LIQUIDITY ROUNDUP. THE ECB'S BURDEN
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -14.3%]

The ECB's burden; liquidity & entrepreneurship; liquidity @ Financial Times: Lagarde, Magnus, Lex.

[1] The ECB's burden. The European Central Bank is discovering the pitfalls of managing an international reserve currency. Ten years ago, surging demand for dollars worldwide baffled the Fed and led to a memorable debate within the FOMC. Monetarists, led by Bill Poole and Jerry Jordan, worried about surging M2 and M3 aggregates, and wished to raise rates. "Internationalists" argued that a global flight-to-quality move was artificially swelling money market funds within M2 and M3. They insisted on lowering the Fed funds target to ease the panic. Now, the ECB is grappling with similar issues: "... the August annual growth rate of close to 12% in the monetary aggregate M3 may have been influenced by a number of temporary or special factors, such as the flattening of the yield curve and the recent financial market volatility, and may therefore overstate the underlying rate of money and credit expansion". Fascinating stuff. [Jean Claude Trichet: "Introductory statement", ECB].

[2] Liquidity & entrepreneurship. Hans Hvide, a professor of finance at the University of Aberdeen, proposes a simple model to test an idea that can be traced back to Adam Smith, who in the Wealth of Nations stated that entrepreneurs: "... have all the knowledge, in short, that is necessary for a great merchant, which nothing hinders him from becoming but the want of sufficient capital." Overall, the model tends to support the view that "entrepreneurs may be unable to establish a venture at an efficient scale due to liquidity-constraints arising from capital market imperfections" [Hans Hvide: "Does lack of liquidity impair entrepreneurs?", VOX].

[3] Liquidity @ Financial Times: Christine Lagarde. The French minister of economy and finance —who recently argued in favor of a "semi-incestuous relationship between the exchanges, bankers, insurers, lawyers and accountants"— calls for a better assessment of liquidity risk by rating agencies: " ... the liquidity of secondary markets for such complex securities can disappear very quickly. Both rating agencies and investors should be able to assess this liquidity risk. Rating agencies should enhance their methodology for assessing structured products so as to capture liquidity risks". The L-word is mentioned no less than five times. [Christine Lagarde: "Securitisation must lose the excesses of youth", Financial Times].

[4] Liquidity @ Financial Times: George Magnus. The UBS Investment Bank advisor warns readers that the credit crisis is not over yet: "The scramble for liquidity is still ongoing, as evidenced by euro interbank rates, which are still hitting new highs". Mr. Magnus doesn't buy into the notion that BRICs-led "global decoupling" will be enough to offset the upcoming slowdown in OECD economies. For my part, as I have stated repeatedly, I'll keep an eye on volatility readings to gauge the validity of the decoupling thesis. So far, the verdict is largely a positive one. [George Magnus: "The credit crisis: why it is still too early to relax", Financial Times].

[5] Liquidity @ Financial Times: Lex. There is little need for another rate cut from the Fed, says Lex: "Last time round, the Fed delighted unsure investors with 25 basis points more than expected. This month, it might be time to remind them that while helicopter Ben has shown he will take off in an emergency, he does not simply hover over the markets unleashing cheaper money on demand". [Lex: "The first cut is the deepest", Financial Times]

[6] Liquidity @ Financial Times: Islamic bonds. This is a truly worrying piece of news. Islamic finance, one of the global credit market's bright spots, now looks vulnerable to the West's credit problems: "Dana Gas, a Middle Eastern natural gas producer, was on Monday forced to lower the size of an Islamic bond issue and offer investors bigger premiums as the credit squeeze took its toll on one of the fastest-growing sectors of the market.
The United Arab Emirates company finally raised $875m with a coupon (or profit rate) of 7.5 per cent. However, the company had initially hoped to raise $1bn with a premium of between 6.5 per cent and 7.25 per cent". [David Oakley: "Dana Gas trims Islamic bond issue", Financial Times].

[7] Liquidity @ Financial Times: the dollar & the adjustment burden. Alan Ruskin, chief international strategist at RBS Greenwich Capital, writes that massive FX intervention by emerging market countries "has shifted much of the adjustment burden of the weaker dollar to the more flexible 'major' currencies". This is precisely the 'magic' of a Bretton Woods-style monetary system: the issuer of the reserve currency enjoys the (temporary, and ultimately self-defeating) benefit of deficits without tears, as Jacques Rueff, Charles de Gaulle's economic advisor, used to describe it in the 1960s. [Alan Ruskin: "Beware moral hazard that has encouraged a weak dollar", Financial Times].