Here's a mental model I find helpful for understanding current circumstances:
"Quantitative easing" means issuing new money -- a government obligation that pays no interest -- to purchase treasury (and agency) bonds -- government obligations that pay interest. Until very recently, for good reasons (a global financial crisis, a global pandemic), the Fed and other central banks around the world have been engaged in quantitative easing at an unprecedented scale, replacing government-issued financial instruments that pay interest (bonds) with government-issued financial instruments that pay no interest (money). The result has been an unprecedented increase in private cash balances -- what many call "liquidity sloshing around."
Last year, some central banks started doing the opposite, "quantitative tightening," i.e., selling previously purchased bonds (or letting them mature), removing liquidity (government-issued money) from financial markets and replacing it, directly or indirectly, with financial instruments that pay interest (government/agency-issued bonds). The result has been a gradual decrease in private cash balances -- one could call it "liquidity evaporating."
For example, you can see the value of the financial instruments the Fed owns (i.e., it has purchased them in the past and continues to hold them) here:
PS. I'm talking only about readily observable facts, not about "excess liquidity" in the abstract sense, e.g., as described by economists who call themselves Keynesians.
I'm not sure what you mean by "excess liquidity ends up in assets." Keep in mind that asset prices are set at each instant by the marginal buyer and the marginal seller. If someone buys a single share of, say, TSLA for twice its most recently quoted price, the market cap of TSLA would instantly double (until the next trade is executed). Prices can rise or drop a lot, even if little money trades hands.
If you're asking how the net present values of long-lived assets change as a consequence of quantitative easing, the answer lies in the impact of quantitative easing on long-term interest rates. All else being equal, when long-term interest rates rise, net present values decline; when long-term interest rates decline, net present values increase.[a]
For example, when the Fed engaged in quantitative easing from 2008 to 2022, it did so expressly with the intention of reducing long-term interest rates. Since last year, the Fed has been engaged in quantitative tightening (selling bonds or letting them mature) expressly with the intention of pushing long-term interest rates up.
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[a] Asset prices (market caps) eventually tend to follow net present values, usually in fits and starts.
Commercial banks actually create the money (by issuing loans) that is used to buy houses (mortgages) and stocks (leverage).
Central banks affect this process by adjusting the rate to which they lend to the commercial banks, and by quantitative easing /tightening which has a similar effect on long term rates.
Rates are low, more loan value is issued (because the income stream servicing the loan translates into a larger loan amount), asset prices go up. And conversely.
The same way previously created money ends up being used for anything in the private sector: by the actions of individuals, businesses, and non-governmental organizations. If money is cheaper to borrow, they may choose to borrow more, or take on more risk, or what have you.
But money does not "go into assets." That's a misconception. Money trades hands: For every buyer of a house there is a corresponding seller, and for every buyer of a share of stock there is a corresponding seller. Asset prices can rise, or fall, with each trade.
> How would you describe the situation when you purchase a treasury bill then?
Your cash (i.e., money) goes to the seller of the treasury bill.
If the seller is a private investor, your cash goes to the private investor (e.g., a mutual fund, a pension plan, an individual).
If the seller is the US Treasury (i.e., you bought a newly issued treasury bill), your cash goes to the US Treasury, which will deposit it, and later on, will use it to pay for the federal government's expenses, including bond interest. (Recall that, unlike the Fed, the Treasury cannot issue newly created money. The Treasury must borrow or collect taxes from the private sector to fund federal spending.)
If the seller is the Fed (through one of its primary dealers, acting as an intermediary), the trade is quantitative tightening.
>> Recall that, unlike the Fed, the Treasury cannot issue newly created money
This is where it begins to unravel and fall apart. What you say is true in theory only, it’s not true in practice:
The fed finances the primary dealer banks that participate in treasuries auctions - it accepts treasuries as collateral for repos.
The primary dealer banks are obligated to stand ready to purchase treasuries and the Federal Reserve ensures there are sufficient reserves to do so by supplying them through temporary repos (a matched purchase of Treasury debt with a requirement that the seller must repurchase later). While the Federal Reserve is not in that case directly buying the new issue directly from the Treasury, it uses the open market purchase to buy an existing bond in order to provide reserves needed for a private bank to buy the new security. The end result is exactly the same as if the central bank had bought directly from the Treasury.
Unless you purchased a treasury bill from the central bank as part of a money-draining operation, the money is still there. Your counterparty has sold a treasury bill and received money for it, that she'll most likely spend elsewhere.
> How does newly created money (which first goes in commercial bank reserves) finally ends being used to buy houses and stocks?
Well, you have some newly created money, whilst the demand for holding money balances (which depends on the price level and the volume of economic activity) stays the same. So what happens is that money is exchanged away like a hot potato until the demand for money balances rises to match the extra created money. In the short run, this is a mixture of higher prices and a higher volume of expected economic activity, both of which would raise asset prices.
>> you have some newly created money, whilst the demand for holding money balances … stays the same
This is a contradiction. You can’t create money without a demand for it first. In this specific case through the demand for money in exchange for treasuries/MBS/etc.
>> So what happens is that money is exchanged away like a hot potato until the demand for money balances rises to match the extra created money
This view derives from monetarist theory, it’d be fair to say this view enjoys less support today than it did in the past. As with all macro views, it’s primarily BS with perhaps a little bit of truth that may or may not apply in any given real world scenario. Probably not a useful model.
> You can’t create money without a demand for it first.
Why not? At the individual level it literally works the same as any purchase of existing assets. In practice, the counterparty of that transaction will probably spend that money in turn on something else that she actually planned to hold.
> This view derives from monetarist theory, it’d be fair to say this view enjoys less support today than it did in the past.
Well, the biggest flaw of monetarist theory is that it treats "the creation of money" as if it was somehow special, whereas what really matters is the product of money and velocity. (Velocity can be seen as a reflection of external changes in the demand for money balances. It also explains how money can seemingly be "created" out of thin air by entities other than the central bank; what we're really seeing in these expanded money measurements is higher velocity for the actual "high-powered" money that the central bank issues.)
> You can’t create money without a demand for it first
>> Why not?
To be clear i’m discounting stimulus checks which would be exactly that but it wouldn’t be right to claim this is a common source of money creation.
The most common source would be A commercial bank issues a loan creating new money, but without a customer demanding a loan, there is no ability to create money.
