8 ms·

I was hoping that the OP would address a related idea that I find rather weird: it’s sometimes said that “this excess liquidity has to go somewhere” and that “t

I was hoping that the OP would address a related idea that I find rather weird: it’s sometimes said that “this excess liquidity has to go somewhere” and that “the excess liquidity has gone into [housing/stocks/commodities/other asset class]”. But I don’t get this: It might seem plausible that if stock prices go up they absorb liquidity from the system. But (ignoring new stock issues / newly build houses) in every transaction there’s both a buyer and a seller. Sure, the buyer parts ways with cash when they buy a share, but that cash goes to the seller. So there should be just as much liquidity as before, just in different hands. If anything a rising stock or housing market should just put more excess liquidity into the system because it’s possible to borrow against those assets. What am I getting wrong? Or is this just an often repeated falsehood?

marketerinland 4y ago
Liquidity means capacity to buy, essentially. Not cash per se. If you reduce the required deposit on a house from 20% to 10%, that increases the liquidity in the market. Suddenly more people ‘have’ the money to buy that $500k property and the market will typically rise until it’s absorbed that added financial capacity This is why low interest rates had such a dramatic impact. Monthly repayments are much lower on a low interest loan, so the average person could ‘afford’ to borrow way more. Note; this is just Real Estate. Lots of other borrowing also occurred. But when Real Estate markets suddenly go up by 20%, now it’s the owners of these houses that are worth a whole lot more. And they often decide to cash in, in some way (selling their J
tinco 4y ago
I think that's the sloshing part. Excess liquidity moves from entities that buy real estate, into the hands of those that were selling that real estate. Then the excess liquidity of the entities that sold real estate goes into whatever they're interested in, like maybe the stock markets. This is not one big movement but lots of mostly chaotic reactive systems hench the sloshing.
mo_42 4y ago
You’re on the right track. Many people including economists don’t get this. It’s a very useful way of thinking economically. (See also my other comment here).
imtringued 4y ago
Keynes divided liquidity preference into transaction demand, precautionary demand and speculative demand. Transaction demand refers to earning money with a job or business and then spending it. Precautionary demand refers to demand for money based around uncertainty in the future, you keep some money around because you want to insure against losing your job (rainy day fund) and finally, once you have so much money you satisfied these two, there is still the fact that money is the most liquid asset. Money can be traded into other things faster than anything else. So this is basically day trading, buying low and selling high. The problem though is that at some point the Keynesian beauty contest begins. People not only react to fundamentals but also the reactions of other investors making investment decisions. Someone invests because they genuinely believe in the stock, then people invest because they think people believe in the stock, then people invest because they think people invest in the stock because people invest in fundamentals. This is a rationality trap that doesn't end until the bubble pops and then people move onto something else. What you are concerned about can be explained by a weakened form of a liquidity trap. The problem with the liquidity trap is that it is pretty theoretical in the sense that it is absolute. Like getting 100% efficiency. But in practice a liquidity trap can also be in the form of trapping liquidity in specific economic sectors and that can be described as a continuum. For example, we separate the economy into the real economy and the financial economy. The financial economy is just a model of reality, but it is possible that messing with the model of reality is more profitable than actually doing something in the real world. This means money is allocated away from the real economy and into the fantasy of the financial economy. People do sell their financial assets but only to buy something else in the financial economy. It is a one way street of money flowing into the financial economy but never back and this is why you need constant government intervention that reinvests the money back into the real economy. It is obviously an ugly solution but what are you going to do? Introduce a wealth tax?
- madaxe_again 4y ago
