Economics and Liquidity

by Michael J. Howell3. January 2014 11:27
Liquidity can be thought of as money serving as means of purchase, i.e. funds that 'start' the monetary circuit. Keynes realised that in a Capitalist economy liquidity and not savings determine the volume of investment, and reinforced later by Kalecki, that investment rather than consumption is the key dynamic behind profitability and economic growth. Liquidity has real effects because it changes the structure of production by increasing duration through portfolio effects and in the process raises the demand for long-dated financial assets, such as equities. Conventional economics not only muddles this by focussing on money as means of settlement, i.e. funds that 'close' the circuit, but it also confuses the price of money --the exchange rate -- with the cost of credit -- the interest rate. Interest is a category of profits and has little or nothing to do with monetary policy. However, attempts to 'fix' interest rates and ignore or 'float' exchange rates always creates instability. Thus, ever since the 1971 end of Bretton Woods and the more recent attempts to straightjacket interest rates into a Taylor Rule, the financial system has suffered a near regular 8 1/2 year repeating cycle of boom and bust. For example, markets saw peaks around end-1973, mid-1981, early-1990, mid-1998, early-2007 and should again around mid-2015. Within around a year of each peak they fell heavily. The way to mitigate the cycle is to stabilise exchange rates, not interest rates. Because liquidity is dominated by credit, the monetary system is debt-based and leveraged. Collateral becomes vulnerable when debt-repayment is compromised and so liquidity becomes hugely pro-cyclical. What's more, since in a crisis the only true collateral is legal tender aka Central Bank money, leverage can be extreme. After having moved down through 2007 and 2008, collateral and liquidity have been together moving up since 2009, helped by Central Bank QE. They still have a bit further to run, but be warned what goes up inevitably comes down. A 2016 Crash perhaps?

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It's Not About Money, Nor Interest Rates.. Liquidity Matters Most

by Michael J. Howell3. January 2014 10:42
Like Mums and apple pie, more Liquidity is better than less. But surely interest rates and money matter more? Interest rates are important, but they are set by the market and not by Central Banks, despite all the pantomime and puff. What's more they derive from liquidity, viz the yield curve which as we show moves 3-6 months behind the liquidity cycle. Sure Central Banks can fix policy rates, like discount rate, but these seem to have little effect on market rates as 2008 proved. A more important price is the 'terms of a loan', but these reflect funding availability (ie liquidity) and typically move oppositely to policy interest rates, anyway. So what about money? For the non-economist, money is probably what we think of anyway as liquidity, ie. sources of funds, such as household savings, retained earnings and credit. For the economist, money supply is defined by bank deposits, or what has become a diminishing part of banks' funding sources, notwithstanding the fact that banks' themselves are also a smaller part of the lending universe. For example, our measures of US liquidity total some US$25 trillion, compared to roughly US$8 trillion for M2 money supply.' However, the damming evidence against money is 2013. US M2 money supply slowed to around a 5% annual growth rate. Admittedly, US credit growth was also tepid, but our measures of total sources of private sector funds leapt higher because US household rebuilt savings and US corporations enjoyed a big jump in their cash flows, viz the pick-up in M&A and persistent share buybacks. Adding these to the small rise in credit still allowed our index of US private sector liquidity to hit multi-year highs in 2013. Therefore, if we are correct this extra cash should underpin a stronger American economy in 2014. Flow of funds and liquidity should matter most.

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What Liquidity Events to Watch For In 2014

by Michael J. Howell3. January 2014 10:13
US monetary 'tapering' was the most talked about story in 2013, but in the event it proved the least important. The same may be true in 2014. The two big events last year were: (1) the success of QE ('quantitative easing') in driving Private Sector liquidity higher in the US, UK, Australia, Canada and Japan, and (2) the fallout across EM from Chinese PBoC 'tapering'. These made for a very 'normal' cycle in the DM and for an unusual one for EM, which despite the pick-up in the Global Economy suffered another sell-off. DM are being driven by their private sectors and not by policy-makers; ironically, it is EM that need policy support. There are four things to look out for in 2014: # positive effect of US shale oil on US flow of funds and US dollar # signs that 'normal' DM cycle continues with a capex revival and negative turning point in credit markets # evidence that Abenomics is continuing to work in Japan # persistence of 'tight' monetary policies in China We accept that the two most out-of-favour asset classes are gold and EM equities, but it still may be too early to jump back in. China needs to adjust away from its heavy bias towards capex and this will be a multi-year transition and runs similar risks to that experienced by the Soviet Economy in the 1980s when it too tried to change. China is capital abundant but energy short: not a good mix. Gold's fate is tied up with the US dollar and with the shale oil boom adding so much to US liquidity and the Fed more like to trim QE than not, the greenback could be in short-supply. This is the greatest risk in 2014. Already the rise in its 'sister' Sterling suggests a firmer dollar ahead. A stronger US dollar is not great news for EM, but it is better news for Europe and Japan. Japan will be a barometer in 2014 partly because Abenomics needs to work and partly because Japan is benefitting from a weak China. If Japan fails to get traction, it could warn that the World return on capital is again coming under pressure. This may compromise any capex recovery in DM; push down real interest rates and bash down risk appetite. All told, with the Global Liquidity cycle at or near a peak 2014 is likely to be a positive year, but it will definitely also be more volatile.