The second most common source would be the government spends into the economy by consuming on its own behalf - there needs to be something for sale in the economy (inc. labour / public sector employment).
Usually new money is created when the central bank issues it in exchange for government bonds. It's practically always possible to do this. You could posit a theoretical situation where government bonds are literally indistinguishable from money, but that just means that government bonds are money, so the government treasury has merged into the central bank. Then the central bank has to buy something else, which means it incurs some risk. Or the government can issue more government bonds. "Spending money in the economy" is like this, assuming that the government bonds are permanently rolled over, and never bought back in full.
The economy is always inflationary. Money today is worth less than it is tomorrow. Money that the bank has is just rotting away, becoming less valuable over time. Banks need to take the cash they have and invest it in something to offset the inflationary losses. Because bonds weren't paying much interest, it was a better return for the bank to loan out the money for mortgages, investors, etc. Eventually those loans become a part of someone's paycheck or into their bank account (ie home sale that ended up with a 2-300% return). Compared to the bank buying bonds which essentially removes money from the economy.
This is a very valid question. Up until 2018 or so the liquidity was provided to banks which in turn controlled how much money to loan out. Hence keeping the inflation in check and reducing their risks. however, due to COVID our governments directly handed money to general public through various bills and benefits. That liquidity found its way into other assets. The low mortgage rates pushed housing markets to new highs increase by 100%-200% further increasing net worth of millions who in turn are spending more (wealth effect) further fueling inflation. Now how do you tame this spending? Only way to do so is to reduce the wealth effect or accept the inflation to be higher than 2% target and admit it will take several years to stop it from increasing.
The Taylor rule is showing that the interest rates should be over 10%.
Issuing new reserves not new money. New money can then be issued by the counterparties of the Fed’s open market operations The counterparties are the “primary dealer” banks (theres around 30 of them), these are the banks whose reserve accounts at the fed get topped up in exchange for the assets the fed wishes to buy. This is the US model, the UK model is a bit simpler (replace the entire faux market with the BoE’s asset purchase facility or APF).
>> replacing … bonds … with money
this is basically the effect and you did say you were describing a model not necessarily the actual system but i’d be remiss not to point out the model you describe is not faithful to how the system operates
>> The result has been an unprecedented increase in private cash balances
This is a function of both private debt (150% GDP) and public debt (125% GDP) in the US. Private debt in the US is more of less ignored by many economists but we know from history that this is a mistake regardless of the kinds of stories certain macro economists prefer.
>> The result has been a gradual decrease in private cash balances
Too early to say yet. There are signs private credit growth has continued despite increased interest rates, in which case cash balances could be higher.
Reserves are money -- they are the key component of the monetary base, included in all money aggregates.
Yes, the Fed trades with the rest of the world only via its primary dealers. But note that these dealers are non-US-government entities (specifically, they're for-profit businesses, part of the private sector), or trade with the Fed acting as intermediaries for other non-US-government entities (businesses, individuals, etc., also part of the private sector). Thus, newly issued money with which the Fed pays to purchase instruments in open-market transactions ends up in the hands of... non-US-government entities -- mainly domestic businesses (e.g., mutual funds), domestic organizations (e.g., pension plans), domestic individuals (e.g., day traders), etc., all part of the private sector.[a] The newly issued money ends up as private cash balances.
[a] For simplicity, I'm excluding foreigners from this mental model. I'm also excluding the so-called "multiplier effect" of bank lending.
Reserves can be cash, but the reserves issued through quantitive easing are not cash. They are not a form of money that can be spent in the economy.
>> Thus, newly issued money with which the Fed pays to purchase instruments in open-market transactions
Newly issued reserves, not money. The reserves go to the primary dealer banks. The mechanism by which this results in the banks being prepared to issue new money (for spending in the economy) is not direct. Empirically shown through the muted money creation in response to the enormous reserves injections of QE.
The reasons for this lethargy are many but it’s fair to say capital requirments are the main one. Lending operations (the mechanism by which QE is supposed to ultimately inject real money to the economy) are not reserve constrained. Since Basel, they’re capital constrained.
As I mentioned in my comment, the Fed's primary dealers can and do act as intermediaries for the rest of the private sector. If you sell a treasury bond you own in your brokerage account, it could well be the Fed buying it on the other side, through one of its dealers -- and vice versa.
Otherwise, I agree with you that banks are capital constrained in their ability to make loans. But as I mentioned elsewhere on this thread, I left bank lending (and its impact on higher-level monetary aggregates) out of this mental model for simplicity.
> Reserves are money -- they are the key component of the monetary base, included in all money aggregates.
Money exists on a spectrum. Reserves are money-like in some aspects, but so are bonds and equities, as is gold. These are all stores of value and media of exchange.
QE is creating new reserves (which is money-like) and buying other types of assets (which are money-like): basically an asset swap. The balance sheet often stays exactly the same.
> replacing government-issued financial instruments that pay interest (bonds) with government-issued financial instruments that pay no interest (money).
Except that the Fed is not giving "government-issued financial instruments" with QE. They are placing reserve credits in the banks' reserve accounts. Bank reserves cannot be used in the wider economy, but only with-in the Federal Reserve inter-bank settlement system.
Cullen Roche has a good series of articles on quantitative easying:
> The result has been an unprecedented increase in private cash balances -- what many call "liquidity sloshing around."
In essence, QE is/was an asset swap: bonds for reserves. There was zero net change in the balance sheet: $100M of bonds was exchanged for $100M of reserves.
Yes, bonds for reserves, and vice versa. But recall that reserves are money -- they are the key component of all measures of money. Also, recall that the primary dealers which trade with the Fed routinely act as intermediaries on behalf of third parties -- mutual funds, companies, individuals, etc. During QE, the Fed was buying bonds previously held by the private sector. Now, with QT, the Fed is letting the treasury/agency bonds it holds mature (it may be selling some of those bonds too), canceling the money it receives, and thus putting the private sector in the position of having to buy the new treasuries/agency bonds that refinance the recently matured ones. So, I think it's OK to simplify things as the parent comment did for the purpose of having a useful mental model.
Adding to this, the key is what these market actors purchase in place of the bonds that were sold.
They shift out and buy more risky assets. Corporate bonds, equities.
