Tuesday, July 25, 2006


'The Great Liquidity Expansion Puzzle'

Reuters has this report out recently. "Call it the weapon of financial destruction. There is so much cheap financing sloshing around the global economy, despite simultaneous interest rate tightening at the world's three major central banks, that some analysts warn that financial bubbles are bound to keep building."

"This could threaten a robust global economy, and it would take a gradual global slowdown and higher central bank interest rates for quite some time to avert the problem, say financial and investment analysts."

"'Monetary authorities have lost control of money,' said Brian Reading, director at Lombard Street Research, a London macroeconomic forecasting company in a research note."

"His statement is provocative, and few economists are willing to go quite that far. But there is widespread concern that global liquidity conditions remain very loose despite a bout of central bank tightening. The Bank of Japan this month joined the European Central Bank and the Federal Reserve in hiking official rates, marking the first time in many years that central banks in the world's largest economies were tightening policy simultaneously."

"Yet Claudio Borio, head of research at the Bank for International Settlements, estimates that global liquidity conditions remain very generous. Borio calculates that the official policy rate charged by the G3 central banks, adjusted for consumer inflation, is about two percentage points lower than the average real G3 policy rate over the last 15 years."

"Additionally, growth in broad money and in credit to the private sector have grown by about 26 percent since 1995 relative to nominal GDP while inflation remained quite stable. 'It is hard to find a period in the post-war era in which inflation-adjusted interest rates have been so low and monetary and credit aggregates have expanded so much without igniting inflation' against a backdrop of strong global growth."

"'One might even call this the Great Liquidity Expansion puzzle,' Borio wrote."

"Gabriel Stein at Lombard Street estimates that lending outside the banking sector for major economies grew at its fastest rate in a decade, or by 10 percent year on year in March. He calls this growth rate destabilizing and blames central banks for starting to tighten rates too late. 'Money and credit growth are still too rapid. We are not talking yet about any serious tightening of monetary policy,' he said."

"Thomas Mayer, European economist at Deutsche Bank, also finds monetary conditions quite loose, despite simultaneous credit tightening by G3 central banks. He estimates that global broad money surged in 2001 and 2002 to a 14 percent year-on-year rate as central banks slashed rates to clean up after the high technology bust. That has left a monetary overhang that still has not been mopped up."

"These still-generous financial conditions leave a number of economists worried that the global liquidity boom is feeding a new asset-price bubble in real estate, and that just like the high-technology bubble of 1999-2000, it could end in a nasty financial meltdown, even global recession."

"To prevent that, Morgan Stanley's global economist Stephen Roach said in a recent research note that central banks need to be willing to keep on tightening. 'The deeper question is whether central banks truly have the will to stay the course that they appear to be on,' he said."

"Lombard Street Research has dubbed this cycle a weapon of financial destruction. 'Every time you inflate a bubble with cheap money, you trash someone's balance sheet,' said Stein. 'First corporate balance sheets, now the households and next the public sector. Where do you go to inflate the next bubble? And they bigger they get, the more difficult it is to get back into financial shape.'"

Raising interest rates will not contain/restrain spending en-mass, lending standards must tighten also. The FED could raise rates to 15% and it would slow borrowing down, but as long as anyone with a pluse can borrow, they will as long as allowed. Many have no intension or plan to ever be out of debt, it is the excepted way of life. That to me is the crux of the lending bubble problem, I'm not sure what the the next FED move will be, but I am sure a pause is on the horizon.
The bubble cycles are getting shorter and shorter, and require greater and greater infusions of credit. As volatility increases, people will reach out for some store of value that will outlive the cycle. We know what that will be, or we would not be reading this blog.
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