What does “excess liquidity sloshing around the financial system” mean?
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renormalizetheworld.wordpress.com
"Quantitative easing" means issuing new money -- a government obligation that pays no interest -- to purchase treasury (and agency) bonds -- government obligations that pay interest. Until very recently, for good reasons (a global financial crisis, a global pandemic), the Fed and other central banks around the world have been engaged in quantitative easing at an unprecedented scale, replacing government-issued financial instruments that pay interest (bonds) with government-issued financial instruments that pay no interest (money). The result has been an unprecedented increase in private cash balances -- what many call "liquidity sloshing around."
Last year, some central banks started doing the opposite, "quantitative tightening," i.e., selling previously purchased bonds (or letting them mature), removing liquidity (government-issued money) from financial markets and replacing it, directly or indirectly, with financial instruments that pay interest (government/agency-issued bonds). The result has been a gradual decrease in private cash balances -- one could call it "liquidity evaporating."
For example, you can see the value of the financial instruments the Fed owns (i.e., it has purchased them in the past and continues to hold them) here:
https://www.federalreserve.gov/monetarypolicy/bst_recenttren...
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PS. I'm talking only about readily observable facts, not about "excess liquidity" in the abstract sense, e.g., as described by economists who call themselves Keynesians.
If you're asking how the net present values of long-lived assets change as a consequence of quantitative easing, the answer lies in the impact of quantitative easing on long-term interest rates. All else being equal, when long-term interest rates rise, net present values decline; when long-term interest rates decline, net present values increase.[a]
For example, when the Fed engaged in quantitative easing from 2008 to 2022, it did so expressly with the intention of reducing long-term interest rates. Since last year, the Fed has been engaged in quantitative tightening (selling bonds or letting them mature) expressly with the intention of pushing long-term interest rates up.
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[a] Asset prices (market caps) eventually tend to follow net present values, usually in fits and starts.
EDIT: Changed 1998 to 2008 (typo).
How does newly created money (which first goes in commercial bank reserves) finally ends being used to buy houses and stocks?
But money does not "go into assets." That's a misconception. Money trades hands: For every buyer of a house there is a corresponding seller, and for every buyer of a share of stock there is a corresponding seller. Asset prices can rise, or fall, with each trade.
How would you describe the situation when you purchase a treasury bill then?
You gave money, the money you gave ceased to exist in the economy - it is no longer available for anyone to spend, you gained an asset.
Your cash (i.e., money) goes to the seller of the treasury bill.
If the seller is a private investor, your cash goes to the private investor (e.g., a mutual fund, a pension plan, an individual).
If the seller is the US Treasury (i.e., you bought a newly issued treasury bill), your cash goes to the US Treasury, which will deposit it, and later on, will use it to pay for the federal government's expenses, including bond interest. (Recall that, unlike the Fed, the Treasury cannot issue newly created money. The Treasury must borrow or collect taxes from the private sector to fund federal spending.)
If the seller is the Fed (through one of its primary dealers, acting as an intermediary), the trade is quantitative tightening.
This case is not of interest
>> If the seller is the US Treasury
This case IS of interest
>> Recall that, unlike the Fed, the Treasury cannot issue newly created money
This is where it begins to unravel and fall apart. What you say is true in theory only, it’s not true in practice:
The fed finances the primary dealer banks that participate in treasuries auctions - it accepts treasuries as collateral for repos.
The primary dealer banks are obligated to stand ready to purchase treasuries and the Federal Reserve ensures there are sufficient reserves to do so by supplying them through temporary repos (a matched purchase of Treasury debt with a requirement that the seller must repurchase later). While the Federal Reserve is not in that case directly buying the new issue directly from the Treasury, it uses the open market purchase to buy an existing bond in order to provide reserves needed for a private bank to buy the new security. The end result is exactly the same as if the central bank had bought directly from the Treasury.
The fed does also buy treasuries (the fed holds around 10% of treasuries issued - https://fred.stlouisfed.org/series/TREAST).
EDIT: moved paragraph for clarity
Central banks affect this process by adjusting the rate to which they lend to the commercial banks, and by quantitative easing /tightening which has a similar effect on long term rates.