  Historically, times where there have been excess liquidity and new technical development along with a labour shortage result in an Industrial Revolution. We have all of these things right now. Consider that newcomen’s engine was based on prior engines, and itself wasn’t that much of a success - but everything that followed was explosive in terms of the changes wrought on society and industry. The technology was interesting, but as long as you could pay a few blokes to man the pumps, installing an expensive engine and buying coal to power it wasn’t an economical route to follow. When the triangle trade had accumulated enough wealth with nowhere to go other than gilding, and when the workforce started emigrating to the colonies to escape their miserable conditions or getting shot on the plains of Europe, and the remaining souls started demanding Real Money, suddenly, those new-fangled engines looked like a sensible investment. Which technology will be our next revolutionary step is up for debate, but I would (and have) place my chips on AI/ML. The last few rounds have been all about the decoupling of unskilled and semi-skilled labour from productivity. Next up on the block is skilled labour. Why would you hire developers or lawyers or diagnosticians or any knowledge worker for $stupid per annum, when you can spend a bit more, and never have to pay a human again?
Cwizard 4y ago
(I'm not an economist) Good, point but think of the following example. You have 10 startups and supply and demands has dictated that $1M is a good price for 10% equity. Now let us say a group of VC suddenly have $20M dollars to deploy. The system only has capacity for $10M, what will play out over time is that VC will bid ever higher amounts for that 10% of equity because they _have_ to deploy capital. It seems silly when outlined like this but imagine this taking place over a few years time and with many complicated variables. It becomes really easy to rationalize that the 10% is really worth $1.2M, $1.4M, etc (there are also some feedback loops here of VCs buying from each other at greater valuation thus justifying their other purchases at higher prices etc). Repeat for X year and you get to $2M. Of course as you point out that money will go to the seller and does not simply evaporate. Now in the heads of a founders. They could decide to sell less equity (say only 5% to still raise just $1M) but let's be honest, they won't VC will tell you it is a bad idea and the startup down the street is expecting the $2M (again still plays out slowly over time so you don't really notice the slight raises in valuation). The founder can then use that money to do more work (initially) of course the founder has to bid for workers (programmers) which to assume a simplified model is also a finite pool. The example repeats, this time not for equity but for labor. The programmer is really worth $100K but you _really_ need one and if you don't pay them $110K he will take an over at the other startup. You can afford them after all you just raised $1.2M. This pattern repeats until you have programmers demanding $200K. All of the sudden you NEED that $2M valuation otherwise you cannot afford to hire anyone. Those programmers have needs to, a house for example, let us assume there are only 10 houses and... You get where this is going. This can continue as long as the underlying value of the business can support it (the margins of VC, founders, programmers, etc just decrease gradually). So who loses? The people that are not part of this subsystem that got money injected, the people holding the 'bag' as they say when the bubble pops. This is essentially a trap that is hard to get out of because there are many different stages in the process each with costs. The programmer can only go work for $100K if the house goes back down in price etc.
- moffkalast 4y ago
  > Now let us say a group of VC suddenly have $20M dollars to deploy. Wouldn't that come from their ever decreasing margins? it sounds like there's a feedback loop there that should balance itself at some value, but that's probably assuming people are rational which they are most decidedly not.
conformist 4y ago
Many good points in the other comments. One important first-order aspect that is usually meant by “excess liquidity” is central bank stimulus: Central banks create more money (buy low risk assets) -> there is more money in the system that has to go somewhere -> more money in total has to go into riskier assets -> they are worth more. This is a very naive equilibrium argument, and the “excess” probably just means “unusually much”, nothing deeper or technical.
state_less 4y ago
