Wednesday, December 19, 2007

[Latest Global Dollar Liquidity measure: +12.4% annual growth rate; latest Endogenous Liquidity Index: -33.1%]

The New York Fed-Princeton Liquidity Conference; M2 & liquidity conditions; William Dudley on the TIPS market; record platinum prices.

[1] Liquidity, an increasingly popular topic! Liquidity issues are making headlines. Today's FT carrries a front-page headline about the ECB's liquidity injections. Last week, the Federal Reserve Bank of New York organized a "Liquidity Conference" together with Princeton University. At the Global Liquidity Blog we welcome this sudden popularity! In his introductory remarks, New York Fed president and CEO Timothy Geithner uttered the L-Word no less than ... 19 times! Describing the current situation in money markets, Mr. Geithner points to factors that tend both to reduce the supply and to increase the demand for funds: "Financial institutions faced a sharp drop in demand for a range of assets, impairing the securitization market as a source of funding. And a substantial amount of these illiquid assets were held in vehicles with implicit or explicit liquidity guarantees provided by banks. This produced a large unexpected increase in demand for funding from banks at the same time banks confronted a reduced capacity to raise financing. As market participants have adjusted to what has been a very acute change in expectations about economic and credit risk, they have become more cautious in how they use their liquidity and capital". [Timothy Geithner: "Restoring Market Liquidity in a Financial Crisis", New York Fed] [The Second New York Fed — Princeton Liquidity Conference]

[2] James Picerno: M2 & liquidity. James Picerno, the editor of the Capital Spectator blog, is at it again. Analyzing trends in M2, he warns readers about the risks of "excess liquidity" created by the Fed. As I have written many times here, M2 is not a liquidity measure. The Fed has little control over M2. Moreover, in times of financial stress, strong M2 growth is a sure sign that liquidity is actually ... decreasing! Flight-to-quality buying of money market funds may artificially inflate M2, just as the monetary base —a true liquidity indicator— may show signs of faltering. This is what happened in 1998. The turmoil led to a memorable debate within the FOMC. While monetarist members led by Jerry Jordan and William Poole argued for increases in the Fed funds rate, "internationalists" such as chairman Alan Greenspan made the case for a rate cut. In the event, Greenspan prevailed and the central bank lowered the Fed funds target — a move that was instrumental in avoiding a major banking crisis. The "monetary multiplier" is a notion that needs to be applied with a considerable degree of caution, especially if the currency in question is also an international reserve asset. Indeed, to the extent that a lower Fed funds rate eases the flight-to-quality stress (and the consequent rush to buy money-market funds), it may well lead to ... less M2 growth! [James Picerno: "Stable prices won't come cheap", Capital Spectator]

[3] William Dudley on the TIPS market. William Dudley, the former Goldman Sachs economist now at the New York Fed, analyzes the Treasury Inflation-Protected Securities market. Key point: "... the 5-year, 5-year forward breakeven inflation measure is a very important part of the monetary policymaking process. Without a TIPS market, this tool would be unavailable and I think it would be safe to say that monetary policy would suffer as a consequence. How much is this tool worth? Of course, it is very difficult to say. Perhaps, we would flatter ourselves and think that we could do just as well without such a market-based, real-time measure of inflation expectations. But I doubt it. After all, inflation expectations, when untethered, are very difficult to re-anchor. TIPS help make it easier to keep inflation expectations firmly in check". [William Dudley: "Reflections on the Treasury Inflation-Protected Securities Market", New York Fed]

[4] Platinum prices at a record high. Platinum hit a record $1,519/oz yesterday. As readers of this blog know, we closely follow the platinum-gold ratio as a key indicator of global economic growth. [Chris Flood: "Platinum jumps to record of $1,519", Financial Times]

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