And then next the people that held the corps/equities that were sold buy still more risky assets (e.g., speculative equities, VC) and so on (e.g., crypto).
I was hoping that the OP would address a related idea that I find rather weird: it’s sometimes said that “this excess liquidity has to go somewhere” and that “the excess liquidity has gone into [housing/stocks/commodities/other asset class]”.
But I don’t get this: It might seem plausible that if stock prices go up they absorb liquidity from the system. But (ignoring new stock issues / newly build houses) in every transaction there’s both a buyer and a seller. Sure, the buyer parts ways with cash when they buy a share, but that cash goes to the seller. So there should be just as much liquidity as before, just in different hands.
If anything a rising stock or housing market should just put more excess liquidity into the system because it’s possible to borrow against those assets.
What am I getting wrong? Or is this just an often repeated falsehood?
You are correct when taking the view of the financial sector as a whole - every asset purchase merely swaps who has the cash and who has the asset. You're not getting much of anything wrong, merely missing a behavioral trait of many market participants: they desire a fixed ratio between their various financial assets. An extreme example of this is an index fund, which has a formulaic relationship between their book value and how much of what assets they own.
In essence, what happens is that cash gets dumped into the laps of various market participants, who then notice that they have "too much" cash. They then bid on various assets until there no longer is "too much" cash in the system for the total value of assets around.
I totally had this happen. When I was growing up we didn't have much money, and I've always tried to be really frugal. I tend to agonize over minor necessary expenses like gloves or shoes. When I went from a couple hundred bucks in the bank to almost a million I felt strange. I tried to ignore those feelings, so I could live like a normal person. It only took me about a year to...
I mean... Well... It goes pretty fast and things are pretty much back to the way things were.
I did not understand at all how people who win the lottery could blow through it all so quickly. Growing up, the limit on my spending was availability. When that availability went up, I didn't really have the right tools to change my internal spending algorithm quickly enough to maintain a comfortable level for a longer time.
It truly didn't fix as many problems as I had hoped, and it turns out a million dollars isn't nearly as much as I thought it was.
It's possible to avoid this by having separate buckets for consumption and savings. Hold your consumption bucket constant (some people call this "budgeting", but it could be done more informally), and all the excess cash you're making, by definition, will go into investments. Then you just have to learn how to invest prudently. :-)
GP is talking about the investment side of this, where "investing prudently" usually means looking at the relative prices of different investments and putting your money only into the ones that are undervalued. If enough people do this, a.) relative prices approach a pretty good approximation of their true value, and b.) those prices are going to be much higher when a lot of cash went into savings than if there's not much cash going into savings.
Oh I invested most of it, and now I don't have all that cash anymore. I have assets instead. I'm back where I can worry about spending a few bucks on something minor.
So let's say that the entire world is index funds (plus the stocks they own). An index fund has "too much cash", so they buy stocks. Some other index fund sees that the price is attractive, and sells, but then that fund has too much cash.
But the funds each keep some amount (1%?) of their assets in cash. So isn't the net result that stock prices go up until the value of the stock is 99 times the amount of cash in the system?
More generally, then, doesn't the price of assets go up until the participants are comfortable with that much cash as part of their asset mix?
"(1) For every share of every asset in existence, someone must willingly hold that share at all times. If no one can be found who wants to hold a share, its market price will fall until someone is found.
(2) The total “amount” or “supply” of a financial asset is the total market value of it in existence: the number of shares outstanding times the market price. Asset “amount” or “supply” is therefore flexible for all assets except cash, whose market price is always unity. If there is more financial wealth that wants to be allocated into an asset than exists of that asset, the market price of each share of the asset will rise, which will expand the supply of the asset so that the demand can be satisfied."
"Money is not something that can go into or come out of assets; rather, it itself is an asset that is traded for other assets. The offered rate of exchange is the price. Changes in the price can create the perception that money is moving, but, in reality, nothing needs to be moving at all. Any movement that does occur is incidental to the underlying process.
Likewise, investors cannot leave or enter any asset class. All they can do is fight with each other over who will hold each asset class, offering to exchange money at various rates in exchange for the privilege of holding something else. The consequence of shifting preferences and exchange rates may be a destruction or creation of wealth in various places, but it is never a “movement” of wealth."
>> The total “amount” or “supply” of a financial asset is the total market value of it in existence: the number of shares outstanding times the market price.
Isn't this assuming 'mark to market' - the assumption that the entire supply of an asset class could be sold at the selling price of some (usually very small) fraction of the supply that has most recently been traded.
If my understanding is correct, this is the fallacy that has underpinned the inflated valuations of many crypto assets (SBF etc)
>Some other index fund sees that the price is attractive
Index funds do not have opinions on the attractiveness of prices. What happens in this hypothetical when one index fund has a cash inflow is that it bids on all the assets it is "short" of, which increases the price until the other index funds have "too much" of the now-higher-priced asset and decide to sell.
But generally speaking yes, there's cash or cash-equivalent in the overall market's mix, and it stays relatively constant. When these cash assets get dumped onto balance sheets, other assets get bid up until their sizes are appropriate for the amount of cash around.
Yes. Except there is also a group of people that sit on the side scamming everyone by building assets that promise to fit in the index but are just trash and return nothing.
Keynes divided liquidity preference into transaction demand, precautionary demand and speculative demand.
Transaction demand refers to earning money with a job or business and then spending it. Precautionary demand refers to demand for money based around uncertainty in the future, you keep some money around because you want to insure against losing your job (rainy day fund) and finally, once you have so much money you satisfied these two, there is still the fact that money is the most liquid asset. Money can be traded into other things faster than anything else. So this is basically day trading, buying low and selling high. The problem though is that at some point the Keynesian beauty contest begins. People not only react to fundamentals but also the reactions of other investors making investment decisions. Someone invests because they genuinely believe in the stock,
then people invest because they think people believe in the stock,
then people invest because they think people invest in the stock because people invest in fundamentals.
This is a rationality trap that doesn't end until the bubble pops and then people move onto something else.
What you are concerned about can be explained by a weakened form of a liquidity trap. The problem with the liquidity trap is that it is pretty theoretical in the sense that it is absolute. Like getting 100% efficiency. But in practice a liquidity trap can also be in the form of trapping liquidity in specific economic sectors and that can be described as a continuum.
