Thursday, October 4, 2007

[Latest Global Dollar Liquidity Measure: +13.6% annual growth rate; latest Endogenous Liquidity Index: -16.9%]

Liquidity is priceless; Brad Setser on central bank reserves; Vietnam & the dollar; China's economy & the global business cycle; daily Endogenous Liquidity watch.

[1] Liquidity is priceless! The Financial Times's John Gapper draws "Three lessons from the credit squeeze". One such lesson is that "liquidity is priceless". Here's Mr. Gapper: "Until August ... liquidity was free. You could get liquidity at the local drug store ... This, however, was an illusion. Although there was still money around in August and September – deposits were flowing into Treasury bonds and money market funds – the tap turned off in the interbank market. 'Liquidity is a very tricky risk to manage', says James Wiener, a managing director at the financial consultancy, Oliver Wyman. 'Many times, there is either an abundance or a complete lack of it'. In the latter times, financial institutions rediscover that liquidity is priceless, first because they are unable to obtain funding at all and second because everything else follows from it. An illiquid broker or bank is potentially a bankrupt one; no matter how much its assets are worth, or may be worth in the future, it must jettison them at fire-sale prices to stave off collapse".

[2] Brad Setser on central bank reserves. Another long and well thought out piece from Brad Setser, the doyen of central bank reserve analysis. ("Central banks came close to financing the entire US current account deficit"). Brad contends that "all the heavy lifting required to finance the US external deficit is being done by the world's central banks". The relative paucity of private flows worries him. But one could also argue that central banks' actions are merely reflecting investors' willingness to hold yuan, won, roubles, reals, pesos, etc. This all but forces foreign CBs to buy more treasury and agency securities. In other words, it would be like the Asian crisis in reverse: a show of confidence in local currencies.

[3] Vietnam & the dollar. Über-bear Ambrose Evans-Pritchard is at it again ("Dollar's double blow from Vietnam and Qatar", Telegraph). The Vietnamese central bank, apparently, has had it with the New Bretton Woods: "The Saigon Times said this morning that the State Bank of Vietnam was abandoning the attempt to hold down the Vietnamese currency through heavy purchases of dollars. The policy is causing the economy to overheat, driving up inflation to 8.8pc". Fellow bear Hans Redeker is cited: "Vietnam is a relatively small country but it is symptomatic of Asia. The entire region is seeing inflation move up as a result of mercantilist policies of holding down their currencies with 'dirty floats', which are designed to help their export sectors". It will be interesting to see how the Vietnamese manage the transition from an exporting periphery to a centre of growth and innovation.

[4] China's economy & the global business cycle. "The fate of the world economy", says The Economist, "now hinges not just on America, but also on China's economic fitness continuing over at least the next two years" ("How fit is the panda?"). Let me add one thing: the fate of endogenous liquidity is also at stake. A balanced global economic cycle, with strong growth from China somehow compensating for G7 weakness, would reduce financial volatility and hence boost market liquidity. The Economist then quotes Tao Wang, Bank of America's economist in Beijing, who "is optimistic about China's economy in the short term and the long term, but thinks the medium term looks risky". I fully agree with that view.

[5] Endogenous Liquidity Watch. Our Endogenous Liquidity Index eased slightly yesterday (-0.22%). Once again, the impact of mildly higher volatility readings was held in check by falling CDS spreads. Nothing to write home about, really. The index is acting in a less volatile fashion, which may indicate, as a Lehman Brothers analyst puts it, that "The credit machine is slowly restarting".

UPDATE: Bank of England mantains the official bank rate at 5.75% [communiqué]; European Central Bank leaves key rates unchanged (4.00%) [statement].

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