Blog | Personal Finance

Global Liquidity Is Drying Up

I believe it’s only a matter of time before the Fed turns back on its printing presses. Until then, beware of falling asset prices.

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Global Liquidity is getting tight. Consequently, our global economic raft is once again beginning to sink. Commodity prices are falling, the consumer price inflation numbers are weakening in all the major economies and asset prices (particularly overvalued equities prices) look increasingly vulnerable to a sharp correction. Without a fourth round of Quantitative Easing the global economy could well be sucked down into a deflationary whirlpool next year.

I have recently uploaded three Macro Watch videos analyzing the outlook for global liquidity:

1. The Outlook For Global Liquidity Points To Deflation Ahead;

2. Analyzing The Five Largest Central Banks; and

3. FX Reserves, The Dollar Crisis & The Outlook For Global Liquidity.

To measure global liquidity, I took the total assets of the five largest central banks (the People’s Bank of China, the Federal Reserve, the European Central Bank, the Bank of Japan and the Bank of England) plus the total foreign exchange reserves of the world’s other central banks and projected this data out to the end of 2016 based on current central bank guidance. Here’s what that looks like:

Looking out to 2015 and 2016, the Fed’s balance sheet flattens out since Quantitative Easing has (supposedly) ended. The BOJ’s assets increase at the rate of Yen 85 trillion a year. The ECB’s assets expand back to the level reached in 2012. The numbers for the PBOC are my estimates and assume that China’s central bank will continue accumulating large amounts of foreign exchange reserves in order to prevent the country’s huge trade surplus from pushing up the value of the Yuan.

Now, by adding all of those assets together, we can calculate the annual percent increase in global liquidity, as shown below:

Notice that at present (the end of 2014), global liquidity has only increased by 5% relative to one year ago. At the peak of the crisis, in 2008 and 2009, global liquidity expanded by 25% to 40% a year. During 2011, it grew by 15% to 20%. Even before the crisis began, global liquidity grew by 15% during much of 2004 and 2005. Therefore, the current growth rate of only 5% is very much less than what the global economy and the financial markets have grown accustomed to.

Looking ahead, thanks to printing by the BOJ and the ECB, the growth rate will pick up to 8% or 9% at the end of 2015, but then move back down again to 7% by the end of 2016. As the base grows larger, it becomes necessary to print more and more money every year to prevent the growth rate in global liquidity from slowing. And, of course, if the growth rate does not remain high, the additional liquidity ceases to provide sufficient monetary stimulus to keep the global economy inflated.

After 2016, if we assume that the BOJ and the ECB eventually end their quantitative easing programs, the growth rate of global liquidity will slow rapidly and soon come to a relative standstill. Global asset prices and the global economy were reflated after 2008 by an unprecedented amount of fiat money creation by the world’s central banks. If that monetary stimulus ends, asset prices are very likely to deflate again and the global economy is likely to begin spiraling back toward depression.

Ultimately, it may prove impossible to keep the global economic bubble inflated, but the Fed almost certainly won’t allow it to deflate without at least attempting QE 4 and possibly QE 5, 6 and 7. I believe it’s only a matter of time before the Fed turns back on its printing presses. Until then, beware of falling asset prices.

For much more detailed analysis of global liquidity and central bank balance sheets, and to learn more about how the global economic crisis will affect you, subscribe to my video-newsletter, Macro Watch:

Click on the “Sign Up Now” tab, and then, for a 50% discount, use the coupon code: richdad

Original publish date: December 15, 2014

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