For example, we separate the economy into the real economy and the financial economy. The financial economy is just a model of reality, but it is possible that messing with the model of reality is more profitable than actually doing something in the real world. This means money is allocated away from the real economy and into the fantasy of the financial economy. People do sell their financial assets but only to buy something else in the financial economy. It is a one way street of money flowing into the financial economy but never back and this is why you need constant government intervention that reinvests the money back into the real economy. It is obviously an ugly solution but what are you going to do? Introduce a wealth tax?
Historically, times where there have been excess liquidity and new technical development along with a labour shortage result in an Industrial Revolution. We have all of these things right now.
Consider that newcomen’s engine was based on prior engines, and itself wasn’t that much of a success - but everything that followed was explosive in terms of the changes wrought on society and industry. The technology was interesting, but as long as you could pay a few blokes to man the pumps, installing an expensive engine and buying coal to power it wasn’t an economical route to follow. When the triangle trade had accumulated enough wealth with nowhere to go other than gilding, and when the workforce started emigrating to the colonies to escape their miserable conditions or getting shot on the plains of Europe, and the remaining souls started demanding Real Money, suddenly, those new-fangled engines looked like a sensible investment.
Which technology will be our next revolutionary step is up for debate, but I would (and have) place my chips on AI/ML. The last few rounds have been all about the decoupling of unskilled and semi-skilled labour from productivity. Next up on the block is skilled labour. Why would you hire developers or lawyers or diagnosticians or any knowledge worker for $stupid per annum, when you can spend a bit more, and never have to pay a human again?
I don't think it's a one-way flow. Here's a company that makes, say, cars. And here's a company that invests. Money flows into the investment company and away from the car company. At some point, the rate of return on the car company starts looking good enough that even the investors notice. At that point, at least some money comes back.
Now, you may say that net "well-being" of society will go up if we make more cars and fewer investments in financial firms. (In the end, you can't eat money.) But where the line should be drawn is going to depend very sensitively on your definition of "well-being". That's not an easy question to answer, even before politics gets involved.
Liquidity means capacity to buy, essentially. Not cash per se.
If you reduce the required deposit on a house from 20% to 10%, that increases the liquidity in the market. Suddenly more people ‘have’ the money to buy that $500k property and the market will typically rise until it’s absorbed that added financial capacity
This is why low interest rates had such a dramatic impact.
Monthly repayments are much lower on a low interest loan, so the average person could ‘afford’ to borrow way more.
Note; this is just Real Estate. Lots of other borrowing also occurred.
But when Real Estate markets suddenly go up by 20%, now it’s the owners of these houses that are worth a whole lot more. And they often decide to cash in, in some way (selling their J
(I'm not an economist) Good, point but think of the following example. You have 10 startups and supply and demands has dictated that $1M is a good price for 10% equity. Now let us say a group of VC suddenly have $20M dollars to deploy. The system only has capacity for $10M, what will play out over time is that VC will bid ever higher amounts for that 10% of equity because they _have_ to deploy capital. It seems silly when outlined like this but imagine this taking place over a few years time and with many complicated variables. It becomes really easy to rationalize that the 10% is really worth $1.2M, $1.4M, etc (there are also some feedback loops here of VCs buying from each other at greater valuation thus justifying their other purchases at higher prices etc). Repeat for X year and you get to $2M.
Of course as you point out that money will go to the seller and does not simply evaporate. Now in the heads of a founders. They could decide to sell less equity (say only 5% to still raise just $1M) but let's be honest, they won't VC will tell you it is a bad idea and the startup down the street is expecting the $2M (again still plays out slowly over time so you don't really notice the slight raises in valuation). The founder can then use that money to do more work (initially) of course the founder has to bid for workers (programmers) which to assume a simplified model is also a finite pool.
The example repeats, this time not for equity but for labor. The programmer is really worth $100K but you _really_ need one and if you don't pay them $110K he will take an over at the other startup. You can afford them after all you just raised $1.2M. This pattern repeats until you have programmers demanding $200K. All of the sudden you NEED that $2M valuation otherwise you cannot afford to hire anyone.
Those programmers have needs to, a house for example, let us assume there are only 10 houses and...
You get where this is going.
This can continue as long as the underlying value of the business can support it (the margins of VC, founders, programmers, etc just decrease gradually). So who loses? The people that are not part of this subsystem that got money injected, the people holding the 'bag' as they say when the bubble pops.
This is essentially a trap that is hard to get out of because there are many different stages in the process each with costs. The programmer can only go work for $100K if the house goes back down in price etc.
> Now let us say a group of VC suddenly have $20M dollars to deploy.
Wouldn't that come from their ever decreasing margins? it sounds like there's a feedback loop there that should balance itself at some value, but that's probably assuming people are rational which they are most decidedly not.
I think that's the sloshing part. Excess liquidity moves from entities that buy real estate, into the hands of those that were selling that real estate. Then the excess liquidity of the entities that sold real estate goes into whatever they're interested in, like maybe the stock markets. This is not one big movement but lots of mostly chaotic reactive systems hench the sloshing.
But isn’t the cash’s purchasing power getting inflated away, at say 6.4%, so the liquidity evaporates?
We can all be given millions (super liquid) but that doesn’t make us millionaires in terms of purchasing power. At first it seems like everyone is rich, then folks realize it’s funny money and suppliers raise prices. Since money is (dynamically) valued by what you can buy with it.
So the seller of the house sold for a million, for example, but it turns out they actually have ~850k if they sat on the cash for a couple years.
Many good points in the other comments.
One important first-order aspect that is usually meant by “excess liquidity” is central bank stimulus:
Central banks create more money (buy low risk assets) -> there is more money in the system that has to go somewhere -> more money in total has to go into riskier assets -> they are worth more.
This is a very naive equilibrium argument, and the “excess” probably just means “unusually much”, nothing deeper or technical.
Part of the confusion is, as others have pointed out, that "liquidity" isn't really the same thing as "money".
If you're talking about money, then that's exactly what happens - the creation of "high-powered" central bank money leads to a multiple of that amount of new money appearing in the economy as it's used (and reused) in the financial system to make net new loans (the multiplier effect).
