly if business activity is further impeded by inadequate property rights and faulty regulations. As a result, excess saving flows to countries with better financial systems.

Businesses in many emerging-market economies face a multitude of hurdles. Red tape, rigid regulations, and weak legal systems impede the formation of businesses, their ongoing operation, and their confidence in having their contracts enforced without long and costly litigation. Accordingly, governments in these countries could greatly improve the environment for domestic capital formation by simplifying business regulations, strengthening property rights, including the rights of creditors, and improving contract enforcement.