What is "Excess Liquidity"

[bbuzzard]

I keep hearing about “excess liquidity” in the market, and I have no clue what this means.

I believe I understand what liquidity means. I would define it as the ability to convert an asset to cash. Therefore, and asset that can be sold quickly is highly liquid (perhaps gold), and an asset that cannot be quickly sold (say raw land or a Picasso), is illiquid.

So what does excessive liquidity mean? It sounds like it means that it is too easy to sell assets. Or similar, perhaps it means too many assets chasing to few dollars (or Euros for our friends in the EU)? Or similar, perhaps it means too many dollars chasing to few assets? Does it mean something else? Please help.

 

[MasterBlaster]

The formal definition of excess liquidity is that the amount of money that central and other banks have on "hold" is in excess over statutory or other requirements.

The informal definition is that interest rates and inflation are so low that there is "excess" capital floating around looking for suitable higher yield investments. This usually leads to banks and others making loans to companies and individuals of marginal capacity to pay the money back.

Excess liquidity periods are usually robust economic periods and are usually followed by correction periods when money is in short suppy and economic growth is small. This so called boom bust business cycle can be somewhat regulated by central bank(s) using the bank overnight loan rates as a controlling mechanism.

- hope that helps

 

[wabmester]

I posted this a few days ago:

link

I'm similarly convinced that Wall Street has no idea what it's talking about when it uses the word “liquidity.” While using the phrase “global liquidity” lends a further element of worldly sophistication, Wall Street still hasn't the slightest idea what it's talking about. The phenomenon that's being called “liquidity” is nothing more than a combination of fiscal irresponsibility and risk blindness, and will ultimately prove itself to be the time-bomb that it is when investors begin to “re-price” that risk.

...

Specifically, the U.S. has issued huge volumes of Treasury securities that have been purchased, largely, by China and Japan . There's your global liquidity. It's a monstrous stock of Treasury debt that represents the claims of foreigners on our future production. That's in addition, of course, to the enormous inter-generational claims that we've promised via Social Security and Medicaid, which place further burdens on our future production.

So yes, enormous volumes of securities, primarily U.S. Treasuries and mortgage securities, have been issued in recent years. Foreigners hold a staggering quantity of the Treasury securities. Our own financial system holds direct and indirect claims on a lot of the toxic stuff like mortgage debt. Wall Street talks about all of this using the upbeat term “liquidity.” But what it really represents is a crushing pile of claims on our future production, as well as high risk junk, some of which (like sub-prime mortgage debt) is already starting to go belly-up. This is not money “looking for a home.” It is a pile of IOU's for money that has already been spent.

To understand the importance of this to the “money on the sidelines” mirage and the “liquidity sloshing around looking for a home” fallacy, notice that as the U.S. issues more Treasury debt, that debt simply must be held by someone. It is clear, then, that we must by necessity observe a rising stock of apparent “money on the sidelines” in the form of Treasuries on the balance sheets of foreign central banks, U.S. corporations, and individual investors. There is no other way. Again, these securities represent spending that our government has already done. It is not wealth (at least, not to the U.S. ) but a claim on future production. Nor it is money that “has to find a home.” It has already arrived, moved in, and in many cases, trashed the place. If somebody sells these bonds to buy stocks, somebody else has to buy the bonds and sell the stocks. In aggregate, no money goes into or out of either stocks or bonds by virtue of such transactions.

 

[d]

no matter how you define it or measure it, interest rates are indicators the liquidity in a market ... high rates indicate insufficient liquidity, low rates, excessive liquidity. so if you think we have "excess liquidity", it must mean that interest rates are too low.

 

[wabmester]

The US has a relatively tight monetary policy right now. And, of course, US lenders are tightening up mortgage underwriting, so that credit flow has stopped.

The "excess" liquidity talked about these days usually refers to the famous global savings glut. As Hussman points out, all it really means is that we are a debtor nation.

 

[haha]

I may not have a deep enough understanding, but to me the Japanese carry trade is a source of what should properly be called liquidity. If I as a hedge fund manager can borrow almost unlimited money in Japan at 1% or less, and turn around and get 5 % in US T-bills I am going to be a strong bidder for T-bills. Especially if my risk/reward profile is different from my investors, which as we know it is. What is the trade risk? Mostly just the risk that the Yen strengthens against the US$.

But my risk is much less. I may be able to get a few years of huge monthly or quarterly performance fees that will all be safely banked by the time the trade blows up. If my fund craps out I just start again with new "investors".

This to me produces excess liquidity in the sense that the phrase is being used today.

Ha

 

[Animorph]

Japan just moved its official interest rate to 0.5% or 0.75%. That's where much of the global cash is coming from. You get a cheap loan wherever you can and invest the proceeds wherever you can get a high rate of return. It's cheap money, so the rate of return doesn't have to be too high. The investment doesn't have to be in the same country as the loan, so it affects markets globally.

Easy to sell also means easy to get cash, so excess liquidity in terms of too much cash floating around is not too far off its meaning when selling investments.

Dan

 

[wabmester]

The real question is what will happen when Japan and China stop the flow, as they've already signaled. (And as Hussman again points out, the BoJ is the biggest player in the carry trade.)

I'd expect the long end of the yield curve to head up. It could also be good for stocks, depending on how they deploy the cash we're giving them. Singapore's central bank is seen as a model for their stock portfolio.

 

[d]

note that the yen carry trade is not risk free ... those engaging in it are betting that the yen won't revalue to reflect the interest rate differential (which one would usually expect to occur) ... point, that risk is a cost.

 

[al_bundy]

my definition of liquidity is the ability to find a sucker to buy your junk because there is too much money out there

 

[bbuzzard]

Thanks for y'alls input. Now I think I may be more confused than before .