Rates are low, more loan value is issued (because the income stream servicing the loan translates into a larger loan amount), asset prices go up. And conversely.
Otherwise, your comment is like grade school levels of understanding of how this all works. Modern banks have the ability to create money.
Well, you have some newly created money, whilst the demand for holding money balances (which depends on the price level and the volume of economic activity) stays the same. So what happens is that money is exchanged away like a hot potato until the demand for money balances rises to match the extra created money. In the short run, this is a mixture of higher prices and a higher volume of expected economic activity, both of which would raise asset prices.
This is a contradiction. You can’t create money without a demand for it first. In this specific case through the demand for money in exchange for treasuries/MBS/etc.
>> So what happens is that money is exchanged away like a hot potato until the demand for money balances rises to match the extra created money
This view derives from monetarist theory, it’d be fair to say this view enjoys less support today than it did in the past. As with all macro views, it’s primarily BS with perhaps a little bit of truth that may or may not apply in any given real world scenario. Probably not a useful model.
Why not? At the individual level it literally works the same as any purchase of existing assets. In practice, the counterparty of that transaction will probably spend that money in turn on something else that she actually planned to hold.
> This view derives from monetarist theory, it’d be fair to say this view enjoys less support today than it did in the past.
Well, the biggest flaw of monetarist theory is that it treats "the creation of money" as if it was somehow special, whereas what really matters is the product of money and velocity. (Velocity can be seen as a reflection of external changes in the demand for money balances. It also explains how money can seemingly be "created" out of thin air by entities other than the central bank; what we're really seeing in these expanded money measurements is higher velocity for the actual "high-powered" money that the central bank issues.)
>> Why not?
To be clear i’m discounting stimulus checks which would be exactly that but it wouldn’t be right to claim this is a common source of money creation.
The most common source would be A commercial bank issues a loan creating new money, but without a customer demanding a loan, there is no ability to create money.
The second most common source would be the government spends into the economy by consuming on its own behalf - there needs to be something for sale in the economy (inc. labour / public sector employment).
The Taylor rule is showing that the interest rates should be over 10%.
https://www.ft.com/content/b71f0c32-6cfb-11ea-89df-41bea0557...
The fed had a role in causing the rise in inflation as well:
https://www.cfr.org/blog/how-fed-bond-binge-predictably-stok...
Issuing new reserves not new money. New money can then be issued by the counterparties of the Fed’s open market operations The counterparties are the “primary dealer” banks (theres around 30 of them), these are the banks whose reserve accounts at the fed get topped up in exchange for the assets the fed wishes to buy. This is the US model, the UK model is a bit simpler (replace the entire faux market with the BoE’s asset purchase facility or APF).
>> replacing … bonds … with money
this is basically the effect and you did say you were describing a model not necessarily the actual system but i’d be remiss not to point out the model you describe is not faithful to how the system operates
>> The result has been an unprecedented increase in private cash balances
This is a function of both private debt (150% GDP) and public debt (125% GDP) in the US. Private debt in the US is more of less ignored by many economists but we know from history that this is a mistake regardless of the kinds of stories certain macro economists prefer.
>> The result has been a gradual decrease in private cash balances
Too early to say yet. There are signs private credit growth has continued despite increased interest rates, in which case cash balances could be higher.
Yes, the Fed trades with the rest of the world only via its primary dealers. But note that these dealers are non-US-government entities (specifically, they're for-profit businesses, part of the private sector), or trade with the Fed acting as intermediaries for other non-US-government entities (businesses, individuals, etc., also part of the private sector). Thus, newly issued money with which the Fed pays to purchase instruments in open-market transactions ends up in the hands of... non-US-government entities -- mainly domestic businesses (e.g., mutual funds), domestic organizations (e.g., pension plans), domestic individuals (e.g., day traders), etc., all part of the private sector.[a] The newly issued money ends up as private cash balances.
[a] For simplicity, I'm excluding foreigners from this mental model. I'm also excluding the so-called "multiplier effect" of bank lending.
>> Issuing new reserves not new money
>>> Reserves are money
Reserves can be cash, but the reserves issued through quantitive easing are not cash. They are not a form of money that can be spent in the economy.
