Liquidity crunch. The mere mention of the phrase raises fear among the highly leveraged, the overextended and anyone else who’s betting heavily on the notion that the bullish momentum of recent history will last one more day.
With textbook-like regularity, yesterday’s worries over the fading of liquidity in some corners of finance replaced greed with fear, inducing a dramatic bout of selling around the world. Ground zero for the liquidity squeeze was Europe, where the ECB yesterday loaned a record $131 billion to 49 banks in an effort to minimize the fallout arising from subprime-mortgage ills in the United States, reported. The Federal Reserve was compelled to engineer a similar injection of liquidity, albeit at a much lower dosage of $12 billion. Other central banks are said to have advanced loans as well yesterday.
It’s hard to judge what the larger trend will be based on just one day. But the idea that the sea of liquidity that’s been bubbling in the 21st century might reverse, and with negative consequences, is hardly a hair-brained nightmare imagined by outcasts to mainstream economics. Much to the chagrin of some, perhaps most investors, cycles are still alive and well. Central banks, in short, haven’t dispatched cycles to oblivion, even if it’s looked otherwise in recent years.
In fact, the latest bout of credit crunching has been years in the making. The law of financial gravity predicted that the Fed’s decisions to favor easy money in the extreme earlier in this decade would come back to haunt the capital markets. In fact, the cornucopia of liquidity has been the elephant in the room for several years, setting the stage for bull markets (inflation?) across the asset spectrum. True, the elephant has been ignored, but a pachyderm won’t suffer obscurity indefinitely, as yesterday’s actions suggest.
Meanwhile, let’s be clear: the Fed and its counterparts around the world have been major players in fueling the bull markets by supplying the necessary credit. Arguably, that credit has been supplied to excess. Few have complained, at least those who’ve been long. Bull markets, after all, have a habit of quieting complaints, easing fear and elevating the demand for martinis and Ferraris. No one wants to spoil a good party, but at some point it’s time to call a cab and head home.
If the corrective power of the bears has returned for an extended stay, a new era of criticism about what central banking has wrought may be in the offing. While we wait for the debate, let’s step back and consider the broader perspective: It’s more than a little ironic that the central banking establishment’s solution for what ails markets is, so far, another dose of the same medicine that brought us to this point. Namely, yesterday’s liquidity injections follow years of the same, albeit in varying forms. Tactically, yesterday’s efforts to ease anxieties by effectively printing more money are really just more of the same policy biases that have been in effect for years. Arguably, the Fed and ECB don’t have much choice at the moment. But that raises questions anew: How did we get pushed into a corner where printing money is at once the problem and the solution? More importantly, what does the constraint imply for the future?
The answer, as always, will arrive one day at a time.