But isn’t the cash’s purchasing power getting inflated away, at say 6.4%, so the liquidity evaporates? We can all be given millions (super liquid) but that doesn’t make us millionaires in terms of purchasing power. At first it seems like everyone is rich, then folks realize it’s funny money and suppliers raise prices. Since money is (dynamically) valued by what you can buy with it. So the seller of the house sold for a million, for example, but it turns out they actually have ~850k if they sat on the cash for a couple years.
janee 4y ago
Yeah I've also wondered the same, i.e. I view it as a closed system and excess liquidity usually results in inflation until demand matches supply of money
ThrustVectoring 4y ago
>What am I getting wrong? You are correct when taking the view of the financial sector as a whole - every asset purchase merely swaps who has the cash and who has the asset. You're not getting much of anything wrong, merely missing a behavioral trait of many market participants: they desire a fixed ratio between their various financial assets. An extreme example of this is an index fund, which has a formulaic relationship between their book value and how much of what assets they own. In essence, what happens is that cash gets dumped into the laps of various market participants, who then notice that they have "too much" cash. They then bid on various assets until there no longer is "too much" cash in the system for the total value of assets around.
- AnimalMuppet 4y ago
  So let's say that the entire world is index funds (plus the stocks they own). An index fund has "too much cash", so they buy stocks. Some other index fund sees that the price is attractive, and sells, but then that fund has too much cash. But the funds each keep some amount (1%?) of their assets in cash. So isn't the net result that stock prices go up until the value of the stock is 99 times the amount of cash in the system? More generally, then, doesn't the price of assets go up until the participants are comfortable with that much cash as part of their asset mix?
  - di4na 4y ago
    Yes. Except there is also a group of people that sit on the side scamming everyone by building assets that promise to fit in the index but are just trash and return nothing. :Cough: VC and Growth-based startup :cough:
  - ClumsyPilot 4y ago
    Yes, Exactly. So if you double amlunt of money is the system, house prices will double. It is not 'inflation' because food prices do not react in the same way. You 'normal' inflation could stay at zero. You can create housing shortage through financial system alone, without changing population/ housebuilding rates
JumpinJack_Cash 4y ago
> > Or is this just an often repeated falsehood? This is correct. Except for inflation it’s impossible for asset prices to rise everywhere. Some places and some assets will see a rise while other places and other assets will see a drop. While everybody was screaming at the everything bubble there were real assets that became defacto worthless (at least temporarily) the entire fleet of passengers Boeings and Airbus. Not to mention cruise ships, casinos, theme parks.. What about NYC real estate? The pandemic had people thinking that life is too short to live in such packed conditions in places so sensitives to pandemics. Can we also talk about oil which collapsed during Covid and hit a negative 37 dollars per barrel? All commodities did bad during the pandemic, oil, LNG, copper etc. It’s a form of selection bias because pundits and commentators always watch where the money is going , not places where money is hemorrhaging (that is unless there is a big bankruptcy), but sector wise they just dont focus on it. A clear example is OPEC. Every pundit focuses on what OPEC does but nobody focuses on what it means for shale oil producers and their survival. The only people who focus on those are their lenders and investors as well as city officials but this profile doesn’t show up on your TV on Bloomberg or CNBC , because these outlets are too busy interviewing the Saudi or the UAE secretary of energy in the aftermath of the OPEC decision As you grow up you understand they most of phenomenons that people swear by are selection bias. There are theories that even stuff like physics is selection bias because we swear by the physics we know but it could be entirely rubbish because it’s not the truth of Nature but just our best intuition of the truth of Nature which is of course subject to selection bias anthropomorphically speaking
- somewhereoutth 4y ago
  Except that when lots of new money is created (by the formation of loans) inflation is exactly what you get. Ultra low interest rates are just a (not very) complicated way of printing money.
  - JumpinJack_Cash 4y ago
