LIQUIDITY ANALYSIS. A SHORT HISTORY OF THE "GLOBAL LIQUIDITY MEASURE" (PART I)
[Latest Global Dollar Liquidity measure: +11.4% annual growth rate; latest Endogenous Liquidity Index: -42.0%]

Henry, a.k.a. the Picky Investor, asked yesterday for background information on ... methodology. His question led me to think about penning a short history of the Global Dollar Liquidity measure. Also, I realized that it was a good time to launch an older project of mine, namely to "open-source" my liquidity indicators. By sharing the information, and by discussing the (numerous) shortcomings of all these measures, I hope to benefit from the interaction with readers. So let's begin with a short history of the GDL measure ...

I. - From Jacques Rueff to John Mueller
As a young international economist working at a boutique investment bank in the 1990s, I was puzzled (together with my boss, who happened to be the chairman of the bank) by the effects of the "Tequila" contagion in early 1995. After reading a Barron's piece by John Mueller, chief economist of Washington, D.C.-based consultants Lehrman, Bell, Mueller & Cannon, we decided to hire them for a couple of months. Mueller's (and Lehman's) insights were based on the writings of French economist Jacques Rueff (1898-1982). In the 1930s, Rueff had given birth to the notion of an international reserve currency. Later, as an advisor to French president Charles de Gaulle, he fought vehemently for the demise of the Bretton Woods System. In order to check the growing power of America, de Gaulle and Rueff urged Western Europe to dump the dollar as the key reserve asset. France was doing just that, with Banque de France buying huge amounts of physical gold against its massive greenback holdings [1].

Rueff's key insight was as simple as it was powerful: when countries invest the proceeds of their trade surplus into the credit markets of the deficit countries, they create a "double pyramid of credit". Interest rates are kept at artificially low levels, the (reserve) currency suffers from chronic overvalution, and dangerous financial bubbles arise. The "neo-Rueffians" at LBMC had created a proprietary measure of these flows, dubbed the World Dollar Base. Clients did not have access to LBMC's methodology. As soon as our contract expired, I decided to take matters into my own hands. Having lived in France as a child, I could read in French (I still can!) After digesting the first pages of Jacques Rueff's Le peché monétaire de l'Occident (Paris: Plon, 1971), I decided to set up my own "Rueffian" liquidity indicators ...

[To be continued]

[1] See Francis J. Gavin. Gold, Dollars, & Power. The Politics of International Monetary Relations 1958-1971 (Chapell Hill: The University of North Carolina Press, 2004).