Monday, August 27, 2007

[Latest Global Dollar Liquidity Measure: +14.8% annual growth rate; latest Endogenous Liquidity Index: -25.1%]

On Friday I wrote a rather bearish piece on the latest weekly Fed balance sheet. Markets duly responded with spectacular ... rallies! Once more, I was reminded of the wisdom of Manuel Johnson & Robert Keleher, authors of the already aged, but wonderful book Monetary Policy: A Market Price Approach (Westport, Connecticut: Quorum Books, 1996). Johnson and Keleher taught me not to put too much trust in quantity indicators suchs a GDP, industrial production and monetary indicators. Instead, look at market price indicators — especially in times of financial stress.

To gauge the Fed's monetary stance, Johnson and Keleher selected three variables: the exchange rate, commodity prices, and the yield curve. Dollar-based liquidity is abundant in situations were the dollar falls, commodity prices rise and the yield curve steepens. That is exactly what was happening as the Fed published its balance sheet! Message to my readers: sorry for Friday's blunder. I'll be hard at work this week on a Market Price Approach Index to monetary policy. [Many thanks to T. McGee for his useful comments].

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