Government Liquidity Driving the Current Market

Cash is worthless with rates near zero, and there's a lot of cash out there needing somewhere to go after the many bailouts and injections into the banking system that have not been converted into new lending. Lots of money into the banks with none coming out indicates that banks have taken their free taxpayer money and put it into stocks, creating a self-fulfilling balance sheet improvement tactic. Toxicity on the accounting ledger has come down as stocks have gone up.

That's one way of saying that liquidity is driving the current market, lots of government liquidity. Gluskin Sheff's David Rosenberg, however, wrote on Friday that such talk "is usually a catch-all phrase for 'we have no clue' but it sounds good."

Apparently quite a few of us think it sounds good. For instance, Kopin Tan wrote in this weekend's Barron's, "Because the current rally is fueled not just by economic recovery but by the government-induced reflation of balance sheets, Michael Hartnett, Merrill Lynch's chief global equity strategist, thinks the risk of correction lies not with the widely feared double-dip recession, but with the withdrawal of monetary easing."

Add to that the following from Steven Pearlstein's column Wednesday in The Washington Post:

So who is borrowing [all the money printed by the Fed]? By and large, it's not households and businesses, which are reluctant to borrow during a recession. Rather, it's hedge funds and other investors, who have been using the money to buy stocks, corporate bonds and commodities, driving prices to levels unsupported by the business and economic fundamentals.

The excess liquidity is even being used to finance a new "carry trade" in which global investors borrow at U.S. rates and buy government bonds in places like Australia, where prevailing rates are higher. Because the carry trade involves exchanging dollars for foreign currencies, it has been a major contributor to the recent decline in the dollar.

Naturally, this has been a blessing for Wall Street's biggest banks, whose trading desks have not only made big money executing and financing the investment strategies of others, but have also been trading actively for their own accounts. And with bubble profits come bubble bonuses..