Icebergs in the Ocean of Global Liquidity

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And so, we arrive at the end of the year and the beginning of the next.

“Investors Ride Liquidity Wave,” says the FT.

Bank Credit Analyst takes it a step further into 2007: “Another Year of Riding the Liquidity Wave,” it forecasts.

Gold rose $6 at the close of markets last week – perhaps prefiguring this. Stocks were off slightly. And the dollar lost ground too…though, not much.

Investors, commentators, and kibitzers are beginning to catch on. In the last couple of days, we have read at least a half dozen reports – even in the Washington Post – making the connection between trade deficits, global liquidity, investor complacency, high-flying asset prices, derivatives, and the widening wealth gap.

We simplify for the benefit of readers with tight schedules or short attention spans:

The United States puts out dollars – trillions of them. U.S. consumers use the dollars to overspend, by buying products from overseas, approximately $1.06 worth of buying for every dollar actually earned. Foreign governments want the spending to continue. Instead of sending the dollars back where they came from by buying American goods, they issue local currencies to buy them and put them in their central bank vaults. All this extra money is then magnified…2…3…10 times…as it is lent, re-lent and used as reserves for various financial instruments.

Meanwhile a whole new industry has risen up to help with the lending, mortgaging, gambling that goes along with this explosion of money. Derivatives now equal seven times world GDP and are growing five times as fast. The new ‘liquidity’ is floating up financial assets all over the world.

Traditionally, more money in the system caused consumer price inflation – which was seen as a threat to the well being of the rich as well as the masses. Central bankers knew they had to get it under control or they would be swamped by it. But this new liquidity is different. People love it. The lumps never get a chance to use it to buy toilet paper. Instead, it sloshes around the hedge funds, banks, financial houses and rich financiers’…in a ‘wave of liquidity’ upon which so many super-wealthy are now riding. In 1980, the ratio of financial assets to GDP stood at about 1.5 to 1. Now, it is about 4 to 1.

Yes, upon this ocean of liquidity rides a great Titanic of asset price inflation. It is why Picasso, Klimt and Pollack paintings sell for such absurd prices. It is why houses in Aspen, Greenwich and Kensington have reached such breathtaking prices. It is why Chinese stocks have doubled in the last year. And it is why the Dow is at an all-time high…and why Manhattan real estate is selling for such high prices that even the rats are having to pack up and move to New Jersey.

Yes…the Titanic is obvious…it is right in front of us. But where is the iceberg?

Oh, you say, there are no more icebergs. And you’re probably right. The geniuses who run hedge funds and central banks have it all figured out. They’ve got their radar screens. They’ve got their charts and graphs. They’ve got their formulae. Who are we to argue with them?

We won’t even try. Instead, strike up the band! Open up the bar! It’s the end of 2006 and we aim to have a good time. Damn the icebergs; full speed ahead!

Best wishes for the New Year. (Next week, a humbling look at our forecast for the year just past…and a look ahead, towards 2007.)

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
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