    Those loans or better we should say that new loan potential is up for grabs for everybody.
Geee 4y ago
Excess liquidity gets eventually absorbed in the form of broad inflation. I.e. the money loses the excess value.
- Supermancho 4y ago
  Eventually, meaning decades, as long as a near equilibrium is eventually reached, wages will rise and wealth ceases to be self-reinforcing at a grand level (back to a few percent). There hasn't been equilibrium for at least a decade. The long tail (the vast majority of people) will continue to suffer for decades and wealth will continue to be disgustingly easy to grow (with a few hundred thousand) in relation to the price increases most people encounter day-to-day. Ofc, maybe I'm just biased.
flakeoil 4y ago
If there are 1000000 stocks of a company around and a lot of people want to buy and almost no-one wants to sell. If one person manage to buy 10 stocks from another person at 10% above last days price ($100), i.e. at $110, then the total marked value of that company has increased by 10% to $110 * 1000000 = $110 million. So $10M were created driven by a small transaction of just $110 * 10 = $1100. It's not that all 1 million stocks have to trade for the total value to go up. All the people who did not trade, but who own the other stocks, have seen their (paper) value go up. And the same, but opposite happens when it goes down of course. Let's say some major event would trigger a panic on the stock market, then very few trades could cut the total market by 50% and very few would get any money for their stocks at the price when the panic started. Most would not have sold and would sit on stocks worth 50% less than the day before. Kind of extreme examples here, but just to show what I believe you are "getting wrong".
tomatocracy 4y ago
Part of the confusion is, as others have pointed out, that "liquidity" isn't really the same thing as "money". If you're talking about money, then that's exactly what happens - the creation of "high-powered" central bank money leads to a multiple of that amount of new money appearing in the economy as it's used (and reused) in the financial system to make net new loans (the multiplier effect). Ultimately as the money gets passed around then some market participants will use the money in ways which reduce either liquidity or money supply or both (repaying loans for example) so there's a decaying effect which is why the multiple isn't infinite. As the money dissipates throughout the system it will end up in the hands of participants who are either slower to reuse it or more likely to put it in something which either is or looks like a central bank deposit - hence the "liquidity" eventually dissipates too.
Rury 4y ago
First, you have to really understand what liquidity is. Liquidity isn't cash, or value per say, but rather a measure of how easy something is to trade. Cash just happens to be the most liquid thing because it is the most actively traded thing. For example, it's not like everyone trades for cars directly using chickens, but both chickens and cars are directly traded for cash, so cash is more liquid (ie easy to trade with) than either cars or chickens. Next, excess liquidity can disappear by market participants simply refusing to do trade (ie a drop in demand). For example, if I have a house, which many people would be willing to trade for me today, tomorrow they could all change their minds and wouldn't even trade me a spoonful of dirt for it. In which case, the liquidity of my house (easiness to trade it), dried up by simply a change in market demand. Now here's the best part, while every transaction has a buyer and seller, every transaction has two supplies and two demands. For example, person A may be willing to trade his supply of cars, but demands X dollars in exchange for any one of them, and person B is willing to trade his supply of dollars, but demands a car of certain condition for them. In this case, there are two supplies (dollars, and cars) and two demands (again dollars, and a car of a certain condition). If the supplies of each participant, meets the demands of the opposing participant, the transaction happens, and the trade is settled between the two parties. So to address your questions. It's entirely possible for something that was easy to trade (cash), was traded for [houses/stocks/commodities/etc], and afterwards, no one is willing to trade things anymore. Which includes people with houses who are not willing to trade them for cash, and people with cash no longer willing to trade them for houses. Liquidity disappeared simply by a change in market demand. But you're not necessarily wrong, as if demand doesn't change, then it doesn't really dry up.

