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ECONOMIC ANALYSIS:

Thinking about Liquidity

by Fred Cederholm
Any change in the FED Funds Target Rate would be admitting a lie: any increase would signal how inflation is far worse than acknowledged; any cut would signal why our booming economy is in trouble. Either way, the FED's credibility as an honest broker of information is shot.
I’ve been thinking about liquidity. Actually I've been thinking about the weather, equity markets, the housing bubble, the Fed's interest rates, Creston, and valuations.

As I begin to write this week's column and look out the window, it's raining. It has rained here off and on for six of the past seven days—the forecast for the coming week is the same. When the ground is already saturated, it doesn't take much more to make a bad situation a whole lot worse. The same can be said as true for the problems unwinding in the world's financial markets because of this whole sub-prime credit housing mess.

You see, the term "liquidity" refers to more than water. In financial/economic terms it refers to the ebb and flow in the ability to redeem or convert one form of asset/liability into another. Money (that is, cash) is regarded as the most fluid medium of exchange. When you wish to purchase something—be it food, clothing, energy, whatever—it is much easier to consummate the deal by using cash than it is to get what you want by swapping stocks, bonds, real property, or bartering commodities for it. A major part of any exchange transaction is valuation. How much of “X” will I give up to get so much of “Y”?

Despite all the claims of some new world order, a new economic “reality,” a new global economy, recent events are showing that all the hype and spin is a bunch of hooey. The traditional economic rules of supply and demand setting pricesare still with us: real wealth or value coming from assets and not liabilities, cash/money being central to transactional exchanges, and something only being worth what someone else will pay for it. This is not going to change regardless of what the poobahs of Washington, DC, the moguls of Wall Street, or the central bankers of the world tell us. It is their “scripting,” however, that got us to this sorry point.

This housing bubble was no accident. It was the deliberate creation of cheap money and excess cash for a “a soft landing” from the “irrational exuberance” of a dot com mania, and by an ill-conceived conspiracy to fluff the US economy by promoting spending and consumption.
This housing bubble was no accident. It was the deliberate creation of cheap money, excess cash, and a decision to create a “a soft landing” from the “irrational exuberance” of a dot com mania, a stock market run amok, and an ill-conceived conspiracy to fluff the US economy by promoting spending and consumption. The spending was facilitated by an increase of debt, fiat money, and inflation, not by any increase in production, growth of real wealth, or rise in productivity. The money came via the printing presses and the recycling of foreign holdings of our existing debts and deficits. We were all too willing to see things pan out that way. Because more money (albeit borrowed money) flowed through our fingers, we thought we were better off.

There is now tremendous pressure on Chairman Bernanke and the FED to “create” more money and cut interest rates to fix liquidity problems, bail out the debt-laden public, and fluff the equity market averages. Has everyone forgotten that it was just such policies that got US/us where we find ourselves now?

The FED did infuse (print) an additional $59 BILLION over a mere 48 hours, and they cut the discount rate (special money created by the FED and lent to banks) by a half a per cent. The FED Funds Target Rate remained the same at 5.25%—for now. Any change there would be admitting a lie: any increase would signal how inflation is far worse than acknowledged; any cut would signal why our booming economy is in trouble. Either way, the FED's credibility as an honest broker of information is shot.

My little home town of Creston, Illinois, was pretty much isolated in the cornfields of northern Illinois from the travails of the world over the years—not any more. Out of a real property stock of some 200 properties, there are currently 15 houses, 9 lots, and 10 rental units on the market in my town alone. The same seems to be true everywhere across this land. People need to (or at least want to) cash out and thus improve their liquidity. The same now seems true for all investments. But what will you get? What's the value?

These loans pooled, packaged, and sold as investments are dragging down everything. With so many properties in arrears, default, foreclosure, and going on the market, is it any wonder why so many “investments” are—at best—worth less; or at worst—worthless? What will all the affiliated costs to global investors, insurance companies, money market funds, mutual funds, or pension funds be when all this “construction dust” settles?

I’m Fred Cederholm, and I’ve been thinking. You should be thinking, too.
Copyright 2007 Questions, Inc. All rights reserved. Fred Cederholm is a CPA/CFE, a forensic accountant, and writer. He is a graduate of the University of Illinois (B.A., M.A. and M.A.S.). He can be reached at asklet@rochelle.net.


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This story was published on August 20, 2007.