>> Thus, newly issued money with which the Fed pays to purchase instruments in open-market transactions
Newly issued reserves, not money. The reserves go to the primary dealer banks. The mechanism by which this results in the banks being prepared to issue new money (for spending in the economy) is not direct. Empirically shown through the muted money creation in response to the enormous reserves injections of QE.
The reasons for this lethargy are many but it’s fair to say capital requirments are the main one. Lending operations (the mechanism by which QE is supposed to ultimately inject real money to the economy) are not reserve constrained. Since Basel, they’re capital constrained.
Otherwise, I agree with you that banks are capital constrained in their ability to make loans. But as I mentioned elsewhere on this thread, I left bank lending (and its impact on higher-level monetary aggregates) out of this mental model for simplicity.
Money exists on a spectrum. Reserves are money-like in some aspects, but so are bonds and equities, as is gold. These are all stores of value and media of exchange.
QE is creating new reserves (which is money-like) and buying other types of assets (which are money-like): basically an asset swap. The balance sheet often stays exactly the same.
Except that the Fed is not giving "government-issued financial instruments" with QE. They are placing reserve credits in the banks' reserve accounts. Bank reserves cannot be used in the wider economy, but only with-in the Federal Reserve inter-bank settlement system.
Cullen Roche has a good series of articles on quantitative easying:
* https://www.pragcap.com/understanding-quantitative-easing/
> The result has been an unprecedented increase in private cash balances -- what many call "liquidity sloshing around."
In essence, QE is/was an asset swap: bonds for reserves. There was zero net change in the balance sheet: $100M of bonds was exchanged for $100M of reserves.
* https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2397992
They shift out and buy more risky assets. Corporate bonds, equities.
And then next the people that held the corps/equities that were sold buy still more risky assets (e.g., speculative equities, VC) and so on (e.g., crypto).
But I don’t get this: It might seem plausible that if stock prices go up they absorb liquidity from the system. But (ignoring new stock issues / newly build houses) in every transaction there’s both a buyer and a seller. Sure, the buyer parts ways with cash when they buy a share, but that cash goes to the seller. So there should be just as much liquidity as before, just in different hands.
If anything a rising stock or housing market should just put more excess liquidity into the system because it’s possible to borrow against those assets.
What am I getting wrong? Or is this just an often repeated falsehood?
If you reduce the required deposit on a house from 20% to 10%, that increases the liquidity in the market. Suddenly more people ‘have’ the money to buy that $500k property and the market will typically rise until it’s absorbed that added financial capacity
This is why low interest rates had such a dramatic impact.
Monthly repayments are much lower on a low interest loan, so the average person could ‘afford’ to borrow way more.
Note; this is just Real Estate. Lots of other borrowing also occurred.
But when Real Estate markets suddenly go up by 20%, now it’s the owners of these houses that are worth a whole lot more. And they often decide to cash in, in some way (selling their J
(See also my other comment here).
Transaction demand refers to earning money with a job or business and then spending it. Precautionary demand refers to demand for money based around uncertainty in the future, you keep some money around because you want to insure against losing your job (rainy day fund) and finally, once you have so much money you satisfied these two, there is still the fact that money is the most liquid asset. Money can be traded into other things faster than anything else. So this is basically day trading, buying low and selling high. The problem though is that at some point the Keynesian beauty contest begins. People not only react to fundamentals but also the reactions of other investors making investment decisions. Someone invests because they genuinely believe in the stock,
then people invest because they think people believe in the stock,
then people invest because they think people invest in the stock because people invest in fundamentals.
This is a rationality trap that doesn't end until the bubble pops and then people move onto something else.
What you are concerned about can be explained by a weakened form of a liquidity trap. The problem with the liquidity trap is that it is pretty theoretical in the sense that it is absolute. Like getting 100% efficiency. But in practice a liquidity trap can also be in the form of trapping liquidity in specific economic sectors and that can be described as a continuum.
