Monday, August 10, 2009


Is the next global liquidity glut on its way?

Some years prior to the crisis, abundant global liquidity and investors’ strong risk appetite boosted asset prices to very high levels. When investors started searching for higher returns in 2003, excess liquidity began to pour into financial asset markets, driving prices up and yields down. At the time when investors were confronted with increased default risk but in turn only received low returns the credit bubble burst, starting in the US mortgage market.

The state of the global economy and financial markets deteriorated dramatically when the subprime crisis turned into a full-blown global banking and economic crisis. Central banks around the world were forced to inject extra liquidity to support the banking sector, the credit channel and the overall economy. Owing to sharply expanding central bank balance sheets, some observers have become worried about the formation of another liquidity glut and
its potential impact on CPI and asset price inflation.

Global excess monetary liquidity has never disappeared but keeps growing. Indeed, global excess liquidity (defined as a rising money-to-GDP ratio) is currently created due to shrinking nominal GDP as well as accelerating narrow money and softer, but still positive broad money supply growth, as central banks support the financial system and the economy.

Despite the presence of global excess liquidity short and medium term risks to CPI inflation appear to be limited because of low capacity utilisation and rising unemployment. However, excess liquidity could still potentially stoke new asset price bubbles. Central banks are aware of this risk and are at the moment preparing post-crisis exit strategies from their current accommodative monetary policy stance.

Given accelerating global excess liquidity creation, it may only be a matter of time until investors become increasingly unwilling to hold liquidity at the current low level of return. Once investors try to reduce their liquidity holdings, asset prices may again receive a temporary boost from global excess liquidity.

To see full report: GLOBAL LIQUIDITY