Ultimately as the money gets passed around then some market participants will use the money in ways which reduce either liquidity or money supply or both (repaying loans for example) so there's a decaying effect which is why the multiple isn't infinite. As the money dissipates throughout the system it will end up in the hands of participants who are either slower to reuse it or more likely to put it in something which either is or looks like a central bank deposit - hence the "liquidity" eventually dissipates too.
If there are 1000000 stocks of a company around and a lot of people want to buy and almost no-one wants to sell. If one person manage to buy 10 stocks from another person at 10% above last days price ($100), i.e. at $110, then the total marked value of that company has increased by 10% to $110 * 1000000 = $110 million. So $10M were created driven by a small transaction of just $110 * 10 = $1100.
It's not that all 1 million stocks have to trade for the total value to go up. All the people who did not trade, but who own the other stocks, have seen their (paper) value go up.
And the same, but opposite happens when it goes down of course.
Let's say some major event would trigger a panic on the stock market, then very few trades could cut the total market by 50% and very few would get any money for their stocks at the price when the panic started. Most would not have sold and would sit on stocks worth 50% less than the day before.
Kind of extreme examples here, but just to show what I believe you are "getting wrong".
This is correct. Except for inflation it’s impossible for asset prices to rise everywhere.
Some places and some assets will see a rise while other places and other assets will see a drop.
While everybody was screaming at the everything bubble there were real assets that became defacto worthless (at least temporarily) the entire fleet of passengers Boeings and Airbus. Not to mention cruise ships, casinos, theme parks..
What about NYC real estate? The pandemic had people thinking that life is too short to live in such packed conditions in places so sensitives to pandemics.
Can we also talk about oil which collapsed during Covid and hit a negative 37 dollars per barrel? All commodities did bad during the pandemic, oil, LNG, copper etc.
It’s a form of selection bias because pundits and commentators always watch where the money is going , not places where money is hemorrhaging (that is unless there is a big bankruptcy), but sector wise they just dont focus on it.
A clear example is OPEC. Every pundit focuses on what OPEC does but nobody focuses on what it means for shale oil producers and their survival. The only people who focus on those are their lenders and investors as well as city officials but this profile doesn’t show up on your TV on Bloomberg or CNBC , because these outlets are too busy interviewing the Saudi or the UAE secretary of energy in the aftermath of the OPEC decision
As you grow up you understand they most of phenomenons that people swear by are selection bias.
There are theories that even stuff like physics is selection bias because we swear by the physics we know but it could be entirely rubbish because it’s not the truth of Nature but just our best intuition of the truth of Nature which is of course subject to selection bias anthropomorphically speaking
First, you have to really understand what liquidity is. Liquidity isn't cash, or value per say, but rather a measure of how easy something is to trade. Cash just happens to be the most liquid thing because it is the most actively traded thing. For example, it's not like everyone trades for cars directly using chickens, but both chickens and cars are directly traded for cash, so cash is more liquid (ie easy to trade with) than either cars or chickens.
Next, excess liquidity can disappear by market participants simply refusing to do trade (ie a drop in demand). For example, if I have a house, which many people would be willing to trade for me today, tomorrow they could all change their minds and wouldn't even trade me a spoonful of dirt for it. In which case, the liquidity of my house (easiness to trade it), dried up by simply a change in market demand.
Now here's the best part, while every transaction has a buyer and seller, every transaction has two supplies and two demands. For example, person A may be willing to trade his supply of cars, but demands X dollars in exchange for any one of them, and person B is willing to trade his supply of dollars, but demands a car of certain condition for them. In this case, there are two supplies (dollars, and cars) and two demands (again dollars, and a car of a certain condition). If the supplies of each participant, meets the demands of the opposing participant, the transaction happens, and the trade is settled between the two parties.
So to address your questions. It's entirely possible for something that was easy to trade (cash), was traded for [houses/stocks/commodities/etc], and afterwards, no one is willing to trade things anymore. Which includes people with houses who are not willing to trade them for cash, and people with cash no longer willing to trade them for houses. Liquidity disappeared simply by a change in market demand. But you're not necessarily wrong, as if demand doesn't change, then it doesn't really dry up.
Yeah I've also wondered the same, i.e. I view it as a closed system and excess liquidity usually results in inflation until demand matches supply of money
Eventually, meaning decades, as long as a near equilibrium is eventually reached, wages will rise and wealth ceases to be self-reinforcing at a grand level (back to a few percent). There hasn't been equilibrium for at least a decade. The long tail (the vast majority of people) will continue to suffer for decades and wealth will continue to be disgustingly easy to grow (with a few hundred thousand) in relation to the price increases most people encounter day-to-day. Ofc, maybe I'm just biased.
> When the rate of return is high, savers can achieve their goals by buying, holding, and harvesting the resulting cash flow. When it is low, they must turn to other strategies: leverage, arbitrage, momentum trading, more sophisticated quant trading, and “beauty contest trading“: betting on what others will find popular, for (arguably) extra-economic reasons.
I don't think this is how people behave.
I think collective behaviour can be better explained by people discounting the painful lessons of previous downturns the more the longer prosperity lasts. Our brains are wired this way, unfortunately and it requires a conscious effort to objectively (if it can be done at all) take into account risks of serious and long lasting financial winter.
Most people don't have the self discipline to do this. They kinda know about it but then they see other people making shitload of money in risky "investments" and our greedy primate brains take over.
I don't think either take is correct but the former is closer to the truth.
It is all risk reward trade-off. If bonds have the same yield as other Investments with no risk, of course Savers and investors would select them over riskier strategies. This has less to do with discounting painful lessons and more to do with the spread on the return rate.
For one concrete data point refer to this[1] chart which tracks the mortgage backed securities (MBS) held by the fed. This is fed creating money (for the lack of a better word) to indirectly fund home ownership. What started out as a short term measure to avoid a Great Depression post 2008[2] crisis ended up being a more permanent policy fixture. That is about $2.7T of new money created since 2008. Let that sink in.
2010s were quite unprecedented years in terms of new money (and hence new debt) created. The repercussions were everywhere; crazy VC funding (Uber/Airbnb etc.,), insane tech salaries, record high stock markets and so on.
Money supply needs to couple with velocity for the comparison with GDP to make sense (think of the degenerate case, you theoretically could use like a single dollar to handle the entire economy, if it moves fast enough).
The easier comparison would be to compare the money supply growth against the GDP growth and see if they differ by much. I have neither number on hands, so someone else might be able to provide them.