For example, we separate the economy into the real economy and the financial economy. The financial economy is just a model of reality, but it is possible that messing with the model of reality is more profitable than actually doing something in the real world. This means money is allocated away from the real economy and into the fantasy of the financial economy. People do sell their financial assets but only to buy something else in the financial economy. It is a one way street of money flowing into the financial economy but never back and this is why you need constant government intervention that reinvests the money back into the real economy. It is obviously an ugly solution but what are you going to do? Introduce a wealth tax?
Consider that newcomen’s engine was based on prior engines, and itself wasn’t that much of a success - but everything that followed was explosive in terms of the changes wrought on society and industry. The technology was interesting, but as long as you could pay a few blokes to man the pumps, installing an expensive engine and buying coal to power it wasn’t an economical route to follow. When the triangle trade had accumulated enough wealth with nowhere to go other than gilding, and when the workforce started emigrating to the colonies to escape their miserable conditions or getting shot on the plains of Europe, and the remaining souls started demanding Real Money, suddenly, those new-fangled engines looked like a sensible investment.
Which technology will be our next revolutionary step is up for debate, but I would (and have) place my chips on AI/ML. The last few rounds have been all about the decoupling of unskilled and semi-skilled labour from productivity. Next up on the block is skilled labour. Why would you hire developers or lawyers or diagnosticians or any knowledge worker for $stupid per annum, when you can spend a bit more, and never have to pay a human again?
These models run on hardware. Pretty specific hardware.
Now, you may say that net "well-being" of society will go up if we make more cars and fewer investments in financial firms. (In the end, you can't eat money.) But where the line should be drawn is going to depend very sensitively on your definition of "well-being". That's not an easy question to answer, even before politics gets involved.
Of course as you point out that money will go to the seller and does not simply evaporate. Now in the heads of a founders. They could decide to sell less equity (say only 5% to still raise just $1M) but let's be honest, they won't VC will tell you it is a bad idea and the startup down the street is expecting the $2M (again still plays out slowly over time so you don't really notice the slight raises in valuation). The founder can then use that money to do more work (initially) of course the founder has to bid for workers (programmers) which to assume a simplified model is also a finite pool.
The example repeats, this time not for equity but for labor. The programmer is really worth $100K but you _really_ need one and if you don't pay them $110K he will take an over at the other startup. You can afford them after all you just raised $1.2M. This pattern repeats until you have programmers demanding $200K. All of the sudden you NEED that $2M valuation otherwise you cannot afford to hire anyone.
Those programmers have needs to, a house for example, let us assume there are only 10 houses and...
You get where this is going.
This can continue as long as the underlying value of the business can support it (the margins of VC, founders, programmers, etc just decrease gradually). So who loses? The people that are not part of this subsystem that got money injected, the people holding the 'bag' as they say when the bubble pops.
This is essentially a trap that is hard to get out of because there are many different stages in the process each with costs. The programmer can only go work for $100K if the house goes back down in price etc.
Wouldn't that come from their ever decreasing margins? it sounds like there's a feedback loop there that should balance itself at some value, but that's probably assuming people are rational which they are most decidedly not.
We can all be given millions (super liquid) but that doesn’t make us millionaires in terms of purchasing power. At first it seems like everyone is rich, then folks realize it’s funny money and suppliers raise prices. Since money is (dynamically) valued by what you can buy with it.
So the seller of the house sold for a million, for example, but it turns out they actually have ~850k if they sat on the cash for a couple years.
You are correct when taking the view of the financial sector as a whole - every asset purchase merely swaps who has the cash and who has the asset. You're not getting much of anything wrong, merely missing a behavioral trait of many market participants: they desire a fixed ratio between their various financial assets. An extreme example of this is an index fund, which has a formulaic relationship between their book value and how much of what assets they own.
In essence, what happens is that cash gets dumped into the laps of various market participants, who then notice that they have "too much" cash. They then bid on various assets until there no longer is "too much" cash in the system for the total value of assets around.
But the funds each keep some amount (1%?) of their assets in cash. So isn't the net result that stock prices go up until the value of the stock is 99 times the amount of cash in the system?
More generally, then, doesn't the price of assets go up until the participants are comfortable with that much cash as part of their asset mix?
:Cough: VC and Growth-based startup :cough:
So if you double amlunt of money is the system, house prices will double.