marketerinland 4y ago

Liquidity means capacity to buy, essentially. Not cash per se. If you reduce the required deposit on a house from 20% to 10%, that increases the liquidity in the market. Suddenly more people ‘have’ the money to buy that $500k property and the market will typically rise until it’s absorbed that added financial capacity This is why low interest rates had such a dramatic impact. Monthly repayments are much lower on a low interest loan, so the average person could ‘afford’ to borrow way more. Note; this is just Real Estate. Lots of other borrowing also occurred. But when Real Estate markets suddenly go up by 20%, now it’s the owners of these houses that are worth a whole lot more. And they often decide to cash in, in some way (selling their J

tinco 4y ago

I think that's the sloshing part. Excess liquidity moves from entities that buy real estate, into the hands of those that were selling that real estate. Then the excess liquidity of the entities that sold real estate goes into whatever they're interested in, like maybe the stock markets. This is not one big movement but lots of mostly chaotic reactive systems hench the sloshing.

mo_42 4y ago

You’re on the right track. Many people including economists don’t get this. It’s a very useful way of thinking economically. (See also my other comment here).

imtringued 4y ago

Keynes divided liquidity preference into transaction demand, precautionary demand and speculative demand. Transaction demand refers to earning money with a job or business and then spending it. Precautionary demand refers to demand for money based around uncertainty in the future, you keep some money around because you want to insure against losing your job (rainy day fund) and finally, once you have so much money you satisfied these two, there is still the fact that money is the most liquid asset. Money can be traded into other things faster than anything else. So this is basically day trading, buying low and selling high. The problem though is that at some point the Keynesian beauty contest begins. People not only react to fundamentals but also the reactions of other investors making investment decisions. Someone invests because they genuinely believe in the stock, then people invest because they think people believe in the stock, then people invest because they think people invest in the stock because people invest in fundamentals. This is a rationality trap that doesn't end until the bubble pops and then people move onto something else. What you are concerned about can be explained by a weakened form of a liquidity trap. The problem with the liquidity trap is that it is pretty theoretical in the sense that it is absolute. Like getting 100% efficiency. But in practice a liquidity trap can also be in the form of trapping liquidity in specific economic sectors and that can be described as a continuum. For example, we separate the economy into the real economy and the financial economy. The financial economy is just a model of reality, but it is possible that messing with the model of reality is more profitable than actually doing something in the real world. This means money is allocated away from the real economy and into the fantasy of the financial economy. People do sell their financial assets but only to buy something else in the financial economy. It is a one way street of money flowing into the financial economy but never back and this is why you need constant government intervention that reinvests the money back into the real economy. It is obviously an ugly solution but what are you going to do? Introduce a wealth tax?

madaxe_again 4y ago
Historically, times where there have been excess liquidity and new technical development along with a labour shortage result in an Industrial Revolution. We have all of these things right now. Consider that newcomen’s engine was based on prior engines, and itself wasn’t that much of a success - but everything that followed was explosive in terms of the changes wrought on society and industry. The technology was interesting, but as long as you could pay a few blokes to man the pumps, installing an expensive engine and buying coal to power it wasn’t an economical route to follow. When the triangle trade had accumulated enough wealth with nowhere to go other than gilding, and when the workforce started emigrating to the colonies to escape their miserable conditions or getting shot on the plains of Europe, and the remaining souls started demanding Real Money, suddenly, those new-fangled engines looked like a sensible investment. Which technology will be our next revolutionary step is up for debate, but I would (and have) place my chips on AI/ML. The last few rounds have been all about the decoupling of unskilled and semi-skilled labour from productivity. Next up on the block is skilled labour. Why would you hire developers or lawyers or diagnosticians or any knowledge worker for $stupid per annum, when you can spend a bit more, and never have to pay a human again?

Cwizard 4y ago

(I'm not an economist) Good, point but think of the following example. You have 10 startups and supply and demands has dictated that $1M is a good price for 10% equity. Now let us say a group of VC suddenly have $20M dollars to deploy. The system only has capacity for $10M, what will play out over time is that VC will bid ever higher amounts for that 10% of equity because they _have_ to deploy capital. It seems silly when outlined like this but imagine this taking place over a few years time and with many complicated variables. It becomes really easy to rationalize that the 10% is really worth $1.2M, $1.4M, etc (there are also some feedback loops here of VCs buying from each other at greater valuation thus justifying their other purchases at higher prices etc). Repeat for X year and you get to $2M. Of course as you point out that money will go to the seller and does not simply evaporate. Now in the heads of a founders. They could decide to sell less equity (say only 5% to still raise just $1M) but let's be honest, they won't VC will tell you it is a bad idea and the startup down the street is expecting the $2M (again still plays out slowly over time so you don't really notice the slight raises in valuation). The founder can then use that money to do more work (initially) of course the founder has to bid for workers (programmers) which to assume a simplified model is also a finite pool. The example repeats, this time not for equity but for labor. The programmer is really worth $100K but you _really_ need one and if you don't pay them $110K he will take an over at the other startup. You can afford them after all you just raised $1.2M. This pattern repeats until you have programmers demanding $200K. All of the sudden you NEED that $2M valuation otherwise you cannot afford to hire anyone. Those programmers have needs to, a house for example, let us assume there are only 10 houses and... You get where this is going. This can continue as long as the underlying value of the business can support it (the margins of VC, founders, programmers, etc just decrease gradually). So who loses? The people that are not part of this subsystem that got money injected, the people holding the 'bag' as they say when the bubble pops. This is essentially a trap that is hard to get out of because there are many different stages in the process each with costs. The programmer can only go work for $100K if the house goes back down in price etc.