Both posts are important here, IMHO. We have two signals to arrive at economic and productive decisions in our society, which favors distributed decisionmaking: democratic votes and price. There are all kinds of problems with the former, as for the latter: we rely on individuals to make efficient decisions, however this requires some kind of scarcity. Scarcity which is largely in effect for the majority of the population that relies on income from work to survive. If individuals make decisions without constraints, they tend to go off track real quick. IMHO, this is the main problem of wealth inequality: rich people make stupid decisions. And stupid, in this case, means unproductive for the society/enviroment etc etc in general.
> If individuals make decisions without constraints, they tend to go off track real quick. IMHO, this is the main problem of wealth inequality: rich people make stupid decisions. And stupid, in this case, means unproductive for the society/enviroment etc etc in general.
i must be missing the point you’re trying to make, or the framing, or something. why would i want to be rich if not to direct more resources to achieving my own preferences? of course this is not maximally productive for society: if all money was required to be directed based on where it were maximally productive then it would no longer mean anything to own money; money would have no value to the individual.
> why would i want to be rich if not to direct more resources to...
These days, I think most of the motivation to be seriously rich (vs. mere "can afford two nicer McMansions, and your kids don't qualify for college financial aid" rich) is a humans-are-primates obsession* with being further up the pecking order.
But your bottom line is still valid. The rich are definitely not allocating resources in ways which are beneficial to society.
*Less-flattering terms, perhaps from the DSM-5, would seem applicable in many cases.
>rich people make stupid decisions. And stupid, in this case, means unproductive for the society/enviroment etc etc in general.
I completely agree but I think you've defined rich wrong. There's only so many multimillionaires and billionaires and most of their money gets plowed into business ventures (even if dumb ones), investments and other things like that that aren't too off the wall.
The economic volatility comes from the much, much more numerous hordes of upper middle class doctors, lawyers, techies and whatnot that are "post scarcity" enough that they can swing a fair amount of money around in pursuit of that.
When a large subset of them decides to do something, like buy toilet paper, or TSLA, or a second house or whatever, there's a huge effect and that's where you get bad tulip mania style volatility and economic patterns from. Nobody on food stamps and nobody with millions to their name lost their ass on beanie babies.
Disagree here. Some rich people make stupid decisions and get flushed out. It's very darwinistic.
But in general rich people are rich BECAUSE they are good at thinking about being rich.
Your point made sense until you mentioned wealth inequality-- but wealth inequality exists EXACTLY because rich people are good at thinking about being rich. These decisions may not be productive in terms of society -- but they generally favour growing or maintaining the status of "being rich".
I generally agree with you, and I could probably have chosen a better word than "stupid" (not a native speaker though). That's why I tried to clarify in my last sentence, that "stupid" in this context means that their decisions don't align with societies interests at large anymore. Kind of like "stupid" as in: a central planner would be stupid, if they applied those decisions when they actually had the goal of maximizing societies productivity and wellbeing.
> which favors distributed decisionmaking: [...] price
Seeing as the top 10% hold over 60% of the wealth (in the US, globally we have a dozen people with as much wealth as the bottom 50%), I don't see how this follows.
We still arrive at concensus based on a (more or less free) market. Weights on this market are heavily skewed to the top, that's true. And as I said, democratic votes also don't exactly live up to the cultural standard that we at least say we have. But in general, we're very far away from a planned economy.
The market may be more or less free, but the distribution of information is not equal or even. That is one of the most important factors that prevent actors from making efficient decisions.
If the trend is more and more concentration of control then that can be concerning. And concerning even if still technically distributed until the moment when there are only 2 people controlling 100% of the resources, in a world of billions of people.
If you believe crypto is purely speculative, maybe you can argue it's a near perfect measurement of excess liquidity sloshing around the financial system
It seems like stable coins would track the excess liquidity people are hoping to reinvest and all other crypto currencies track the amount of excess people are willing to just lose.
Only when its potential upside vs risk is better than any other option. As is with any other investing (though probably a bit more buffered since it’s relatively scary investing to anyone even mildly risk averse).
I strongly believe there is not one but there are two monetary systems today. One is for assets and the other for daily life consumption. They are only weakly coupled less than maybe in the past. This allowed raging inflation in the asset system for decades while daily life saw deflation or low inflation. And now we have exactly the opposite. There are a lot of reasons - many related to decision body captures - why transmission between the two sides slowed down. Any analysis looking at only one side and trying to explain the whole is bound to fail. Traditional methods work as long as they focus on one side only - influence from the other can be neglected.
I agree. What we have seen over the past decade+ has been asset inflation. This is exactly the same as goods inflation (what we are seeing now), except that asset inflation seems like a good thing at first blush. People want their assets to go up in price. It makes them feel rich. But assets should be priced based on what they return to you in future dollars, and THAT return has been going down and down over the past decade. This is not a good thing.
What is happening now is that asset inflation is correcting and goods inflation (a related but distinct concept) is taking hold.
That distinction should be formalized and a simple law could fix the inequality- financial gains can only be spent/reinvested in Real world goods and services unrelated to finance.
Real world money would have no restrictions
There is always as much liquidity as is required. "Excess liquidity" flows around until it finds somebody where paying off the loan they hold is the 'best use of funds'. That destroys the liquidity, and the loan - shrinking financial balance sheets and freeing up whatever physical asset collateral that loan is secured upon, which then becomes 'equity'.
Increasing base rates is an artificial market intervention that suppresses asset prices. High asset prices, as with everything else priced high, is just a market signal to produce more of that particular asset.
Asset prices rise until the portfolio indifference point is reached - loans created against asset collateral are matched by loans destroyed by received liquidity created by those loans (as the 'best use' of that liquidity).
All fairly straightforward once you accept there isn't a fixed amount of money and that money and bonds are essentially the same thing with different terms and interest rates.
I don’t fully understand the point the author is trying to make. I appreciate that there are boom and bust cycles for some sorts of assetes
I would have liked to author to talk more about wording. What is actually liquidity? Today’s money appears in many gradual forms of moneyness.
Also is there anything like "excessive money"? Where does it come from? Central banks don’t just print money. They trade it for usually governmental bonds.
If other than central banks have excessive liquidity they may trade it for other assets. This means they need to find a counter party that has the reverse situation. So overall the economy cannot have excessive money.