It is not 'inflation' because food prices do not react in the same way. You 'normal' inflation could stay at zero.
You can create housing shortage through financial system alone, without changing population/ housebuilding rates
But it's not the only one. Fear of a price drop can be motivating too.
https://www.philosophicaleconomics.com/2013/08/the-great-rot...
"(1) For every share of every asset in existence, someone must willingly hold that share at all times. If no one can be found who wants to hold a share, its market price will fall until someone is found.
(2) The total “amount” or “supply” of a financial asset is the total market value of it in existence: the number of shares outstanding times the market price. Asset “amount” or “supply” is therefore flexible for all assets except cash, whose market price is always unity. If there is more financial wealth that wants to be allocated into an asset than exists of that asset, the market price of each share of the asset will rise, which will expand the supply of the asset so that the demand can be satisfied."
"Money is not something that can go into or come out of assets; rather, it itself is an asset that is traded for other assets. The offered rate of exchange is the price. Changes in the price can create the perception that money is moving, but, in reality, nothing needs to be moving at all. Any movement that does occur is incidental to the underlying process.
Likewise, investors cannot leave or enter any asset class. All they can do is fight with each other over who will hold each asset class, offering to exchange money at various rates in exchange for the privilege of holding something else. The consequence of shifting preferences and exchange rates may be a destruction or creation of wealth in various places, but it is never a “movement” of wealth."
Isn't this assuming 'mark to market' - the assumption that the entire supply of an asset class could be sold at the selling price of some (usually very small) fraction of the supply that has most recently been traded.
If my understanding is correct, this is the fallacy that has underpinned the inflated valuations of many crypto assets (SBF etc)
Index funds do not have opinions on the attractiveness of prices. What happens in this hypothetical when one index fund has a cash inflow is that it bids on all the assets it is "short" of, which increases the price until the other index funds have "too much" of the now-higher-priced asset and decide to sell.
But generally speaking yes, there's cash or cash-equivalent in the overall market's mix, and it stays relatively constant. When these cash assets get dumped onto balance sheets, other assets get bid up until their sizes are appropriate for the amount of cash around.
I mean... Well... It goes pretty fast and things are pretty much back to the way things were.
I did not understand at all how people who win the lottery could blow through it all so quickly. Growing up, the limit on my spending was availability. When that availability went up, I didn't really have the right tools to change my internal spending algorithm quickly enough to maintain a comfortable level for a longer time.
It truly didn't fix as many problems as I had hoped, and it turns out a million dollars isn't nearly as much as I thought it was.
GP is talking about the investment side of this, where "investing prudently" usually means looking at the relative prices of different investments and putting your money only into the ones that are undervalued. If enough people do this, a.) relative prices approach a pretty good approximation of their true value, and b.) those prices are going to be much higher when a lot of cash went into savings than if there's not much cash going into savings.
This is correct. Except for inflation it’s impossible for asset prices to rise everywhere.
Some places and some assets will see a rise while other places and other assets will see a drop.
While everybody was screaming at the everything bubble there were real assets that became defacto worthless (at least temporarily) the entire fleet of passengers Boeings and Airbus. Not to mention cruise ships, casinos, theme parks..
What about NYC real estate? The pandemic had people thinking that life is too short to live in such packed conditions in places so sensitives to pandemics.
Can we also talk about oil which collapsed during Covid and hit a negative 37 dollars per barrel? All commodities did bad during the pandemic, oil, LNG, copper etc.
It’s a form of selection bias because pundits and commentators always watch where the money is going , not places where money is hemorrhaging (that is unless there is a big bankruptcy), but sector wise they just dont focus on it.
A clear example is OPEC. Every pundit focuses on what OPEC does but nobody focuses on what it means for shale oil producers and their survival. The only people who focus on those are their lenders and investors as well as city officials but this profile doesn’t show up on your TV on Bloomberg or CNBC , because these outlets are too busy interviewing the Saudi or the UAE secretary of energy in the aftermath of the OPEC decision
As you grow up you understand they most of phenomenons that people swear by are selection bias.