moffkalast 4y ago
> Now let us say a group of VC suddenly have $20M dollars to deploy. Wouldn't that come from their ever decreasing margins? it sounds like there's a feedback loop there that should balance itself at some value, but that's probably assuming people are rational which they are most decidedly not.

conformist 4y ago

Many good points in the other comments. One important first-order aspect that is usually meant by “excess liquidity” is central bank stimulus: Central banks create more money (buy low risk assets) -> there is more money in the system that has to go somewhere -> more money in total has to go into riskier assets -> they are worth more. This is a very naive equilibrium argument, and the “excess” probably just means “unusually much”, nothing deeper or technical.

state_less 4y ago

But isn’t the cash’s purchasing power getting inflated away, at say 6.4%, so the liquidity evaporates? We can all be given millions (super liquid) but that doesn’t make us millionaires in terms of purchasing power. At first it seems like everyone is rich, then folks realize it’s funny money and suppliers raise prices. Since money is (dynamically) valued by what you can buy with it. So the seller of the house sold for a million, for example, but it turns out they actually have ~850k if they sat on the cash for a couple years.

janee 4y ago

Yeah I've also wondered the same, i.e. I view it as a closed system and excess liquidity usually results in inflation until demand matches supply of money

ThrustVectoring 4y ago

>What am I getting wrong? You are correct when taking the view of the financial sector as a whole - every asset purchase merely swaps who has the cash and who has the asset. You're not getting much of anything wrong, merely missing a behavioral trait of many market participants: they desire a fixed ratio between their various financial assets. An extreme example of this is an index fund, which has a formulaic relationship between their book value and how much of what assets they own. In essence, what happens is that cash gets dumped into the laps of various market participants, who then notice that they have "too much" cash. They then bid on various assets until there no longer is "too much" cash in the system for the total value of assets around.

AnimalMuppet 4y ago
So let's say that the entire world is index funds (plus the stocks they own). An index fund has "too much cash", so they buy stocks. Some other index fund sees that the price is attractive, and sells, but then that fund has too much cash. But the funds each keep some amount (1%?) of their assets in cash. So isn't the net result that stock prices go up until the value of the stock is 99 times the amount of cash in the system? More generally, then, doesn't the price of assets go up until the participants are comfortable with that much cash as part of their asset mix?
- di4na 4y ago
  Yes. Except there is also a group of people that sit on the side scamming everyone by building assets that promise to fit in the index but are just trash and return nothing. :Cough: VC and Growth-based startup :cough:
- ClumsyPilot 4y ago
  Yes, Exactly. So if you double amlunt of money is the system, house prices will double. It is not 'inflation' because food prices do not react in the same way. You 'normal' inflation could stay at zero. You can create housing shortage through financial system alone, without changing population/ housebuilding rates

JumpinJack_Cash 4y ago

> > Or is this just an often repeated falsehood? This is correct. Except for inflation it’s impossible for asset prices to rise everywhere. Some places and some assets will see a rise while other places and other assets will see a drop. While everybody was screaming at the everything bubble there were real assets that became defacto worthless (at least temporarily) the entire fleet of passengers Boeings and Airbus. Not to mention cruise ships, casinos, theme parks.. What about NYC real estate? The pandemic had people thinking that life is too short to live in such packed conditions in places so sensitives to pandemics. Can we also talk about oil which collapsed during Covid and hit a negative 37 dollars per barrel? All commodities did bad during the pandemic, oil, LNG, copper etc. It’s a form of selection bias because pundits and commentators always watch where the money is going , not places where money is hemorrhaging (that is unless there is a big bankruptcy), but sector wise they just dont focus on it. A clear example is OPEC. Every pundit focuses on what OPEC does but nobody focuses on what it means for shale oil producers and their survival. The only people who focus on those are their lenders and investors as well as city officials but this profile doesn’t show up on your TV on Bloomberg or CNBC , because these outlets are too busy interviewing the Saudi or the UAE secretary of energy in the aftermath of the OPEC decision As you grow up you understand they most of phenomenons that people swear by are selection bias. There are theories that even stuff like physics is selection bias because we swear by the physics we know but it could be entirely rubbish because it’s not the truth of Nature but just our best intuition of the truth of Nature which is of course subject to selection bias anthropomorphically speaking

somewhereoutth 4y ago
Except that when lots of new money is created (by the formation of loans) inflation is exactly what you get. Ultra low interest rates are just a (not very) complicated way of printing money.
- JumpinJack_Cash 4y ago
  Those loans or better we should say that new loan potential is up for grabs for everybody.