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Safe Assets, Low Risks

by Michael J. Howell31. December 2013 12:42
At CrossBorder Capital we measure risk appetite by the 'normalised' actual portfolio exposure of investors to equities less bonds. Based on an index that can range +/- 100, the current reading is around +20 for Developed stock markets. Significant corrections tend to occur at +60, or noticeably different from current readings. These readings reflect the balance between risky and 'safe' assets. In other words risk appetite is currently above average, but not by too much. What are safe assets? Simply, cash and government bonds or looked at another way the sum of Central Bank QE policies and the swollen Government deficits. Any chance of these reversing? Not much. Therefore, the safe asset mix is only just below average and the supply of safe assets looks set to continue expanding. Not too bad for risk asset prices? See Report 'Risk Appetite Indexes'

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Global Liquidity...What A Year!

by Michael J. Howell31. December 2013 12:41
Latest Global Liquidity Index (GLI) hit a value of 59.8 at end- November 2013 ('normal' range 0- 100). Yet Developed market liquidity hit a whopping 76.7. EM liquidity slumped to only 19.2, dragging back the global total. There are two Worlds out there and the big event in 2013 was not the fear of Fed tapering but the reality of Chinese tapering. The strength of DM liquidity coes not from generous Central Banks but from a resurgent private industrial sector. This may be confirmed by the parallel leap in real interest rates to break their decade-long downtrend. Capex looks set to pick-up in 2014 giving economies an extra spur but in the process depleting the pool of financal liquidity. Given that the GLI is losing momentum, this combination of high but decelerating liquidity conditions moves us out of Calm and puts us into the Speculation phase of the cycle. This eponymous investment regime is associated with stronger cyclical growth, rising interest rates and outperformance from cyclical value sectors, like industrials. 2014 will be a profitable year, but it will also be a more volatile one.

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Global Liquidity...What A Year!

by Michael J. Howell31. December 2013 12:20
Latest Global Liquidity Index (GLI) hit a value of 59.8 at end- November 2013 ('normal' range 0- 100). Yet Developed market liquidity hit a whopping 76.7. EM liquidity slumped to only 19.2, dragging back the global total. There are two Worlds out there and the big event in 2013 was not the fear of Fed tapering but the reality of Chinese tapering. The strength of DM liquidity coes not from generous Central Banks but from a resurgent private industrial sector. This may be confirmed by the parallel leap in real interest rates to break their decade-long downtrend. Capex looks set to pick-up in 2014 giving economies an extra spur but in the process depleting the pool of financal liquidity. Given that the GLI is losing momentum, this combination of high but decelerating liquidity conditions moves us out of Calm and puts us into the Speculation phase of the cycle. This eponymous investment regime is associated with stronger cyclical growth, rising interest rates and outperformance from cyclical value sectors, like industrials. 2014 will be a profitable year, but it will also be a more volatile one.

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Global Liquidity Update

Latest Global Liquidity & Capital Flow Data - November Update

by Michael J. Howell18. November 2013 12:03
Our latest Global Liquidity Index (GLI) hit 55.0 (range 0-100) at end-October2013. This above average score is being depressed by still very weak Emetging Market liquidity. Without this drag and excluding soft cross-border flows Developed Market liquidity hit an equivalent GLI of 76.2. The two key stories from our data are (1) DM liquidity still outpaces EM, and (2) Central Bank liquidity injections are being eclipsed by robust private sector flows. Indeed, as our latest research shows, this is the very reason why gold is sliding. We stand at a major inflection point in markets where market leadership is set to change, Volatility looks too low and cyclicals have underperformed too much over the past few years. Tapering will affect psychology more than it affects real economies.

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Latest Global Liquidity & Capital Flow Data

by Michael J. Howell18. November 2013 12:03
Our latest Global Liquidity Index (GLI) hit 55.0 (range 0-100) at end-October2013. This above average score is being depressed by still very weak Emetging Market liquidity. Without this drag and excluding soft cross-border flows Developed Market liquidity hit an equivalent GLI of 76.2. The two key stories from our data are (1) DM liquidity still outpaces EM, and (2) Central Bank liquidity injections are being eclipsed by robust private sector flows. Indeed, as our latest research shows, this is the very reason why gold is sliding. We stand at a major inflection point in markets where market leadership is set to change, Volatility looks too low and cyclicals have underperformed too much over the past few years. Tapering will affect psychology more than it affects real economies.

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OMG EM FX!

by Michael J. Howell11. November 2013 19:48
It's happening again. Key EM forex markets are weakening again in November. Indeed, we fear they should. Our data collection shows that private sector liquidity aka 'good money' flows into EM are weak, and far below equivalent data for the West. These poor fundamentals point to further EM forex losses and investors should note that every EM crisis is first-and-foremost a currency crisis. See our latest EM monthly for details.

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Global Liquidity...boom?

by Michael J. Howell29. October 2013 21:12
Recent UK Media comment has picked up the buoyant Liquidity story. No question that Liquidity is strong and little doubt that strong liquidity acts through rising asset prices. However, our database covers all cah and credit flows to the private sector across 80 economies and not just deposit flows to banks. To be accurate our data shows there is a World of difference between Developed Market Liquidity which is close to previous highs (although not yet at new highs) and Emerging Market Liquidity which is near its lows. For completeness, we can add that Frontier Market is closer in strength to Developed Markets. Emerging Markets are the odd man out. The reason in our view remains the slowing Chinese economy which has clipped EM private sector cash flow. We should be worrying about recent Chinese PBoC tapering, and not only upcoming Fed tapering.

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