>>>greater risk going into 2007 that a shock or a drying up of liquidity could cause a spike in the default rate<<<
I think that that is about 90% of the story.
It is easy to get confused in all the speculation about deflation, inflation, helicopters, petrodollars in the 10 year, exchange rates, etc., and focus on the basics.
There are two types of "liquidity:" the greenback form printed by the FEDs and the "loan/Keynesian multiplier" form as somewhat controlled by the FEDs.
In the greenback form, the FED prints 'em, deposits 'em in the banks which in turn lend them out, a portion of which gets lent out again. Interest rates and bucks in circulation are two different things. Japan began raising rates a while ago, and then started reducing liquidity by taking Yen out of circulation. I see about zero change of Bernanke calling in a few bucks.
As far as the multiplier goes, the FED can control the "reserve requirements." These were effectively lowered in '95, and as an amateur economist, I think this started the decade long liquidity bubble. There is no way the Fed will raise the reserve requirements. The FED has only a modicum of control over liquidity via its reserve requirements authority. The rest is in bondholders' hands. That would be the Saudis and whoever else is buying mortgage backed securities and junk. When things get dicey those debt instruments may get sold and the proceeds lodged firmly under the mattress. Poof. A lot of liquidity vanishes, and those who borrowed to make leveraged and questionable investments in an overheated/overpriced economy may be seen to be swimming w/o any trunks when the tide goes out (per Warren Buffett).
Are we at monster liquidity levels?? Lots of pundits think so. Are stocks, bonds, real estate overheated??? The pundits and I think so. The hedge fund managers and J6P keep buying the crap. Castles in the air built upon castles in the air. Can it go on forever?? I think so - crazy as it sounds. Will it??? I don't think so. Somebody somewhere will flinch. |