>If other than central banks have excessive liquidity they may trade it for other assets. This means they need to find a counter party that has the reverse situation. So overall the economy cannot have excessive money.
But you are assuming that there is no zero lower bound. If there is an excess of liquidity like there being an excess of trash then people would expect to get paid to get rid of it and the market would just find a garbage collection fee for this excess liquidity. But if there is a zero lower bound, then the people with the excess liquidity have no incentive to dispose of it. Instead, they would just keep accumulating more and more liquidity indefinitely as the market tells (or rather is forbidden to tell) them there is no excess liquidity.
I mean, take this example. The interest rate in the market is 3% and the interest set by the central bank is 5%. People will accumulate more liquidity than is optimal. There will be an excess of liquidity. It doesn't matter what the absolute numbers are. They can be -3% and 0% and you run into the same problem.
If excess liquidity is a form of economic pollution like CO2 is, then you would expect to pay for this pollution. But since the government doesn't charge a pollution tax, people will overproduce both CO2 and excess liquidity.
Your example doesn’t make any sense. The entire reason for the US Fed’s interest rate is to dictate the lower nominal bound of market returns in global capital markets. The FedFunds rate is the risk free rate, thus the market rate of return cannot be lower than this rate. Ie. The public equity market will return risk free rate + market risk premium.
A better explanation would be:
A pension funds needs to achieve long term nominal returns of 5% to meet liabilities.
Fed funds rate is suddenly set to 0%, and treasury curve peaks at 2%.
Market risk premium is 5% for public equities.
Market risk premium is 10 % for private equities.
To reach target returns while anticipating volatilities, it must allocate capital towards both public and private equities. This is the “sloshing”. Simple mathematics.
I've been assuming that the "excess liquidity sloshing around" is all those profits from decades of I.T.-fueled increases in productivity that did not trickle down to have-nots, but rather were accumulated by the haves. More than they can spend, or even invest carefully. So it sloshes.
`Excess liquidity` simply means we were in the middle period where valuations increased, and debt levels hadn't yet caught up, so new credit was being issued fast, and money from loans was entering the system accelerating the cycle.
I interpret "excess liquidity" to mean that there is a larger than average share of people, businesses, or governments that have enough excess wealth to want, need, or be required to invest that excess wealth.
i.e. There are more people with money that needs to be spent.
I interpret "sloshing around" to be a metaphor for the damage that can be caused to various markets (real estate, stock, etc) by a sudden increase in demand (caused by the above people, businesses, or governments excess money suddenly flowing into a given market).
i.e. When lots of money is suddenly spent in a single market it causes a harmful amount of price inflation.
The rationale that seems most reasonable to me is decades of low interest rates.
Interest rates are essentially an indication of how expensive money is. When interest rates are low, money is "cheap".
Outside of the FED purchasing bonds, Banks giving loans is another way to "print money". So when interest rates are low, more people and businesses take out loans, and as a consequence there is more money circulating, "sloshing around", in the economy.
There are other factors at work though, outside of interest rates, that can cause wealth to pool.
Various forces since the mid-1990s in the United States, mostly related to the tax and regulatory environment of corporate compensation packages (i.e. paying senior employees in stock, etc), have caused net wealth transfers to the upper classes. The wealth gains those classes have achieved also causes them to have excess wealth that wants to go somewhere.
Let's say the average cost of the stock market is $1 for every $2 of expected income. People say "Oh, that's cheap, stocks are a good idea to buy". Everyone starts buying stocks, and the prices rise. Eventually stocks are $1 for every $10 of expected income. People say "Oh, stocks are not going to go up much more, they're expensive. Hrm, Real estate is only $1 for every $2 of expected income. Let's move there". People move there money into Real estate. Or bitcoin. Or Bonds. Etc.
Because, due to inflation, it evaporates sitting still.
So anyone with a lot of money laying around knows they need to put it to work, so that it evaporates more slowly than it grows (due to investment returns).
And the best places to put your excess wealth are often constantly changing, so the money moves around following what everyone perceives to be the best places to put it to get the highest return.
This is actually one of the reasons central banks try to keep positive inflation, because it encourages people to put their money to work rather than just keepping it in a savings account providing no value.
When people are putting their money to work, human flourishing is increased. More jobs, more restaurants, more research, more activity, etc.
thanks for trying to help, but I feed like you just described normal investment.
Does Excess liquidity "move" any different than normal liquidity?
My understanding is that the difference is that excess liquidity is excessive because it it is greater than available positive growth investments to lock it up.
Maybe you are right and the movement from sector to sector is simply herd mentality and trend following, but I would intuitively expect that process to reach equilibrium faster
The shorthand that I have seen is that every actor in financial markets has a preference for cash/stocks/bonds/real estate/other things; the market equilibrium is when all of those preferences are satisfied. There can be dislocations to these preferences which cause "sloshing".
As an example - consider the sale of an owned house, where the buyer takes out a mortgage. The owner who sold now has cash, and the buyer has a liability (mortgage), meaning he has need for cash in the future. This type of mismatch can create excess liquidity (now, at the sale point), and the cash keeps moving until someone who needs to pay off a loan acquires it (cash gets "destroyed" when paying off asset-backed loans from the bank). In the meantime, that cash can go towards bidding up financial assets (until it finds the marginal need to service debt obligations)
When there's less excess it doesn't "slosh", which is to say investments cause less damage because supply and demand reach equilibrium without as much disruption.
The metaphor is supposed to conjure an image of liquid smashing into something, as the money does when there's too much of it and it all tries to go to the same place.
I think the focus should be on the volume not the motion.
Investment moving from place to place is natural. Too much is disruptive.
Which just means maintaining a balanced asset portfolio and not chasing every hot asset unless you are intentionally trying to ride a pump and dump wave.
It's not the economic system "considering" excess wealth as a bad thing.
It's just an unfortunate natural consequence of how people spend money when they have a lot of it, and of how businesses react when their products or services are in demand.
There's no natural law, or tenet of capitalism, that says people acquiring lots of money is a bad thing.
There's only our historical observations that
- When lots of people have extra money to spend, they spend or invest it.
- When lots of money is being spent or invested prices rise.
Keeping those two forces in balance is the challenge, and the function of regulation, or FED policy, etc, etc.
