Wednesday, October 10, 2007

[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -10.7%]

Domestic v. global liquidity; McKinsey & petrodollars; Governor Warsh on liquidity & market-based indicators; amazing Larry Kudlow; a look at the Endogenous Liquidity Index; liquidity @ Financial Times.

[1] Domestic v. global liquidity. John Husman does a good job at debunking one of today's most persistent myths, namely that the Fed is "inundating" markets with liquidity. This is certainly not the case: "... investors are putting so much false hope on the notion that the Fed is 'injecting' all sorts of 'liquidity' into the markets". My own numbers show that the stock of Treasury securities held by the Fed is growing at around ... 3%. Moreover, Husman hits the nail on the head as he mentions foreign holdings of U.S. bonds: "Foreign purchases of U.S. Treasuries outweigh the Fed's actions many, many times over". Yet, one is left with the impression that Dr. Husman pays perhaps too much attention to (anemic) domestic liquidity, and not enough attention to (booming) global dollar liquidity. [John P. Husman: "The Bag Will Not Inflate, And Liquidity Will Not Be Flowing", Husman Funds Weekly Market Comment] [HT: JJ].

[2] McKinsey & petrodollars. Bloomberg's Daniel Kruger cites a McKinsey report on the impact of petrodollars in terms of the U.S. credit markets: "Oil exporters eclipsed Asian nations last year as the biggest source of global capital for the first time since the 1970s, McKinsey found. At $70 a barrel, $628 billion of fresh petrodollars will flood through global financial markets yearly". Here's the really important part: "Yields on 10-year notes are 21 basis points lower because of the additional petrodollar reinvestment". That sounds about right to me. The essence of Bretton Woods-type models is to avoid adjustment through the recycling of savings carried out by surplus countries. [Daniel Kruger: "Treasuries Fueled by Petrodollars From Mideast Funds", Bloomberg].

[3] Governor Warsh & market price indicators. Liquidity analysis isn't always concerned with quantity indicators (monetary aggregates). Market prices provide an alternative route — especially in times of crisis. That is the key lesson from the already aged, but wonderful book by Manuel Johnson & Robert Keleher. Monetary Policy. A Market Price Approach (Westport, Connecticut: Quorum Books, 1996). Fed governor Kevin Warsh appears to agree: "Particularly in times of financial distress, we must draw on a full range of market indicators ... Signs of illiquidity were evident in a number of important markets ... In this respect, market-based indicators are certainly informative". All sorts of spreads are taken into consideration. But note the conspicuous absence of ... FX markets. [Kevin Warsh: "Financial Stability and the Federal Reserve", Federal Reserve Board].

[4] Amazing Larry Kudlow. CNBC's Larry Kudlow and an astonishing piece on Ben Bernanke's "liquidity flip-flop": "On the afternoon of August 7, the Federal Reserve chair was an inflation hawk — according to the unchanged FOMC policy statement — fearful of adding liquidity to the markets. By day’s end on August 9, however, he was leading the liquidity charge, initiating a process that would help unlock the credit seize-up that started in late-July ... And he got the liquidity ball rolling. As we now know, the Fed started pouring liquidity into the system on August 9. Then, on August 17, it slashed its base discount rate for member-bank loans by 50 basis points. Finally, on September 18, it enacted a shock-and-awe liquidity-adding half-point drop in the federal funds rate". [Larry Kudlow: "Anatomy of a Fabulous Fed Flip-Flop", National Review Online].

[5] Endogenous Liquidity watch. Our Endogenous Liquidity Index surged 4.2% yesterday, spurred by the falling VIX, by tightening CDS spreads, and by surging share prices of financial innovators (Goldman Sachs at a new all-time high).

[6] Liquidity @ Financial Times: John Plender. The former FT editor, now chairman of Quintain, argues vehemently in favor of incorporating liquidity risk into the next Basel regulatory round: "Bill Cuthbert of Liquidatum, an advisory and data services firm specialising in liquidity risk, points out that liquidity risk has become the poor cousin of other types of risk. A survey by his firm of the annual reports of 59 of the world's biggest banks shows that liquidity risk is consistently granted much fewer mentions than market risk, credit risk and operational risk". Mr. Plender mentions the L-word no less tan ... eleven times (a new record) [John Plender: "Let's not forget to mention liquidity risk at the Basel round", Financial Times].

[7] Liquidity @ Financial Times: Kazakhstan. Remember the ECB's burden? Now things are taking a spectacular turn. Banking systems at the periphery of the eurozone are getting shaky; local investors rush to protect their property by buying ... euros! The euro appreciates, and politicians in Brussels complain. Dear ECB: welcome to the not-always-pleasant world of the issuers of international reserve currencies! (More on that soon) [Joanna Chung and Stacy-Marie Ishmael: "Kazakhstan hit hard by the shortage of liquidity", Financial Times].

[More updates coming up].

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