Geee 4y ago

Excess liquidity gets eventually absorbed in the form of broad inflation. I.e. the money loses the excess value.

Supermancho 4y ago
Eventually, meaning decades, as long as a near equilibrium is eventually reached, wages will rise and wealth ceases to be self-reinforcing at a grand level (back to a few percent). There hasn't been equilibrium for at least a decade. The long tail (the vast majority of people) will continue to suffer for decades and wealth will continue to be disgustingly easy to grow (with a few hundred thousand) in relation to the price increases most people encounter day-to-day. Ofc, maybe I'm just biased.

flakeoil 4y ago

If there are 1000000 stocks of a company around and a lot of people want to buy and almost no-one wants to sell. If one person manage to buy 10 stocks from another person at 10% above last days price ($100), i.e. at $110, then the total marked value of that company has increased by 10% to $110 * 1000000 = $110 million. So $10M were created driven by a small transaction of just $110 * 10 = $1100. It's not that all 1 million stocks have to trade for the total value to go up. All the people who did not trade, but who own the other stocks, have seen their (paper) value go up. And the same, but opposite happens when it goes down of course. Let's say some major event would trigger a panic on the stock market, then very few trades could cut the total market by 50% and very few would get any money for their stocks at the price when the panic started. Most would not have sold and would sit on stocks worth 50% less than the day before. Kind of extreme examples here, but just to show what I believe you are "getting wrong".

tomatocracy 4y ago

Part of the confusion is, as others have pointed out, that "liquidity" isn't really the same thing as "money". If you're talking about money, then that's exactly what happens - the creation of "high-powered" central bank money leads to a multiple of that amount of new money appearing in the economy as it's used (and reused) in the financial system to make net new loans (the multiplier effect). Ultimately as the money gets passed around then some market participants will use the money in ways which reduce either liquidity or money supply or both (repaying loans for example) so there's a decaying effect which is why the multiple isn't infinite. As the money dissipates throughout the system it will end up in the hands of participants who are either slower to reuse it or more likely to put it in something which either is or looks like a central bank deposit - hence the "liquidity" eventually dissipates too.

Rury 4y ago

First, you have to really understand what liquidity is. Liquidity isn't cash, or value per say, but rather a measure of how easy something is to trade. Cash just happens to be the most liquid thing because it is the most actively traded thing. For example, it's not like everyone trades for cars directly using chickens, but both chickens and cars are directly traded for cash, so cash is more liquid (ie easy to trade with) than either cars or chickens. Next, excess liquidity can disappear by market participants simply refusing to do trade (ie a drop in demand). For example, if I have a house, which many people would be willing to trade for me today, tomorrow they could all change their minds and wouldn't even trade me a spoonful of dirt for it. In which case, the liquidity of my house (easiness to trade it), dried up by simply a change in market demand. Now here's the best part, while every transaction has a buyer and seller, every transaction has two supplies and two demands. For example, person A may be willing to trade his supply of cars, but demands X dollars in exchange for any one of them, and person B is willing to trade his supply of dollars, but demands a car of certain condition for them. In this case, there are two supplies (dollars, and cars) and two demands (again dollars, and a car of a certain condition). If the supplies of each participant, meets the demands of the opposing participant, the transaction happens, and the trade is settled between the two parties. So to address your questions. It's entirely possible for something that was easy to trade (cash), was traded for [houses/stocks/commodities/etc], and afterwards, no one is willing to trade things anymore. Which includes people with houses who are not willing to trade them for cash, and people with cash no longer willing to trade them for houses. Liquidity disappeared simply by a change in market demand. But you're not necessarily wrong, as if demand doesn't change, then it doesn't really dry up.