There are theories that even stuff like physics is selection bias because we swear by the physics we know but it could be entirely rubbish because it’s not the truth of Nature but just our best intuition of the truth of Nature which is of course subject to selection bias anthropomorphically speaking
Ultra low interest rates are just a (not very) complicated way of printing money.
It's not that all 1 million stocks have to trade for the total value to go up. All the people who did not trade, but who own the other stocks, have seen their (paper) value go up.
And the same, but opposite happens when it goes down of course.
Let's say some major event would trigger a panic on the stock market, then very few trades could cut the total market by 50% and very few would get any money for their stocks at the price when the panic started. Most would not have sold and would sit on stocks worth 50% less than the day before.
Kind of extreme examples here, but just to show what I believe you are "getting wrong".
If you're talking about money, then that's exactly what happens - the creation of "high-powered" central bank money leads to a multiple of that amount of new money appearing in the economy as it's used (and reused) in the financial system to make net new loans (the multiplier effect).
Ultimately as the money gets passed around then some market participants will use the money in ways which reduce either liquidity or money supply or both (repaying loans for example) so there's a decaying effect which is why the multiple isn't infinite. As the money dissipates throughout the system it will end up in the hands of participants who are either slower to reuse it or more likely to put it in something which either is or looks like a central bank deposit - hence the "liquidity" eventually dissipates too.
Next, excess liquidity can disappear by market participants simply refusing to do trade (ie a drop in demand). For example, if I have a house, which many people would be willing to trade for me today, tomorrow they could all change their minds and wouldn't even trade me a spoonful of dirt for it. In which case, the liquidity of my house (easiness to trade it), dried up by simply a change in market demand.
Now here's the best part, while every transaction has a buyer and seller, every transaction has two supplies and two demands. For example, person A may be willing to trade his supply of cars, but demands X dollars in exchange for any one of them, and person B is willing to trade his supply of dollars, but demands a car of certain condition for them. In this case, there are two supplies (dollars, and cars) and two demands (again dollars, and a car of a certain condition). If the supplies of each participant, meets the demands of the opposing participant, the transaction happens, and the trade is settled between the two parties.
So to address your questions. It's entirely possible for something that was easy to trade (cash), was traded for [houses/stocks/commodities/etc], and afterwards, no one is willing to trade things anymore. Which includes people with houses who are not willing to trade them for cash, and people with cash no longer willing to trade them for houses. Liquidity disappeared simply by a change in market demand. But you're not necessarily wrong, as if demand doesn't change, then it doesn't really dry up.
I don't think this is how people behave.
I think collective behaviour can be better explained by people discounting the painful lessons of previous downturns the more the longer prosperity lasts. Our brains are wired this way, unfortunately and it requires a conscious effort to objectively (if it can be done at all) take into account risks of serious and long lasting financial winter.
Most people don't have the self discipline to do this. They kinda know about it but then they see other people making shitload of money in risky "investments" and our greedy primate brains take over.
It is all risk reward trade-off. If bonds have the same yield as other Investments with no risk, of course Savers and investors would select them over riskier strategies. This has less to do with discounting painful lessons and more to do with the spread on the return rate.
More people will opt for a risky investment if it's paying substantially more then their safe one.
If there is little difference in return, few people will opt for the risky bets
Read this: https://monevator.com/bond-market-crash/
2010s were quite unprecedented years in terms of new money (and hence new debt) created. The repercussions were everywhere; crazy VC funding (Uber/Airbnb etc.,), insane tech salaries, record high stock markets and so on.
[1] https://fred.stlouisfed.org/series/WSHOMCB
[2] https://home.treasury.gov/data/troubled-assets-relief-progra...
The easier comparison would be to compare the money supply growth against the GDP growth and see if they differ by much. I have neither number on hands, so someone else might be able to provide them.
Seeing as the top 10% hold over 60% of the wealth (in the US, globally we have a dozen people with as much wealth as the bottom 50%), I don't see how this follows.
i must be missing the point you’re trying to make, or the framing, or something. why would i want to be rich if not to direct more resources to achieving my own preferences? of course this is not maximally productive for society: if all money was required to be directed based on where it were maximally productive then it would no longer mean anything to own money; money would have no value to the individual.
