Liquidity and markets

The Economist writes about the effects that global liquidity is having on emerging economies. Link: The global gusher

Worldwide, an abundance of liquidity has lured investors into riskier assets in search of higher returns. [...] The deluge of spare cash has two main sources. First, average real interest rates in the developed world are still below their long-term average. Second, America's huge current-account deficit and the consequent build-up of foreign-exchange reserves by countries with external surpluses has also pumped vast quantities of dollars into the financial system. A large chunk of Asia's reserves and oil exporters' petrodollars have been used to buy American Treasury securities, thereby reducing bond yields. In turn, low bond-market returns have encouraged bigger inflows into higher yielding emerging-market bonds, equities and property, especially in Asia. Liquidity has been further boosted by the use of derivatives, and by carry trades (borrowing in currencies with low interest rates, such as yen, to buy higher-yielding currencies).

This liquidity is a problem for many emerging economies today, as the article explains, but what can we say about how the situation will look in the future. The Economist does not make any predictions but let me venture some guesses. If liquidity remains:

• Global (real) interest rates will continue to stay low for the foreseeable future.
• Use of this cheap capital will continue to grow especially in developed countries by consumers, entrepreneurs (new start-ups) and companies on the acquisition trail.
• Some emerging economies will impose controls on capital inflows while others will gradually allow their currencies to move more freely.
• Markets for some assets will become overcrowded with investors, move to unreasonable highs (property comes to mind) and experience corrections that will scare away liquidity, at least temporarily.
• The use of derivatives will continue to grow (duh) and boost liquidity.

There you have it. A hotch-potch of guesses by a non-economist. Would anyone like to comment?

Technorati Tags: economics, emerging markets, liquidity, money supply, interest rates

Comments

[Rathi]

Point 3: You're becoming quite an economist! :-)

[Murli]

Noooooooo