Until there is a widely available open source model of how the economic system works (here and now) people will go on beating about the bush in eternal cycles.
The elements for this to happen are actually there. We are not talking about a detailed replica with real time data, but a reasonably accurate model that includes all the public data from central banks, private bank statements, public market valuations etc.
With such a system the question "excess liquidity sloshing around" is a specific query with a quantitative answer, not an endless, low-information discussion.
It's the economists paradox, any sufficiently good model will drive decisions and policy, changing the conditions away from the assumptions included in the model.
This might apply to a dynamic model of the entire economy including agent preferences etc. But that is not what is required to educate and elevate the debate. Accounting what the economic system does at any given moment is not subject to assumptions.
It means greedy people have too much cash and are still looking for investments. They are forced to put money into investments that are less than ideal. If something isn't worth it but you can't find anything else that is the case with everyone else meaning all the shitty assets are going to be driven up. If a billionaire has a billion dollars they are looking to get rid of that trash and find something they can write their name on. They know where that toilet paper came from. I mean money.
This article does a pretty bad job of explaining the concept.
> This is one instantiation of an idea that was omnipresent in 2021-2022—that much of the weirdness in financial markets, from GameStop to crypto to stock market volatitlity, was driven by an excess of liquidity. This idea made a certain amount of inarticulable, pre-intuitive sense, but that sensibility does not a gears-level understanding make.
This is tangential but I asked it in another thread a little too late. But with the Fed's interest payments exceeding their asset income interest for the first time in history, does this effectively cause an increase in M1 like QE? The official charts seem to imply that the answer is "no" but I don't understand why.
The interest income the Fed earns now, is from assets which were created in the past at lower interest rates, where what it's paying out to banks is in current higher interest rates. While this may seem like it could essentially result in QE, the Fed covers the difference via what's considered a deferred asset, which is something that goes away when the income balance changes in the future. It's kind of like paying a future expense now. So, the effect is temporary.
Thanks. I've heard of the deferred asset, kind of an IOU to itself. But that only changes, like you said, when the income balance changes. Similarly, we could say that QE is just deferred until the purchased assets are sold again in the future?
I'm not entirely sure, but I think that depends. It's like the Fed is making up the difference in income, by handing out promises which will be paid in the future when the Fed has a positive net income again, so to speak. If the Fed decides in the future to pay for such with newly printed money, then I think you could consider it deferred QE, but if in the future it merely uses the income from its assets to pay for them, then in effect it's not really QE at all. Or vice versa, if the Fed is paying out new money to cover such today, it is reversed in the future (and it therefore acts like temporary QE and deferred QT). Either way, in aggregate, it should balance out, and would only result in QE if it results in new money added to the monetary base.
To fight excess cash feds increase interest rates. Excess cash in a low interest rate environment causes inflation because of the multiplier effect of loaning money. The increased rate slows down how much people will borrow.
It’s a nice NLP-generated text, so now, what is scientific correct about it, given that ChatGPT is not configured for reasonings or for citing sources?
There is a reason why HN guidelines forbids robot-generated answers.
Just to clarify your position, do you think this specific passage contains mistakes or is misleading in any way (if so, please be precise), or are you generally doubtful about this technology but are fine with the text above?
The issue with ChatGPT is that it produces convincingly sounding texts that more often than not contain factual errors that are obvious to people familiar with the field, but require effort to disprove for lay persons. Made up citations, for example. As such, they’re worthless. A human is capable of producing a similar made up text, but ChatGPT makes it trivial to anyone, flooding the conversation with useless noise, crowding out the signal.
Asking your parent to engage with an essentially unlimited firehose of unfounded claims just plays into that hand.
The problem with ChatGPT is indeed that it is trained to look like an authoritative source independent of the input query. What ChatGPT is doing is transforming the original input and filling the gaps but the gaps it filled must all be acknowledged by the original author and that is hard to impossible for a layman.
It’s even worse. The model contains the information that claims are statistically likely to be followed by a citation, for example. So when the output produces a claim, it follows up with a citation- and it completely makes that one up. It has no concept of what a citation is, or what purpose it serves or that a reader might actually go and validate that. It's just a specific sequence of words that follows a specific sequence of words.
Thank you for the reference, I know about the dangers of chatgpt and some skepticism is certainly warranted.
However, dismissing anything produced by chatgpt simply because it was made by chatgpt is not right, which is why I was asking an opinion about that passage: if the text is accurate, it should not matter who or what wrote it.
You're missing my point: The text is produced by an agent known to be unreliable. It might be right by chance, but the onus to prove that (by citing references, for example) is on the poster. It's entirely warranted to dismiss the text, otherwise you essentially DOS the conversation.
You know, the most unreliable agents still appear to be people. If someone is right 90% of the time, we don’t require references for everything they say to save for that 10%.
To clarify my position: I believe the generated text is indistinguishable from human-generated reasonings and is most probably true in most cases (probably no factual error).
However, on average, ChatGPT content will contain more errors than humans (who it can be assumed want to see the truth), and therefore, it should be put in the same bucket as both “propaganda facts” and “con artist facts”. It’s still facts, just misleading.
"Quantitative easing" means issuing new money -- a government obligation that pays no interest -- to purchase treasury (and agency) bonds -- government obligations that pay interest. Until very recently, for good reasons (a global financial crisis, a global pandemic), the Fed and other central banks around the world have been engaged in quantitative easing at an unprecedented scale, replacing government-issued financial instruments that pay interest (bonds) with government-issued financial instruments that pay no interest (money). The result has been an unprecedented increase in private cash balances -- what many call "liquidity sloshing around."
Last year, some central banks started doing the opposite, "quantitative tightening," i.e., selling previously purchased bonds (or letting them mature), removing liquidity (government-issued money) from financial markets and replacing it, directly or indirectly, with financial instruments that pay interest (government/agency-issued bonds). The result has been a gradual decrease in private cash balances -- one could call it "liquidity evaporating."
For example, you can see the value of the financial instruments the Fed owns (i.e., it has purchased them in the past and continues to hold them) here:
https://www.federalreserve.gov/monetarypolicy/bst_recenttren...
--
PS. I'm talking only about readily observable facts, not about "excess liquidity" in the abstract sense, e.g., as described by economists who call themselves Keynesians.