These days, I think most of the motivation to be seriously rich (vs. mere "can afford two nicer McMansions, and your kids don't qualify for college financial aid" rich) is a humans-are-primates obsession* with being further up the pecking order.
But your bottom line is still valid. The rich are definitely not allocating resources in ways which are beneficial to society.
*Less-flattering terms, perhaps from the DSM-5, would seem applicable in many cases.
I completely agree but I think you've defined rich wrong. There's only so many multimillionaires and billionaires and most of their money gets plowed into business ventures (even if dumb ones), investments and other things like that that aren't too off the wall.
The economic volatility comes from the much, much more numerous hordes of upper middle class doctors, lawyers, techies and whatnot that are "post scarcity" enough that they can swing a fair amount of money around in pursuit of that.
When a large subset of them decides to do something, like buy toilet paper, or TSLA, or a second house or whatever, there's a huge effect and that's where you get bad tulip mania style volatility and economic patterns from. Nobody on food stamps and nobody with millions to their name lost their ass on beanie babies.
But in general rich people are rich BECAUSE they are good at thinking about being rich.
Your point made sense until you mentioned wealth inequality-- but wealth inequality exists EXACTLY because rich people are good at thinking about being rich. These decisions may not be productive in terms of society -- but they generally favour growing or maintaining the status of "being rich".
No? Unless I misunderstood something.
Food for thought
What is happening now is that asset inflation is correcting and goods inflation (a related but distinct concept) is taking hold.
There is always as much liquidity as is required. "Excess liquidity" flows around until it finds somebody where paying off the loan they hold is the 'best use of funds'. That destroys the liquidity, and the loan - shrinking financial balance sheets and freeing up whatever physical asset collateral that loan is secured upon, which then becomes 'equity'.
Increasing base rates is an artificial market intervention that suppresses asset prices. High asset prices, as with everything else priced high, is just a market signal to produce more of that particular asset.
Asset prices rise until the portfolio indifference point is reached - loans created against asset collateral are matched by loans destroyed by received liquidity created by those loans (as the 'best use' of that liquidity).
All fairly straightforward once you accept there isn't a fixed amount of money and that money and bonds are essentially the same thing with different terms and interest rates.
I would have liked to author to talk more about wording. What is actually liquidity? Today’s money appears in many gradual forms of moneyness.
Also is there anything like "excessive money"? Where does it come from? Central banks don’t just print money. They trade it for usually governmental bonds.
If other than central banks have excessive liquidity they may trade it for other assets. This means they need to find a counter party that has the reverse situation. So overall the economy cannot have excessive money.
But you are assuming that there is no zero lower bound. If there is an excess of liquidity like there being an excess of trash then people would expect to get paid to get rid of it and the market would just find a garbage collection fee for this excess liquidity. But if there is a zero lower bound, then the people with the excess liquidity have no incentive to dispose of it. Instead, they would just keep accumulating more and more liquidity indefinitely as the market tells (or rather is forbidden to tell) them there is no excess liquidity.
I mean, take this example. The interest rate in the market is 3% and the interest set by the central bank is 5%. People will accumulate more liquidity than is optimal. There will be an excess of liquidity. It doesn't matter what the absolute numbers are. They can be -3% and 0% and you run into the same problem.
If excess liquidity is a form of economic pollution like CO2 is, then you would expect to pay for this pollution. But since the government doesn't charge a pollution tax, people will overproduce both CO2 and excess liquidity.
A better explanation would be:
A pension funds needs to achieve long term nominal returns of 5% to meet liabilities.
Fed funds rate is suddenly set to 0%, and treasury curve peaks at 2%.
Market risk premium is 5% for public equities.
Market risk premium is 10 % for private equities.
To reach target returns while anticipating volatilities, it must allocate capital towards both public and private equities. This is the “sloshing”. Simple mathematics.
Side note: any retail investor can access the risk-free rate (very close to it, minus transaction costs/expenses) through large money market funds. ie. https://investor.vanguard.com/investment-products/mutual-fun...
