Working Papers

‘Excess Liquidity’ and Asset Prices

The always sensible Stephen Jen tries to give his colleagues an education on so-called ‘excess liquidity’ and asset prices:

What fraction of the financial activities (hedge funds’ long positions in risky assets, carry trades, etc.) is financed through bank credit?  I suspect that many analysts have put too much emphasis on the outdated concept of monetary aggregates driving asset prices.  It is the yield curve — the opportunity cost of liquidity — that is key, in my view, in thinking about asset prices.  Since central banks no longer have a great influence on the yield curves, it is perhaps not correct to blame the central banks for high asset prices.  So much of the financial activities are not a function of what banks do, but the non-bank financial institutions such as hedge funds.  The monetary aggregates say nothing about what these institutions are up to, what their perceived risk is, and what their risk taking appetite is. 

Further, the Marshallian-k analysis actually says that the US base money to nominal GDP ratio has declined over the past decade, and the broad money to nominal GDP ratio being flat for the past few years.  Those who believe there is a positive link between the Marshallian-k and asset prices have to explain away these facts.  Moreover, we need to be very careful about three concepts:  interest rates, asset prices and the real economy.  Clearly, they are all related, but the Marshallian-k says very little about asset prices, though it might have some implications for inflation.

I suspect that even in relation to inflation, most of the analysis based on conventional measures of ‘excess liquidity’ is mistaken.  Given the largely demand-determined nature of monetary aggregates, what is commonly thought of as ‘excess’ liquidity is more likely to be an ‘excess’ demand for money, reflecting portfolio choices between money, other assets and spending that only indirectly reflect central bank policy actions.

UPDATE:  David Miles makes a similar point:

shifts in the private sector’s desire to hold a part of its total wealth in a subset of assets labelled ‘money’ (bank deposits of various sorts) are many and varied. To a large extent they reflect portfolio movements that are driven by shifts in the perceived attractiveness of a very wide range of assets. Quite what the interpretation of a shift in broad money for spending and inflationary pressures should be is absolutely unclear, until you drill down to what is driving it.


posted on 29 June 2006 by skirchner in Economics, Financial Markets

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I think Stephen underestimates the level of influence.

Direct Manipulation

One is direct through daily injections of repos (repurchase agreements) into the market by the Federal Reserve. Repurchase agreements are loans (at Fed Fund rates) issued daily by the Federal Reserve to primary dealers, the proceeds of which are used to buy, for example, Dow index futures, if the Fed seeks to boost the Dow.

So, the several primary dealers (e.g. Goldman Sachs, J.P. Morgan) who apparently work under the Fed’s direction are able to use these loaned funds to buy or sell various securities and futures to affect the markets. [Note: One species of Repos, POMOS, never has to be repaid, but explaining the significance of that (beyond the obvious) is beyond the scope of this article.] The fact that the loaned funds can be used to purchase derivatives (as well as plain equities) gives the manipulators the tremendous leverage which derivatives afford.

Those who doubt whether the Cartel has the capacity to manipulate the markets (and especially the larger markets like the multi-trillion dollar currency and bond markets) are invited to inform themselves about the $32 trillion interest rate derivatives colossus at J.P. Morgan Chase, or the $1.5 trillion derivatives position at the Bank for International Settlements (the Central Banker’s Bank). And that $32 trillion derivative position at J.P. Morgan is the position at just one of the Fed’s several “primary dealer” firms.

The profound impact of these manipulation efforts has been most well documented regarding the price capping of the gold market. For those who have any doubts whatsoever about the fact and extent of government (Central Banks) manipulation, we have (thanks to Bill Murphy, founder of the Gold Antitrust Action Committee) the following June, 2005 blatant admission of manipulation by the Head of the BIS (Bank for International Settlements - - i.e. the Central Bankers’ Bank) Monetary and Economic Department, W.R. White:

        “…it is perhaps worth spending a minute on what is meant by central bank
        cooperation…{it includes]…last, the provision of international credits and
        joint efforts to influence asset prices (especially gold and foreign exchange)
        in circumstances where this might be thought useful…”

Indeed, if one looks at the Interventional Indicators, the fact that the manipulation takes place is amply documented. First we have the aforementioned quote from W.R. White, Head of the Bank for International Settlements (BIS), in which he explicitly admits manipulating the gold and currency markets.

In addition, in one of his typically creative and thorough analyses, Mike Bolser called our attention to statements in the Federal Reserve Chairman’s (B.S. Bernanke) September 9, 2004, academic paper “Zero Rate Bound Economies” in which he admitted the Federal Reserve is engaged in “targeted long bond purchases.”

In effect, the Fed is purchasing its own paper, otherwise known as monetizing the debt. Specifically, regarding long bond purchases, the purpose of this would be to boost the 10 and 30-year bonds, and, therefore, reduce long-term interest rates.

This, of course, is a key Fed goal, both to support the housing market by lowering interest rates, thus encouraging continuing robust consumer spending. In addition, it is very much in the Fed’s interest to focus investors’ funds on purchase of this paper (and, especially, their 10-year Note) and to buoy their fiat currency. In this way, the Fed maintains and enhances its power as the Cartel of private banks which it is.

Indirect Manipulation

The other major form of government market manipulation can most accurately be called indirect. It consists of “massaging” various statistical measures and data .

And here is how they did it:

Originally, the whole purpose of the CPI was to “measure the change in the cost of a fixed basket of goods over time.” But Boskin and Greenspan said that we should allow for substitution because people can buy hamburger when the price of steak goes up.

But, of course, “if you allow substitutions you aren’t measuring a constant standard of living, you’re measuring the cost of survival.”

In a similar manipulatory vein, the Bureau of Labor Statistics (BLS) during the Clinton Administration constructed and began to employ a weighting regimen whereby if the price of something went up it automatically got a lower weight in calculating the CPI, but if it went down in price it automatically got a higher weight. The result, of course, was, and still is, to further shaft those people (like Social Security recipients) whose income was dependent upon the CPI measure.

“If the same CPI were used today as it was used when Jimmy Carter was President, Social Security checks would be 70% higher,”

“” Free markets ? I dont think so. “”

Craig Stevens

Posted by .(JavaScript must be enabled to view this email address)  on  07/03  at  11:52 AM

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