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Causes And Effects


Economic history

Therefore if we should plot world liquidity against time, we should be able to correlate major economic events and incidents to it. Take a look at the plot below

Few of the historical events as they happened:

1 - 1979: Volker takes over the US Fed rising interest rates to ridiculous highs in order to "fight inflation". Liquidity plummets.

2 - Regan is elected in US. He imposes "supply-side" economics. Liquidity increases.

3 - Latin America Debt Crisis. Several Latin American countries enter default partially due to very high interest rates in US. Liquidity first drops due to defaults (i.e. lack of payments) but it is later increased substantially by Central Banks in order to prevent major US and EU banks from going bankrupt.

4 - Private equity boom in early 1980's. All the previously generated liquidity is used to finance private equity purchases and leveraged buyouts. A stock bubble also forms.

5 - The USD surges as a consequence of high interest rates in US. Liquidity begins to dry.

6 - The Plaza Accord is signed between key Central Banks to depreciate the USD. The Johnson Matthey Bank collapses in UK threatening to take the entire UK Banking system with it.

7 - Despite the depreciation of the USD, liquidity drops presumably due to market fears of price overextension (i.e. bubbles) and instability generated due to large liquidity, particularly in the stock and private equity sectors. This leads to the market crash of 1987 (bubble burst).

8 - As a consequence of the 1987 crash, Central Banks step in generating liquidity to prevent further market decreases. This liquidity is funnelled to Japanese stocks which enter into a bubble phase. Liquidity is also funnelled to Savings & Loans financial organizations in US which also enter a bubble phase.

9 - Japanese stock market crashes. S&L operations crash. Liquidity is increased by Central Banks in order to prevent further economic and financial collapses. This creates an Emerging Markets stock and financial bubble.

10 - Emerging Markets bubble grows and it finally bursts. This reduces liquidity.

11 - Baring Brothers Bank in UK goes bankrupt. Bond crash in US. Mexican Peso Crisis. Liquidity is increased to prevent the collapse of the world financial system.

12 - Asian crisis. Several countries in Asia (Asian Tigers) can no longer afford to finance their debt. Liquidity drops in the beginning but it is later on increased to prevent a "contagion" throughout the world financial system.

13 - Russian collapse. Russia can no longer afford to finance their debt. Liquidity is increased again. Liquidity is re-directed towards "safe" investments such as the Technology sector in stocks in US creating a bubble.

14 - Technology stock bubble crashes in US. Liquidity begins to dry out.

15 - Argentina can no longer afford to finance their debt and it defaults. Liquidity is increased to prevent a financial system collapse. Liquidity is re-directed towards "safe" investments creating the Real Estate and Commodity bubbles.

16 - Liquidity is soaked by Real Estate and Commodity bubbles.

17 - Several crises happened. Each time that liquidity is increased a new crisis soaks it in. Example: the US housing correction, recessions, pre-2008 mini-crisis.

18 - US Sub-Prime Crisis and world-wide contagion. Liquidity is drastically increased which creates a bubble in Gold.

19 - Gold bubble collapses.

20 - European debt crisis. Fuelled by previous decades of liquidity creation, many EU nations find themselves incapable of financing their debts. After an initial drop in liquidity, it is increased to prevent a world-wide financial catastrophe. This crisis is ongoing.

World Liquidity


From this historical account it is obvious that although liquidity data is not 100% accurate, it offers a compelling explanation of most crises. After even the most superficial analysis a pattern emerges:

Increases in liquidity create bubbles which burst and subsequent further increases in liquidity are created to prevent financial damages which in turn create more bubbles that burst and so on.

There is a clear pattern of cause and effect originating primarily in the actions of Central Banks.

Note: please see the Glossary if you are unfamiliar with certain words.

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