`Excess liquidity` simply means we were in the middle period where valuations increased, and debt levels hadn't yet caught up, so new credit was being issued fast, and money from loans was entering the system accelerating the cycle.
i.e. There are more people with money that needs to be spent.
I interpret "sloshing around" to be a metaphor for the damage that can be caused to various markets (real estate, stock, etc) by a sudden increase in demand (caused by the above people, businesses, or governments excess money suddenly flowing into a given market).
i.e. When lots of money is suddenly spent in a single market it causes a harmful amount of price inflation.
Edit:
That is to say, why is the liquidity moving from place to place.
To follow the analogy, If I put water in a bucket, it levels relatively quickly. Why does the liquidity "slosh" around for years.
Interest rates are essentially an indication of how expensive money is. When interest rates are low, money is "cheap".
Outside of the FED purchasing bonds, Banks giving loans is another way to "print money". So when interest rates are low, more people and businesses take out loans, and as a consequence there is more money circulating, "sloshing around", in the economy.
There are other factors at work though, outside of interest rates, that can cause wealth to pool.
Various forces since the mid-1990s in the United States, mostly related to the tax and regulatory environment of corporate compensation packages (i.e. paying senior employees in stock, etc), have caused net wealth transfers to the upper classes. The wealth gains those classes have achieved also causes them to have excess wealth that wants to go somewhere.
So anyone with a lot of money laying around knows they need to put it to work, so that it evaporates more slowly than it grows (due to investment returns).
And the best places to put your excess wealth are often constantly changing, so the money moves around following what everyone perceives to be the best places to put it to get the highest return.
This is actually one of the reasons central banks try to keep positive inflation, because it encourages people to put their money to work rather than just keepping it in a savings account providing no value.
When people are putting their money to work, human flourishing is increased. More jobs, more restaurants, more research, more activity, etc.
Does Excess liquidity "move" any different than normal liquidity?
My understanding is that the difference is that excess liquidity is excessive because it it is greater than available positive growth investments to lock it up.
Maybe you are right and the movement from sector to sector is simply herd mentality and trend following, but I would intuitively expect that process to reach equilibrium faster
As an example - consider the sale of an owned house, where the buyer takes out a mortgage. The owner who sold now has cash, and the buyer has a liability (mortgage), meaning he has need for cash in the future. This type of mismatch can create excess liquidity (now, at the sale point), and the cash keeps moving until someone who needs to pay off a loan acquires it (cash gets "destroyed" when paying off asset-backed loans from the bank). In the meantime, that cash can go towards bidding up financial assets (until it finds the marginal need to service debt obligations)
This comment is the best explanation: https://news.ycombinator.com/item?id=34858813
Also this article could be helpful: https://www.philosophicaleconomics.com/2013/08/the-great-rot...
The metaphor is supposed to conjure an image of liquid smashing into something, as the money does when there's too much of it and it all tries to go to the same place.
I think the focus should be on the volume not the motion.
Investment moving from place to place is natural. Too much is disruptive.
It's just an unfortunate natural consequence of how people spend money when they have a lot of it, and of how businesses react when their products or services are in demand.
There's no natural law, or tenet of capitalism, that says people acquiring lots of money is a bad thing.
There's only our historical observations that
- When lots of people have extra money to spend, they spend or invest it.
- When lots of money is being spent or invested prices rise.
Keeping those two forces in balance is the challenge, and the function of regulation, or FED policy, etc, etc.
The elements for this to happen are actually there. We are not talking about a detailed replica with real time data, but a reasonably accurate model that includes all the public data from central banks, private bank statements, public market valuations etc.
With such a system the question "excess liquidity sloshing around" is a specific query with a quantitative answer, not an endless, low-information discussion.
> This is one instantiation of an idea that was omnipresent in 2021-2022—that much of the weirdness in financial markets, from GameStop to crypto to stock market volatitlity, was driven by an excess of liquidity. This idea made a certain amount of inarticulable, pre-intuitive sense, but that sensibility does not a gears-level understanding make.
Seriously? This paragraph is fucking garbage.
Thus assets will see their price rise. Certain hot assets will see large price rises.
This will continue until interest rates revert to the norm (whatever that is) and correctly price risk.
People will try to maximize their gains wherever they can.