Tuesday, February 23, 2010

Noah's Ark In A World Of Excess Liquidity

The global fact today is excess liquidity. The excess liquidity was created by Greenspan over nearly two decades of unrestrained monetary exuberance, justified somewhat by the need to lubricate the IT revolution, and which has resulted in the following:

1. The rise of China as a global economic power fed first by the battle for cheap exports to the US and second by the flight of investment cash to the brave new Chinese market. This is probably the single biggest consequence of the Greenspan monetary mismanagement.

2. Underneath the China rise is the relentless search for better returns by investment bankers in markets around the world, which resulted in the flooding of every equity market of any substance with the flow and ebb of investment capital which accentuates the fluctuations in the forex and equity markets. There is now the IMF rethink that probably capital restraint is not a bad think - and I think it should better be directed at the money market rather than in the capital market.

3. With any excessive monetary creation is always the problem of inflation - and there are many analysts who would like to think that, given the quantity of money supply and the output level, inflation is not excessive. In the initial stages, when the excessive money is sloshing in the equity market and then, when that dies, and the cash goes into the property market, triggered by hapless bankers seeking to earn supernormal bonuses, the inflation in real estate is "bearable" and some would even say "desirable." Less so in Malaysia than the US where the property bubble burst after the bubble burst in Malaysia and our neighbours and that was after the Japan bubble burst not that long ago.

4. By the rescue of financial institutions, the US is doing what we less beings had done with ours. Whether that act is justified or not is a subject for debate - at least in the academic world of monetary and banking theory. The rescue of banks by central banks is a necessary evil in this articial monetary world of fiat money we have unfortunately created for ourselves - clever, yes, as well as illusionary. But don't let us think there is no appreciable consequence. The key effect is that asset prices are now artificially held up above equilibrium levels that time becomes the only solution as income struggles to rise to justify the high asset prices. Struggles because the asset-rich elite now do not have to work, and the poor workers on low pay in stagnant economies have to live in cramp conditions to give the asset-rich their rental income that they live on.

5. But the ultimate consequence of the excess liquidity in the world is the rise of China which unleashes a world new world of consequence, when a third of the world which used to be hungry is now not so destitute. With the frenzy of consumption (and investment), there is a significant and noticeable shift in the global aggregate demand curve to the right and hence a global rise in prices across all markets - except for the finished Chinese products. Nobody should think that the excess liquidity created by Greenspan had no impact on global inflation.

Noah's Ark

If there is excess liquidity, where is Noah's Ark to save us all?

The excess liquidity remains because the central banks have all plunged the holes with their bank rescues and so we are now all trapped in a world of ample worthless cash. Unplugging the holes does not appear to be a practical option.

The larger world now seems caught in a stalemate. The only way out for most countries seems to be a pray that somehow investors would be inspired with new innovative ideas to start a new round of investment projects - creating products that will entice the people of the world to consume and hence stimulating more economic activities.

In economies where confidence is at the lowest, the interest rate for savings would be the lowest because politicians, in their desperate bid to save their political careers, are very willing to punish the small savers in order to applease the big investors. This policy may work to opposite effects - as small savers, i.e., the many voters - will be unhappy over the erosion of true traditional values of hard work and saving, while the big investors will take the cheap funds and invest where the market exists.

In more confident economies, of which there is probably only one in the world at present, i.e., China, the policy action is exactly the opposite - instilling monetary discipline, raise interest and generally trying to slowdown the growth of the bubble. China is the only country in the world where the people are hungry and the environment is conducive for people to work hard to pull themselves up by their bootstraps. China is probably the Noah's Ark, if any one should be looking for one to climb onboard.

1 comment:

walla said...