The breakdown was fundamentally a liquidity crisis, and liquidity was easily restored in several ways the New York banks issued their own liquidity through a clearing house one massively powerful financial institution, J.P. Morgan, bought up collapsing shares, and thus reversed a market panic and a scramble for liquidity and European central banks supplied gold to the American market.

Suddenly, as today, even big banks did not trust each other. The breakdown was fundamentally a liquidity crisis, and liquidity was easily restored in several ways the New York banks issued their own liquidity through a clearing house one massively powerful financial institution, J.P. Morgan, bought up collapsing shares, and thus reversed a market panic and a scramble for liquidity and European central banks supplied gold to the American market.

Furthermore, ample worldwide liquidity and the rise of other commodity prices induced market speculators to buy into oil futures.

Liquidity position

Liquidity policy

This trend would continue with the introduction of the Euro and the creation of a much larger market with greater liquidity, stability and visibility.

Is Liquidity Enough?

The Liquidity Puzzle

5. Liquidity position

The Liquidity Time Bomb

However, countries could face abrupt changes in the cost and availability of liquidity when unexpected events triggered shifts in market sentiment, creating a strong need for additional reserves.

What determines a liquidity crisis?

This is the paradoxical result of the policy response to the financial crisis. Macro liquidity is feeding booms and bubbles but market illiquidity will eventually trigger a bust and collapse.

The major problem with these flows was volatility, and was characterized by heavy concentration on the most mature markets with a large stock market capitalization and high levels of liquidity.

G. Liquidity available cash versus liabilities

Statement IV. Liquidity position at 31 December 1997

2. Cash flow and liquidity . 13 18 19

But another Fed faction led by Governors Jeremy Stein and Daniel Tarullo argues that macro prudential tools are untested, and that limiting leverage in one part of the financial market simply drives liquidity elsewhere. Indeed, the Fed regulates only banks, so liquidity and leverage will migrate to the shadow banking system if banks are regulated more tightly.

For more than half that time say, 85 years it has been accepted doctrine that markets are also not to be trusted even in normal times, lest doing so lead to a liquidity squeeze or to an inflationary bubble. So, central banks must set the price of liquidity in the market day in and day out.

Banks known to be healthy can borrow at much less than 5.25 . But banks facing possible liquidity problems which the Fed wants to be able to borrow at 5.25 are borrowing from the Fed itself at 5.75 , as are a few big banks that want more liquidity but don t believe they could get it without disrupting the market.

In short, though central banks creation of macro liquidity may keep bond yields low and reduce volatility, it has also led to crowded trades (herding on market trends, exacerbated by HFTs) and more investment in illiquid bond funds, while tighter regulation means that market makers are missing in action.

Statement IV. Liquidity position (consolidated) at 31 December 1997

He or she should not attempt to centralize information, but rather to make it flow more smoothly. Call it information liquidity, akin to financial liquidity.

This was how central banking got started in the first place letting the market and the market alone determine the price of liquidity was judged too costly for the businessmen who voted and the workers who could overthrow governments. Now it looks as though letting the market alone determine the price of risk is similarly being judged too costly for today s voters and campaign contributors to bear.

Unlike the West s QE enabled market manipulation, which works circuitously through central bank liquidity injections, the Chinese version is targeted more directly at the market in distress in this case, equities. Significantly, QE is very much a reactive approach aimed at sparking revival in distressed markets and economies after they have collapsed.

European banks remain balkanized, with a patchwork of national regulators seeking to promote their own champions. European governments debt may all be denominated in euro, but German and Italian debt are hardly the same thing, so the government euro bond market lacks the depth and liquidity of the US Treasury Bill market.

They held large inventories of these assets, thus providing liquidity and smoothing excess price volatility. But, with new regulations punishing such trading (via higher capital charges), banks and other financial institutions have reduced their market making activity.

UNICEF met its internal liquidity guideline for the year 2004.

Table I.3 shows the overall liquidity of active missions.

The only plausible inflationary scenario presupposes that when economies recover, central banks do not raise interest rates sufficiently in the coming boom, keeping too much of the current liquidity in the market. Such a scenario is not impossible.

If you believe that the crisis was caused by a shortage of liquidity, we had plenty of models analyzing liquidity shortages and their effects on financial institutions. If you believe that the blame lies with greedy bankers and unthinking investors, lulled by the promise of a government bailout, or with a market driven crazy by irrational exuberance, we had studied all this too, in great detail.

After the government clamped down on that too, the liquidity was channeled toward stock exchanges once those crashed, it sloshed into the bond market. But the bond market is not large enough to absorb it all, so some has now returned to the stock exchanges, leading to a partial recovery in share prices, with the Shanghai index reaching 3,500.

18. Also notes the initial discussion in the International Monetary Fund on a new liquidity instrument that would enable high access financial support to developing countries that have market access and strong economic policies but nonetheless remain vulnerable to shocks

Chinese officials presumably believe that this situation will change over time. Once banks offer new assets denominated in renminbi, more customers will be drawn into the market, thereby adding liquidity and reducing transaction costs for purchases of renminbi in European currencies.

But the policy failures fueling this stock market fiasco go back further, to the massive government fueled surge in credit since the global financial crisis. Without that, brokerages would not have had all of that liquidity to lend for margin trading.

These events have fueled fears that, even very deep and liquid markets such as US stocks and government bonds in the US and Germany may not be liquid enough. So what accounts for the combination of macro liquidity and market illiquidity?

In China, unlike in advanced countries, monetary and sterilization policy are often one in the same. The degree to which monetary policy is expansionary depends on the degree to which the liquidity created by currency market intervention has been sterilized.

As such, the timing could not be worse to float the idea of speeding up capital account liberalization. On the contrary, the Peoples Bank of China (PBoC) and other relevant authorities should consider capital controls, market suspensions, and emergency liquidity provision.

Allocating new SDR s also is inappropriate. Above all, SDR s represent liquidity and can be allocated only if and when there is a global need, which would currently be difficult to prove given highly liquid and easy international capital market conditions.

Fourth, large scale liquidity provision for solvent governments is necessary to avoid a spike in spreads and loss of market access that would turn illiquidity into insolvency. Even with policy changes, it takes time for governments to restore their credibility.

The disinflation and ample liquidity created by the accommodative monetary policy of central governments have driven the market interest rates down to the extent that the fixed income markets no longer offer the returns that investors have enjoyed in the past.

At that point, global policymakers got religion and started to use most of the weapons in their arsenal vast fiscal policy easing conventional and unconventional monetary expansion trillions of dollars in liquidity support, recapitalization, guarantees, and insurance to stem the liquidity and credit crunch and, finally, massive support to emerging market economies. In the last two months alone, one can count more than 150 different policy interventions around the world.

In these days of froth, the persistence of extraordinary policy accommodation in a financial system flooded with liquidity poses a great danger. Indeed, that could well be the lesson of recent equity and currency market volatility and, of course, plummeting oil prices.

But now it appears that, despite all this, we still have not had enough central planning in finance. For, even as the central banking authority administered the price of liquidity, the price of risk was left to the tender mercies of the market.

First, normal bankruptcy rules don t apply to repos. Second, much repo financing flows into large risk taking financial firms like MF Global, Lehman, and Bear Stearns through money market funds, which must invest very short term, because their depositors want immediate liquidity.